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STRICTLY CONFIDENTIAL (FR)
Class I - FOMC
TASK FORCE
ON
SYSTEM FOREIGN
CURRENCY OPERATIONS
MARCH 1990
Authorized for public release by the FOMC Secretariat on 1/31/2020
March 1990
STRICTLY CONFIDENTIAL (FR)
Class I - FOMC
TASK FORCE
ON
SYSTEM FOREIGN CURRENCY OPERATIONS
Tab
A. OVERVIEW
Task Force on system Foreign Currency Operations
(Sam Y. Cross and Edwin M. Truman)
B. LEGAL AND PROCEDURAL FRAMWORK FOR FEDERAL RESERVE
FOREIGN CURRENCY OPERATIONS
Legal Bases for System Foreign Currency Operations.......................
Evolution of Formal Procedures for FOMC Oversignt of System Foreign
Currency Operations................................................. ..........................
1
2
C. POLICY, STRATEGY AND TACTICS
The Evolution of U.S. Exchange Rate Policy .................................... ......
Historical Review of System Objectives and Use of Intervention...................
Review of Approaches and Tactics of Intervention in the Context of
Changing Market Conditions, Policy and Objectives............................... .
3
4
5
D. INSTITUTIONAL FRAMEWORK FOR DECISION MAKING
Federal Reserve-Treasury Coordination ........................................
.........
Review of Organization of Foreign Currency Operations in Other G-7
Countries and Switzerland ................................................. ................
6
7
E. RESOURCES FOR FINANCING U.S. INTERVENTION
Historical Review of U.S. Official Holdings of Foreign Currency ...................
Historical Review of Reciprocal Currency Arrangements
(The "Swap" Network) ..................................................... ...................
8
9
F. ANALYTICAL ISSUES RAISED BY INTERVENTION
Profits and Losses in U.S. and system Foreign Currency Operations ............
Foreign Currency Operations: An annoted Bibliography ............................. .
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11
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March 9, 1990
TO:
Federal Open Market Committee
Subject: Task Force on System
Foreign Currency Operations
FROM: Sam Y. Cross and Edwin M. Truman
STRICTLY CONFIDENTIAL (FR)
Class I - FOMC
Introduction
At the August 22, 1989 meeting of the Federal Open Market
Committee, the FOMC endorsed Chairman Greenspan's proposal to establish a
task force under our joint direction to review System foreign currency
operations from an historical and institutional perspective and to provide
the Committee with a report in about six months.
To this end, we commissioned 11 papers that review essentially all
aspects of System foreign currency operations: the legal basis for our
operations and formal FOMC oversight procedures; U.S. intervention policy,
strategy and tactics as they have evolved over the past 30 years; the
institutional framework for decision making on these matters in this
country and in major foreign countries; resources for financing U.S.
intervention (principally balances of foreign currency and drawings on the
swap network); and a number of analytical issues.
Near-final versions of
these papers and the issues they raised were discussed at an all-day
conference of Research Directors at the Board on February 23.
¹ The 11 papers were prepared by members of the staffs of the Board of
Governors and the Federal Reserve Bank of New York, with comments from
others. Steven A. Meyer (Federal Reserve Bank of Philadelphia) and John
P. Judd (Federal Reserve Bank of San Francisco) participated actively in
the work of the Task Force, contributing to the design of the overall
project, commenting on the papers at various stages of their preparation,
and participating in the conference of Research Directors.
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Section I of this overview memorandum provides a brief summary of
the 11 papers in the order in which they are included in this binder.
Section II offers some observations on some of the major topics considered.
Section III suggests some issues that the FOMC may want to discuss at its
meeting on March 27.
I. Summary of Task Force Papers
The Task Force's papers total about 350 pages, not including
appendices.
There is considerable overlap among some of the papers; it was
our view that it was desirable for each paper to stand alone as part of a
more or less consistent whole.
The authors have endeavored to make their
substance reasonably accessible by including detailed tables of contents
and summaries.
(Readers will find that the papers also include a wealth of
statistical information about U.S. and System foreign currency operations
over the past 30 years.)
We provide in the following few pages a very
brief reader's guide to the 11 papers.
The first group of two papers covers the legal bases of System
foreign currency operations and the evolution of formal procedures for FOMC
oversight of these operations.
Before the System resumed operations in foreign currencies in 1962
(at the request of the U.S. Treasury) after a hiatus of almost thirty
years, an extended investigation of the legal authority to do so was
undertaken.
Questions arose because the Gold Reserve Act of 1934
established the Exchange Stabilization Fund (ESF) of the U.S. Treasury for
the purpose of stabilizing the exchange value of the dollar.
Although the
Act did not state that the System could no longer engage in foreign
exchange operations, the Federal Reserve did not conduct such operations
for many years after the passage of the Act.
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Paper
#1 ("Legal Bases for System Foreign Currency Operations")
reviews the analysis developed in a memorandum prepared by the FOMC's
General Counsel, Howard Hackley, in 1961, which found the legal basis for
System foreign currency operations in provisions of the Federal Reserve Act
that authorize Federal Reserve Banks to purchase and sell cable transfers
(foreign exchange), bankers' acceptances, and bills of exchange in the open
market;
to open and maintain accounts in foreign countries; and to appoint
correspondents and agencies in foreign countries.
The paper also reviews
the legal reasoning that allowed the System to establish the swap network
and to engage in warehousing operations with the ESF and the Treasury.
Finally, the paper notes the System's authority has been strengthened by
subsequent review and actions of Congress, including the amendment of the
Federal Reserve Act in 1980 for the express purpose of permitting the
System to invest its foreign exchange reserves in obligations of foreign
governments.
Paper #2 ("Evolution of Formal Procedures for FOMC Oversight of
System Foreign Currency Operations") reviews System operations prior to
1934, the Committee's deliberations in 1961 and early 1962 on the
resumption of foreign currency operations, and the evolution of the FOMC's
foreign currency instruments (Authorization, Directive, and Procedural
Instructions), which provide direction and oversight to these operations.
Appendices include a 1961 letter from the Secretary of the Treasury to the
Chairman requesting that the System resume foreign currency operations,
documentation of changes in the foreign currency instruments (including
copies of the current instruments approved at the February 6, 1990,
meeting of the Committee), and a comprehensive list of memoranda to the
Committee on matters pertaining to System foreign currency operations.
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After an initial trial period, the Authorization and Directive emerged in
recognizable form in 1966 and have been subject to one major overhaul in
1976 after it was clear that there would not be a quick return to the par
value system of exchange rates.
At that time, the Procedural Instructions
were also introduced to provide more systematic oversight of System
operations.
The second group of three papers deals with U.S. exchange rate
policy, intervention objectives, and intervention tactics.
Paper #3 ("The Evolution of U.S. Exchange Rate Policy") reviews
U.S. policy over the period from 1958 to the present, with major emphasis
on the evolution of policy during the floating rate period.
The overriding
objective of U.S. policy under the Bretton Woods system was to maintain the
par value system of fixed exchange rates, based on a U.S. dollar
convertible into gold at an unchanged par value.
Direct U.S. exchange
market intervention was minimal, but a wide variety of other policies were
used to protect the U.S. gold stock and, thus, the credibility of dollar
convertibility.
U.S. exchange rate policy under floating rates is not so
easily summarized.
The basic statement of policy has been to counter
"disorderly market conditions".
However, the execution of that policy has
included periods when that policy has been narrowly defined and
intervention has been limited to small amounts on rare occasions as well as
periods when that policy has been broadly defined and operations have been
more extensive and frequent.
Paper #4 ("Historical Review of System Objectives and the Use of
Intervention") presents a comprehensive description of U.S. and System
intervention operations from the early 1960s to the present.
It reviews
intervention in specific episodes and with different exchange market
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objectives:
countering disorderly market conditions both narrowly and
broadly understood, repayment of debt and building-up of owned reserves,
and fostering exchange market stability.
The paper includes extensive
statistical information on intervention operations since March 1973.
Paper #5 ("Review of Approaches and Tactics of Intervention in the
Context of Changing Market Conditions, Policy and Objectives") describes
the techniques used by the Desk in its execution of intervention policy.
It discusses the specific objectives and conditions, as well as the various
approaches and constraints under which the Desk operates.
It also
comments on the structure of the foreign exchange market and its
evolution.
It describes how the operations of the Foreign Exchange Desk,
differ from those of the Open Market Desk and relates these differences to
the nature of the markets in which the two Desks are operating and the
nature of their respective objectives.
The paper also presents an
evaluation of the results of the Foreign Exchange Desk's operations during
the period of floating exchange rates in the context of different specific
objectives for those operations and a variety of conditions at the time
they were undertaken.
The third group of papers deals with Federal Reserve-Treasury
coordination of U.S. intervention policy and its formulation and with the
organization of foreign currency operations in other major countries.
Paper #6 ("Federal Reserve-Treasury Coordination") reviews the
extensive record of coordination of intervention operations between the
Federal Reserve and the Treasury and the manifestation of that coordination
in the form of letters between the Secretary of the Treasury and the
Chairman of the Federal Reserve, testimony to Congress, and correspondence
with the Congress.
Copies of the relevant documents are appended to the
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paper.
The paper also describes how the process of Treasury-Federal
Reserve consultation has worked in practice during the period of
generalized floating where the Treasury has specified the basic U.S.
policy, but the System has played an active role in policy formulation and
implementation and has often acted as a kind of "balance wheel" to Treasury
policy shifts.
Paper #7 ("Review of Organization of Foreign Currency Operations
in other G-7 Countries and Switzerland") outlines exchange rate policy in
each of the other G-7 countries and Switzerland.
It also discusses the
division of responsibilities between central banks and finance ministries
in this area, coordination of foreign currency operations, and the
relationship to monetary policy including the extent to which the effect of
operations on the central bank's balance sheet are sterilized (the norm for
most major countries).
Finally, the paper describes the operational
aspects of intervention activities in each of these countries today in
terms of tactics and frequency of operations.
The fourth group of papers includes two papers on the financing of
U.S. intervention: one reviews the history of U.S. holdings of foreign
currency balances and the other reviews the history of the Federal
Reserve's reciprocal currency arrangements ("Swap" Network).
Paper #8 ("Historical Review of U.S. Official Holdings of Foreign
Currencies") traces the shifts in System and Treasury foreign exchange
assets and liabilities from 1962 to the present.
The U.S. monetary
authorities "net open position" (that is, foreign currency assets minus
liabilities) was negative until late 1980, at which time foreign currency
balances were acquired in an amount which exceeded liabilities for the
first time.
The paper also discusses the investment facilities for U.S.
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foreign exchange balances and contains a review of System warehousing
operations for the Treasury.
The paper contains a comprehensive set of
charts and tables.
Paper #9 ("Historical Review of Reciprocal Currency Arrangements")
reviews the provisions and mechanics of the swap arrangements, changes in
the terms and conditions that have been made (mostly after floating
exchange rates became the norm), and the history of the use of the swap
network.
In the 1960s and 1970s, the swap network was used extensively by
both the Federal Reserve and other industrial countries.
Since 1980, the
System has not drawn on the network; since a drawing by Sweden in 1981 and
The
by the BIS in 1982, the only drawings have beenby the Bank of Mexico.
paper concludes with a brief assessment of the usefulness and limitations
of the swap network as it has evolved along with the international monetary
system.
This paper also provides a comprehensive set of historical
statistics.
The final set of papers covers some analytical aspects of foreign
currency operations: one assesses the profitability of U.S. and System
foreign currency operations and the other reviews the research literature,
focusing primarily on the issue of the effectiveness of intervention.
Paper
#10
("Profits and Losses in U.S. and System Foreign
Currency Operations") examines some of the conceptual and methodological
issues in measuring the profitability of foreign currency intervention.
The paper recognizes that profitability should not be the only nor even the
major criterion for evaluating foreign exchange market intervention.
It
presents a qualitative overview of the profits and losses associated with
U.S. pre-March 1973 operations.
For U.S. operations since March 1973, the
paper employs a specific analytical framework for estimating the
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profitability of U.S. operations.
The paper concludes that, on balance,
over the whole period since 1973 U.S. foreign currency operations have been
profitable.
That conclusion is sensitive to the fact that at present our
foreign currency balances are at record levels, and future changes in
exchange rates can substantially alter the profitability.
Paper #11 ("Foreign Currency Operations:
An Annotated
Bibliography") primarily reviews the empirical research literature.
Most
of the paper is devoted to studies of the effectiveness of intervention; it
covers work done for the 1982-83 Working Group on Exchange Market
Intervention mandated by the Versailles economic summit as well as
subsequent research.
The paper describes the analytical framework within
which most of this research has been conducted and the two principal
channels through which economic theorists have suggested that sterilized
intervention has its effects: the so-called portfolio balance channel
operating through changes in supplies of domestic- and foreign-currency
bonds that are imperfect substitutes and the so-called expectations or
signalling channel through which such changes in supplies cause changes in
expected future exchange rates.
The great bulk of formal statistical tests
of the effectiveness of sterilized intervention operating through the socalled portfolio balance channel (influencing the relative supplies of
bonds denominated in different currencies) have not found a quantitatively
significant effect for sterilized intervention.
In all of the much smaller
number of studies of the so-called expectations channel (influencing the
expected future exchange rate), intervention has been found to have had at
least some statistically significant effect; most of these studies did not
assess the quantitative significance of the effects that the researchers
found.
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Other sections of the paper cover studies of the profitability of
intervention, intervention reaction functions, and work related to the
substitutability of assets denominated in different currencies.
A final
section of the paper presents some research done at the Board for the Task
Force on the question of the effects of intervention on the volatility of
interest rates; the statistical work shows that U.S. interest rates are no
more volatile in periods of heavy or moderate U.S. intervention than in
periods of little or no U.S. intervention.
II. Observations
1. U.S. Exchange Rate Policy
U.S. exchange rate policy is established by the Secretary of the
Treasury (and, ultimately, the President) within the framework of (a) the
Federal Reserve Act, the Gold Reserve Act of 1934, and the Bretton Woods
Agreements Act as amended and (b) international understandings (for example
within the Group of Seven (G-7)).
That policy has evolved over time as the
international monetary system and the world economy have changed.
The
current statement of U.S. policy, notified to the IMF as required by
Article IV of the IMF Articles of Agreement, is:
The U.S. authorities do not maintain margins in respect of
exchange transactions, and spot and forward exchange rates are
determined on the basis of demand and supply conditions in the
exchange markets. However, the authorities intervene when
necessary to counter disorderly market conditions in the exchange
market or when otherwise deemed appropriate.
The Federal Reserve historically has been and continues to be an
active and constructive participant in the process of formulating and
implementing U.S. exchange rate policy, a traditional role of central
banks.
As U.S. Alternate Governor of the IMF and as a participant in G-7
meetings of finance ministers and central bank governors, the Chairman of
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the Federal Reserve reflects the views and concerns of the System as
appropriate.
2. Federal Reserve Relations with the U.S. Treasury
The Federal Reserve resumed foreign currency operations in 1962 at
the request of the U.S. Treasury, in part, to supplement the resources
available to the Treasury's Exchange Stabilization Fund (ESF) and, in part,
because such operations were viewed as appropriate for the central bank.
It has always been clear what the respective roles of the Treasury and the
Federal Reserve are:
[T]he Secretary of the Treasury . . . is primarily and directly
responsible to the President and Congress for formulating and
defending international financial and monetary policy, for
assessing the position of the United States in the world economy,
and for conducting negotiations on these matters. At the same
time, since exchange markets are closely linked to money markets
and questions of monetary policy, there is a distinct role and
responsibility for the Federal Reserve to work in cooperation both
with foreign central banks, which are operating in their own
markets, and with the Treasury.²
It is also clear that under present arrangements the U.S. Treasury
cannot commit Federal Reserve resources to intervention operations.
The
Federal Reserve, for its part, has agreed consistently that its operations
will be carried out "in close and continuous consultation and cooperation
with the United States Treasury".
The few conflicts that have arisen
between the Treasury and the Federal Reserve on exchange rate policy,
strategy and tactics generally have been worked out satisfactorily.
In
effect, the Federal Reserve has served as a kind of "balance wheel" to
shifts in Treasury policy in the past 15 years, thus, lending a greater
degree of consistency to overall U.S. policy in this area.
²
Paul A. Volcker letter to Representative Sam Gibbons, May 7, 1976.
See paper #6 ("Federal Reserve-Treasury Coordination".)
³
Foreign Currency Directive, Section 4.A.
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3. Disorderly Market Conditions
The Task Force papers document extensively that the rubric under
which U.S. foreign currency operations are currently conducted, "countering
disorderly market conditions", has been interpreted in an elastic manner
almost from the time it was first included in the U.S. notification of its
exchange arrangements to the IMF and in the related foreign currency
directive approved in 1976. 4
That concept has been used to justify a minimalist approach to
exchange market intervention from 1981 through 1984; it has,also been used
to justify heavy intervention operations in 1978-79, 1985, and 1987-89
directed at correcting what was viewed as an undervaluation or
overvaluation of the dollar or at trying to stabilize the dollar in line
with understandings reached at G-7 meetings.
concept may contribute to ambiguity at times.
The elasticity of this
Some of the ambiguity may be
unavoidable and even constructive since intervention can be at times part
of a response to changing or uncertain conditions or to the emergence of
trends that may become clear only in retrospect.
In any event, it is important that the Federal Reserve monitor
closely the evolution and implementation of U.S. exchange rate policy and
intervention operations; this would be true regardless of the Federal
Reserve's direct financial role in such activities.
4. "System operations in foreign currencies shall generally be directed
at countering disorderly market conditions, provided that market exchange
rates of the U.S. dollar reflect actions and behavior consistent with the
IMF Article IV, Section 1."
(Section 1, Foreign Currency Directive; see
Appendix C of paper #2 ("Evolution of Formal Procedures for FOMC
Oversight of System Foreign Currency Operations".)) This language
closely tracks the statement of U.S. policy quoted above; the world
"generally", which was the subject of intense negotiations with the U.S.
Treasury in 1976, can be viewed as providing the same elasticity as the
phrase "or when otherwise deemed appropriate".
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4. Role of Exchange Rates
Economists and policymakers have disagreed among themselves since
at least the inter-war period about how exchange rates should be viewed in
the context of overall economic policy.
On the one hand are those that
consider exchange rates as just another set of prices; on the other hand
are those that consider them an important constraint on or a key indicator
of economic policy.
U.S. official thinking about exchange rates has
evolved along with the world economy and the international monetary system.
In the 1960s, it was accepted as an article of faith that our interest was
in preserving the role of the gold-convertible dollar at the center of a
par value system.
In the 1970s, floating exchange rates were seen by many
as smoothly equilibrating external imbalances and as imparting greater
freedom to policymakers.
Since the late-1970s, and especially since the
mid-1980s, U.S. policymakers increasingly have felt that exchange rates,
which respond to shifts in monetary and fiscal policies here and abroad as
well as to other factors, are important economic variables that cannot be
ignored because of their pervasive effects on the economy.
This evolution of U.S. official thinking has paralleled changes in
the position of the U.S. economy and financial markets in the world economy
and financial system.
With a dominant and essentially closed economy in
the 1950s and 1960s, U.S. policymakers could ignore exchange rates and let
the finance ministers and central bankers of other countries worry about
them.
Today our economy is less dominant and more open, U.S. policymakers
are more concerned about exchange rates, and they no longer can expect that
exchange rates will take care of themselves or be taken care of by other
countries in ways that U.S. policymakers would like or find acceptable
with respect to conditions in the domestic economy.
One manifestation of
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this evolution has been the fact that the U.S. authorities in recent years
have been as active as the authorities of other major countries in their
foreign currency operations -- more active than some and less active than
others.
5. Exchange Rates and Monetary Policy
As a technical matter, Federal Reserve foreign exchange operations
are routinely sterilized, as is generally the case in most other major
industrial countries.
Nevertheless, exchange market considerations have at
times influenced the day-to-day implementation of Federal Reserve policy,
and exchange-rate considerations at times have been prominent in the FOMC's
deliberations -- in 1977-79, 1984-85, and 1987.
In this broader sense,
some would argue that the distinction between sterilized and unsterilized
intervention is at best artificial and at times misleading.
As noted
above, U.S. monetary policy policy cannot and has not ignored the exchange
value of the dollar; this would remain the case regardless of whether the
Federal Reserve intervenes in the foreign exchange market for its own
account.
However, the evidence presented in the Task Force papers is that
the Federal Reserve's active participation has been constructive both in
terms of U.S. exchange rate policy and U.S. macroeconomic policy.
An important consideration for the Federal Reserve is whether our
foreign currency operations interfere with our other open market
operations; to date, there have been no problems in this regard.
Another
important question is whether U.S. intervention operations have added to
the volatility of U.S. interest rates; we found no evidence to support this
5. One must be careful about such generalizations; however, see Table
III in paper #7 ("Review of Organization of Foreign Currency Operations
in the Other G-7 Countries and Switzerland") for data for 1989.
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hypothesis.6
A related concern at times has been that U.S. intervention
operations are insufficiently sensitive to conditions in markets for other
financial instruments.
In its operations, the Foreign Exchange Desk tries
to be sensitive to these concerns, and the Federal Reserve's hand is
strengthened in this regard by the fact that the Desk normally operates
with System as well as with ESF resources.
A more complex question is whether Federal Reserve monetary policy
might be subverted by inappropriate exchange rate considerations or by
international (G-7) understandings on exchange rates.
While
interpretations of the past do differ, we do not believe that there is any
strong evidence of this having happened in recent years.
in the future?
Yes.
Could it happen
What is the best way of avoiding its happening?
We
believe that the best way is to ensure that the Federal Reserve continues
to play an active role in the formulation and execution of U.S. exchange
rate policy, but others may differ.
6. Effectiveness of Intervention
Just because a quantitatively significant effect for sterilized
intervention has not been found in most of the research studies to date
does not mean that such an effect does not exist; it does mean that the
research literature cannot be cited to justify the effectiveness of
sterilized intervention.
It has proved difficult to discover stable and significant
statistical relationships between exchange rates and postulated
determinants, such as interest rates and other fundamentals as well as
6. See Section IX of paper #11 ("Foreign Currency Operations: An
Annotated Bibliography").
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sterilized intervention.
It is, therefore, difficult to draw definite
conclusions about the effectiveness of intervention on the basis of
existing statistical evidence.
Some analysts argue that finding reliable
statistical relationships between exchange rates and sterilized
intervention has been no more difficult than finding such relationships
between exchange rates and other economic variables and that, therefore,
the failure to find a quantitatively significant effect for sterilized
intervention should not be taken very seriously.
However, most analysts
argue that finding reliable statistical relationships between exchange
rates and sterilized intervention has been more difficult than finding such
relationships between exchange rates and other economic variables and that,
therefore, the failure to find a quantitatively significant effect for
sterilized intervention should not be dismissed.
It is highly unlikely that research studies conducted over the
next decade will affect significantly the positive propensity of the
monetary authorities of the major countries to intervene in foreign
exchange markets.
Those authorities believe that foreign exchange market
intervention can be a useful policy tool, at least on occasion, and they
are likely to continue to use it.
Indeed, the consensus of the 1982-83 Working Group on Foreign
Exchange Market Intervention was that intervention can be a useful and
effective tool in influencing exchange rates in the short run especially
when such operations are consistent with fundamental economic policies.
The Task Force papers provide no basis upon which to disagree with this
consensus.
However, it is useful to note that the direction of fundamental
economic policies is not always clear at the time intervention takes place.
Thus, consistency cannot always be assumed.
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7. Federal Reserve Procedures
7/
implicitly presume that
The FOMC's foreign currency instruments
sterilized foreign exchange market intervention is an effective and useful
tool in pursuit of exchange market and broader policy objectives at least
in the short run.
They also presume that it is appropriate for the Federal
Reserve to be involved with and guided by the Treasury in these operations.
The Authorization for Foreign Currency Operations provides the
framework within which the Foreign Exchange Desk is to carry out operations
for System Open Market Account, including importantly a limit on the
8
the
System's overall open position (risk) in all foreign currencies;
Foreign Currency Directive provides a very general set of instructions to
the Foreign Exchange Desk;
and the Procedural Instructions provide a
mechanism through which the Chairman, the Foreign Currency Subcommittee,
and the Committee conduct day-to-day and inter-meeting oversight of the
Desk's operations.
One might view this latter document as a substitute for
the more detailed directive concerning "domestic" operations with the
distinction necessitated by the institutional differences between the two
types of operations as well as by the fact that under today's conditions it
is inherently impossible to anticipate all the circumstances under which
intervention might potentially be desirable.
Thus, the foreign currency instruments can be viewed as seeking a
balance between FOMC direction, oversight, and monitoring of the Desk's
7. See paper #2 ("Evolution of Formal Procedures for FOMC Oversight of
System Foreign Currency Operations").
8. The FOMC's Authorization in Section I.D defines the System's "overall
open position in all foreign currencies" as "the sum (disregarding signs)
of net positions in individual currencies. The net position in a single
foreign currency is defined as holdings of balances in that currency,
plus outstanding contracts for future receipt, minus outstanding
contracts for future delivery of that currency, i.e., as the sum of these
elements with due regard to sign."
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operations (both with regard to the scale and risk of System operations and
with regard to what those operations are trying to achieve) and the
need for the Desk to be prepared to intervene and to change its tactics in
response to changing circumstances.
Of course, there can be differences in
view in the striking of that balance, but in considering changes the
presumptions noted above should be borne in mind.
8. System Risk and Foreign Exchange Balances
The Federal Reserve System now holds for its own account more than
$20 billion in assets denominated in foreign currencies (valued at
historical cost) plus $8 billion "warehoused" for the ESF (as of March 8,
1990).
Total U.S. holdings of foreign currencies are about $40 billion, or
$44 billion at current market rates.
However, this amount is substantially
less than what is held by other major countries, Germany and Japan in
particular, both absolutely and relative to such traditional measures as
imports of goods and services.
Moreover, U.S. holdings of foreign
currencies increased substantially in 1989 (by more than $25 billion), and
circumstances could develop in which balances could decline just as
rapidly.
Recall that it was only in 1988 that Treasury and Federal Reserve
were almost devoid of yen balances and were seeking special arrangements to
acquire them.
In case of need, the Federal Reserve could draw on the $30 billion
swap network including lines of $6 billion with the Bundesbank and $5
billion with the Bank of Japan.
However, at times in the past, the United
9. Paper #8 ("Historical Review of U.S. Official Holdings of Foreign
Currencies") provides estimates that U.S. foreign currencies reserves
cover 23 days of U.S. imports of goods and services, compared with 81 and
83 days for Germany and Japan respectively. Estimates based on total
reserves less gold holdings (including SDR and claims on the IMF) would
reduce the difference somewhat; the coverage of U.S. reserves rises
to 33 days while that for Germany and Japan rises to 88 days.
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States has not been comfortable with the conditionality on intervention
operations and economic policies associated with swap drawings.
More
generally, as noted above, the international economy and the financial
system have changed dramatically over the past several decades.
The U.S.
economy is less dominant, and at the same time its sensitivity to external
influences has increased; the United States should expect to have to fend
for itself in international financial relations to a greater degree than it
has in the past.
The existing level of Federal Reserve balances of foreign exchange
(as well as the level of overall of U.S. balances) involves a significant
exchange rate risk (potential gain as well as potential loss).
However,
the existence of balances provides a cushion which can allow the United
States to respond to exchange market developments without changes in U.S.
monetary and other other policies when such changes are not deemed
appropriate for domestic objectives.
10
If it were felt that on balance U.S.
interests are well served by continuing to hold and accumulate (essentially
passively through intervention) balances of foreign exchange, the Federal
Reserve and the Treasury might want to consider whether it would be
appropriate to make the case more systematically to the Congress and the
public about how these balances have accumulated and why they are needed.
If the Federal Reserve was not comfortable holding sizeable balances,
consideration could be given to ways of limiting the balances, or to a
10. It is useful to distinguish between the risk associated
position and that associated with a change in that position
intervention. The latter is present whether or not we hold
foreign exchange already; we either add to balances (or pay
reduce balances (or acquire debt). See paper #10 ("Profits
U.S. Foreign Currency Operations").
with a given
because of
balances of
off debt) or
and Losses in
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possible comfort letter from the Secretary of the Treasury that such
Federal Reserve holdings are in the national interest.
9. Warehousing for the ESF and U.S. Treasury
As noted above, the Federal Reserve is now warehousing $8 billion
in foreign currencies for the ESF; the FOMC has authorized warehousing up
to $10 billion in foreign currencies for the ESF or the U.S. Treasury.
The
System is protected from exchange risk on the principal amount of those
holdings; moreover, as far as the ESF is concerned, the action of
warehousing foreign currencies is analogous to the purchase of gold and SDR
certificates from the ESF to finance ESF foreign exchange operations.
Nevertheless, questions reasonably can be raised about such operations
especially if they persist for an extended period of time, which could well
be the case.
In our view, the fundamental issue is whether the Federal Reserve
System would want to deny the ESF the U.S. dollar resources it needs to
purchase foreign currencies.11
This is a complex issue that goes to the
core of the Federal Reserve's relationship with the rest of the government.
Although we cannot know all the circumstances at the time of consideration,
we would advise against such a decision.
It would run counter to the
entire history of System foreign exchange operations since their resumption
in 1962.
The System has always been guided by the policy of the United
States in this area as established by the Secretary of the Treasury.
Moreover, from the start, a major argument for the System's participation
in foreign exchange operations was that the System has resources at its
11. We assume that at the same time the System would decline to purchase
foreign currencies for its own account.
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- 20 disposal that can and should be used to supplement the resources of the
ESF.
Of course, views can differ on this matter.
However, we believe,
and the experience of the past year demonstrates, that it is appropriate
and desirable for the System to establish limits on warehousing in order to
focus the attention of the Committee (and, through the Chairman, the
Treasury) on the risks associated with large holdings of foreign exchange
balances as well as on broader aspects of U.S. exchange rate policy.
III. Issues for Possible FOMC Discussion
At the FOMC meeting on March 27, members of the Committee may have
some questions about the Task Force papers.
Once those questions have been
answered to the best of our abilities, the Committee might want to turn to
a general discussion of some of the issues raised by the Task Force's
review.
Among the issues that the committee might want to discuss are the
following:
1. Should the Federal Reserve continue to participate for its own
account in U.S. foreign currency operations?
2. What are the implications for Federal Reserve monetary policy
(objectives, effectiveness and implementation) resulting from
the System's participation in U.S. foreign currency operations?
3. In light of the sometimes amorphous nature of U.S. exchange
rate policies and objectives and G-7 understandings, should the
Committee consider ways and means to keep itself more fully
informed on such matters?
4. Is the Committee satisfied with its existing foreign currency
instruments and the amount of information it receives about
System foreign currency operations? NOTE: this is a question
primarily about how the System conducts and monitors these
operations not about whether it should undertake them; the
latter question is addressed in question #1.
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5. Should the Federal Reserve undertake a more exhaustive study of
particular aspects of its foreign currency balances, including
benefits, risks, and possible modifications in U.S. policy in
this regard?
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LEGAL BASIS FOR SYSTEM FOREIGN CURRENCY OPERATIONS
Summary........................................................
1
History of Foreign Currency Operations..................
4
I.
II.
Statutory Authority for Foreign Currency Operations:
The Federal Reserve Act.................................
(First Paragraph) -- Warehousing..........
8
8
A.
Section 14
B.
Section 14(e) -- Swaps.............................. 12
C.
Section 12A -- Open Market Operations............... 18
III. Congressional Consideration of the Federal Reserve's
Foreign Currency Operations............................. 20
IV.
Past Criticism of the Authority Set Forth in the
Hackley Memorandum.....................................
Appendix:
Hackley Memorandum (Nov. 22, 1961)
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Legal Basis for System Foreign Currency Operations¹
Summary
The legal basis for the Federal Reserve System's
foreign currency operations is found in the provisions of the
Federal Reserve Act ("Act") that authorize Federal Reserve Banks:
to purchase and sell cable transfers (foreign exchange), bankers'
acceptances, and bills of exchange in the open market; to open
and maintain accounts in foreign countries; and to appoint
correspondents and establish agencies in foreign countries.
Read
together, these provisions have been interpreted to authorize not
only spot and forward purchases and sales of foreign exchange in
the open market, but also swap and warehousing transactions.
The legal analysis underpinning the Federal Reserve's
decision to resume foreign currency operations in 1962 was set
forth in a memorandum prepared by Howard Hackley, the General
Counsel of the Federal Open Market Committee ("FOMC") and the
Board of Governors of the Federal Reserve System ("Board").²
Most of the analysis in that memorandum (the "Hackley
¹ Prepared by J. Virgil Mattingly, Jr., Ernest T. Patrikis,
Ricki Rhodarmer Tigert, and N. Peter Knoll.
² See Memorandum, "Legal Aspects of Proposed Plan for
Federal Reserve Operations in Foreign Currencies," to the FOMC
A copy of the
from Mr. Hackley, General Counsel (Nov. 22, 1961).
Paper.
this
to
Appendix
as
the
attached
is
Memorandum
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Memorandum") is equally relevant today.
For that reason, this
paper is drawn in large measure from the Hackley Memorandum.
The
Hackley Memorandum concludes that the Federal Reserve has the
authority to engage in foreign currency operations, although this
conclusion is not entirely free from doubt.
The Hackley Memorandum finds that, although as a
general matter foreign currency operations are consistent with
the purposes of the Act, not all kinds of foreign exchange
transactions have explicit statutory authority.
Specifically, it
concludes that foreign currency operations conducted through open
market purchases and sales of foreign exchange are expressly
authorized by the Act.
Although operations conducted through
swap agreements are not expressly authorized, the Hackley
Memorandum concludes -- and the Board has accepted -- that such
operations are authorized through the statutory provision
permitting Reserve Banks to establish foreign accounts.
Because of the incomplete express authority, the
Hackley Memorandum states that its conclusions as to the Federal
Reserve's authority to engage in foreign currency operations
might be criticized.
Two members of the FOMC dissented from the
decision in early 1962 to authorize foreign currency operations, 3
and several members of the Congress raised questions about the
3
See notes 72-76 below and accompanying text.
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Federal Reserve's authority in a hearing held two weeks after the
FOMC's decision to engage in such operations. 4
At that same hearing, Congressional committee members
requested the Federal Reserve's legal opinion as to its authority
to engage in foreign currency operations, 5 and Chairman Martin
responded by giving the Hackley Memorandum to the committee.
The
Hackley Memorandum's conclusion that various provisions of the
Act, when read together, authorize the Federal Reserve's foreign
currency operations was concurred in by the General Counsel of
the United States Department of the Treasury and the Attorney
General of the United States. 6
Since 1962 the Congress has reviewed the foreign
currency operations of the Federal Reserve in hearings on related
issues.
More significantly, the Congress amended the Act in 1980
for the express purpose of permitting the Federal Reserve to
invest its foreign exchange holdings in obligations of foreign
governments. 7
The amendment suggests tacit Congressional
acceptance of the Federal Reserve's foreign currency operations.
4
See note 59 below and accompanying text.
5 See Bretton Woods Agreements Act Amendment: Hearings on
H.R. 10162 Before the House Comm. on Banking and Currency, 87th
Cong., 2d Sess. 128, 141-42 (1962)(hereinafter "Bretton Woods
Hearings").
6
Id. at 90-92, 157.
7
See notes 63-65 below and accompanying text.
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- 4 Therefore, while questions were raised at the outset
about the authority of the Federal Reserve to engage in foreign
currency operations, that authority has been strengthened by the
subsequent review and actions of the Congress, as well as by the
consistent interpretation and practice of the Federal Reserve
over nearly three decades.
This paper examines these issues in
more detail.
This paper is divided into four parts.
Part one
provides a short history of the Federal Reserve's foreign
currency operations.
Part two sets forth the legal authority for
the Federal Reserve's foreign currency operations.
Part three
discusses Congressional consideration of the Federal Reserve's
foreign currency operations since 1962.
Part four considers
criticism of the Hackley Memorandum's conclusions regarding the
Federal Reserve's authority to conduct foreign currency
operations.
I.
History of Foreign Currency Operations8
In the period between the First and Second World Wars,
the Federal Reserve participated in various forms of loans and
credits to foreign central banks.
From 1924 through 1929, the
8 See also Task Force Paper entitled "Evolution of Formal
Procedures for FOMC Oversight of System Foreign Exchange
Operations," pp. 1-3.
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Federal Reserve played a "significant part" internationally
through the extension of stabilization credits. 9
Generally
acting together with other central banks, the Federal Reserve
extended stabilization credits at least seven times during this
period to strengthen or add to the monetary reserves of the
borrowing country and to establish confidence in that country's
currency. 10
These credits took several forms, including short-
term revolving credit on 100-percent gold collateral, credit
through the purchase of commercial paper from the borrower, the
sale of gold on credit, and agreements to purchase the borrower's
currency, with provision for repurchase by the borrower at the
same exchange rate. 11
In 1929 and 1930, the Federal Reserve purchased foreign
bills to support the British pound sterling.
By the end of 1930,
Federal Reserve holdings of foreign currency-denominated bills
amounted to $36 million, more than twice as great as that figure
had ever been previously. 12
In addition, the Federal Reserve,
9 "International Role of the Federal Reserve System,"
pp. 5-6, attached to Memorandum to Governor Szymczak from
Frank M. Tamagna (Dec. 16, 1949)(hereinafter "International
Role").
10
"Loans and Credits to Foreign Central Banks and
Governments in the Inter-War Period," pp. 1-5, attached to
Memorandum to Governor Szymczak from Frank M. Tamagna (Dec. 16,
1949)(hereinafter "Loans and Credits").
11
12
Id.
International Role at 9.
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employing some of the approaches used in the 1920s, extended
emergency credit assistance in 1931 to four central banks to meet
their immediate needs for foreign exchange or to replenish their
monetary reserves.13
The Federal Reserve continued at least through the
1940s to extend credit to foreign central banks using loans
secured by gold. 14
However, the Federal Reserve did not extend
other forms of credit to foreign central banks after the
enactment of the Gold Reserve Act of 1934. 15
This legislation
transferred to the Treasury title to all gold held by the Federal
Reserve and established the Exchange Stabilization Fund ("ESF")
for the purpose of stabilizing the exchange value of the
dollar. 16
How the Congress intended the establishment of the ESF
to affect the Federal Reserve's foreign currency operations is
not clear.17 The Federal Reserve's involvement in stabilization
13
Loans and Credits at 2, 5-7.
14
See note 44 below.
15
Pub. L. No. 73-87, 48 Stat. 337.
16
Id. SS 2(a), 10(a).
17 Compare 78 Cong. Rec. 989 (1934)("[W]e are turning over
to the Secretary of the Treasury the right to buy and sell
foreign exchange.")(statement of Rep. McFadden) with Gold Reserve
Act of 1934: Hearings on S. 2366 Before the Senate Comm. on
Banking and Currency, 73d Cong., 2d Sess. 328 (1934)("As I see
it, this bill does not interfere with the ordinary functions of
the Federal Reserve System except to the extent that the
activities of the Treasury Department might impinge upon the
activities of the Federal Reserve System with reference to the
(continued...)
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credits between 1934 and 1962 seems to have been limited to the
activity by the Federal Reserve Bank of New York ("FRBNY") in
maintaining the ESF's accounts and conducting its operations. 18
In 1962, the Federal Reserve resumed foreign currency
operations on its own behalf.
Specifically, the Board amended
Regulation N to regulate the opening and maintenance of Reserve
Bank accounts with foreign banks.
The FOMC authorized the FRBNY
to purchase and sell nine 19 foreign currencies.
By the end of
the year, reciprocal currency agreements ("swap lines") had been
established with nine foreign central banks and the Bank for
International Settlements. 20
In 1963, the FOMC authorized
warehousing of foreign exchange held by the Department of the
17(...continued)
stabilization of foreign exchange.") (emphasis supplied)(comment
See also Memorandum, "Foreign Currency
of Sen. Barkley).
Operations: Reasons for Federal Reserve Participation;
Legislative History of Gold Reserve Act of 1934; System-Treasury
Coordination," to Messrs. Mattingly and Truman from Ms. Tigert
and Mr. Knoll (Jan. 26, 1990), pp. 3-5.
18
International Role at 11-12.
19 The original number was six. 49th Annual Report of the
Board, 1962, p. 63. By the end of 1962, it had been increased to
nine. Id. at 98.
See Charles A. Coombs, "Treasury and Federal Reserve
Foreign Exchange Operations," 48 Federal Reserve Bulletin 1138,
1146-47 (Sept. 1962)(hereinafter "Coombs Article"); 49th Annual
Report of the Board, 1962, pp. 54-63, 78-79. See also Task Force
Paper entitled "Evolution of Formal Procedures for FOMC Oversight
of System Foreign Exchange Operations," pp. 8-9.
20
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Treasury's ESF for the first time. 21
In 1978, the FOMC
supplemented its prior authorization by authorizing warehousing
of foreign exchange held directly by the Treasury, in addition to
that held by the ESF. 22
II.
Statutory Authority for Foreign Currency Operations:
The Federal Reserve Act
On the basis of several provisions of section 14 of the
Federal Reserve Act, the Hackley Memorandum concludes that the
Act permits Reserve Banks to acquire and hold foreign exchange
obtained through swap lines with foreign central banks and
through open market purchases, including purchases from the ESF.
To the extent that the foreign exchange is obtained through, or
used in, open market operations, section 12A of the Act is also
applicable.
A.
Section 14
(First Paragraph) -- Warehousing
The first paragraph of section 14 of the Federal
Reserve Act authorizes any Federal Reserve Bank, subject to
regulation by the Board, to "purchase and sell in the open
market, at home or abroad, . . . cable transfers and bankers'
acceptances and bills of exchange . . . eligible for
21 50th Annual Report of the Board, 1963, pp. 117-18; 1963
FOMC Minutes, pp. 931-36 (Nov. 12, pp. 5-10).
22
65th Annual Report of the Board, 1978, pp. 252-53.
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rediscount." 23
9 -
When the Act was passed in 1913, cable transfers
were the medium through which holdings of foreign exchange could
be acquired and disposed of, and the purchase of foreign exchange
was frequently referred to as the purchase of a cable transfer. 24
The purchaser of the cable transfer, in effect, purchased a bank
balance in a foreign country, typically denominated in a foreign
currency.25
The Hackley Memorandum is unequivocal in its conclusion
that the cable transfer provision of section 14 authorizes the
Federal Reserve to purchase foreign exchange in the open market:
To the extent that the proposed foreign
exchange operations would be effected through
purchases of cable transfers in the open
market from domestic banks or dealers in
foreign exchange or from foreign banks, there
would, in my opinion, be no legal question of
authority involved, whether the cable
23 12 U.S.C. 353. The insertion of the word "and" and the
lack of a comma after "cable transfers" demonstrate that the
authority to purchase and sell cable transfers is not conditioned
on a requirement that they be eligible for rediscount. 12 U.S.C.
343. See Hackley Memorandum at 26.
24 See Memorandum, "Legal Authority for Federal Reserve
Foreign Exchange Operations," initialed by Howard Hackley (Feb.
19, 1962)(hereinafter "1962 Legal Summary"), p. 1. See also
Louis A. Rufener, Money and Banking in the United States 316-17,
346 (1934); Glenn G. Munn, Encyclopedia of Banking and Finance 90
(5th ed. 1949).
25
See, e.g.,
Strohmeyer & Arpe Co. v. Guaranty Trust Co.,
172 App. Div. 16, 157 N.Y.S. 955, 956 (Sup. Ct. 1916); In re
Pacat Finance Corp., 295 F. 394, 410 (S.D.N.Y. 1923).
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transfers related to "spot" or "forward"
transactions.26
The Hackley Memorandum also concludes that this provision
authorizes the foreign currency operations that have since become
known as "warehousing." 27
Warehousing involves simultaneous spot purchases and
forward sales of foreign exchange by the Federal Reserve from the
ESF or from the Treasury's General Fund.
The purpose of
warehousing is to provide the ESF or the Treasury with liquid
dollar resources for conducting its foreign currency operations.
The forward resale to the ESF or the Treasury at the same
exchange rate protects the Federal Reserve from market risk. 28
The Hackley Memorandum reaches the conclusion that the
cable transfer provision of section 14 authorizes the purchase of
foreign exchange from the ESF because such a purchase is a
purchase of foreign exchange ("cable transfer") in the "open
26
Hackley Memorandum at 16.
27 At the 1963 meeting in which the FOMC first authorized
purchases of foreign exchange from the ESF, Charles Coombs, the
manager of System foreign currency operations, stated that "the
System had an opportunity to help stabilize a situation by
warehousing foreign currencies without capital risk until they
were needed by the Treasury, whose resources for this kind of
1963 FOMC Minutes, p. 933 (Nov. 12, p.
operation were limited."
See also Appendix to Task Force Paper
7)(emphasis supplied).
entitled "Historical Review: U.S. Official Holdings of Foreign
Currencies"; Task Force Paper entitled "Evolution of Formal
Procedures for FOMC Oversight of System Foreign Exchange
Operations," pp. 18-20.
28
65th Annual Report of the Board, 1978, p. 252.
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market" from a "domestic corporation."
In order to reach this
result, the Hackley Memorandum reasons that (1) the United States
is a "domestic corporation" for purposes of this section; and (2)
"an 'open market' in cable transfers may be regarded as embracing
any person with whom a Reserve Bank may feel free to deal,
including the United States Treasury, which is a part of that
market." 29
In reaching the second conclusion, the Hackley
Memorandum distinguishes the open market in foreign exchange from
the open market in U.S. government securities.
Purchases of U .S.
government securities by the Federal Reserve directly from the
Treasury, the issuer of those securities, would not be purchases
in the open market because an issuer "is not a seller in the
open-market sense." 30
In comparison, the purchase of foreign
currencies from the Treasury (or its ESF) are purchases in the
29 Hackley Memorandum at 18. Thus, the "open market" for
cable transfers referred to in the first paragraph of section 14
is different than the "open market" for U.S. government
securities referred to in section 14(b)(l). See also Memorandum,
"Federal Reserve Holdings of, and Operations in, Foreign
Exchange," from John J. Clarke (Assistant General Counsel,
Federal Reserve Bank of New York) to Legal Department Files (Nov.
10, 1961)(hereinafter "Clarke Memorandum"), pp. 7-17. Generally,
the Clarke Memorandum and the Hackley Memorandum discuss the same
issues and reach the same conclusions.
30 Clarke Memorandum at 13; see Hackley Memorandum at 18.
The Banking Act of 1935 amended section 14(b)(1) of the Federal
Reserve Act to provide that the Federal Reserve may buy and sell
U.S. government securities "without regard to maturities but only
12 U.S.C. 355.
in the open market."
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open market, as the Treasury is not the issuer of those
currencies. 31
B.
Section 14(e) -- Swaps
Section 14(e) of the Act authorizes any Federal Reserve
Bank, with the consent or upon the order and direction of the
Board, "to open and maintain accounts in foreign countries,
appoint correspondents, and establish agencies in such countries
wheresoever it may be deemed best for the purpose of purchasing,
selling, and collecting bills of exchange." 32
In the early 1930s, the Board and the FRBNY debated the
proper interpretation of this provision. 33
The FRBNY believed
that the "wheresoever it may be deemed best for the purpose of
purchasing, selling, and collecting bills of exchange" clause did
not "limit the power to open and maintain accounts in foreign
31
See Hackley Memorandum at 18; Clarke Memorandum at 8-10,
13.
32 12 U.S.C. 358. The Board's Regulation N governs Reserve
Bank relationships with foreign banks. See 12 C.F.R. 214.
During this same time period, some members of the
Congress expressed concern that the Reserve Banks were acting
without sufficient supervision by the Board and beyond their
statutory authority in the field of foreign currency operations.
See, e.g., 75 Cong. Rec. 9884 (statement of Sen. Glass), 9973-74
(statement of Sen. Norbeck)(1932). Apparently to address this
concern, section 14(g) was added to the Act in 1933 to require
the Board to "exercise special supervision over all relationships
and transactions of any kind entered into by any Federal
12 U.S.C.
[R]eserve [B]ank with any foreign bank or banker."
348a.
33
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countries or appoint correspondents because of the comma after
the word
correspondents.'"
34
The Board disagreed with the
FRBNY's statutory construction and interpreted section 14(e) as
permitting the establishment of foreign accounts only for the
purpose of buying and selling bills of exchange in foreign
countries, and not for other purposes such as holding foreign
exchange.35
The Board's interpretation appears to have reflected
its view that the "wheresoever" clause modifies all three of its
possible antecedents -- "open and maintain accounts," "appoint
correspondents," and "establish agencies."36 The Board's
interpretation of section 14(e) remained in effect until 1962,
when the Board implicitly adopted the Hackley Memorandum's
contrary conclusion by amending Regulation N to permit Reserve
34 Office Correspondence, "Right of Federal Reserve Bank to
Establish Six Months' Time Deposit with Bank for International
Settlements," from Mr. Wyatt, General Counsel, to Files (July 28,
1931)(hereinafter "Wyatt"), p. 2 (summarizing the views of Mr.
See also Office
Logan, General Counsel of the FRBNY).
Correspondence, "Right of Federal Reserve Bank of New York to
Open an Account and Make a Deposit for Six Months with Bank for
International Settlements," to Governor Harrison [of the FRBNY]
from Walter S. Logan (July 27, 1931), p. 2.
35 Letter to Governor George L. Harrison, Federal Reserve
Bank of New York, from Chester Morrill, Secretary (Mar. 20,
1933), p. 2.
See Wyatt at 1.
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Banks to conduct open market operations using foreign accounts
under the direction of the FOMC.37
In concluding that section 14(e) authorizes the opening
of foreign accounts for purposes other than the purchase, sale,
or collection of bills of exchange, the Hackley Memorandum adopts
the statutory construction argument made by the FRBNY in the
early 1930s.38 In support of that view, the Hackley Memorandum
also relies on two pieces of legislative history.
First, in its report accompanying the bill that was
adopted as the Act, the House Banking and Currency Committee
stated with respect to the provision that would become section
14(e) of the Act:
The final power to open and maintain
banking accounts in foreign countries for the
purpose of dealing in exchange and of buying
foreign bills is necessary in order to enable
a reserve bank to exercise its full power in
controlling gold movements and in
facilitating payments and collections
abroad.39
This language suggests that foreign accounts may properly be used
to acquire foreign exchange.
37 27 Federal Register 1719 (Feb. 22, 1962), adding 12
C.F.R. 214.5 ("Accounts with foreign banks").
38
Hackley Memorandum at 13.
39H. Rep. No. 69, 63d Cong., 1st Sess. 52 (1913)(quoted in
Hackley Memorandum at 11)(emphasis supplied).
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Second, shortly after the Act was enacted, a Board
member expressed the view that the Congress had intended no
substantial difference between section 14(e) and the
corresponding provision of the so-called Aldrich Bill, the
antecedent of the Act.40
The Hackley Memorandum notes that this
corresponding provision "appeared to limit the establishment of
agencies to the purpose of buying and selling bills of exchange
but not to place such a limitation upon the opening of foreign
accounts." 41
The corresponding provision states in relevant
"to open and maintain banking accounts in foreign
part:
countries, and to establish agencies in foreign countries for the
purpose of purchasing, selling, and collecting foreign bills of
exchange. 42
In addition, the Hackley Memorandum notes that the last
sentence of section 14(e) provides that a Reserve Bank may, under
rules and regulations provided by the Board, use an account
opened by any other Reserve Bank to carry on or conduct any
transaction authorized by section 14,43 for example, to deal in
40 Clarke Memorandum at 20-21 (referring to memorandum from
Paul M. Warburg to the Board dated Oct. 4, 1915).
Hackley Memorandum at 9.
41
42
43
Id.
Id. at 10-11.
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gold. 44
Given that this provision grants Reserve Banks other
than the one opening the account the authority to use the account
for purposes other than purchasing, selling, or collecting bills
of exchange, it makes no sense to interpret the "to open and
maintain accounts" provision of the same section so as not to
permit the Reserve Bank that opened the account also to use it to
carry on or conduct any transaction authorized by section 14. 45
The Hackley Memorandum further concludes that one
proper purpose of establishing foreign accounts (other than
purchasing, selling, or collecting bills of exchange) is to
establish foreign currency swap agreements ("swap lines") with
44 The Hackley Memorandum concludes that the establishment
of foreign accounts through sales of gold is authorized by
section 14(a) of the Act, 12 U.S.C. 354, which authorizes the
Reserve Banks to deal in gold at home or abroad and to make loans
on gold. Hackley Memorandum at 16. This provision was the
authority for certain early stabilization credits. "Background
Memorandum on the Problem of Currency Stabilization Credits,"
(Oct. 17, 1949), p. 14, attached to Memorandum to Board of
Governors from Senior Staff (Oct. 17, 1949); Memorandum,
"Authority to Extend International Credits," to Allen Raiken from
A.F. Cole (Aug. 24, 1976), p. 2. In the 1920's, Reserve Banks
engaged in several stabilization transactions with European
countries involving gold or loans collateralized by gold. See
notes 9-11 above and accompanying text. Reserve Banks also
established accounts abroad to hold foreign exchange acquired in
these transactions. For example, with respect to the first such
credit, the FRBNY opened an account in 1925 with the Bank of
England as part of an arrangement in which the FRBNY agreed to
provide credit to the Bank of England through a transfer of $200
million in gold. Hackley Memorandum at 12. This credit was
apparently never drawn upon. "Legal Aspects of International
Stabilization Credits by Federal Reserve" (June 4, 1954), p. 14.
45
Clarke Memorandum at 22.
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foreign central banks and to obtain foreign exchange by drawing
against those swap lines.46
A foreign currency swap arrangement
is "a reciprocal credit facility under which a central bank
agrees to exchange on request [a deposit on its books denominated
in] its own currency for [a deposit in] the currency of the other
party up to a maximum amount over a limited period of time, such
as 3 months or 6 months."47
The foreign exchange acquired in a
swap transaction may be disbursed to conduct spot transactions in
foreign exchange or to meet forward exchange obligations, or it
may be invested in a time deposit or other investment
instrument.48
Obtaining foreign exchange through swaps with foreign
central banks is authorized by section 14(e) because such foreign
exchange is held in Reserve Bank accounts with those banks.
For
example, in a typical drawing against a swap line by the FRBNY,
the foreign central bank credits the FRBNY's account at the
foreign central bank with foreign currency, and the FRBNY credits
the foreign central bank's account at the FRBNY with U.S.
dollars.
46
Hackley Memorandum at 15.
47
Coombs Article at 1147.
48
Id. at 1147-48.
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C.
Section 12A -- Open Market Operations
Section 12A(b) of the Act specifies that no Reserve
Bank may "engage or decline to engage in open-market operations
under section 14 of the Act except in accordance with the
direction of and regulations adopted by the [FOMC]."
49
Therefore, a Reserve Bank must obtain the authorization of the
FOMC before engaging in open market operations in foreign
currencies.
Under section 12A(c) of the Act, open market operations
"shall be governed with a view to accommodating commerce and
business and with regard to their bearing upon the general credit
situation of the country." 50
Foreign currency operations are
intended, among other things, to "preserve the strength of the
dollar in the international payments system." 51
The Hackley
49 12 U.S.C. 263(b).
The FOMC's authorizations for open
market operations in foreign currencies are discussed in the Task
Force Paper entitled "Evolution of Formal Procedures for FOMC
Oversight of System Foreign Exchange Operations."
50
12 U.S.C. 263(c).
51 Bretton Woods Hearings at 89 (statement of Chairman
Martin).
Among the other purposes of foreign currency operations
Chairman Martin identified in his testimony were "correct[ing] or
avoid[ing] disorderly movements of exchange rates" and
"improv[ing] the international payments system by cooperative
Id. at 92. The basic
arrangements with foreign reserve banks."
purposes of foreign currency operations were discussed at length
in a paper submitted to the FOMC entitled "Aims and Scope of
System Foreign Exchange Operations" (three drafts: Nov. 2, Nov.
28, and Dec. 12, 1961).
(continued...)
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Memorandum identifies the principal purposes of conducting
foreign currency operations using accounts with foreign central
banks as "promot[ing] international monetary cooperation among
the central banks of countries maintaining convertible
currencies, . . . foster[ing] orderly conditions in exchange
markets for such currencies, . . . facilitat[ing] the expansion
and balanced growth of international trade, and . . .
supplement[ing] the activities of the International Monetary
Fund." 52
The Hackley Memorandum assumes that the accomplishment
of these purposes contributes to the accommodation of commerce
and business and the maintenance of sound credit conditions in
the United States, in accordance with the governing principles of
section 12A of the Act. 53
The validity of the System's foreign
currency operations depends in the final instance on the
soundness of this assumption.
This question is addressed in the
51 (...continued)
Chairman Martin also noted in his testimony that "[i]f
we want cooperation from others, we must be prepared to cooperate
Bretton Woods Hearings at 92. A month later,
with them."
Governor Mills seemed to suggest that such cooperation includes
the obligation to support currencies other than the U.S. dollar:
"Where the Federal Reserve was obtaining support of the dollar
through swap arrangements with other foreign central banks, there
would seem to be an inescapable responsibility to reciprocate."
Board Vice Chairman
1962 FOMC Minutes, p. 340 (Mar. 27, p. 53).
Balderston and President Wayne of the Federal Reserve Bank of
Richmond expressed the same sentiment as Governor Mills. Id. at
341 (Mar. 27, p. 54).
52
53
Hackley Memorandum at 1.
Id.
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other Task Force papers accompanying this one.
The conclusions
in this paper, as in the Hackley Memorandum, are based on the
assumption that the System's foreign currency operations satisfy
the general requirements of section 12A.
III.
Congressional Consideration of the Federal Reserve's
Foreign Currency Operations
The Congress was informed almost immediately of the
resumption of foreign currency operations by the Federal Reserve
in early 1962.
Chairman William McChesney Martin testified that
"the Federal Reserve has recently decided to reenter the field of
foreign-exchange transactions," 54 an apparent reference to the
participation of the Federal Reserve in economic stabilization
and emergency credits during the interwar period.
Chairman
Martin stated that the Federal Reserve had "acquired small
amounts of several convertible currencies widely used in
international transactions from the [ESF] and ha[d] opened
accounts with several European reserve banks." 55
He further said
that the Federal Reserve "planned to acquire further amounts
through open-market purchases of cable transfers or bills of
54
Bretton Woods Hearings at 90 (emphasis supplied).
5
5
Id. at 91.
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exchange at home or abroad . . . and also through reciprocal
transactions with foreign reserve banks." 56
At the request of members of the House Committee on
Banking and Currency, more detailed information was provided to
the Committee on the Federal Reserve's foreign currency
operations for the Federal Reserve and the Treasury (ESF).57
Included in those materials, which were printed in the hearing
record, were the Hackley Memorandum and the opinion of the
General Counsel of the Department of the Treasury, expressing his
concurrence, and that of the Attorney General of the United
States, in the view that the Federal Reserve has the authority to
engage in foreign currency operations. 58
Two members of the
House Committee -- Henry Reuss and Wright Patman -- expressed the
contrary view in the 1962 hearings. 59
The Congress has been apprised of the Federal Reserve's
foreign currency operations periodically since 1962.
The Hackley
Memorandum was published a second time in a 1972 hearing record
56
Id. at 91-92.
57
Id. at 128, 141-42 (requests by Representatives Patman
and Reuss), 142-43 (letter from William McChesney Martin to Brent
Spence, Chairman of the House Committee on Banking and Currency,
Mar. 1, 1962).
58
Id. at 143-57.
59
Id. at 102, 127-29, 140.
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of the House Banking Committee.60 In addition, the Annual
Reports of the Board have described and provided data on the
Federal Reserve's foreign currency operations, 61 and the FRBNY
has submitted quarterly reports to the Congress on Treasury and
Federal Reserve foreign currency operations.62 Although the
Congress can properly be considered to have been fully aware of
these published materials, it has not acted to restrict the
authority of the Federal Reserve to engage in these operations.
In fact, the Congress has recognized and facilitated
the Federal Reserve's foreign currency operations by amending a
related provision of the Act to permit the investment of foreign
exchange obtained through those operations.63 In 1980, the
To Amend the Par Value Modification Act of 1972:
Hearings on H.R. 4546 Before the Subcomm. on International
Finance of the House Comm. on Banking and Currency, 93d Cong.,
1st Sess. 353-65 (1973).
61 See, e.g., 50th Annual Report of the Board, 1963,
pp. 171-90.
62 See, e.g., "Treasury and Federal Reserve Foreign
Exchange Operations: August-October 1987," Federal Reserve Bank
of New York Quarterly Review 48-53 (Winter 1987-88), reprinted in
74 Federal Reserve Bulletin 14-17 (1988).
63 Unless inconsistent with the plain language of the
statute, the validity of an agency interpretation has been
recognized by the Supreme Court where (i) the interpretation has
been long-standing and consistent; see Udall v. Tallman, 380 U.S.
1, 16-18 (1965); (ii) the Congress has failed to criticize or
revise the statutory authority upon which the interpretation is
based; see North Haven Board of Education v. Bell, 456 U.S. 512,
533-34 (1982); and (iii) substantial foreign and private
interests have relied on a consistent interpretation of the
agency's authority. See Zenith Radio Corp. v. United States, 437
(continued...)
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Congress amended section 14(b)(1) of the Act to grant Reserve
Banks the authority to invest foreign exchange in "short-term
foreign government securities."64 The provision was enacted as
part of the Monetary Control Act of 1980 in response to a longstanding request from the Board. 65
Its enactment demonstrated
Congressional awareness, and suggested tacit acceptance, of the
Federal Reserve's foreign currency operations.
The amendment to the Act had only one purpose:
providing a vehicle for investment of the foreign exchange
holdings of the Federal Reserve.
The Congress sought assurances
that the amendment would not be used for any other purpose.
After the onset of the international lending problems of
developing countries in 1982, some members of the Congress became
concerned that the Federal Reserve would use its new authority to
invest in the obligations of foreign governments as an indirect
63(...continued)
U.S. 443, 457-58 (1978).
In Board of Governors v. First Lincolnwood Corp., 439
the Court upheld the Board's long-standing
234
(1978),
U.S.
statutory mandate under section 3(c) of the
of
its
construction
Bank Holding Company Act, noting that the Congress had been made
aware of the Board's interpretation, "yet four times ha[d]
'revisited the Act and left it untouched.'" Id. at 248 (quoting
Saxbe v. Bustos, 419 U.S. 65, 74 (1974)).
Federal Reserve Membership: Hearings on Amendment No.
398 to S. 85, S. 353 and H.R. 7 Before the Senate Comm. on
Banking, Housing, and Urban Affairs, 96th Cong., 1st Sess. 14
(1979); see 12 U.S.C. 355.
64
65
See 59th Annual Report of the Board, 1972, pp. 200-01.
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way of providing financial support for heavily indebted
countries.
In March 1983, Governor J. Charles Partee testified
before the House Committee on Banking, Finance, and Urban Affairs
that there were "ample safeguards" to prevent the provision from
being used for that purpose.66 In addition, Chairman Paul
Volcker assured the Congress that "the Federal Reserve has not
purchased and has no plans to purchase obligations of developing
countries."67
There is no evidence that the concerns of members of
the Congress about the use of the new authority to support
heavily indebted countries derived in any way from questions
about the Federal Reserve's authority to engage in foreign
currency operations, including swap transactions.
Moreover,
direct and published information has been made available to the
Congress on foreign exchange swap and warehousing transactions.68
66 Statement of Governor J. Charles Partee, 69 Federal
Reserve Bulletin 193, 195 (1983).
67 Letter from Chairman Paul A. Volcker to Senator David
Durenberger (May 18, 1981), p. 2.
68 See, e.g., 66th Annual Report of the Board, 1979, pp.
30-32; 64th Annual Report of the Board, 1977, pp. 174-75; 59th
Annual Report of the Board, 1972, p. 189; Letter from Chairman
Paul A. Volcker to Representative Ronald E. Paul (Dec. 3, 1982),
p. 1; Letter from Chairman Paul A. Volcker to Representative
Ronald E. Paul (July 10, 1981), pp. 1, 2, 5; Statement of
Governor J. Charles Partee, 69 Federal Reserve Bulletin 193, 194
(1983).
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Furthermore, although the Congress has considered
legislation mandating coordination between the Federal Reserve
and the Treasury with respect to foreign currency operations, the
legislation has been abandoned following assurances of the close
coordination between the two agencies. 69
Because there is
substantial coordination between the Federal Reserve and the
Treasury with regard to swap and warehousing transactions, these
operations are fully consistent with the Federal Reserve's
commitment to interagency coordination.70
IV.
Past Criticism of the Authority Set Forth in the Hackley
Memorandum
Although its analysis is reasonable, the Hackley
Memorandum's conclusions as to the legal authority of the Federal
Reserve to conduct foreign currency operations have been
questioned.
In addition to criticism by Representatives Reuss
and Patman that the Federal Reserve was exceeding its
authority,71 Hackley's opinion did not enjoy the support of all
of the members of the FOMC.
Two members, Governors Robertson and
Mitchell, dissented from the FOMC's decision to authorize foreign
69 See Letter from Chairman Arthur F. Burns to
Representative Thomas J. Rees (June 15, 1976), pp. 1-2.
70 See also Task Force Paper entitled "Federal ReserveTreasury Coordination."
71
See note 59 above and accompanying text.
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currency operations in January 1962. 72Governor Robertson argued
that the incidental power to maintain foreign accounts contained
in section 14 of the Act could not be "regarded as an
authorization to exercise the broad policy functions contemplated
by the instant proposal."73
Governor Robertson emphasized that
the Act nowhere authorized "the stabilization function that is
the core of this proposal,"47 and which was already being
exercised by the ESF.75 Governor Mitchell also sought
"legislative clarification of the System's statutory authority to
acquire, hold, and sell foreign currency assets.76
Moreover, Governor Robertson noted that the Board had
determined in 1933 that foreign accounts could "be opened and
maintained only for the purpose of facilitating the purchase,
sale, and collection of bills of exchange and the conduct of open
market transactions of the kinds specified in section 14 of the
Federal Reserve Act."77
In light of this long-standing
72 1962 FOMC Minutes, pp. 113-14 (Jan. 23, pp. 41-42).
73 1961 FOMC Minutes, p. 1038 (Dec. 5, p. 58); 49th Annual
Report of the Board, 1962, p. 56.
74 1961 FOMC Minutes, p. 1039 (Dec. 5, p. 59).
75
49th Annual Report of the Board, 1962, pp. 56-57.
76
Id. at 56.
1961 FOMC Minutes, p. 1038 (Dec. 5, p. 58) (quoting
Letter to George L. Harrison, Governor, Federal Reserve Bank of
New York, from Chester Morrill, Secretary (Mar. 20, 1933), p.
2.).
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administrative interpretation, Governor Robertson argued that
departing from it after almost thirty years was unwarranted
without specific legislative authorization.
Notwithstanding the Federal Reserve's extended absence
from foreign currency operations, the FOMC concluded in 1962 that
it was desirable to resume those operations.
In reaching that
conclusion, the FOMC considered the Federal Reserve's regular
correspondent relationships with foreign central banks, its
experience in conducting foreign currency operations for the ESF,
and the inadequacy of the ESF's funds for the task of stabilizing
international exchange rates. 78
The Board and the FOMC also determined that the Federal
Reserve had the statutory authority to engage in the proposed
foreign currency operations.
The Hackley Memorandum, upon which
the FOMC relied in making this determination, has been conveyed
to the Congress on at least two occasions.
Moreover, although
the Congress has never articulated the Federal Reserve's
authority in straightforward, modern-day terminology, the
Congress has effectively recognized that authority by amending
the Act to allow the Federal Reserve to invest the foreign
See, e.g., Memorandum to the FOMC from Mr. Wayne,
President of the Federal Reserve Bank of Richmond (Nov. 6, 1961),
pp. 3-5; Letter to President Kennedy from Treasury Secretary
Dillon (Dec. 22, 1961); Letter to Chairman Martin from Treasury
Secretary Dillon (Dec. 19, 1961), reprinted in 1961 FOMC Minutes,
pp. 1145-46 (Dec. 19, pp. 85-86).
78
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exchange acquired through its operations in the obligations of
foreign governments.
Accordingly, Governor Robertson's argument
that any uncertainties as to the construction of the Act should
be resolved in favor of long-standing practice is now an argument
supporting the authority of the Federal Reserve to engage in
foreign currency operations on the basis of the legal opinion set
forth in the Hackley Memorandum nearly thirty years ago.
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Paper No. 6
CONFIDENTIAL (FR)
November 22, 1961.
Federal Open Market Committee
Subject: Legal aspects of proposed
plan for Federal Reserve operations
in foreign currencies
Mr. Hackley, General Counsel
At the September 12, 1961 meeting of the Federal Open Market
Committee,
legal questions were raised regarding a proposed plan under
which the Federal Reserve Bank of New York would open and maintain
accounts in certain foreign currencies with foreign central banks,
acting pursuant to directions and regulations of the Committee and,
to the extent legally necessary, in accordance with regulations of
the Board of Governors.
It
is understood that in general the principal purposes of
operations in foreign currencies through such accounts would be to
promote international monetary cooperation among the central banks of
countries maintaining convertible currencies, to foster orderly conditions in exchange markets for such currencies, to facilitate the
expansion and balanced growth of international trade, and to supplement
the activities of the International Monetary Fund in this field.
It
is assumed that the underlying basic objective would be to accommodate
commerce and business and maintain sound credit conditions in the
United States, in accordance with the governing principles stated in
section 12A of the Federal Reserve Act.
It
is also understood that such accounts with foreign
central banks would be opened and maintained principally through the
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purchase of cable transfers by the Federal Reserve Bank of New York,
although they might also be created through sales of gold to foreign
central banks and the direct establishment of "cross-credits".
It
is
further understood that, while such accounts would be established
primarily for the purposes above indicated,
any amounts in
minimum working balances might be invested in
As the plan has been described,
legal questions,
it
excess of
foreign bills
of exchange.
gives rise to a number of
some of basic importance and others that may be of
only minor or secondary importance.
In general,
it
appears that the
questions may be regarded as falling within the six categories indicated
below, and they will be discussed here in
(1)
that order:
authority of a Federal Reserve Bank to open
and maintain accounts with foreign central banks (pp.
(2)
the legality of the proposed methods of acquiring
foreign exchange (pp.
15-20);
(3) investments of foreign accounts (pp.
(4)
7-15);
20-22);
the respective jurisdictions of the Board of
Governors and the Federal Open Market Committee (pp.
23-33);
(5) the possible effects of the Gold Reserve Act of
1934 and the Bretton Woods Agreements Act (pp.
33-36); and
(6) administration of the proposed plan, including
delegations of authority with respect to "day-to-day"
operations (pp. 36-38).
This memorandum does not consider policy questions that may
be involved in
the present proposal.
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Federal Open Market Committee
CONCLUSIONS
For the reasons hereafter presented, my conclusions are
as follows:
1.
General.
- The opening of accounts with foreign central
banks by the Federal Reserve Bank of New York for the purposes and
through the methods contemplated by the proposed plan would be consistent with the law, provided appropriate actions are taken by the
Board of Governors and the Federal Open Market Committee within their
respective jurisdictions.
However,
to question; and, while it
is
in court,
it
this matter is
admittedly subject
unlikely that the plan would be challenged
there can be no assurance,
in
the absence of legislation, that
would not be criticized from some sources on legal grounds.
Certain
suggested features of the plan (e.g., purchases of foreign Treasury
bills)
would require specific legislation.
2.
Opening of accounts with foreign banks.
section 14(e) of the Federal Reserve Act,
- Pursuant to
a Federal Reserve Bank may
open an account with a foreign central bank even though such account
is
not opened for the principal purpose of purchasing foreign bills
of exchange and is
not fully or extensively utilized for that pur-
pose; but any questions as to such authority would be lessened if
some portion of the account was used to purchase foreign bills
(pp. 7-15).
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3.
Methods of acquiring foreign currency accounts.
- A
Federal Reserve Bank may lawfully open and maintain such an account
through cross-credits,
sales of gold to the foreign bank,
or transfers
of credit to the account through either spot or forward purchases of
cable transfers in the open market (pp. 15-16).
4.
Purchases from Stabilization Fund. - The purchase by a
Federal Reserve Bank of cable transfers directly from the Stabilization
Fund of the Treasury would constitute a purchase in the "open market"
as authorized by the first paragraph of section 14 of the Federal
Reserve Act.
It
is possible that such purchases from the Stabilization
Fund might be criticized as being inconsistent with section 14(b) of
the Act which indicates that direct purchases of Government obligations
from the Treasury are not purchases in the "open market"; but in my
opinion any such criticism would not have legal validity (pp. 16-19).
5.
Dealings with International Monetary Fund. - Purchases
of cable transfers by a Federal Reserve Bank for its
own account
directly from the International Monetary Fund could be regarded as
"open market" transactions authorized by section 14 of the Act;
but, unless otherwise interpreted by the Fund, it
seems questionable
whether the Fund would have authority to sell cable transfers to a
Federal Reserve Bank except in the Reserve Bank's capacity as fiscal
agent of the United States (pp.
19-20).
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6.
Investment of foreign accounts. - Such foreign accounts
could be invested in foreign bills of exchange and acceptances that
arise out of actual commercial transactions and have maturities of not
more than 90 days.
They could not, in the absence of further legisla-
tion, be invested in foreign Treasury bills or other obligations of
foreign Governments or central banks.
Some portion of any such
account could lawfully be invested in a time deposit with a foreign
central bank (pp. 20-22).
7.
Jurisdictions of Board and FOMC. - All of the above
actions would be subject to regulations of the Board of Governors or
the Federal Open Market Committee,
or both, as follows:
(a) Open market purchases of cable transfers, bills
of exchange,
and acceptances would be subject to direc-
tion and regulations of the Committee (pp.
24-27);
(b) The opening and maintenance of accounts with
foreign banks, negotiations and arrangements with foreign
banks for this purpose, and sales of gold to foreign banks
would be subject to the consent and regulations of the
Board pursuant to sections 14(e) and 14(g) of the Federal
Reserve Act (pp. 28-31); and
(c) The Board could not lawfully delegate to the
Committee the Board's statutory responsibilities with
respect to supervision and regulation of such foreign
accounts and incidental transactions with foreign banks.
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However,
the Board could, by regulation,
consent to the
maintenance of such accounts and to such negotiations and
arrangements with foreign banks as may be authorized or
order to effectuate open market
directed by the FOMC in
transactions,
to such limitations and
subject, however,
reporting requirements as the Board may prescribe,
subject also to reservation in
the Board of the right to
modify or revoke such authorizations
8.
and the Board,
and
(pp. 31-33).
Effect of other laws. - The authorities of the Committee
as above described, would not be legally limited by
the provisions of section 10 of the Gold Reserve Act with respect to
the Stabilization Fund of the Treasury.
course,
(Dealings in
gold would,
of
continue to be subject to the licensing authority of the
Secretary of the Treasury.)
Nor would such authorities be legally
limited by provisions of the Bretton Woods Agreements Act, although it
would be desirable,
in view of the language and purposes of that Act,
for any plan of the kind proposed to be brought to the attention of the
National Advisory Council (pp.
9.
33-36).
Administration. - If
the Board should take appropriate
actions along the lines indicated in paragraph 7(c)
believed that the Committee could lawfully (a)
above,
it
is
direct the Federal
Reserve Bank of New York to open accounts and execute transactions
pursuant to the plan, subject to limitations prescribed by the Committee,
(b) delegate to a Subcommittee of the Committee authority for supervision
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of day-to-day operations by the New York Bank,
subject to general
policies established by the Committee (pp. 36-38).
I.
AUTHORITY TO OPEN FOREIGN ACCOUNTS
Section 14(e) of the Federal Reserve Act (12 U.S.C.
358)
authorizes any Federal Reserve Bank
with the consent or upon the order and direction
". ..
of the Board of Governors of the Federal Reserve System
and under regulations to be prescribed by said board,
to open and maintain accounts in foreign countries,
appoint correspondents, and establish agencies in such
countries wheresoever it may be deemed best for the
purpose of purchasing, selling, and collecting bills
of exchange. . . ." (Underscoring supplied)
A basic legal question is whether the underscored
"wheresoever" clause in
this provision has the effect of permitting
a Reserve Bank to open an account with a foreign bank only for the
purpose of "purchasing, selling, and collecting bills
and as, therefore,
of exchange"
forbidding the opening of such accounts for the
purposes contemplated by the present proposal.
Previous position of Board. - In 1933,
Federal Reserve Bank of New York,
in
a letter
to the
the Federal Reserve Board stated:
"...
Federal reserve banks are authorized to
establish and maintain accounts in foreign countries
only with the consent of the Federal Reserve Board and
subject to such regulations as the Board may prescribe;
and it is the Board's view that such accounts may be
opened and maintained only for the purpose of facilitating
of exchange and
the purchase, sale and collection of bills
the conduct of other open market transactions of the kind
specified in section 14 of the Federal Reserve Act. . . .
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The same position was indicated by the Board in another letter to
the New York Reserve Bank dated August 16, 1934:
". . . it is the Board's view that the deposit
balance with the Bank for International Settlements
should be reduced as soon as practicable to the minimum
amount which is actually needed for the purpose of
facilitating the purchase, sale and collection of bills
of exchange and the conduct of other open market transactions of the kinds specified in section 14 of the
Federal Reserve Act. . . ."
These letters have sometimes been referred to as reflecting
the position of the Board that a foreign account may not legally be
opened except for the purpose of buying, selling, and collecting bills
of exchange.
However,
it
is
not clear that the Board in these letters
intended to express such a legal conclusion; it
ing only its view as to policy.
Moreover,
may have been indicat-
even if
the Board's letters
are considered as interpretations of the statute, it may be argued
that the present proposal would be entirely consistent with those
letters since they stated that one of the permissible purposes of a
foreign account is to facilitate "the conduct of other open market
transactions of the kinds specified in section 14" and since foreign
accounts under the present proposal would be designed to facilitate
purchases of cable transfers pursuant to that section.
Language of the statute. - Presumably, the Board's 1933-34
position was based on a construction of the language of the statute
under which the "wheresoever" clause was regarded as limiting not only
the authority of a Reserve Bank to appoint correspondents and establish
agencies but also its authority to open foreign accounts.
reasonable ground, however,
There is
for a contrary construction.
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While comas appear after the authorities "to open and
maintain accounts in foreign countries" and to "appoint correspondents",
there is no comma after the authority to "establish agencies in such
countries" and, consequently, it may be argued that, as a matter of
grammatical construction, the "wheresoever" clause modifies only the
nearest antecedent, that is,
the authority to establish agencies.
However, it seems unreasonable to suppose that Congress intended to
make an arbitrary distinction in this respect between correspondents
and agencies.
The so-called Aldrich Bill, upon which the Federal Reserve
Act was based, contained a corresponding provision that appeared to
limit the establishment of agencies to the purpose of buying and selling
bills of exchange but not to place such a limitation upon the opening
of foreign accounts.
The Aldrich Bill would have authorized a Reserve
Bank
". . . to open and maintain banking accounts in foreign
countries, and to establish agencies in foreign countries
for the purpose of purchasing, selling, and collecting
foreign bills of exchange, and . . . to buy and sell, with
or without its indorsement, through such correspondents or
agencies. . . ."
The provision of section l4(e) that authorizes the opening
of accounts, the appointment of correspondents, and the establishment
of agencies is immediately followed by language authorizing a Reserve
Bank to buy and sell bills of exchange or acceptances
"through such
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correspondents or agencies", again suggesting, although not
conclusively, that the purchase and sale of bills of exchange was
intended to be linked with correspondents and agencies but not with
the maintenance of accounts with foreign banks.
A final, and perhaps the strongest, argument for the more
liberal construction of the statute may be based upon the ambiguous
nature of the phrase "wheresoever may be deemed best".
Even if that
phrase is interpreted as applying not only to the appointment of
correspondents and agencies but also to the opening of foreign accounts,
it does not expressly require such accounts, correspondents, or
agencies to be utilized only for the purpose of buying and selling
bills of exchange.
It is susceptible of the construction that such
accounts may be opened wherever geographically it may be reasonably
contemplated that they might be used at some time for such purpose but
that they need not be limited to that purpose.
Some support for this construction may be derived from the
last sentence of section 14(e).
That sentence provides in effect
that whenever a Reserve Bank opens a foreign account or appoints or
establishes a foreign correspondent or agency, any other Reserve Bank
may carry on, through such Reserve Bank, "any transaction authorized
by this section
section 14]"
In other words, where one Reserve Bank
opens foreign accounts or appoints foreign correspondents or agencies,
other Reserve Banks may conduct through such accounts, correspondents,
or agencies not only transactions in bills of exchange but any
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Federal Open Market Committee
transactions authorized by section l4
transactions,
that it
such as dealings in
would be illogical if
- even non-open market
gold.
From this, it
may be argued
not absurd to hold that the Reserve
Bank opening such accounts or appointing such correspondents or
agencies could use them only for the purpose of buying and selling
bills of exchange.
This argument, of course,
that the "wheresoever" clause,
even if
it
points to the conclusion
modifies the authority to open
foreign accounts, was not intended to limit the use of such accounts to
the buying and selling of bills
of exchange.
The argument is
also
entirely consistent with the language of the Board's letters of 1933
and 1934, which stated that foreign accounts could be opened, not only
to purchase and sell bills
of exchange,
but also in
order to facilitate
the conduct of any of the open market transactions authorized by
section 14.
Intent of Congress.
of the provision in
- The intent of Congress in
question is
tive history tends in
not crystal clear.
the enactment
However,
legisla-
some degree to support the conclusion that
Congress contemplated that foreign accounts opened by the Reserve Banks
might be used to influence foreign exchange and to control international
movements of gold as well as to purchase and sell bills
For example,
of exchange.
the House Committee Report on the original Act contained
the following statement with respect to this provision:
"The final power to open and maintain banking accounts
in foreign countries for the purpose of dealing in exchange
is necessary in order to enable
and of buying foreign bills
a reserve bank to exercise its full power in controlling gold
movements and in facilitating payments and collections abroad."
Since it
refers to "dealing in exchange" as well as "buying foreign
bills", this statement might be interpreted as contemplating that
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Federal Open Market Committee
foreign accounts could be broadly used as a means of dealing in
exchange,
other than through purchases of bills,
in
foreign
order to control
gold movements and facilitate payments and collections abroad.
Admittedly, however, the statement is not entirely convincing, since
the phrase "dealing in exchange" might have been used only as a loose
phrase to cover dealings in
foreign bills of exchange.
Administrative construction. - In 1925, the Federal Reserve
Bank of New York opened an account with the Bank of England which
was clearly not for the purpose of buying,
bills
of exchange.
to place
Under that arrangement,
selling, and collecting
the Reserve Bank agreed
200 million of gold at the disposal of the Bank of England,
with the understanding that the proceeds of sales of such gold would
be deposited in
an account in
pounds sterling with the Bank of England
to the credit of the Reserve Bank to be available for investment for
the account of the Reserve Bank in
sterling commercial bills
guaranteed
by the Bank of England, and with the further understanding that, at
the end of the standby period, any amount outstanding was to be payable
at the Reserve Bank in
gold or its
was described by the Board in
year 1925,
its
dollar equivalent.
This arrangement
Annual Report to Congress for the
and as thus described it
was made clear that the account
with the Bank of England might be used from time to time for the
purchase of commercial bills, but that this was not the principal
purpose of the arrangement.
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Although the Board subsequently (in 1933 and 1934) construed
section 14(e)
of exchange,
as limiting foreign accounts to the purchase of bills
the fact remains that the 1925 arrangement with the
Bank of England did not conform to this construction and that Congress,
with full knowledge of that arrangement,
did not then or subsequently
amend the statute in any manner designed to prevent such an arrangement.
Conclusion. - For all
of the reasons above indicated,
it
is
my opinion that a Federal Reserve Bank may lawfully open and maintain
an account in
foreign currency with a foreign central bank whether or
not the account is
in foreign bills
maintained and utilized for the purpose of investing
of exchange and that, therefore,
the opening of such
accounts for the purposes now contemplated would not be inconsistent
with the statute.
I do not believe that the "wheresoever" phrase
was intended to limit the authority to open foreign accounts; but,
even if
it
may be so regarded, I believe that it
can be construed as
meaning only that such accounts shall be established where it
may
reasonably be expected that they might be used for the purchase and
sale of bills
of exchange.
The present proposal would comply with
that requirement.
Consultation with Banking and Currency Committees.
Admittedly, the question is
debatable, particularly in view of the
1933-1934 position of the Board.
1932, Senator Glass
-
Moreover,
it
may be noted that in
had criticized certain foreign operations of the
Federal Reserve Bank of New York, which might be considered as
similar to those now contemplated,
as being contrary to the law.
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When the bill
that subsequently became the Banking Act of
1933 was under consideration by Congress,
Senator Glass on the floor
of the Senate referred to Federal Reserve "stabilization" operations
under which credits had been extended to European banks,
and suggested
that such operations were inconsistent with the Federal Reserve Act.
The pertinent portions of his statement were the following:
"For a period of six years one of the Federal reserve
banks has apparently given more attention to 'stabilizing'
Europe and to making enormous loans to European institutions than it has given to stabilizing America.
Accordingly, we have a provision in this bill
asserting,
in somewhat plainer terms, the restraint the Federal
reserve supervisory authority here at Washington should
exercise over the foreign and open market operations of
banks which may assume to be a 'central bank of America.'
"We did not think that we were having a central bank.
We thought we were having 12 regional banks.
The operations
of the bank particularly referred to were so extensive in the
liable for hundreds of
European field that it found itself
millions of dollars of foreign acceptances which could not
be collected, which had to be renewed at maturity--just a
sort of revolving fund--absolutely foreign to the intent,
and, as I contend, to the text of the Federal reserve act."
(75 Cong. Rec. 9884, May 10, 1932)
For the reasons heretofore indicated, it is believed that
the legal validity of Senator Glass's statement may be questioned.
In any event, he was obviously referring to instances in which the
Federal Reserve had undertaken operations to bolster the credit of
foreign countries;
and some distinction may
operations and the plan now proposed, which,
be drawn between those
in net effect, is
designed
to insure international monetary cooperation and convertibility of
currencies,
as well as to protect the American dollar.
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Nevertheless,
in
view of the uncertainties as to the
construction of the law and the history of this matter,
desirable,
before instituting the plan now proposed,
Banking and Currency Committees of Congress.
of course, have any legal significance; but it
the likelihood of adverse criticism.
it
might be
to inform the
Such action would not,
could help to diminish
On the other hand, of course,
such action might tend to generate criticism and controversy.
II.
A.
METHODS OF ACQUIRING FOREIGN EXCHANGE
Cross-Credits and Sales of Gold
As indicated at the outset of this memorandum,
it
is
understood that the proposed foreign currency operations would be
effected principally through purchases of cable transfers that would
result in
credits in
accounts with foreign central banks.
However,
such credits could be established also through direct arrangements for
cross-credits between the Federal Reserve Bank of New York and foreign
banks or through sales of gold to foreign banks.
Opening of foreign accounts through straight cross-credit
arrangements would be authorized by section l4(e) of the Federal Reserve
Act,
subject to the consent of the Board and under regulations of the
Board as provided in
section 14(e)
and section 14(g).
Unless such
arrangements involved the purchase of cable transfers or bills of
exchange,
they would not constitute open market operations.
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As to the establishment of foreign accounts through sales
of gold, it
seems clear that this would be authorized by section l4(a)
of the Federal Reserve Act (12 U.S.C. 354) which empowers the Reserve
Banks to "deal in gold coin and bullion at home or abroad."
Again,
such sales of gold would not be open market operations and, as hereafter discussed, would be subject only to such regulations as the
Board might prescribe pursuant to sections 14(e) and 14(g).
B.
Purchase of Cable Transfers Generally
The first paragraph of section 14 provides in part that
"Any Federal Reserve Bank may, under.rules and
regulations prescribed by the Board of Governors of
the Federal Reserve System, purchase and sell in the
open market, at home or abroad, either from or to
domestic or foreign banks, firms, corporations, or
individuals, cable transfers. . . ."
(12 U.S.C. 353)
To the extent that the proposed foreign exchange operations
would be effected through purchases of cable transfers in the open
market from domestic banks or dealers in foreign exchange or from
foreign banks, there would, in my opinion, be no legal question of
authority involved, whether the cable transfers related to "spot" or
"forward" transactions.
C.
Dealings with Stabilization Fund
A more difficult question would be presented if
the Federal
Reserve Bank of New York (or any other Federal Reserve Bank) should
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purchase cable transfers from the Stabilization Fund administered by
the Secretary of the Treasury under section 10 of the Gold Reserve
Act (31 U.S.C. 822a).
First, it
may be questioned whether such a purchase from
the Treasury would be an "open market" purchase within the meaning
paragraph of section 14 of the Federal Reserve Act.
of the first
Doubt on this score might be engendered by the provisions
of section
14(b) of the Act (12 U.S.C.
355), which clearly regard
direct purchases of Government obligations from the Treasury as not
constituting "open market" purchases.
after indicated, it
is
However,
for the reasons here-
believed that these provisions are not incon-
sistent with holding that direct purchases of cable transfers from
the Treasury constitute "open market" purchases within the meaning of
the first
paragraph of section 14.
differently construed in
The same term may sometimes be
the light of different statutory contexts
and purposes.
From 1913 until 1935, the Reserve Banks under section 14(b)
freely purchased Government obligations directly from the Treasury,
even though section 14 was designated as relating to "open market
operations".
By the Banking Act of 1935, Congress prohibited such
purchases of Government obligations except in
1942,
the "open market".
In
Congress permitted the "direct" purchase of Government obligations
from the Treasury for a temporary period and up to a limited amount;
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and this authorization has been extended by subsequent amendments.
seems clear, however,
It
that this limitation on direct purchases of
Government obligations was intended to prevent the Federal Reserve
System from lending its
resources to the Treasury in
a manner that
might be inconsistent with the System's monetary and credit responsibilities.
These considerations,
of course,
are not applicable to
purchases of cable transfers from the Treasury.
"open market" in
In other words,
cable transfers may be regarded as embracing any
person with whom a Reserve Bank may feel free to deal,
United States Treasury, which is
"open market" in
an
including the
a part of that market; whereas an
Government obligations may be regarded as excluding
the United States Treasury, which issues such obligations and consequently
is not a part of that market.
A further question arises as to whether the United States
is
a "corporation" within the meaning of the first
paragraph of
section 14 from which a Reserve Bank may properly purchase cable
transfers.
Obviously, the United States is
not a corporation in the
usual sense of a business corporation with stock outstanding; and it
is probable that, in the original Federal Reserve Act, Congress had in
mind only such corporations.
However, the courts have held that,
depending upon the context, the United States may be regarded as a
"corporation" in the sense envisaged by Chief Justice Marshall in the
Dartmouth College case (4 Wheat. 636):
"an artificial being, invisible,
intangible and existing only in contemplation of law."
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On balance,
it
is
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my opinion that a Reserve Bank's purchases
of cable transfers from the Stabilization Fund may reasonably be
regarded as "open market" purchases from a "domestic corporation"
within the meaning of the first
paragraph of section
14.
Admittedly, such purchases might be criticized on the ground
that, like direct purchases of Government obligations under section 14(b),
direct purchases of cable transfers from the Treasury should not be
treated as "open market" transactions; but I would not regard any such
criticism as having legal validity.
If
cable transfers purchased from
the Treasury had previously been acquired by the Treasury from the
International Monetary Fund solely for purpose of sale to the Federal
Reserve Bank,
such a transaction might be criticized as a device for
accomplishing directly what could not be accomplished directly, i.e.,
direct acquisition of cable transfers by the Reserve Bank from the IMF;
but, again, any such criticism would,
in my opinion, relate to policy
and not to legal validity.
D.
Dealings with International Monetary Fund
Section 1 of Article V of the Articles of Agreement of the
International Monetary Fund provides:
"Each member shall deal with the Fund only through its
Treasury, central bank, stabilization fund or other similar
fiscal agency and the Fund shall deal only with or through
the same agencies."
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On the assumption that the Federal Reserve System may be
considered the "central bank" of the United States, the United States
could purchase cable transfers from the Fund through the Federal
Reserve Bank of New York acting under directions of the Board of
Governors and the Federal Open Market Committee; but obviously this
would not constitute an "open market" transaction by the Reserve Bank.
Literally, the first
part of the above-quoted provision of the
Articles of Agreement of the Fund would not prohibit a Reserve Bank
from dealing for its
own account with the IMF, and it
might be argued
that the second part of the provision would permit the Fund to deal
directly "with" the Reserve Bank as well as "through" the Reserve Bank.
This is,
of course,
a question for determination by the Fund; but it
is
my opinion that the provision contemplates that the Fund will deal only
with a member country or with or through its
that, therefore,
it
is
fiscal "agencies" and
seriously questionable whether dealings between
the Fund and the Reserve Bank in
a capacity other than fiscal agent
for the Treasury would be permissible.
III.
INVESTMENT OF FOREIGN ACCOUNTS
Assuming that the proposed plan would not be impeded by
lack of authority of the Federal Reserve Banks to open and maintain
accounts with foreign central banks or to purchase cable transfers,
questions arise as to the types of instruments in
which such accounts
may lawfully be invested.
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Bankers'
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acceptances and bills
of exchange.
- The first
para-
graph of section 14 of the Federal Reserve Act authorizes any Reserve
Bank, under rules and regulations prescribed by the Board, to purchase
and sell in
and bills
the open market, at home or abroad,
"bankers'
acceptances
of exchange of the kinds and maturities by this Act made
eligible for rediscount, with or without the indorsement of a member
bank."
(12 U.S.C.
353)
Putting aside for the moment the question
whether such purchases are subject to regulations of the Board (to be
discussed hereafter),
it
seems clear that under this provision a Reserve
Bank could use accounts with foreign banks only for investment in
acceptances and bills of exchange that would be eligible for rediscount
under sections 13 and 13a of the Federal Reserve Act.
In general,
this
would limit such investments to 90-day commercial paper, 9-months agricultural paper, and acceptances of the kinds and maturities described
in
section 13.
In addition, section 14(e) authorizes a Reserve Bank, with
the consent or upon the order and direction of the Board of Governors
and under regulations of the Board, to "buy and sell, with or without
its indorsement", through foreign correspondents or agencies, "bills of
exchange (or acceptances)
arising out of actual commercial transactions
which have not more than ninety days to run, exclusive of days of grace,
and which bear the signature of two or more responsible parties."
Unlike the authority conferred by the first
paragraph of section 14,
section 14(e) does not require that paper purchased through foreign
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Federal Open Market Committee
correspondents or agencies must comply with the eligibility
ments of the Federal Reserve Act; instead,
requireown
section 14(e) sets its
requirements as to such purchases through foreign correspondents or
agencies.
However,
like those of section 13, limit
these requirements,
purchases to paper arising out of "actual commercial transactions" with
maturities not exceeding 90 days.
- In
Foreign Treasury bills.
just discussed, it
view of the provisions of law
seems clear that Federal Reserve Banks would have
no authority to purchase through an account with a foreign central
bank paper that does not arise from actual commercial or agricultural
transactions.
Consequently, such accounts could not be utilized for
obligations of foreign Governments,
the purpose of investment in
as foreign Treasury bills.
such obligations is
If
such
the investment of foreign accounts in
considered desirable,
further legislation would be
necessary.
Time accounts. - Question has been raised as to whether any
part of an account with a foreign bank could be invested in
account with a foreign bank.
If,
as heretofore concluded,
a time
the opening
of accounts with foreign banks need not be conditioned upon investment
of such accounts in
bills of exchange,
there appears to be no reason
for which a Reserve Bank may not maintain a time deposit with such a
foreign bank.
The authority conferred by section 14(e) is
not limited
to the opening and maintenance of demand accounts with banks in
foreign countries.
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Federal Open Market Committee
IV.
A.
RESPECTIVE JURISDICTIONS OF BOARD OF GOVERNORS
AND FEDERAL OPEN MARKET COMMITTEE
General
So far in
this memorandum,
the powers of the Reserve Banks
with respect to the opening of foreign accounts,
such accounts may be opened and maintained,
the methods by which
and investments through
such accounts, have been discussed without reference to the extent to
which the exercise of those powers may be limited or regulated by the
Board of Governors or the Federal Open Market Committee or both.
cussion of this aspect of the matter has been deferred because,
Diswhile
it
directly affects the exercise of the powers of the Reserve Banks,
it
presents somewhat separate and distinct considerations.
In general,
it
is
clear that the Committee has regulatory
authority with respect to "open market" transactions of the Reserve
Banks and that the Board has supervisory and regulatory authority
with respect to other operations of the Reserve Banks.
However,
the
exact boundaries between the jurisdictions of the Board and the
Committee are difficult to determine when,
as in
the present matter,
certain of the operations of the Reserve Banks appear to fall
in both
areas of jurisdiction.
All of the Reserve Bank powers heretofore discussed are based
upon provisions of section 14
titled
of the Federal Reserve Act which is
"Open-Market Operations",
en-
and which was a part of the original
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Federal Reserve Act.
As described in
section 14, some of these powers,
such as the powers to purchase cable transfers and bills
and to open foreign accounts,
Board.
of exchange
are made subject to regulation by the
section 12A of the Act, as amended by the Banking
However,
Act of 1935, provides that
"No Federal Reserve bank shall engage or decline to
engage in open-market operations under section 14 of this
Act except in accordance with the direction of and
regulations adopted by the [Federal Open Market]
Committee. . . ."
(12 U.S.C. 263)
The jurisdictional question is
complicated by the fact that
the contemplated operations involve both open market transactions and
non-open market transactions which are nevertheless closely interrelated.
B.
Purchase of Cable Transfers, Bankers'
Exchange
The first
Accentances,
and Bills of
paragraph of section 14 provides that a Federal
Reserve Bank
". . . may, under rules and regulations prescribed
by the Board of Governors of the Federal Reserve System,
purchase and sell
in the open market, at home or
abroad . . . cable transfers and bankers' acceptances
and bills
of exchange of the kinds and maturities by
this Act made eligible for rediscount, with or without
the indorsement of a member bank."
(12 U.S.C. 353)
Although this provision, which was a part of the original
Federal Reserve Act, continues to refer to rules and regulations of
the Board, it
seems clear that, since the transactions described are
"open market" operations,
they are now subject to the direction and
regulation of the FOMC pursuant to section 12A of the Act.
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Cable transfers.
Banking Act of 1933, it
- When section 12A was first
vested the Board with regulatory authority
over open market operations of the Reserve Banks; and,
that authority,
things,
enacted by the
the Board issued its
pursuant to
Regulation M which,
among other
made purchases and sales of cable transfers subject to the
Board's approval.
However, when section 12A was amended in
vest regulation of open market operations in
1935 to
the FOMC, the Board
withdrew that regulation.
The current Regulation of the FOMC clearly assumes that
open market purchases and sales of cable transfers by the Reserve
Banks are within the Committee's jurisdiction.
Section 7 of that
Regulation provides:
"(4) No Federal Reserve Bank shall engage in the
purchase or sale of cable transfers for its
own account
except in accordance with the directions of the Committee."
Apparently pursuant to this provision of its
Regulation, the Committee
adopted on November 20, 1936 a resolution which is
still
in
effect
authorizing the Reserve Banks to purchase and sell
cable transfers
"to the extent that they may be deemed necessary or advisable in
connection with the establishment, maintenance,
operation, increase,
reduction, or discontinuance of accounts of Federal Reserve Banks in
foreign countries."
It
may be noted that this resolution assumes
that the FOMC has authority with respect to purchases and -sales of
cable transfers even though they relate to the opening and maintenance
of foreign accounts.
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Bills of exchange and acceptances. - It seems clear that
the Committee,
rather than the Board,
now has regulatory authority with
respect to the open market purchase and sale of bills of exchange
and bankers'
acceptances pursuant to the first
paragraph of section 14.
There is, however, a distinction to be noted between cable
transfers on the one hand and bills of exchange and acceptances on
the other.
The former are not eligible for discount under the
Federal Reserve Act, whereas acceptances and bills of exchange are
eligible for discount subject to certain requirements of the law and
regulations of the Board.
Consequently, even though the Committee has
regulatory authority with respect to the open market purchase of
acceptances and bills of exchange, they must still comply with statutory and regulatory requirements as to eligibility for discount.
Moreover, the Board still has outstanding a regulation (Regulation B)
regarding the eligibility of acceptances and bills of exchange for
purchase by the Reserve Banks, despite the authority of the Committee
to regulate such purchases in the open market.
jurisdiction, however,
is
Any conflict of
resolved by section 7(2)
of the Committee's
Regulation:
"(2) Only acceptances and bills of exchange which
are of the kinds made eligible for purchase under the
provisions of Regulation B of the Board of Governors
of the Federal Reserve System may be purchased:
Provided, That no obligations payable in foreign currency shall be purchased and sold for the account of
the Federal Reserve Bank except in accordance with
directions of the Committee."
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In addition to the authority contained in the first paragraph
of section 14 for the open market purchase of bills
of exchange and
acceptances,
authority for the purchase of such obligations is
contained in
subsection (e)
of that section.
Subsection (e)
also
of
section l4 provides that "with the consent or upon the order and
direction of the Board of Governors of the Federal Reserve System and
under regulations to be prescribed by said board," a Federal Reserve
Bank may buy and sell, through foreign correspondents or agencies,
"bills of exchange (or acceptances)
arising out of actual commercial
transactions which have not more than ninety days to run, exclusive of
days of grace.
. . ."
Even though here again the law continues to
refer to regulations of the Board, it
is
my opinion that purchases of
bills of exchange and acceptances through foreign correspondents and
agencies under this provision are subject to regulation by the Committee
rather than the Board, despite the failure of Congress to repeal the
Board's regulatory authority in
this respect when in
1935 it
transferred
to the FOMC authority over open market operations.
That such purchases through foreign correspondents and
agencies,
like other open market operations,
are subject to the
jurisdiction of the Committee, was indicated by the Board in
a letter
to the Federal Reserve Bank of Boston dated May 15, 1936 (F.R.L.S.
wherein the Board stated:
". . . no Federal Reserve bank can open and maintain
accounts in foreign countries, appoint correspondents or
establish agencies in such countries except with the consent
of the Board, nor can it engage in the purchase or sale
of bills through such accounts, correspondents or agencies
without the consent also of the Federal Open Market Committee. . . ."
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Dealings in Gold
To the extent that the proposed plan may involve acquisitions
of foreign exchange through sales of gold by a Reserve Bank it seems
clear that such transactions would not constitute open market transactions subject to regulatory authority of the Committee.
Section 14(a)
of the Federal Reserve Act authorizes the Reserve Banks to "deal in
gold coin and bullion at home or abroad."
(12 U.S.C.
354)
Any such
transactions would seem to be subject to supervision by the Board of
Governors, under both its general power of supervision conferred by
section ll(j)
of the Federal Reserve Act (12 U.S.C. 248(j))
and its
special supervisory powers over relationships with foreign banks
conferred by section 14(g) of the Act (12 U.S.C.
348a),
to be discussed
later in this memorandum.
D.
Opening of Foreign Accounts
Section 14(e) authorizes a Federal Reserve Bank
". . . with the consent or upon the order and direction
of the Board of Governors of the Federal Reserve System and
under regulations to be prescribed by said board, to open
and maintain accounts in foreign countries . .
."
(12 U.S.C. 358)
The question whether such foreign accounts may be opened
and maintained only for the purpose of buying and selling bills of
exchange has heretofore been discussed.
At this point, we are concerned
only with the question whether regulatory authority as to the opening of
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such accounts is vested in the Board or in the FOMC.
Clearly, the
language of the statute seens to vest such authority in the Board.
However,
such accounts are established
it may be argued that, if
through the open market purchase of cable transfers, the opening and
maintenance of such foreign accounts is merely an incident to open
market operations and therefore subject to regulation by the Committee.
(This argument might be considered implicit in the Committee's 1936
resolution previously mentioned.)
Conversely, however, it
might be
argued that the purchase of cable transfers is merely a mechanical
incident to the opening of foreign accounts and that, therefore, the
authority of the Board is paramount.
It would not seem necessary, however, to determine whether
the Board or the FOMC has paramount authority.
The question seems to
be resolved by the over-all intent of Congress that the Board and the
Committee shall have separate but coordinate jurisdictions.
This
intent, I believe, is clearly reflected in the legislative history
of the Banking Act of 1935 as hereafter discussed.
E.
Authority with Respect to Foreign Relationships
Section 14(g) of the Federal Reserve Act (12 U.S.C. 348a)
provides in effect that -
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(1) the Board of Governors shall exercise "special
supervision" over all relationships and transactions
of any kind between any Federal Reserve Bank and any
foreign banks;
(2) all such relationships and transactions shall
be subject to "such regulations, conditions, and
limitations as the Board may prescribe";
(3) no representative of a Reserve Bank shall
conduct negotiations with representatives of a foreign
bank without the Board's permission;
(4) the Board shall have the right to be represented
in any such negotiations; and
(5) a full report of any such negotiations shall be
filed with the Board.
When section 14(g) was added by the Banking Act of 1933,
the same Act authorized the Board of Governors (in section 12A of the
Federal Reserve Act) to regulate not only the open market operations
of the Federal Reserve Banks but also "the relations of the Federal
Reserve System with foreign central or other foreign banks."
Subsequently, the Bankin
Act of 1935 amended section 12A
to vest authority over open market operations in the FOMC instead of
the Board.
Significantly, however,
the 1935 amendment to section 12A
eliminated the reference to relationships with foreign banks, thus
indicating the intent of Congress that the Board should retain its
authority with respect to this matter, despite the Open Market
Committee's authority over open market transactions.
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is my conclusion, therefore, that, whether or not the
opening of foreign accounts as the result of open market purchases
of cable transfers would be subject to the "consent" and regulations
of the Board under section 14(e) of the Federal Reserve Act, any such
foreign accounts would be subject to supervision and regulation by
the Board under section 14(g) of the Act, even though they may also
be subject to regulation by the FOMC to the extent that they involve
open market transactions.
F.
Possible Actions by Board and Committee
On the basis of the foregoing discussion, it
is my opinion
that effectuation of the plan here proposed would require actions by
both the Board and the Committee but that such actions may be coordinated
without conflict.
1.
Such actions might be taken along the following lines:
The Board could authorize the New York Reserve Bank
(a) to open accounts with foreign banks in such foreign currencies,
through such methods, and in such amounts as may be determined by the
FOMC to be necessary for effectuation of the proposed plan; and (b) to
conduct such negotiations and enter into such arrangements with foreign
central banks as, in the judgment of the FOMC may be necessary to
effectuate or implement open market transactions under the plan.
Logically, any such action by the Board should be taken in
the form of an appropriate amendment to the Board's Regulation N,
"Relations with Foreign Banks and Bankers."
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Federal Open Market Committee
Such action would be based upon the Board's authority under
both sections l4(e) and 14(g)
exercise,
and it
should be in
the form of an
rather than a delegation to the Committee,
of the Board's
statutory responsibilities with respect to foreign transactions of the
Reserve Banks.
For this reason,
to include a requirement,
it
would be desirable for the action
conformity with section 14(g),
in
of agreements with foreign banks and operations in
that reports
such foreign accounts
be made to the Board at periodic intervals.
The Board's action might also include consent to participation by other Reserve Banks in
accounts opened by the New York Reserve
Bank.
2.
directives,
The Committee could issue appropriate regulations or
or both, regarding (a)
the purchase and sale by the New
York Reserve Bank of cable transfers in
connection with the opening
and maintenance of accounts with foreign banks and (b)
and sale of bills
accounts.
the purchase
of exchange and acceptances through such foreign
Action as to these matters would be within the Committee's
own authority over open market transactions; and logically such action
might be taken through appropriate amendments to provisions relating
to cable transfers and bills
and acceptances now contained in
section 7
of the Committee's Regulation.
3.
The Committee could take action,
action of the Board described in
in
paragraph 1 above,
accordance with the
regarding the
foreign currencies to be acquired, limitations on aggregate amount
and on the amounts of particular currencies,
the foreign banks with
which accounts could be opened, minimum balances in
such accounts,
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Federal Open Market Committee
4.
To the extent that the operations of the plan might
involve purchases and sales of gold or borrowings or loans on gold by
the New York Reserve Bank,
such transactions should have the approval
of the Board.
The above or similar actions would,
in my opinion, be con-
sistent with the law and would properly preserve the respective authorities
of the Board and the Committee.
It
is
necessary,
however,
whether the authority to take such actions would in
to consider
any way be affected
by other statutes that may appear to give other Government agencies
certain responsibilities in this field.
V.
A.
EFFECT OF OTHER LAWS
Gold Reserve Act of 1934
Section 10 of the Gold Reserve Act of 1934, as originally
enacted (31 U.S.C. 822a) established a "Stabilization Fund" of
$2 billion under the Secretary of the Treasury,
"stabilizing the exchange value of the dollar."
for the purpose of
Since the purposes of
this provision were so obviously similar to the purposes of the plan
now proposed, question arises whether Congress by the Gold Reserve Act
meant in
any way to modify or supersede whatever powers the Federal
Reserve System might have had in this field.
In my opinion,
there is
no evidence that Congress had any
such intent.
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Federal Open Market Committee
In the first
place, the Stabilization Fund was originally
designed as a temporary measure to expire two years after the date of
enactment.
It
is
not reasonable to suppose,
therefore,
that it
was
intended as a substitute for whatever powers the Federal Reserve System
might have in
this respect.
Secondly, when
the Fund was made permanent by the Bretton
Woods Agreements Act of 1945,
it
was reduced to $200 million, since the
rest of the Fund was allocated for investment in the International
Monetary Fund.
This action was hardly consistent with the exclusive
use of the Fund as a means for stabilizing the exchange value of the
dollar.
Finally, section 3 of the Gold Reserve Act of 1934 itself
authorized the Federal Reserve Banks to hold gold for the purpose of
settling international balances or of maintaining the equal purchasing
power of United States currency.
Such action, again, would be incon-
sistent with any intent by Congress to repeal any authority possessed
by the Federal Reserve System to maintain the integrity of the dollar.
Even though the provisions of section 10 of the Gold Reserve
Act do not affect Federal Reserve authority in this field, it
would,
of course, be desirable as a matter of policy for Federal Reserve
activities under the proposed plan to be coordinated with the utilization of the Stabilization Fund for related purposes.
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B.
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Bretton Woods Agreements Act of 1945
Section 4 of the Bretton Woods Agreements Act of 1945,
relating to the National Advisory Council on International Monetary
and Financial Problems (of which the Chairman of the Board of
Governors is a member) provides in part as follows:
"SEC. 4.
"
(a) . . .
* * *
"(3) The Council shall coordinate, by consultation
or otherwise, so far as is practicable, the policies and
operations of the representatives of the United States
on the Fund and the Bank, the Export-Import Bank of
Washington and all other agencies of the Government to
the extent that they make or participate in the making
of foreign loans or engage in foreign financial,
exchange or monetary transactions.
"(c) The representatives of the United States on
the Fund and the Bank, and the Export-Import Bank of
Washington (and all other agencies of the Government
to the extent that they make or participate in the
making of foreign loans or engage in foreign financial,
exchange or monetary transactions) shall keep the
Council fully informed of their activities and shall
provide the Council with such further information
or data in their possession as the Council may deem
necessary to the appropriate discharge of its responsibilities
under this Act."
While the Federal Reserve Banks are quasi-governmental
agencies exercising public functions,
they are not "agencies of the
Government" within the meaning of these provisions.
However,
extent that the Board and the FOMC would participate in
to the
the plan here
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Federal Open Market Committee
proposed, it
seems clear that they would be "agencies of the Government"
participating in "foreign financial, exchange or monetary transactions".
Nevertheless,
to coordination,
cable."
It
the Bretton Woods Agreements Act refers only
"by consultation or otherwise,
so far as is practi-
does not endow the National Advisory Council with any
enforceable authority.
Consequently, there would appear to be no legal
respect in which activities by the Board and the Committee would be
subject to control by the Council.
At the same time,
it
would seem
desirable as a matter of policy for any Federal Reserve operations of
the kind contemplated to be brought to the attention of the Council in
advance, particularly in view of the related operations of the
Stabilization Fund of the Treasury and of the International Monetary
Fund.
VI.
ADMINISTRATION
As the proposed plan has been described, it
would contemplate
that the Committee would designate the Federal Reserve Bank of New York
to execute the transactions (opening of accounts with foreign banks,
purchase of cable transfers, etc.) necessary to accomplish the purposes
of the plan on behalf of the System Open Market Account, pursuant to
directions of the Committee.
The plan further contemplates that
immediate direction and supervision of operations in foreign exchange
would be vested by the Committee in a Subcommittee consisting of the
Chairman and Vice Chairman of the Committee and the Vice Chairman of
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the Board of Governors in his capacity as a member of the Committee;
that the New York Reserve Bank would select an officer of that Bank
satisfactory to the Committee who would act as "Special Manager of the
System Open Market Account for Foreign Currency Operations" and would
conduct day-to-day operations in
this field; and that the Subcommittee
would establish maximum amounts of currencies to be purchases, rates of
exchange,
and other guidelines for such day-to-day operations.
The proposed designation of the New York Reserve Bank and
selection of the Special Manager would be consistent with section 5 of
the present Regulations of the Committee and with section 3(b) of the
Committee's Rules on Organization and Information.
There would appear to be no legal objection to the proposed
delegation to a Subcommittee of authority to supervise and direct
day-to-day operations in
foreign currencies, provided,
of course,
that general policies are established by the full Committee.
Market Committee,
unlike the Board of Governors,
Government agency; and it
is
is
clear that Congress in
The Open
not a "full-tie"
section 12A did not
expect that the Committee would meet daily or exercise day-to-day
supervision over the implementation of policies formulated by the
Committee.
This is
evidenced by the fact that the Committee was
required to consist of the 7 members of the Board of Governors and
5 of the Federal Reserve Bank Presidents - individuals who are obviously
already fully occupied as a daily matter.
It
is
also significant that
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required to meet only at least four times each
year, a requirement scarcely consistent with any intent that the
Committee should directly supervise day-to-day implementation of its
policies.
In addition, the presently proposed delegation of authority
to a Subcommittee is similar (and perhaps not even as extensive) to
the delegation of authority to an "Executive Committee" that existed
with the knowledge of Congress for many years prior to 1955.
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STRICTLY CONFIDENTIAL
CLASS I - FOMC
(FR)
EVOLUTION OF FORMAL PROCEDURES
FOR FOMC OVERSIGHT OF SYSTEM FOREIGN CURRENCY OPERATIONS*
I. Background ...................................................
II. Resumption of System Foreign Currency Operations in 1962 .....
2
4
Revision of Authorization and Directive, June 1966 ...........
11
IV.
Revision of Foreign Currency Instruments, December 1976 ......
15
V.
Procedural Instructions ......................................
17
VI.
Warehousing ..................................................
19
III.
VII.
Appendix
A. Letter from Treasury Secretary Dillon to Chairman
Martin, December 18, 1961 .............................
Initial Foreign Currency Instruments, As Approved
February 13, 1962 .....................................
B. Authorization for Foreign Currency Operations,
.
1966 to Date ...........................................
Current Authorization .................................
C. Foreign Currency Directive, 1966 to Date .................
Current Directive .....................................
D. Procedural Instructions, December 1976 to Date ...........
Current Instructions ................................ .
E. Informal Limits on Holdings of Foreign Currencies,
September 1975 to March 1989 .............................
F. Memoranda Related to System Foreign Exchange Operations
Circulated to FOMC, 1961-1989 ............................
Table--Informal Limits on Holdings of Foreign Currency Balances ....
* Prepared by Gary Gillum, FOMC Secretariat, Division of Monetary
Affairs, Board of Governors with the invaluable help of Normand
Bernard. Helpful comments were received from many members of the
task force.
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24
27
37
67
71
76
77
82
84
86
85
-2-
This paper begins with a brief review of the Federal Reserve
System's early experience with foreign currency operations and with
subsequent Congressional actions in the 1930s to transfer the principal
responsibility for such operations from the Federal Reserve to the
Treasury.
Next there is a recounting of the System's decision in early
1962 to resume foreign currency operations for System Account, in
coordination with the Treasury, and the authorization, directive, and
other instructions that were developed for oversight by the Federal Open
Market Committee (FOMC) of System operations in foreign currencies.
The
rest of the paper examines the evolution of these instruments over time.
Background.¹
The Federal Reserve Act, as enacted, authorized any Federal
Reserve Bank, under rules and regulations prescribed by the Board of
Governors, to conduct transactions in the foreign exchange markets.²
The Federal Reserve Banks initiated their first, shortlived series of
foreign currency operations in 1918 for the purposes of administering
exchange controls established under the Trading with the Enemy Act of
1917 and the Executive Order of January 1918; dealing with sizable and
apparently speculative movements of gold; and stabilizing the foreign
exchange value of the dollar.
No further operations were undertaken
until the mid-1920s, and then primarily for the purpose of providing
stabilization credits to a number of European central banks for the
defense of their currencies.
These operations were conducted largely by
¹ A more detailed history of System operations in the foreign exchange
markets from 1918 to the early 1930s is contained in Appendix A of a
Board staff memorandum entitled "Federal Reserve Operations in Foreign
Exchange, 1962-1965," prepared by Charles C. Baker. This memorandum was
distributed to the FOMC on March 21, 1966.
² The governing Board regulation is Regulation N.
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the Federal Reserve Bank of New York, apparently with only cursory
supervision by the Board of Governors.
As a result of Congressional concerns regarding these Reserve
Bank activities (notably, strong criticism voiced by Senator Carter
Glass regarding credits extended by the New York Reserve Bank in support
of certain foreign currencies), the Federal Reserve Act was amended in
1933 to remove from the Banks the authority to conduct foreign currency
operations without the special supervision and advance approval of the
Board of Governors.
The Gold Reserve Act was enacted the following
year, and its Section 10 vested in the Treasury the responsibility for
stabilizing the value of the dollar through dealings in gold and foreign
exchange and established the Exchange Stabilization Fund (ESF) for the
purpose of carrying out these responsibilities.
For many years, the Treasury made little use of the broad
authority it had been granted.
By 1961, however, the post-WWII recovery
of the European industrial economies and the formation of the European
Common Market had altered the balance of the world economy and the
international position of the dollar.
In March of that year, against a
backdrop of persisting official settlements deficits in the U. S.
balance of payments, drains on the U.S. gold stock, and concerns
regarding the exchange value of the dollar in world markets, the
Treasury--through its ESF and with the Federal Reserve Bank of New York
acting as its fiscal agent--began conducting foreign currency
operations.
These operations were undertaken within a framework of
3. In addition, the Federal Reserve's authority to control gold
movements to and from the United States, as well as title to the gold
held by the System, was transferred to the Treasury.
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reciprocal credit ("swap") arrangements with foreign central banks in
countries on both sides of the Atlantic and were seen as a "first line
of defense" in countering short-term speculative capital flows in
foreign exchange markets.
Because most of the ESF's resources were tied
up in currency stabilization agreements with Latin American governments,
foreign currency holdings of the ESF in 1961 were relatively small in
size, at no point exceeding $125 million.4
Resumption of System Foreign Currency Operations.
The Federal Reserve began to contemplate a resumption of
foreign currency operations around the time that the Treasury reentered
the foreign exchange markets.
After nearly a year of study and
discussion, the FOMC acted at its meeting on January 23, 1962, to
approve in principle the initiation on an experimental basis of a
program of System foreign currency operations.
In addition,
representatives of the Committee were authorized to explore with the
Treasury, on the Committee's behalf, the development of guidelines for
such operations along with plans for effective working relationships
4. A more detailed history of Treasury activities in the foreign
exchange market during 1961 is contained in a Treasury staff memorandum
entitled "Treasury Experience in the Foreign Exchange Market" that was
circulated to the FOMC on February 9, 1962.
5. Messrs. Mitchell and Robertson dissented from this action. Mr.
Mitchell dissented on the grounds that the institution of such a program
should be preceded by analysis by outside experts, public discussion,
and legislative clarification of the System's statutory authority to
acquire, hold, and sell foreign currency assets. Mr. Robertson
dissented on both legal and economic grounds. In his view, the Federal
Reserve Act provided no general and positive authorizations for such
operations, and an incidental power like the power to maintain foreign
accounts should not be relied upon as an authorization to exercise the
broad policy functions involved in the proposed operations. Moreover,
the operations would be inconsistent with the express intent of Congress
to confer upon the Treasury's Exchange Stabilization Fund a limited
authority for operations to stabilize the exchange value of the dollar.
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between the Federal Reserve and the Treasury in foreign exchange
matters.
Consultations with key members of Congress also were quietly
undertaken to review the purposes and authorities under which such
operations would be carried out.
Upon the successful completion of
discussions with the Treasury, the FOMC acted at its meeting on February
13, 1962, to approve, effective immediately, an Authorization Regarding
Open Market Transactions in Foreign Currencies, a statement of
Guidelines for System Foreign Currency Operations, and a Continuing
Authority Directive on System Foreign Currency Operations.6,7
documents are included in Appendix A, beginning on page 27.)
(These
The
approved instruments were more elaborate than those governing domestic
operations, reflecting the experimental nature of this activity and the
Committee's desire to move with caution.
In deciding to move forward with a program of foreign currency
operations, FOMC members generally felt that the importance to the
United States and the rest of the world of an efficient and orderly
world payments system made it imperative that the Federal Reserve take
an active part along with other central banks in fostering relative
6. This action was approved by all members, including Messrs. Mitchell
and Robertson who had dissented from the motion to approve in principle
the initiation of a program of System foreign currency operations at the
meeting on January 23. Their affirmative votes on this action reflected
their view that the actions being taken involved the implementation of a
basic decision that already had been made.
7. On February 28, the National Advisory Council on International
Monetary and Financial Problems approved the System's decision to enter
the foreign currency field.
8. At its meeting on December 19, 1961, the Committee had chosen to
replace the single directive of the type it had previously issued to the
Federal Reserve Bank of New York with a "current economic policy
directive" and a "continuing authority directive." The current policy
directive was a brief two paragraphs long and the continuing policy
directive contained just five paragraphs.
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stability in currency values.
Members also saw a need to supplement the
relatively small resources of the ESF so that the dollar might be
adequately defended, in cooperation with the monetary authorities of
other leading trading nations, from speculative attacks in foreign
exchange markets.
It was understood that official intervention could
not substitute for fundamental policy measures in eliminating the
persisting deficits in the U.S. balance of payments and maintaining the
value of the dollar.
However, it was thought that these ends could be
achieved more readily in the absence of unsettled foreign exchange
market conditions resulting from speculative pressures, and that timely
foreign currency operations could serve to help moderate such pressures.
These basic purposes along with specific aims for intervention
operations were set forth in the approved Authorization Regarding Open
Market Transactions in Foreign Currencies.
The action of Congress in 1934 to vest in the Treasury the
responsibility for stabilizing the value of the dollar was a source of
considerable concern to FOMC members regarding the legality of foreign
exchange operations by the System and, even if not expressly prohibited
by law, the advisability of resuming such operations.
Members' concerns
were largely resolved through an opinion of Committee counsel (with the
concurrence of counsel from the Treasury and the Attorney General of the
United States) and a strong expression of interest by then-Secretary of
the Treasury Douglas Dillon in having the Federal Reserve join with the
Treasury in its stabilization efforts (letter to Chairman William
McChesney Martin, dated December 18, 1961, reproduced on page 24,
Appendix A).
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It was agreed by the Treasury and the Federal Reserve that
their sharing of foreign currency operations called for close
consultation and coordination between the two agencies.
The Treasury,
having primary responsibility for foreign currency operations under the
law, would take the lead in such efforts but "the Treasury would . . .
avoid impinging on the independence of the Federal Reserve System within
the Government." 9
All intervention activities for both agencies would
continue to be conducted at the Federal Reserve Bank of New York under
the supervision of a senior officer of the Bank.
The Authorization approved by the FOMC on February 13, 1962,
provided that Federal Reserve intervention operations would be under the
continuing supervision of the FOMC. 10
Operations in foreign currencies
would be conducted at the Federal Reserve Bank of New York, on behalf of
all of the Reserve Banks, under a Special Manager of the System Open
Market Account selected in accordance with the procedures already
established for the selection of the Manager of the System Open Market
Account.
For those cases where a decision was needed on operations
9. Letter to Chairman William McChesney Martin, dated December 18,
1961.
10. To enable the FOMC to carry out its supervision of foreign exchange
operations, the Committee began, at the following meeting of the
Committee on March 6, to receive written and oral reports of the same
type as those given on open market operations in domestic markets.
11. To enable the Reserve Banks to undertake foreign exchange
operations, the Board of Governors had acted on February 13, during a
recess of the FOMC meeting on that date, to amend Regulation N to
regulate the opening and maintenance by Federal Reserve Banks of
accounts with foreign banks, and to provide that negotiations and
agreements, contracts, or understandings entered into by a Federal
Reserve Bank with foreign banks were to be subject to such
authorizations, directions, regulations, and limitations as might be
prescribed by the FOMC to the extent necessary to effectuate the conduct
of open market transactions by the Federal Reserve Banks through such
foreign accounts.
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before the Committee could be consulted, the Authorization provided for
a Subcommittee consisting of the Chairman and Vice Chairman of the
Committee and the Vice Chairman of the Board of Governors to give
instructions to the Special Manager, within the guidelines issued by the
Committee.
The Authorization also provided for alternate members in the
absence of Subcommittee members.
The New York Bank was authorized to purchase and sell foreign
currencies through spot and forward transactions on the open market at
home and abroad in such currencies and within such limits as the FOMC
might from time to time specify.
The Continuing Authority Directive
provided that such transactions could be carried out in British pounds,
French francs, German marks, Italian lira, Netherlands guilders, and
Swiss francs, but limited the total of foreign currencies held at any
one time to no more than $500 million.
The manner in which operations
might be conducted in permitted currencies was spelled out in some
detail in the Guidelines.
Additional guidance as to the scope and
character of initial System foreign currency operations was provided to
the Special Manager in a document agreed upon by Treasury and FOMC
representatives as a basis for coordinated Treasury and System
operations and reviewed by the full Committee at its meeting on February
13.
Following the decision to undertake foreign currency
operations, System officials began to attend monthly meetings of the
Bank for International Settlements and to participate in U.S.
delegations to meetings of committees and working parties of the OECD in
Paris.
The System also began to purchase modest amounts of German
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marks, Swiss francs, Dutch guilders, and Italian lira from the
ESF; in all, foreign currencies acquired in this manner amounted to the
equivalent of $33.5 million.
Most of the foreign currencies acquired in
1962 were obtained through drawings under swap arrangements negotiated
by the Special Manager with central banks in those countries whose
currencies were listed in the Continuing Authority Directive.
Initially, six currencies were included in the Continuing Authority, but
at subsequent meetings the FOMC added Belgian francs, Canadian dollars,
and Austrian schillings, and raised the maximum amount of foreign
currencies permitted to be held at one time to $1 billion.
In addition,
a swap agreement was negotiated with the Bank of International
Settlements. 12
At its meeting on November 13, 1962, the FOMC amended both the
Authorization and the Guidelines to provide expressly for swap
arrangements on a standby basis and for somewhat greater flexibility for
operations in circumstances where disequilibrating movements of funds
might not be reversed over the foreseeable future.
Swap agreements were seen as a convenient mechanism for gaining
access on call to needed amounts of foreign currencies without having to
build up holdings over a period of time through purchases in the
exchange markets and also for expanding the total amount of
12. For further information on the foreign exchange activities of the
Treasury and the Federal Reserve from March 1961 to August 1962, see
Charles A. Coombs, "Treasury and Federal Reserve Foreign Exchange
Operations," Federal Reserve Bulletin, September 1962, pp. 1138-1153.
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international reserves available to the signatories.
There remained,
however, an important question as to how and when debt incurred under
these arrangements should be paid off.
At its meeting of May 28, 1963,
the FOMC adopted the recommendation of the Special Manager that swap
debt should not be outstanding for more than a full year.
Following
this action, there developed an understanding with foreign central banks
that a debtor central bank should begin exploring how its swap debt
would be liquidated well before the one-year limit was reached.
This
one-year limit occasionally caused some problems for the Federal Reserve
when its debts to foreign central banks proved difficult to reverse
within a year without undertaking undesirable spot purchases of the
needed currency.
In such instances, the Treasury stepped into the
breach and issued "Roosa" bonds in effect to provide repayment to the
foreign central bank.14
In November 1963, the FOMC amended the Foreign Currency
Directive to add a paragraph authorizing purchases from the ESF and
concurrent forward sales to the Fund of any foreign currencies in which
the Treasury had outstanding indebtedness.
Purchases and sales were
13. Under a swap arrangement, the Federal Reserve could acquire a
specified amount of a foreign currency in exchange for a corresponding
dollar credit in favor of the other party. Each party was protected
against loss if a revaluation of the other's currency were to occur
while a drawing was outstanding. Both parties received the same rate of
interest on invested balances; foreign-owned balances generally were
invested in special U.S. Treasury certificates while Federal Reserve
balances were placed in interest-earning deposits abroad. Swap
drawings generally carried 3- or 6-month maturities but were renewable
by consent of both parties.
14. Roosa bonds were special nonmarketable Treasury debt that were
denominated in foreign currencies and issued to foreign treasuries or
central banks as a means of sopping up excess dollar reserve balances
that might otherwise have been used to purchase U.S. gold. In the
latter part of the 1970s, obligations denominated in foreign currencies
but issued in foreign private markets were called "Carter" bonds.
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required to be at the same exchange rates, and the total amount of such
transactions outstanding was limited to $100 million.
This initial
authority to "warehouse" foreign currency holdings for the Treasury was
undertaken-on an experimental basis to assist the Treasury in
accumulating Italian lira, partly for the purpose of repaying Treasury
debt denominated in lira.
At the time, the Committee contemplated that
similar warehousing operations might prove useful in other instances
where the Treasury would need to accumulate currencies to repay
outstanding debt.
(Warehousing arrangments are discussed more fully in
the section on warehousing that begins on page 19.)
Authorization and Directive, Revised June 7, 1966.
At its meeting on June 7, 1966, the FOMC consolidated the
three instruments governing foreign currency operations into two: an
Authorization for System Foreign Currency Operations and a Foreign
Currency Directive.
(These instruments as revised in 1966 may be found
on pages 37 and 71 of Appendixes B and C, respectively, along with a
chronology of subsequent amendments.)
The Committee's purpose was to
streamline and clarify its instructions by removing duplication of
content, drawing together related instructions previously occurring at
separate points, deleting language considered superfluous, and otherwise
clarifying and simplifying the wording.
In addition, the Authorization
was expanded to include a listing of all of the reciprocal currency
arrangements authorized by the Committee.
The one substantive change made in the new instruments related
to the authority of the Special Manager for foreign currency operations
to engage in market transactions when exchange market instability
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threatened to produce disorderly conditions.
At such times, under the
terms of the original Guidelines for System Foreign Currency Operations
(fourth paragraph of Section 3),
the Special Manager was required to
consult with the FOMC--or in an emergency with the members of the
Subcommittee designated for that purpose--prior to engaging in
However, experience at the time of the assassination of
transactions.
President Kennedy had demonstrated that in a sudden major crisis it
might not be possible for the Special Manager to reach all of the
designated members in time to obtain authorization for necessary
operations.
Accordingly, paragraph 2.C of the new Foreign Currency
Directive provided leeway for the Special Manager to engage in
operations on his own initiative to meet a threat of disorderly
conditions, with the requirement that he consult as soon as practicable
with the Committee or, in an emergency, with the members of a
Subcommittee designated (in paragraph 6 of the new Authorization) for
that purpose.
The new instruction was intended to require advance
consultation if practicable, but to permit operations if it were not.
Following this action to consolidate the foreign currency
instruments, the Foreign Currency Directive remained essentially
unchanged over the next ten years; by contrast, the Authorization for
System Foreign Currency Operations was subject to frequent minor
amendments.
Most of the amendments to the Authorization took the form
of increases or decreases in the authorized amount of individual swap
agreements, but some were more substantive in nature.
Initially,
changes to the maximum maturity of individual swap agreements required
amendments to the Authorization, but the FOMC remedied this at its
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meeting on July 18, 1967, by amending the text of paragraph 2 to provide
that the maximum period for all swap arrangements would be no more than
twelve months.
At its meeting on March 5, 1968, the FOMC deleted the second
sentence of paragraph 3, which had placed restrictions on spot sales of
foreign currencies at prices below par and on spot purchases at prices
above par.
These restrictions were viewed as undesirable in
circumstances where such sales might be useful in furthering the
purposes specified in paragraph 2 of the Foreign Currency Directive and
unncessary in light of limitations set out in that same paragraph on the
purposes for which foreign currency operations could be undertaken.
At the FOMC meeting on March 9, 1971, paragraph 3 of the
Authorization was amended to authorize the purchase of currencies needed
for the liquidation of System commitments from the foreign central bank
on which the swap was drawn at the same exchange rate at which the
drawing took place.
The previous wording, which had specified that
unless otherwise expressly authorized by the Committee all transactions
of this nature should be undertaken at prevailing market rates, exposed
the two parties to a swap drawing to the risk of financial loss if the
exchange rate at the time of repayment differed from the rate at the
time of the drawing.
To remove this risk, some European central banks
had urged since the fall of 1970 that swap drawings be liquidated at the
same rate as that at which the drawing had been made.
As a partial
accommodation to these central banks, the new wording gave the Special
Manager leeway to enter into an understanding on terms of repayment at
the time of a drawing, if the foreign bank were agreeable, but did not
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preclude repayment of swap drawings by the Federal Reserve on or before
maturity through purchase of the needed foreign currency at market rates
in the exchange market or elsewhere (e.g., from the Bank for
International Settlements).
At its meeting on February 19, 1975, the FOMC amended the
Foreign Currency Directive to delete the word "Special" from the phrase
Special Manager wherever the phrase appeared.
This action was taken in
light of the announced retirement of the incumbent Special Manager,
Charles A. Coombs.
In other action, the Committee approved the
assignment of responsibility for the conduct of open market operations
in foreign currencies, as well as in domestic securities, to the Manager
of the System Open Market Account.
At its meeting on September 16, 1975, the FOMC began to set
informal limits on the System's uncovered holdings of foreign currency
balances within the broader limit authorized under the Committee's
Authorization for Foreign Currency Operations.
Thereafter, the Account
Management consulted with the Committee from time to time as to whether
a change in the informal limit would be appropriate.l5
(A chronology of
these informal limits can be found on page 85, Appendix E.)
At its meeting on February 18, 1976, the FOMC amended paragraph
6 of the Authorization in order to create a new Foreign Currency
Subcommittee.
The new Subcommittee would have the same special duties
in the foreign currency area as had been delegated to the previous
Subcommittee, but its membership would be augmented by such other member
15. Beginning in May 1979, the Committee established limits on holdings
of individual currencies, initially for Japanese yen and later for
German marks. These limits were removed in March 1989.
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It was contemplated that
of the Board as the Chairman might designate.
the Chairman would select for this purpose the member of the Board
having particular responsibilities for international matters.
Foreign Currency Instruments, Revised December 20, 1976.
At its meeting on December 20, 1976, the Committee agreed on
broad revisions of both the Authorization for Foreign Currency
The main purpose of the
Operations and the Foreign Currency Directive.
revisions was to bring the documents up to date in light of changes
under way in the international monetary system and its functioning,
especially the evolving regime of floating exchange rates.
Another
purpose was to simplify and clarify the Committee's instructions to the
Federal Reserve Bank of New York.
The Committee also established a set
of procedural instructions, which are discussed in the section that
begins on page 17.
The main wording change to the Directive was to omit the
detailed listing of basic purposes and specific objectives of System
foreign currency operations, many of which no longer applied, and to
indicate instead that System operations were generally to be directed at
countering disorderly conditions in the exchange markets.
In the Authorization, the several separate limits in paragraphs
1.B and 1.C on various types of spot and forward transactions were
replaced with a single limit of $1 billion on the System's "overall open
position" as defined in a new paragraph 1.D.
The previous separate
limits, which had been developed under the Bretton Woods system, were
judged to have lost relevance in a floating-rate environment.
In
paragraph 2, a sentence was added to reflect the prevailing practice
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that changes in terms of existing swap arrangements and proposed terms
of new swap arrangements must be referred for review and approval to the
FOMC.
Paragraph 6 was amended to require that all foreign exchange
operations-be reported daily to the Foreign Currency Subcommittee and to
delete the requirement that all actions of the Subcommittee under the
paragraph be reported promptly to the FOMC.
This paragraph was
further amended to provide that meetings of the Subcommittee could be
called by any member of the Subcommittee or by the Manager and to
provide that any member of the Subcommittee could request referral of
any questions arising from reviews and consultations to the FOMC for
determination.
Since December 1976, the Foreign Currency Directive has
remained essentially unchanged.
The Authorization, on the other hand,
has been amended numerous times, mostly to reflect changes in the
permitted size of swap arrangements with foreign central banks and
changes in the authorized overall open position in all foreign
currencies (these changes are included in Appendix B.)
In addition, the
Authorization was amended in June 1978 to place in paragraph 1.D a new
definition of the overall open position in all foreign currencies as the
sum, disregarding signs, of net positions in individual currencies.17
In December of that year, paragraph 1.A was amended to provide that
16. At its meeting on March 31, 1981, the Committee amended this
paragraph further to provide that operations be reported promptly rather
than daily to the Foreign Currency Subcommittee and to the Committee.
This requirement is met by means of the "2:30 call" sent out by Board
staff.
17. However, the net position in a single foreign currency was defined
with due regard for sign as holdings of balances in that currency plus
outstanding contracts for future receipt minus outstanding contracts for
future delivery of that currency.
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foreign exchange operations could be conducted directly with the
Treasury as well as with its ESF.
The purpose of the amendment was to
provide for contemplated System purchases of proceeds from the sale in
foreign private markets of U.S. Treasury securities denominated in
foreign currencies (so-called "Carter" bonds).
Finally, in May 1979 and
then again in March 1981, the Authorization was amended to provide more
flexibility in arranging investment facilities for System holdings of
foreign currencies.
The 1981 amendment incorporated new authority
granted in the Monetary Control Act of 1980 to permit the System to
invest in securities issued or fully guaranteed by foreign governments.
The Authorization and the Foreign Currency Directive, as
reaffirmed on February 6, 1990, are included at the end of Appendixes B
and C at pages 67 and 76, respectively.
Procedural Instructions.
At the same meeting (December 28, 1976) at which the FOMC
extensively revised its Authorization for Foreign Currency Operations
and its Foreign Currency Directive, it agreed upon certain procedural
instructions with respect to consultations and clearance by the Manager
with the Committee, the Foreign Currency Subcommittee, and the Chairman
of the Committee.
(These instructions are included in Appendix D, which
begins on page 77, along with a chronology of amendments to the
instructions.)
These instructions were intended to clarify the
respective roles of the Committee, the Foreign Currency Subcommittee,
and the Chairman in providing guidance to the Manager of the System Open
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Market Account with respect to proposed or ongoing foreign currency
operations.
18
At its meeting on June 20, 1978, the FOMC amended the
procedural instructions to make less cumbersome the consultation
procedures between the Manager and the Committee (or, as necessary, the
Subcommittee) by removing the limit in paragraph 1.B on gross
transactions in individual currencies and substituting a new limit on
changes in net positions.
In addition, language was added that called
for clearance of any large-scale operations, and certain other
clarifying changes also were made elsewhere in the instructions.
Later
that year, on November 1, in connection with the package of actions in
support of the dollar announced by President Carter on that date,
Chairman Miller approved a suspension until the next Committee meeting
of the daily and intermeeting limits on the change in the System's
overall open position and on the change in the System's net position in
a single foreign currency.
In mid-December, the Foreign Currency
Subcommittee approved an indefinite suspension of these limits.
These
limits were reinstated by the FOMC at its meeting on March 20, 1979, but
at higher levels than previously had been specified.
In August 1979, to
reflect changes in positions and titles relating to management of the
System account, the procedural instructions and other Committee rules
18. Mr. Coldwell dissented from this action because he objected to the
parenthetical statement in paragraph 2 that permitted, under particular
circumstances relating to the availability of time, the Foreign Currency
Subcommittee, or the Chairman if the Chairman believed that consultation
with the subcommittee was not feasible, to approve market transactions
by the System and swap drawings by foreign central banks exceeding
specified amounts. Mr. Coldwell felt that such power, which extended to
operations up to the limits permitted by the Authorization, should be
reserved to the full Committee except under circumstances of extreme
emergency.
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were changed to include the new title of Manager of Foreign Operations,
System Open Market Account.
The procedural instructions have remained
unchanged since August 1979; as reaffirmed on February 6, 1990, they are
to be found at the end of Appendix D on pages 82-83.
Warehousing.
As noted previously, warehousing was first authorized in
November 1963 when the FOMC amended its Foreign Currency Directive to
permit concurrent spot purchases and forward sales of foreign currencies
by the Federal Reserve with the ESF. 19
Such transactions were to take
place on a "flat" basis--that is, at identical spot and forward exchange
rates--so that neither party would be subject to a financial loss.
The
purpose of this warehousing arrangement was to supplement temporarily,
on an as-needed basis, the liquidity of the ESF.
The initial use contemplated for the warehousing facility was
to aid the Treasury in accumulating the amount of Italian lira needed to
pay a maturing swap debt.
A ceiling for the amount of lira acquired
initially was set at $100 million equivalent but was raised in April
1966 to $200 million equivalent.
19. When the foreign currency instruments were extensively revised in
June 1966, the warehousing provision was shifted to the Authorization
for System Foreign Exchange Operations. In Section 1(A) of the current
Authorization, the Federal Reserve Bank of New York is authorized "to
purchase and sell the following foreign currencies . . . through spot or
forward transactions on the open market at home and abroad, including
transactions with the U.S. Exchange Stabilization Fund established by
Section 10 of the Gold Reserve Act of 1934 . . ."
Section 1(B) contains
authorization "To hold balances of, and to have outstanding forward
contracts to receive or to deliver, the foreign currencies listed in
paragraph A above." In addition, paragraph 3.B of the Foreign Currency
Directive provides that transactions may be undertaken "To provide means
for meeting System and Treasury commitments in particular currencies,
and to facilitate operations of the Exchange Stabilization Fund."
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In November 1967, the U. S. participated in an international
credit package for the United Kingdom.
The U. S. pledged to purchase up
to $500 million equivalent of "guaranteed" sterling (pounds sterling
held under an exchange guarantee by the Bank of England).
Direct
participation by the Federal Reserve was set at $100 million equivalent
with the remaining $400 million equivalent of guaranteed sterling
proposed for the Treasury.
Because a Treasury purchase of this
magnitude would have strained the liquidity of its ESF, the FOMC agreed
to warehouse up to $150 million of the guaranteed sterling and amended
paragraph 1.C(1) of the Authorization for System Foreign Currency
Operations to increase the limit on outstanding forward commitments to
deliver foreign currencies to the Stabilization Fund (the overall
warehousing limit) from $200 million to $350 million equivalent.
In May
1968, the FOMC noted that warehousing operations--none of which had been
undertaken to date--would involve forward transactions and thought it
desirable to amend paragraph 4 of the Foreign Currency Directive to make
a conforming change in the list of purposes for which forward
transactions were authorized.
The warehousing facility was not used until June 1968 when $200
million of guaranteed sterling was warehoused.
In September 1968, in
connection with U.S. participation in the Second Sterling Balance
Arrangement, the overall warehousing authorization was increased to $1
billion equivalent.
The full authorized limit (consisting of guaranteed
sterling, French francs, and Italian lira) was reached for a short
period in January 1970, but by February System holdings of warehoused
Treasury balances had returned to zero.
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The warehousing arrangement was not reactivated until January
1977 when, in connection with U. S. participation in an official
sterling balance facility put together that month, the FOMC agreed to a
Treasury request that the Federal Reserve undertake to warehouse up to
$1.5 billion equivalent for the ESF, $750 million of which would be
available for periods of twelve months and the remainder for periods of
six months.
The Committee also decided that the warehousing arrangement
should be reviewed periodically, with reconsideration normally taking
place at the yearly organization meeting (beginning in 1990, the first
regular Committee meeting in the new year, but previously the first
regular meeting in March).
In December 1978, the Federal Reserve agreed to broaden the
agreement to provide for warehousing of currencies held directly by the
Treasury as well as by the ESF and to increase the warehousing limit to
$5 billion equivalent, all of which would be available for periods of up
to twelve months.
These steps were taken to provide for the warehousing
of foreign currencies acquired through issuance of foreign-currency
denominated ("Carter") bonds.
At its meeting on March 18, 1980, the FOMC reaffirmed, subject
to annual review, its agreement that the Federal Reserve would be
prepared to warehouse up to $5 billion equivalent of eligible foreign
currencies for the U. S. Treasury or the ESF.
The Committee also agreed
to eliminate the twelve-month limitation previously imposed on the
period such currencies could be warehoused.
The $5 billion limit on the
amount of eligible-foreign currencies that could be warehoused for the
Treasury and the ESF remained in effect until September 19, 1989, when
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the Committee approved an increase to $10 billion.
The purpose of the
increase was to enable the ESF to finance its continued participation
with the System in foreign currency operations.
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APPENDIX A
LETTER FROM TREASURY SECRETARY DOUGLAS DILLON
TO CHAIRMAN WILLIAM McCHESNEY MARTIN
DECEMBER 18, 1961
FOREIGN CURRENCY INSTRUMENTS,
APPROVED FEBRUARY 13, 1962
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THE SECRETARY
.
OF THE TREASURY
WASHINGTON
December 18,
1961
Dear Bill:
As you know, I have been much interested in the work
of the Open Market Committee and its staff in exploring
the possibility of Federal Reserve operations in and
The
holdings of selected convertible foreign currencies.
proposal which has been developed seems to me highly
constructive.
The Treasury,
relying upon the Federal Reserve Bank of
New York as fiscal agent, has experimented with foreign
currency operations and holdings over the past nine months,
with very useful effects on the functioning of the foreign
exchange markets and desirable effects in safeguarding the
international value of the dollar. During this short period,
our recently attained convertible international payments
system has been going through its first real test. From
time to time, we have had to deal with unusual payments
flows of quite some size, occasioned in part by uncertainty
about the relationship of currency values.
I share the view of many European financial leaders
that we must not allow these volatile flows of funds to
undermine the international financial mechanism we have
all struggled so hard to rebuild during postwar years.
As
you are aware from last week's press announcement regarding
the IMF, we have just negotiated an important supplement
to the Fund's resources to help us deal with any developing
disequilibrium in balance of payments relationships among
the larger industrial countries that threatens an impairment
of the monetary system.
While the IMF special resources arrangement will be a
major reinforcement of the world's payments system, we must
not overlook other means of keeping that system convertible,
efficient
and sustainable.
Operations along lines in which
the Treasury's Stabilization Fund has experimented are one
of these means.
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In view of its limited resources, the Fund's foreign
currency operations have necessarily been on a pilot basis.
In my opinion, these pilot activities justify the belief that
operations carried out on a broader and more adequate scale
will be beneficial to the functioning of exchange markets and
to the pivotal role which the dollar plays in them.
At the same time, it is important to recognize that such
operations can best be conducted by the central bank because
only the central bank can make the prompt smooth adjustments
that are called for domestically. In view of the established
responsibility that central banks have for sound and stable
monetary conditions, the world's financial community is
naturally looking to them to play an active role in maintaining
a sound payments system. It is surely a proper central banking
function to engage in temporary operations that will help to
buffer and moderate tendencies towards volatile flows of funds.
Over the longer period, the very existence of a central banking
capability for coping promptly and effectively with volatile
flows can give confidence to international traders and
investors, and further the orderly evolution of international
market processes.
If the Federal Reserve decides to undertake foreign
currency operations, the Treasury and the Federal Reserve will
both need to recognize in advance, of course, that they will
have to feel their way; that effective methods of operations
and effective working relationships between them can only be
worked out gradually; and that they need to learn together
the best ways of carrying our mutual responsibilities for a
sound dollar internationally. In such an effort, the Treasury
on its part would naturally want to avoid impinging on the
independence of the Federal Reserve System within the Government.
If the Open Market Committee decides to consider its
current proposal further, we will need to consult together
on the details of any division of responsibilities between
the Treasury and the Federal Reserve.
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I realize
that the Committee might be hesitant to embark
on operations in which it has not engaged since the establishment of the Stabilization Fund under the Gold Reserve Act of
1934.
If the Committee should be interested in the opinion
of the Treasury's General Counsel regarding the statutory
provisions governing foreign exchange operations by Government
agencies, or if the Committee desires to obtain some statutory
clarification of these provisions, the Treasury's legal staff
will be ready to cooperate with yours.
It would be helpful if questions about the Committee's
plans in the foreign currency field could be resolved before
our legislative program for the next session of the Congress
has to be submitted. Before final activation, of course,
any specific proposal will need to be reviewed and discussed
with the National Advisory Council in accordance with the
provisions of the Bretton Woods Agreements Act.
In view of the current sensitivity being shown by the
foreign exchange markets to the balance of payments problem
of the United States, it is desirable to make progress in
this matter as rapidly as is feasible.
In closing, I might add that, according to my information,
foreign currency operations by the Federal Reserve on a broader
basis than those pioneered by the Stabilization Fund would be
welcomed by other central banks.
With best wishes,
Sincerely,
Douglas Dillon
The Honorable William McChesney Martin
Chairman, Federal Reserve System
Washington 25, D. C.
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AUTHORIZATION REGARDING OPEN MARKET TRANSACTIONS
IN FOREIGN CURRENCIES
Pursuant to Section 12A of the Federal Reserve Act 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 value of the dollar in international
exchange markets;
(2) To aid in making the existing system of international
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 international 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.
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 liabilities of those
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fluctuations in the international flow of payments to or
from the United States that are deemed to reflect
temporary disequilibrating forces or transitional market
unsettlement;
(2) To temper and smooth out abrupt changes in spot exchange
rates and moderate forward premiums and discounts judged
to be disequilibrating;
(3) To supplement international exchange arrangements such as
those made through the International 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.
V.
Authorized Currencies.
The New York Bank is authorized to conduct transactions for
System Account in the 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.
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Unless the Bank is otherwise authorized, all transactions 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 Subcommittee
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 of 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:
(1) 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 operations between the System and the
Secretary;
(2) 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;
(3) From time to time, to transmit appropriate reports and
information to the National Advisory Council on
International Monetary and Financial Problems.
IX. Special Manager of 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
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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
Committee shall arrange for the prompt transmittal to
all statistical and other information relating to the
and the amounts of holdings of foreign currencies for
Committee as to conformity with its instructions.
officials of the
the Committee of
transactions in
review by the
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.
XI.
Amendment of Authorization.
The Federal Open Market Committee may at any time amend or
rescind this authorization.
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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.
Holdings of a currency shall generally be kept sufficient to
meet forward contracts in that currency (exclusive of contracts made
under parallel arrangements with foreign monetary authorities which
provide their own cover) expected to mature in the following three-week
period.
Foreign currency holdings above a certain minimum 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 mainly be geared to
pressures of payments flows so as to cushion or moderate disequilibrating movements of volatile funds and their destabilizing
effects on U.S. and foreign official reserves and on exchange markets.
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
reviews of the System's evaluation of international payments flows.
This review might suggest a temporary change in System holdings of a
particular convertible currency and possibly direct exchange
transactions with the foreign central bank involved to be able to
accommodate a larger demand or supply.
Starting operations
experiencing a net inflow of
that initial System holdings
from the Stabilization Fund)
banks.
at a time when the United States is not
any eligible foreign currency may require
(apart from sums that might be acquired
be purchased directly from foreign central
It shall be the practice to arrange with foreign central banks
for the coordination of foreign currency transactions in order that
System transactions do not conflict with those being undertaken by
foreign monetary authorities.
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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 Funds Agreement or by
central bank practices, index affirmatively the interaction of
underlying economic forces 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 transactions.
Whenever exchange market instability threatens to produce
disorderly conditions, System transactions are appropriate if the
Special Manager, in consultation with the Federal Open Market Committee,
or in an emergency the members of the Committee designated for that
purpose, reaches a judgment that they may help to reestablish supply and
demand balance at a level more consistent with the prevailing flow of
underlying payments. Whenever supply or demand persists in influencing
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.
4. Transactions in Forward Exchange
Occasion to engage in forward transactions will arise mainly
when forward premiums or discounts are inconsistent with interest rate
differentials and are giving rise to a disequilibrating movement of
short-term funds, or when it is deemed appropriate to supplement
existing market facilities for forward cover as a means of encouraging
the retention or accumulation of dollar holdings abroad.
Proposals of the Special Manager to initiate forward operations
shall be submitted to the Committee for advance approval.
For such operations, the New York Bank may, where authorized,
take over from the Stabilization Fund outstanding contracts for forward
sales or purchases of authorized currencies.
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5.
Exchange Rates
Insofar as practicable, the New York Bank
currency through spot transactions at or below its
lower the rate at which it is prepared to purchase
holdings of that currency approach the established
shall purchase a
par value, and should
a currency as its
maximum.
The Bank shall also, where practicable, sell a currency through
spot transactions at rates at or above its par value, and should raise
the rate at which it is prepared to sell a currency as its holdings of
that currency approach zero.
Spot transactions at rates other than those set forth in the
preceding paragraphs shall be specially authorized by the members of the
Committee designated in Section VIII of the Authorization for Open
Market Transactions in Foreign Currencies.
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CONTINUING AUTHORITY DIRECTIVE ON SYSTEM
FOREIGN CURRENCY OPERATIONS
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 issued by the Federal Open Market Committee on
February 13, 1962:
Pounds sterling
French francs
German marks
Italian lira
Netherlands guilders
Swiss francs
Total foreign currencies held at any one time shall not exceed
$500 million.
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SCOPE AND CHARACTER OF INITIAL FOREIGN CURRENCY
OPERATIONS OF THE SYSTEM
I. The System would acquire in the market or directly from
foreign central banks small amounts of authorized foreign currencies
whenever pressure on the dollar relaxes and the rate of one of these
currencies falls from recent high levels. Holdings thus acquired would
constitute a modest inventory to be used for sales in the market if
market pressures or instability clearly warranted. Initially then, the
System would enter the market only as an occasional buyer; barring
unusual market conditions, the System would aim to defer any program of
currency sales until minimum balances had been accumulated.
II. In order to facilitate the early stages of the Federal
Reserve program, the Secretary of the Treasury would stand ready to sell
to the Federal Reserve modest amounts of German marks (approximately $7
million equivalent), Swiss francs, Netherlands guilders, and Italian
lira (approximately $1 million equivalent of each) at market rates of
exchange on the day of the sale. The Federal Reserve already has
accounts with the Bank of England and the Bank of France. These
currency take-overs from the Treasury would permit the System to open
accounts at once with four of the other central banks, to establish
appropriate bookkeeping procedures for transactions through them, and to
become familiar with procedures and techniques for administering and
investing the accounts.
III. The Treasury would continue to conduct foreign currency
operations under existing agreements with Germany, Switzerland, the
Netherlands, and Italy. The System, however, would stand prepared to
purchase currencies of these countries from the Treasury, either
outright or under mutually satisfactory resale agreement, in the event
that exchange market developments obliged the Fund to exhaust available
resources. The Treasury and the System would consult before either
entered into any agreements with foreign central banks or governments
regarding possible foreign currency operations.
IV. With a view to being in immediate position to meet any
unusual demands for foreign currencies, the System would stand ready,
within agreed limits:
(a) to enter into reciprocal currency transactions with
designated foreign central banks, especially the Bank of
England and the Bank of France;
(b) to supplement any arrangement that the Swiss National Bank
might make with the IMF or the Treasury;
(c) to purchase from the Treasury part or all of foreign
currency amounts acquired under Treasury credit
arrangements with major European central banks or
governments already negotiated or, after consultation with
the System, to be negotiated; and
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(d) to purchase from the Treasury part or all of foreign
currency amounts that may be drawn from the International
Monetary Fund.
V. Since the System's foreign currency operations are to be on
an experimental and trial basis, the Treasury and the Federal Reserve
agree that a specific understanding as to a division of operations
between them can be delayed until experience has made clear the way in
which such a delineation can be most effectively achieved. Initially,
there need only be arrangements for the exchange of information about
currency operations, channels for regular communciation, and procedures
for continuing consultations.
VI. The National Advisory Council will be informed of the
general plan for System foreign currency operations on an experimental
and trial basis.
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APPENDIX B
AUTHORIZATION FOR SYSTEM FOREIGN CURRENCY OPERATIONS
1966 TO DATE
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AUTHORIZATION FOR SYSTEM FOREIGN CURRENCY OPERATIONS
(Adopted June 7, 1966)
1. The Federal Open Market Committee authorizes and directs the
Federal Reserve Bank of New York, for System Open Market Account,
to the extent necessary to carry out the Committee's foreign
currency directive:
A. To purchase and sell the following 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 U. S. Stabilization Fund
established by Section 10 of the Gold Reserve Act of 1934,
with foreign monetary authorities, and with the Bank for
International Settlements:
Austrian schillings
Belgian francs
Canadian dollars
Pounds sterling
French francs
German marks
Italian lire
Japanese yen
Netherlands guilders
Swedish kronor
Swiss francs
B. To hold foreign currencies listed in paragraph A above, up
to the following limits:
(1) Currencies held spot or purchased forward, up to
the amounts necessary to fulfill outstanding
forward commitments;
(2) Additional currencies held spot or purchased
forward, up to the amount necessary for System
operations to exert a market influence but not
exceeding $150 million equivalent; and
(3) Sterling purchased on a covered or guaranteed
basis in terms of the dollar, under agreement
with the Bank of England, up to $200 million
equivalent.
C. To have outstanding forward commitments undertaken under
paragraph A above to deliver foreign currencies, up to the
following limits:
(1) Commitments to deliver to the Stabilization Fund
foreign currencies in which the United States
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Treasury has outstanding indebtedness, up to $200
million equivalent;
(2) Commitments to deliver Italian lire, under
special arrangements with the Bank of Italy, up
to $500 million equivalent; and
(3) Other forward commitments to deliver foreign
currencies, up to $275 million equivalent.
D.
To draw foreign currencies and to permit foreign banks to
draw dollars under the reciprocal currency arrangements
listed in paragraph 2 below, provided that drawings by
either party to any such 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, specifically authorizes a delay.
2. The Federal Open Market Committee directs the Federal Reserve Bank
of New York to maintain reciprocal currency arrangements ("swap"
arrangements) for System Open Market Account with the following
foreign banks, which are among those designated by the Board of
Governors of the Federal Reserve System under Section 214.5 of
Regulation N, Relations with Foreign Banks and Bankers, and with
the approval of the Committee to renew such arrangements on
maturity:
Amount of
arrangement
(millions of
dollars equivalent)
Foreign bank
Austrian National Bank
National Bank of Belgium
Bank of Canada
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Netherlands Bank
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
(System drawings in Swiss francs)
Bank for International Settlements:
(System drawings in authorized
European currencies other than
Swiss francs)
Period of
Arrangement
(months)
50
100
250
750
100
250
450
250
100
50
150
12
12
12
12
3
6
12
12
3
12
6
150
6
150
6
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3. All transactions in foreign currencies undertaken under paragraph
l.A above shall be at prevailing market rates and no attempt shall
be made to establish rates that appear to be out of line with
underlying market forces. Insofar as is practicable, foreign
currencies shall be purchased through spot transactions when rates
for those currencies are at or below par and sold through spot
transactions when such rates are at or above par, except when
transactions at other rates (i) are specifically authorized by the
Committee, (ii)are necessary to acquire currencies to meet System
commitments, or (iii) are necessary to acquire currencies for the
Stabilization Fund, provided that these currencies are resold
forward to the Stabilization Fund at the same rate.
4. It shall be the practice to arrange with foreign central banks for
the coordination of foreign currency transactions. In making
operating arrangements with foreign central banks on System
holdings of foreign currencies, the Federal Reserve Bank of New
York shall not commit itself to maintain any specific balance,
unless authorized by the Federal Open Market Committee. Any
agreements or understandings concerning the administration of the
accounts maintained by the Federal Reserve Bank of New York with
the foreign banks designated by the Board of Governors under
Section 214.5 of Regulation N shall be referred for review and
approval to the Committee.
5. Foreign currency holdings shall be invested insofar as practicable,
considering needs for minimum working balances. Such investments
shall be in accordance with Section 14(e) of the Federal Reserve
Act.
6. A Subcommittee 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 of 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) is authorized to act on behalf of the
Committee when it is necessary to enable the Federal Reserve Bank
of New York to engage in foreign currency operations before the
Committee can be consulted. All actions taken by the Subcommittee
under this paragraph shall be reported promptly to the Committee.
7.
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) is authorized:
A. 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 operations between the System and the Secretary;
B. To keep the Secretary of the Treasury fully advised
concerning System foreign currency operations, and to
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consult with the Secretary on such policy matters as may
relate to the Secretary's responsibilities; and
C. From time to time, to transmit appropriate reports and
information to the National Advisory Council on
International Monetary and Financial Policies.
8. Staff officers of the Committee are authorized to transmit
pertinent information on System foreign currency operations to
appropriate officials of the Treasury Department.
9. 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.
10.
The special Manager of the System Open Market Account for foreign
currency operations shall keep the Committee informed on conditions
in foreign exchange markets and on transactions he has made and
shall render such reports as the Committee may specify.
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AMENDMENTS TO AUTHORIZATION FOR SYSTEM FOREIGN CURRENCY OPERATIONS
Action taken: September 9, 1966
Effective date: September 9, 1966
Action ratified: September 13, 1966
The table in paragraph 2 was amended to increase the authorized
amounts of most swap arrangements (the new amounts are underlined below)
and to add the word "maximum" to the caption of the second column of the
table.
Maximum
Amount of
arrangement
(millions of
Foreign bank
Austrian National Bank
National Bank of Belgium
Bank of Canada
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Netherlands Bank
Bank of Sweden
Swiss National Bank
Bank for International Settlements
(System drawings in Swiss francs)
Bank for International Settlements
(System drawings in authorized
European currencies other than
Swiss francs)
period of
arrangement
dollars equivalent)
(months)
100
150
500
1,350
100
400
600
450
150
100
200
Actions taken: May 12, 1967
Effective date: May 17, 1967
Actions ratified: May 23, 1967
The list of authorized currencies in paragraph 1.A was amended
to read as follows:
Austrian schillings
Italian lire
Belgian francs
Canadian dollars
Japanese yen
MEXICAN PESOS
DANISH KRONER
Netherlands guilders
Pounds sterling
French francs
German marks
NORWEGIAN KRONER
Swedish kronor
Swiss francs
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The table in paragraph 2 was amended to read as follows:
Foreign bank
Austrian National Bank
National Bank of Belgium
Bank of Canada
NATIONAL BANK OF DENMARK
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
BANK OF MEXICO
Netherlands Bank
BANK OF NORWAY
Bank of Sweden
Swiss National Bank
Bank for International Settlements
System drawings in Swiss francs
System drawings in authorized
European currencies other than
Swiss francs
Amount of
Maximum
arrangement
(millions of
dollars equivalent)
period of
arrangement
(months)
100
150
500
100
1,350
100
400
600
450
130
150
100
100
200
12
12
12
12
12
3
6
12
12
12
3
12
12
6
200
6
200
6
Action taken: June 29, 1967
Effective date: June 30, 1967
Action ratified: July 18, 1967
The table in paragraph 2 was amended to change the maximum
period of the arrangement with the Netherlands Bank from 3 to 6 months.
Action taken: July 18, 1967
Effective date: July 18, 1967
Paragraph 2 was amended to replace the columns setting maximum
periods of swap arrangements for each currency with wording in the
preceding text that set the maximum period at 12 months for all lines.
In addition, the sizes of three swap arrangements were increased. The
amended paragraph read as follows:
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2. The Federal Open Market Committee directs the Federal Reserve Bank
of New York to maintain reciprocal currency arrangements ("swap"
arrangements) for System Open Market Account FOR PERIODS UP TO A
MAXIMUM OF 12 MONTHS with the following foreign banks, which are
among those designated by the Board of Governors of the Federal
Reserve System under Section 214.5 of Regulation N, Relations with
Foreign Banks and Bankers, and with the approval of the Committee to
renew such arrangements on maturity:
Foreign bank
Amount of arrangement
(millions of dollars equivalent)
Austrian National Bank
National Bank of Belgium
Bank of Canada
National Bank of Denmark
Bank of England
Bank of France
German Federal Bank
Bank of Italy
100
150
500
100
1,350
100
400
600
Bank of Japan
450
Bank of Mexico
Netherlands Bank
Bank of Norway
Bank of Sweden
Swiss National Bank
Bank for International Settlements
System drawings in Swiss francs
System drawings in authorized European
currencies other than Swiss francs
130
150
100
100
250
250
300
Action taken: November 14, 1967
Effective date: November 21, 1967
Paragraph 1.B(3) was amended to increase from $200 to $300
million equivalent the limit on System Account holdings of sterling on a
covered or guaranteed basis in terms of the dollar.
Action taken: November 14, 1967
Effective date: November 22, 1967
Paragraph 1.C(1) was revised to increase from $200 million to
$350 million equivalent the limit on System Account forward commitments
to deliver foreign currencies to the Stabilization Fund, and to change
the language as follows:
1.C(1)
Commitments to deliver [DEL:
to the StabilizationFund]
foreign currencies TO THE STABILIZATION FUND[DEL:
in which
the United States Treasury has outstanding
indebtedness,]up to [DEL:
$200] $350 million equivalent.
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Action taken: November 27, 1967
Effective date: November 27, 1967
Paragraph 1.B(3) was amended to decrease from $300 million to
$200 million equivalent the limit on System Account holdings of sterling
on a covered or guaranteed basis in terms of the dollar.
Paragraph 1.C(3) was amended to increase from $275 million to
$550 million equivalent the limit on outstanding forward commitments to
deliver foreign currencies.
The table in paragraph 2 was amended to increase the authorized
amount of swap arrangements with five foreign banks. The amended table
read as follows:
Foreign bank
Amount of arrangement
(millions of dollars equivalent)
Austrian National Bank
100
225
National Bank of Belgium
Bank of Canada
500
National Bank of Denmark
100
Bank of England
1,350
Bank of France
100
German Federal Bank
400
Bank of Italy
750
Bank of Japan
450
Bank of Mexico
130
Netherlands Bank
225
Bank of Norway
100
Bank of Sweden
200
Swiss National Bank
250
Bank for International Settlements:
System drawings in Swiss francs
250
System drawings in authorized European
currencies other than Swiss francs
600
Action taken: November 27, 1967
Effective date: November 28, 1967
The table in paragraph 2 was amended to increase the authorized
amount of swap arrangements with the Bank of England from $1,350 million
to $1,500 million equivalent, and with the Bank of Japan from $450
million to $750 million equivalent.
Action taken: November 27, 1967
Effective date: November 30, 1967
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the German Federal Bank from $400
million to $750 million equivalent.
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Action taken: November 30, 1967
Effective date: November 30, 1967
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of Canada from $500 million
equivalent to $750 million equivalent.
Action taken: December 14, 1967
Effective date: December 14, 1967
The table in paragraph 2 was amended to increase the authorized
amount of swap arrangements with the Swiss National Bank and with the
BIS provision for System drawings in Swiss francs, each from $250
million equivalent to $400 million equivalent. As of December 14, 1967,
the table read as follows:
Foreign bank
Amount of arrangement
(millions of dollars equivalent)
Austrian National Bank
100
225
National Bank of Belgium
750
Bank of Canada
National Bank of Denmark
100
1,500
Bank of England
Bank of France
100
German Federal Bank
750
750
Bank of Italy
750
Bank of Japan
Bank of Mexico
130
Netherlands Bank
225
100
Bank of Norway
Bank of Sweden
200
Swiss National Bank
400
Bank for International Settlements:
System drawings in Swiss francs
400
System drawings in authorized European
currencies other than Swiss francs
600
Action taken: March 5, 1968
Effective date: March 5, 1968
Paragraph 3 was amended to read as follows:
3. UNLESS OTHERWISE EXPRESSLY AUTHORIZED BY THE COMMITTEE, all
transactions in foreign currencies undertaken under paragraph l.A
above shall be at prevailing market rates and no attempt shall be
made to establish rates that appear to be out of line with
underlying market forces. [DEL:
Insofar as is practicable, foreign
currencies shall be purchased through spot transactions when rates
for those currencies are at or below par and sold through spot
transactions when such rates are at or above parr except when
transactions at other rates (i) are specifically authorized by the]
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[DEL:
Committee, (ii)
are necessary to acquire currencies to meet System
commitments, or (iii) are necessary to acquire currencies for the
Stabilization Fund, provided that these currencies are resold
forward to the Stabilization Fund at the same rate.]
Actions taken: March 14, 1968
Effective date: March 17, 1968
The table in paragraph 2 was amended to increase the following
swap arrangements, as indicated:
Foreign bank
Amount of arrangement
(millions of dollars equivalent)
To
From
Bank of Canada
Bank of Japan
Netherlands Bank
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
System drawings in Swiss francs
System drawings in authorized European currencies other than Swiss
francs
750
750
225
200
400
1,000
1,000
400
250
600
400
600
600
1,000
Action taken: March 16, 1968
Effective date: March 17, 1968
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the German Federal Bank from $750
million to $1,000 million equivalent.
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Action taken: March 17, 1968
Effective date: March 17, 1968
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of England from $1,500
million to $2,000 million equivalent. The table then read as follows:
Foreign bank
Amount of arrangement
(millions of dollars equivalent)
Austrian National Bank
National Bank of Belgium
Bank of Canada
National Bank of Denmark
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Bank of Mexico
Netherlands Bank
Bank of Norway
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
System drawings in Swiss francs
System drawings in authorized European
currencies other than Swiss francs
100
225
1,000
100
2,000
100
1,000
750
1,000
130
400
100
250
600
600
1,000
Action taken: April 30, 1968
Effective date: April 30, 1968
Paragraph 1.B(3) was amended to increase from $200 million to
$250 million equivalent the limit on System Account holdings of sterling
on a covered or guaranteed basis in terms of the dollar.
Action taken: May 28, 1968
Effective date: May 28, 1968
Paragraph 1.B(3) was amended to increase from $250 million to
$300 million equivalent the limit on System Account holdings of sterling
on a covered or guaranteed basis in terms of the dollar.
Action taken: July 2, 1968
Effective date: July 2, 1968
Action ratified: July 16, 1968
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of France from $100 million
to $700 million equivalent.
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Action taken: July 16, 1968
Effective date: September 24, 1968
Paragraph l.C(1) was amended to increase, from $350 million to
$1 billion equivalent, the limit on commitments to deliver foreign
currencies to the Stabilization Fund. The July 16 action authorized an
increase in this limit up to an amount not to exceed $1,050 million,
with the precise amount and the effective date subject to determinations
by Chairman Martin.)
Action taken: March 14, 1968
Effective date: October 8, 1968
Reflecting the recent successful completion of negotiations
with the Bank of Italy, the table in paragraph 2 was amended to increase
the authorized amount of the swap arrangement with the Bank of Italy
from $750 million to $1 billion equivalent.
Action taken: November 22, 1968
Effective date: November 22, 1968
Action ratified: November 26, 1968
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of France from $700 million
to $1 billion equivalent.
Action taken: March 4, 1969
Effective date: March 4, 1969
Paragraph 1 was amended to read as follows:
1. The Federal Open Market Committee authorizes and directs the Federal
Reserve Bank of New York, for System Open Market Account, to the
extent necessary to carry out the Committee's foreign currency
directive AND EXPRESS AUTHORIZATIONS BY THE COMMITTEE PURSUANT
THERETO:
Paragraphs l.B and 1.C were amended to read as follows:
B. To hold foreign currencies listed in paragraph A above, up
to the following limits:
(1) CURRENCIES PURCHASED SPOT, INCLUDING CURRENCIES
PURCHASED FROM THE STABILIZATION FUND, AND SOLD
FORWARD TO THE STABILIZATION FUND, UP TO $1
BILLION EQUIVALENT;
[DEL:
(1)] (2) Currencies held spot or purchased SPOT OR
forward, up to the amounts necessary to fulfill
OTHER[DEL:
outstanding]forward commitments;
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held spot or]purchased
[DEL:
(2)] (3) Additional currencies [DEL:
SPOT OR forward, up to the amount necessary for
System operations to exert a market influence but
not exceeding[DEL:
$150] $250 million equivalent; and
[DEL:
(3)] (4) Sterling purchased on a covered or
guaranteed basis in terms of the dollar, under
agreement with the Bank of England, up to $300
million equivalent.
C. To have outstanding forward commitments undertaken under
paragraph A above to deliver foreign currencies, up to the
following limits:
(1) Commitments to deliver foreign currencies to the
Stabilization Fund, up to [DEL:
$1 billion equivalent]
THE LIMIT SPECIFIED IN PARAGRAPH 1.B(1) ABOVE;
Action taken: May 14, 1969
Effective date: May 14, 1969
Action ratified: May 27, 1969
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the National Bank of Belgium from
$225 million to $300 million equivalent and to reduce the arrangement
with the Netherlands Bank from $400 million to $300 million equivalent.
Action taken: August 27, 1969
Effective date: September 2, 1969
Action ratified: September 9, 1969
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with National Bank of Belgium from $300
million to $500 million equivalent.
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Action taken: October 7, 1969
Effective date: October 7, 1969
The table in paragraph 2 was amended to increase the authorized
amounts of swap arrangements with the Austrian National Bank, the
National Bank of Denmark, and the Bank of Norway, each from $100 million
to $200 million equivalent. As of October 7, 1969, the table in
paragraph 2 read as follows:
Amount of arrangement
(millions of dollars equivalent)
Foreign bank
Austrian National Bank
National Bank of Belgium
Bank of Canada
National Bank of Denmark
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Bank of Mexico
Netherlands Bank
Bank of Norway
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
System drawings in Swiss francs
System drawings in authorized European
currencies other than Swiss francs
200
500
1,000
200
2,000
1,000
1,000
1,000
1,000
130
300
200
250
600
600
1,000
Action taken: March 10, 1970
Effective date: March 10, 1970
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of Italy from $1 billion to
$1,250 million equivalent.
Action taken: April 7, 1970
Effective date: April 7, 1970
Paragraph 1.B(4) was amended as follows:
(4) Sterling purchased on a covered or guaranteed
basis in terms of the dollar, under agreement
with the Bank of England, up to [del:
$300]$200 million
equivalent.
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Paragraph 1.C was amended as follows:
C. To have outstanding forward commitments undertaken under
paragraph A above to deliver foreign currencies, up to the
following limits:
(1) Commitments to deliver foreign currencies to the
Stabilization Fund, up to the limit specified in
paragraph 1.B(1) above; AND
[Del:
(2) Commitments to deliver Italian lire, under
special arrangements with the Bank of Italy, up
to $500
(3)]
[DEL:
million equivalent, and]
(2) Other forward commitments to deliver foreign
currencies, up to $550 million equivalent.
Action taken: March 9, 1971
Effective date: March 9, 1971
Paragraph 3 was amended to read as follows:
3. CURRENCIES TO BE USED FOR LIQUIDATION OF SYSTEM SWAP COMMITMENTS MAY
BE PURCHASED FROM THE FOREIGN CENTRAL BANK DRAWN ON, AT THE SAME
EXCHANGE RATE AS THAT EMPLOYED IN THE DRAWING TO BE LIQUIDATED.
Unless
APART FROM ANY SUCH PURCHASES AT THE RATE OF THE DRAWING [DEL:
otherwise expressly authorized by the Committee],all transactions in
foreign currencies undertaken under paragraph 1.A above shall,
UNLESS OTHERWISE EXPRESSLY AUTHORIZED BY THE COMMITTEE, be at
prevailing market rates and no attempt shall be made to establish
rates that appear to be out of line with underlying market forces.
Action taken: August 9, 1971
Effective date: August 12, 1971
Action ratified: August 24, 1971
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the National Bank of Belgium from
$500 million to $600 million.
Action taken: August 11, 1971
Effective date: August 12, 1971
Action ratified: August 24, 1971
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Swiss National Bank from $600
million to $1 billion.
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Action taken: March 20, 1973
Effective date: March 20, 1973
The title of the "Authorization for System Foreign Currency
Operations" was changed to "Authorization for Foreign Currency
Operations."
Paragraph 10 in the Authorization was deleted.
Paragraph 6 in the Authorization was amended as follows:
6. THE[DEL:
A] Subcommittee NAMED IN SECTION 272.4 (c) OF THE COMMITTEE'S
RULES OF PROCEDURE [DEL:
consisting of the Chairman and the Vice Chairman
of the Beard of Governors (or in the absence of the Chairman or of
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)] is authorized to act
on behalf of the Committee when it is necessary to enable the
Federal Reserve Bank of New York to engage in foreign currency
operations before the Committee can be consulted. All actions taken
by the Subcommittee under this paragraph shall be reported promptly
to the Committee.
Actions taken:
Effective date:
March 20, 1973 for increases in the swap arrangements
with the Bank of International Settlements and the
Central Banks of Belgium, Canada, France, Germany,
Italy, Japan, the Netherlands and Switzerland.
June 19, 1973 for increases in swap arrangements with
the Central Banks of Austria, Denmark, Mexico, Norway,
and Sweden.
July 10, 1973
Table in paragraph 2 was amended to increase swap arrangements
as indicated on the next page:
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Foreign bank
Amount of arrangement
(millions of dollars equivalent)
To
From
Austrian National Bank
National Bank of Belgium
Bank of Canada
National Bank of Denmark
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Bank of Mexico
Netherlands Bank
Bank of Norway
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
Dollars against Swiss francs
Dollars against other European
currencies
200
600
1,000
200
2,000
1,000
1,000
1,250
1,000
130
300
200
250
1,000
250
1,000
2,000
250
2,000 (no change)
2,000
2,000
2,000
2,000
180
500
250
300
1,400
600
600 (no change)
1,000
1,250
Action taken: January 22, 1974
Effective date: February 1, 1974
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of Italy from $2 billion to
$3 billion. The increase was to become effective upon approval by the
Subcommittee (consisting of the Chairman and Vice Chairman of the
Committee and the Vice Chairman of the Board of Governors) designated in
the Committee's Rules of Procedure, after consultation with the U. S.
Treasury. Subcommittee approval was given on January 29, 1974.
Action taken: March 19, 1974
Effective date: March 26, 1974
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of England from $2 billion
to $3 billion.
Action taken: August 19, 1975
Effective date: August 29, 1975
Subject to an understanding that
effective upon approval by Chairman Burns
technical details, the table in paragraph
authorized amount of the swap arrangement
$180 million to $360 million.
the action would become
after a final review of
2 was amended to increase the
with the Bank of Mexico from
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Action taken: February 18, 1976
Effective date: February 18, 1976
Paragraph 6 was amended as follows in order to create a new
Foreign Currency Subcommittee:
272.4(c) of the
named in Section
6. The FOREIGN CURRENCY Subcommittee [Del:
Committee's rules of procedure]is authorized to act on behalf of the
Committee when it is necessary to enable the Federal Reserve Bank of
New York to engage in foreign currency operations before the
Committee can be consulted. THE FOREIGN CURRENCY SUBCOMMITTEE
CONSISTS OF THE CHAIRMAN AND VICE CHAIRMAN OF THE COMMITTEE, THE
VICE CHAIRMAN OF THE BOARD OF GOVERNORS, AND SUCH OTHER MEMBER OF
THE BOARD AS THE CHAIRMAN MAY DESIGNATE (OR IN THE ABSENCE OF
MEMBERS OF THE BOARD SERVING ON THE SUBCOMMITTEE, OTHER BOARD
MEMBERS DESIGNATED BY THE CHAIRMAN AS ALTERNATES, AND IN THE ABSENCE
OF THE VICE CHAIRMAN OF THE COMMITTEE, HIS ALTERNATE). All actions
taken by the FOREIGN CURRENCY Subcommittee under this paragraph
shall be reported promptly to the Committee.
Action taken: December 20, 1976
Effective date: December 28, 1976
The Committee agreed upon broad revisions in its Authorization
for Foreign Currency Operations in an effort to simplify and clarify its
instructions to the Federal Reserve Bank of New York and to bring the
document up to date in light of changes under way in the international
monetary system and its functioning. There were revisions throughout
the document, but the main change in the Authorization was to replace
the several separate limits on various types of spot and forward
transactions with a single limit on the System's "overall open
position," as defined in paragraph 1.D. The document as amended is
shown on the next page.
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AUTHORIZATION FOR FOREIGN CURRENCY OPERATIONS
(As amended December 20, 1976)
1. The Federal Open Market Committee authorizes and directs the Federal
Reserve Bank of New York, for System Open Market Account, to the
extent necessary to carry out the Committee's foreign currency
directive and express authorizations by the Committee pursuant
thereto, AND IN CONFORMITY WITH SUCH PROCEDURAL INSTRUCTIONS AS THE
COMMITTEE MAY ISSUE FROM TIME TO TIME:
A. To purchase and sell the following 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 U.S. EXCHANGE Stabilization
Fund established by Section 10 of the Gold Reserve Act of
and]with the Bank
1934, with foreign monetary authorities, [DEL:
for International Settlements, AND WITH OTHER INTERNATIONAL
FINANCIAL INSTITUTIONS:
Austrian schillings
Belgian francs
Canadian dollars
Danish kroner
Pounds sterling
French francs
German marks
Italian lire
Japanese yen
Mexican pesos
Netherlands guilders
Norwegian kroner
Swedish kronor
Swiss francs
B. To hold BALANCES OF, AND TO HAVE OUTSTANDING FORWARD
CONTRACTS TO RECEIVE OR TO DELIVER, THE foreign currencies listed in
paragraph A above[DEL:
, up tothe following limits:].
[DEL:
(1) Curreneies purchased spot, including currencies
purchased from the Stabilization Fund, and sold
forward to the Stabilization Fund, up to $1
billion equivalent;]
[DEL:(2)
Currencies purchased spot or forward, up to the
amounts necessary to fulfill other forward
commitments;]
[DEL:(3)
Additional currencies purchased spot or forward,
up to the amount necessary for System operations
to exert a market influence but net exceeding
$250 million equivalent; and]
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Sterling purchased on a covered or guaranteed
[DEL:(4)
basis in terms of the dollar, under agreement
with the Bank of England up to $200 million
equivalent.]
[DEL:
C.) To have outstanding forward commitments undertaken under
paragraph A above to deliver foreign currencies, up to the
following limits:]
[DEL:
(1) Commitments to deliver foreign currencies to the
Stabilization Fund, up to the limit specified in
paragraph 1B(1)above, and]
2) Other forward commitments to deliver foreign
[DEL:
currencies, up to $550 million equivalent.]
[DEL:
B.] C. To draw foreign currencies and to permit foreign banks
to draw dollars under the reciprocal currency arrangements listed in paragraph 2 below, provided that
drawings by either party to any such 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,
specifically authorizes a delay.
D. TO MAINTAIN AN OVERALL OPEN POSITION IN ALL FOREIGN
CURRENCIES NOT EXCEEDING $1.0 BILLION, UNLESS A LARGER
POSITION IS EXPRESSLY AUTHORIZED BY THE COMMITTEE. FOR
THIS PURPOSE, THE OVERALL OPEN POSITION IN ALL FOREIGN
CURRENCIES IS DEFINED AS THE SUM (DISREGARDING SIGNS) OF
OPEN POSITIONS IN EACH CURRENCY. THE OPEN POSITION IN A
SINGLE FOREIGN CURRENCY IS DEFINED AS HOLDINGS OF BALANCES
IN THAT CURRENCY, PLUS OUTSTANDING CONTRACTS FOR FUTURE
RECEIPT, MINUS OUTSTANDING CONTRACTS FOR FUTURE DELIVERY OF
THAT CURRENCY, I.E., AS THE SUM OF THESE ELEMENTS WITH DUE
REGARD TO SIGN.
2. The Federal Open Market Committee directs the Federal Reserve Bank
of New York to maintain reciprocal currency arrangements ("swap"
arrangements) for THE System Open Market Account for periods up to a
maximum of 12 months with the following foreign banks, which are
among those designated by the Board of Governors of the Federal
Reserve System under Section 214.5 of Regulation N, Relations with
Foreign Banks and Bankers, and with the approval of the Committee to
renew such arrangements on maturity:
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Foreign bank
Amount of arrangement
(millions of dollars equivalent)
Austrian National Bank
National Bank of Belgium
Bank of Canada
National Bank of Denmark
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Bank of Mexico
Netherlands Bank
Bank of Norway
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
Dollars against Swiss francs
Dollars against authorized European
currencies other than Swiss francs
250
1,000
2,000
250
3,000
2,000
2,000
3,000
2,000
360
500
250
300
1,400
600
1,250
ANY CHANGES IN THE TERMS OF EXISTING SWAP ARRANGEMENTS, AND THE PROPOSED
TERMS OF ANY NEW ARRANGEMENTS THAT MAY BE AUTHORIZED, SHALL BE REFERRED
FOR REVIEW AND APPROVAL TO THE COMMITTEE.
3. Currencies to be used for liquidation of System swap commitments may
be purchased from the foreign central bank drawn on, at the same
exchange rate as that employed in the drawing to be liquidated.
Apart from any such purchases at the rate of the drawing, all
transactions in foreign currencies undertaken under paragraph 1.A
above shall, unless otherwise expressly authorized by the Committee,
and no attempt shall be made to
be at prevailing market rates [DEL:
establish rates that appear to be out of line with underlying market
forces.]
4. It shall be the NORMAL practice to arrange with foreign central
banks for the coordination of foreign currency transactions. In
making operating arrangements with foreign central banks on System
holdings of foreign currencies, the Federal Reserve Bank of New York
shall not commit itself to maintain any specific balance, unless
authorized by the Federal Open Market Committee. Any agreements or
understandings concerning the administration of the accounts
maintained by the Federal Reserve Bank of New York with the foreign
banks designated by the Board of Governors under Section 214.5 of
Regulation N shall be referred for review and approval to the
Committee.
5. Foreign currency holdings shall be invested insofar as practicable,
considering needs for minimum working balances. Such investments
shall be in accordance with Section 14(e) of the Federal Reserve
Act.
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6. ALL OPERATIONS UNDERTAKEN PURSUANT TO THE PRECEDING PARAGRAPHS SHALL
is authorized
BE REPORTED DAILY TO the Foreign Currency Subcommittee [DEL:
to act on behalf of the Committee when it is necessary to enable the
Federal Reserve Bank of New York toengage in foreign currency
operations before the Committee can be consulted]. The Foreign
Currency Subcommittee consists of the Chairman and Vice Chairman of
the Committee, the Vice Chairman of the Board of Governors, and such
other member of the Board as the Chairman may designate (or in the
absence of members of the Board serving on the Subcommittee, other
Board members designated by the Chairman as alternates, and in the
All
absence of the Vice Chairman of the Committee, his alternate). [DEL:
this
actions taken by the Foreign currency Subcommittee under
paragraph shall be reported promptly to the Committee.] MEETINGS OF
THE SUBCOMMITTEE SHALL BE CALLED AT THE REQUEST OF ANY MEMBER, OR AT
THE REQUEST OF THE MANAGER, FOR THE PURPOSES OF REVIEWING RECENT OR
CONTEMPLATED OPERATIONS AND OF CONSULTING WITH THE MANAGER ON OTHER
MATTERS RELATING TO HIS RESPONSIBILITIES. AT THE REQUEST OF ANY
MEMBER OF THE SUBCOMMITTEE, QUESTIONS ARISING FROM SUCH REVIEWS AND
CONSULTATIONS SHALL BE REFERRED FOR DETERMINATION TO THE FEDERAL
OPEN MARKET COMMITTEE.
7.
The Chairman [DEL:(and in his absence the Vice Chairman of the Committee,
and in the absence of bOth, the Vice Chairman of the Board of
Governors)]is authorized:
A. 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
Secretary]
currency operations between the System and the [DEL:
TREASURY;
B. To keep the Secretary of the Treasury fully advised
concerning System foreign currency operations, and to
consult with the Secretary on [DEL:
such]policy matters [DEL:
as may
relate to the Secretary's responsibility]RELATING TO
FOREIGN CURRENCY OPERATIONS; [DEL:
and]
C. From time to time, to transmit appropriate reports and
information to the National Advisory Council on
International Monetary and Financial Policies.
8. Staff officers of the Committee are authorized to transmit
pertinent information on System foreign currency operations to
appropriate officials of the Treasury Department.
9. 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.
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Action taken: January 6, 1978
Effective date: January 6, 1978
Pursuant to paragraph 1.D of the Authorization for Foreign
Currency Operations, the Committee expressly authorized an overall open
position in all foreign currencies of $1.5 billion.
Action taken: January 17, 1978
Effective date: January 17, 1978
Pursuant to paragraph 1.D of the Authorization for Foreign
Currency Operations, the Committee expressly authorized an overall open
position in all foreign currencies of $1.75 billion.
Action taken: February 28, 1978
Effective date: February 28, 1978
Pursuant to paragraph 1.D of the Authorization for Foreign
Currency Operations, the Committee expressly authorized an overall open
position in all foreign currencies of $2.0 billion.
Action taken: March 10, 1978
Effective date: March 11, 1978
The Committee authorized Chairman Miller to negotiate an
increase of up to $2 billion in the System's swap arrangement with the
German Federal Bank and also voted to approve a corresponding amendment
to the table in paragraph 2. On March 11, Chairman Miller approved a $2
billion increase in the swap arrangement with the German Federal Bank,
from $2 billion to $4 billion, and the amendment of the table was
effectuated.
Action taken: March 21, 1978
Effective date: March 21, 1978
Pursuant to paragraph 1.D of the Authorization for Foreign
Currency Operations, the Committee expressly authorized an overall open
position in all foreign currencies of $2.25 billion.
Action taken: May 16, 1978
Effective date: May 16, 1978
Pursuant to paragraph 1.D of the Authorization for Foreign
Currency Operations, the Committee expressly authorized an overall open
position in all foreign currencies of $2.0 billion.
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Action taken: June 20, 1978
Effective date: June 20, 1978
Pursuant to paragraph 1.D of the Authorization for Foreign
Currency Operations, the Committee expressly authorized an overall open
position in all foreign currencies of $1.5 billion.
In the interest of clarity and to make the language conform to
new language concurrently introduced in the procedural instructions,
paragraph 1.D was amended as follows:
D. To maintain an overall open position in all foreign
currencies not exceeding $1.0 billion, unless a larger
position is expressly authorized by the Committee. For
this purpose, the overall open position in all foreign
currencies is defined as the sum (disregarding signs) of
each curreney]INDIVIDUAL CURRENCIES.
[DEL:
open]NET positions in [DEL:
open] NET position in a single foreign currency is
The [DEL:
defined as holdings of balances in that currency, plus
outstanding contracts for future receipt, minus outstanding
contracts for future delivery of that currency, i.e., as
the sum of these elements with due regard to sign.
Action taken: October 27, 1978
Effective date: October 27, 1978
Pursuant to paragraph 1.D of the Authorization for Foreign
Currency Operations, the Committee expressly authorized an overall open
position in all foreign currencies of $2.0 billion.
Action taken:
Effective date:
October 31, 1978
November 1, 1978
On October 31, the Committee authorized Chairman Miller to take
certain actions--including the negotiation of increases in the System's
swap arrangements with the German Federal Bank, the Bank of Japan, and
the Swiss National Bank--to implement a program to strengthen the dollar
and to counter inflationary pressures, if he determined that
arrangements with other authorities were substantially as contemplated
in a consultation among members of the Committee on the preceding day.
The Committee also voted to approve a corresponding amendment to the
table in paragraph 2 and a delegation of authority to Chairman Miller to
expressly authorize an open position of $5 billion under paragraph 1.D
of the Authorization for Foreign Currency Operations.
On November 1, in accordance with the authority delegated to
him, Chairman Miller approved increases of $2 billion, $3 billion, and
$2.6 billion in the System's swap arrangements with the German Federal
Bank, the Bank of Japan, and the Swiss National Bank, respectively.
Chairman Miller also authorized an overall open position of $5 billion.
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Effective immediately, the table in paragraph 2 was amended to read as
follows:
The Federal Open Market Committee directs the Federal Reserve
Bank of New York to maintain reciprocal currency arrangements
("swap" arrangements) for the System Open Market Account for
periods up to a maximum of 12 months with the following foreign
banks, which are among those designated by the Board of
Governors of the Federal Reserve System under Section 214.5 of
Regulation N, Relations with Foreign Banks and Bankers, and
with the approval of the Committee to renew such arrangements
on maturity:
Foreign bank
Amount of arrangement
(millions of dollars equivalent)
Austrian National Bank
National Bank of Belgium
Bank of Canada
National Bank of Denmark
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Bank of Mexico
Netherlands Bank
Bank of Norway
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
Dollars against Swiss francs
Dollars against authorized European
currencies other than Swiss francs
250
1,000
2,000
250
3,000
2,000
6,000
3,000
5,000
360
500
250
300
4,000
600
1,250
Action taken: December 14, 1978
Effective date: December 14, 1978
Paragraph 1.A was amended to provide for transactions in
foreign currencies directly with the U. S. Treasury as well as with the
Exchange Stabilization Fund. As amended, part A of paragraph 1 read as
follows:
A.
To purchase and sell the following 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 U. S. TREASURY, with the
U. S. Exchange Stabilization Fund established by Section 10
of the Gold Reserve Act of 1934, with foreign monetary
authorities, with the Bank for International Settlements,
and with other international financial institutions:
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(The list of eligible currencies was unchanged in this
action.)
Action taken: December 19, 1978
Effective date: December 19, 1978
Pursuant to paragraph 1.D of the Authorization for Foreign
Currency Operations, the Committee expressly authorized an overall open
position in all foreign currencies of $8 billion.
Action taken: May 9, 1979
Effective date: May 9, 1979
Paragraph 5 was amended to authorize certain transactions to
provide investment facilities for System balances in foreign currencies.
As amended, paragraph 5 read as follows:
5. Foreign currency holdings shall be invested insofar as practicable,
Such investments
considering needs for minimum working balances. [DEL:
shall be in accordance with Section 14(c)of the Federal Reserve
Act.] WHEN APPROPRIATE IN CONNECTION WITH ARRANGEMENTS TO PROVIDE
INVESTMENT FACILITIES FOR FOREIGN CURRENCY HOLDINGS, U.S. GOVERNMENT
SECURITIES MAY BE PURCHASED FROM FOREIGN CENTRAL BANKS UNDER
AGREEMENTS FOR REPURCHASE OF SUCH SECURITIES WITHIN 30 CALENDAR
DAYS.
Action taken: August 14, 1979
Effective date: August 17, 1979
The table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of Mexico from $360 million
to $700 million.
Action taken: March 18, 1980
Effective date: March 18, 1980
Paragraph 6 was amended by substituting the title "Manager for
Foreign Operations" for "Manager" the first time the latter appeared, to
reflect changes in positions and titles relating to management of the
System Open Market Account that had taken place since the last annual
review of the Authorization.
Pursuant to paragraph 3, the Committee expressly authorized
the Federal Reserve Bank of New York to enter into contracts to purchase
foreign exchange at specified rates that reflected market rates of late
February and early March when contract discussions were initiated and
simultaneously to transfer the foreign exchange so acquired directly to
the ESF.
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Action taken: May 20, 1980
Effective date: May 23, 1980
Table in paragraph 2 was amended to increase the authorized
amount of the swap arrangement with the Bank of Sweden from $300 million
to $500 million, for a period of one year, after which the amount would
revert to $300 million.
Action taken: March 31, 1981
Effective date: March 31, 1981
The Committee adopted several amendments to simplify and
clarify its instructions to the New York Bank and to bring the document
up to date in light of recent developments. Paragraphs 1.D, 3, 5 and 6
were amended as follows:
1.D.
To maintain an overall open position in all foreign
unless a
$1.0]$8.0 billion[DEL:
currencies not exceeding [DEL:
larger position is expressly authorized by the Committee].
For this purpose . .
3. [DEL:
Currencies to be used for liquidation of System swap commitments may
be purchased from the foreign central bank drawn on, at the same
exchange rate as that employed in the drawing to be liquidated.
Apart from any such purchases at the rate of the drawing,]All
transactions in foreign currencies undertaken under paragraph 1.A
above shall, unless otherwise expressly authorized by the Committee,
be at prevailing market rates. FOR THE PURPOSE OF PROVIDING AN
INVESTMENT RETURN ON SYSTEM HOLDINGS OF FOREIGN CURRENCIES, OR FOR
THE PURPOSE OF ADJUSTING INTEREST RATES PAID OR RECEIVED IN
CONNECTION WITH SWAP DRAWINGS, TRANSACTIONS WITH FOREIGN CENTRAL
BANKS MAY BE UNDERTAKEN AT NONMARKET EXCHANGE RATES.
5. Foreign currency holdings shall be invested insofar as practicable,
considering needs for mimimum working balances. SUCH INVESTMENTS
SHALL BE IN LIQUID FORM, AND GENERALLY HAVE NO MORE THAN 12 MONTHS
REMAINING TO MATURITY. When appropriate . . .
6. All operations undertaken pursuant to the preceding paragraphs shall
be reported daily PROMPTLY to the Foreign Currency Subcommittee AND
THE COMMITTEE . .
Action taken: August 24, 1982
Effective date: August 28, 1982
Paragraph 2 was amended to include for the period through
August 23, 1983, a special reciprocal currency arrangement with the Bank
of Mexico of $325 million in addition to the regular $700 million
arrangement. (On August 23, 1983, the special reciprocal currency
arrangement with the Bank of Mexico expired as scheduled.)
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Action taken: October 1, 1985
Effective date: October 1, 1985
Paragraph 1.D was amended to raise the limit on the overall
open position in all foreign currencies from $8.0 billion to $10.0
billion.
Action taken: March 31, 1987
Effective date: March 31, 1987
Paragraph 1.D was amended to raise the limit on the overall
open position in all foreign currencies from $10.0 billion to $12.0
billion.
Action taken: May 16, 1989
Effective date: May 16, 1989
Paragraph 1.D was amended to raise the limit on the overall
open position in all foreign currencies from $12.0 billion to $15.0
billion.
Action taken: June 14, 1989
Effective date: June 14, 1989
Paragraph 1.D was amended to raise the limit on the overall
open position in all foreign currencies from $15.0 billion to $18.0
billion.
Action taken: August 22, 1989
Effective date: September 14, 1989
Paragraph 2 was amended to reflect a special reciprocal
currency arrangement of $125 million with the Bank of Mexico that was to
supplement the regular $700 million arrangement. The special facility
was part of a multilateral arrangement under which the Bank of Mexico
could draw up to $2 billion in short-term financing in support of its
Government's program for economic reform and growth. (Participants
included the U. S. Treasury through its ESF, central banks from the
other Group of Ten countries acting under the aegis of the Bank for
International Settlements, and the Bank of Spain.) The facility became
effective on September 14, and Chairman Greenspan, acting under a
delegation of authority from the Committee, gave final clearance on
September 22 for drawings by the Bank of Mexico on the reciprocal
currency arrangements. The final maturity date of the special facility
was set at February 15, 1990, and on that date the Bank of Mexico repaid
in full outstanding drawings on both facilities.
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Action taken: September 25, 1989
Effective date: September 25, 1989
Paragraph 1.D was amended to raise the limit on the overall
open position in all foreign currencies from $18.0 billion to $20.0
billion.
Action taken: December 18, 1989
Effective date: December 18, 1989
Paragraph 1.D was amended to raise the limit on the overall
open position in all foreign currencies from $20.0 billion to $21.0
billion.
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AUTHORIZATION FOR FOREIGN CURRENCY OPERATIONS
(As reaffirmed February 6, 1990)
1. The Federal Open Market Committee authorizes and directs the Federal
Reserve Bank of New York, for System Open Market Account, to the
extent necessary to carry out the Committee's foreign currency
directive and express authorizations by the Committee pursuant
thereto, and in conformity with such procedural instructions as the
Committee may issue from time to time:
A. To purchase and sell the following 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 U.S. Treasury, with the
U.S. Exchange Stabilization Fund established by Section 10
of the Gold Reserve Act of 1934, with foreign monetary
authorities, with the Bank for International Settlements,
and with other international financial institutions:
Austrian schillings
Belgian francs
Canadian dollars
Danish kroner
Pounds sterling
French francs
German marks
Italian lire
Japanese yen
Mexican pesos
Netherlands guilders
Norwegian kroner
Swedish kronor
Swiss francs
B. To hold balances of, and to have outstanding forward
contracts to receive or to deliver, the foreign currencies
listed in paragraph A above.
C. To draw foreign currencies and to permit foreign banks to
draw dollars under the reciprocal currency arrangements
listed in paragraph 2 below, provided that drawings by
either party to any such 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, specifically authorizes a delay.
D. To maintain an overall open position in all foreign
currencies not exceeding $21.0 billion. For this purpose,
the overall open position in all foreign currencies is
defined as the sum (disregarding signs) of net positions in
individual currencies. The net position in a single
foreign currency is defined as holdings of balances in that
currency, plus outstanding contracts for future receipt,
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minus outstanding contracts for future delivery of that
currency, i.e., as the sum of these elements with due
regard to sign.
2. The Federal Open Market Committee directs the Federal Reserve Bank
of New York to maintain reciprocal currency arrangements ("swap"
arrangements) for the System Open Market Account for periods up to a
maximum of 12 months with the following foreign banks, which are
among those designated by the Board of Governors of the Federal
Reserve System under Section 214.5 of Regulation N, Relations with
Foreign Banks and Bankers, and with the approval of the Committee to
renew such arrangements on maturity:
Foreign bank
Amount of arrangement
(millions of dollars equivalent)
Austrian National Bank
National Bank of Belgium
Bank of Canada
National Bank of Denmark
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Bank of Mexico
Regular
Special
Netherlands Bank
Bank of Norway
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
Dollars against Swiss francs
Dollars against authorized European
currencies other than Swiss francs
*
250
1,000
2,000
250
3,000
2,000
6,000
3,000
5,000
700
125 *
500
250
300
4,000
600
1,250
Facility with maturity date of February 15, 1990.
Any changes in the terms of existing swap arrangements, and the proposed
terms of any new arrangements that may be authorized, shall be referred
for review and approval to the Committee.
3. All transactions in foreign currencies undertaken under paragraph
1.A above shall, unless otherwise expressly authorized by the
Committee, be at prevailing market rates. For the purpose of
providing an investment return on System holdings of foreign
currencies, or for the purpose of adjusting interest rates paid or
received in connection with swap drawings, transactions with foreign
central banks may be undertaken at non-market exchange rates.
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4. It shall be the normal practice to arrange with foreign central
banks for the coordination of foreign currency transactions. In
making operating arrangements with foreign central banks on System
holdings of foreign currencies, the Federal Reserve Bank of New York
shall not commit itself to maintain any specific balance, unless
authorized by the Federal Open Market Committee. Any agreements or
understandings concerning the administration of the accounts
maintained by the Federal Reserve Bank of New York with the foreign
banks designated by the Board of Governors under Section 214.5 of
Regulation N shall be referred for review and approval to the
Committee.
5. Foreign currency holdings shall be invested insofar as practicable,
considering needs for minimum working balances. Such investments
shall be in liquid form, and generally have no more than 12 months
remaining to maturity. When appropriate in connection with
arrangements to provide investment facilities for foreign currency
holdings, U. S. Government securities may be purchased from foreign
central banks under agreements for repurchase of such securities
within 30 calendar days.
6. All operations undertaken pursuant to the preceding paragraphs shall
be reported promptly to the Foreign Currency Subcommittee and the
Committee. The Foreign Currency Subcommittee consists of the
Chairman and Vice Chairman of the Committee, the Vice Chairman of
the Board of Governors, and such other member of the Board as the
Chairman may designate (or in the absence of members of the Board
serving on the Subcommittee, other Board members designated by the
Chairman as alternates, and in the absence of the Vice Chairman of
the Committee, his alternate). Meetings of the Subcommittee shall
be called at the request of any member, or at the request of the
Manager for Foreign Operations, for the purposes of reviewing recent
or contemplated operations and of consulting with the Manager on
other matters relating to his responsibilities. At the request of
any member of the Subcommittee, questions arising from such reviews
and consultations shall be referred for determination to the Federal
Open Market Committee.
7. The Chairman is authorized:
A. 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 operations between the System and the Treasury;
B. To keep the Secretary of the Treasury fully advised
concerning System foreign currency operations, and to
consult with the Secretary on policy matters relating to
foreign currency operations;
C. From time to time, to transmit appropriate reports and
information to the National Advisory Council on
International Monetary and Financial Policies.
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8. Staff officers of the Committee are authorized to transmit pertinent
information on System foreign currency operations to appropriate
officials of the Treasury Department.
9. 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.
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APPENDIX C
FOREIGN CURRENCY DIRECTIVE
1966 TO DATE
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FOREIGN CURRENCY DIRECTIVE
(Adopted June 7, 1966)
1. The basic purposes of System operations in foreign currencies are:
A. To help safeguard the value of the dollar in international
exchange markets;
B. To aid in making the system of international payments more
efficient;
C. To further monetary cooperation with central banks of other
countries having convertible currencies, with the
International Monetary Fund, and with other international
payments institutions;
D. To help insure that market movements in exchange rates,
within the limits stated in the International Monetary Fund
Agreement or established by central bank practices, reflect
the interaction of underlying economic forces and thus
serve as efficient guides to current financial decisions,
private and public; and
E. To facilitate growth in international liquidity in
accordance with the needs of an expanding world economy.
2. Unless otherwise expressly authorized by the Federal Open Market
Comittee, System operations in foreign currencies shall be
undertaken only when necessary:
A. To cushion or moderate fluctuations in the flows of
international payments, if such fluctuations (1) are deemed
to reflect transitional market unsettlement or other
temporary forces and therefore are expected to be reversed
in the foreseeable future; and (2)are deemed to be
disequilibrating or otherwise to have potentially
destabilizing effects on U. S. or foreign official reserves
or on exchange markets, for example, by occasioning market
anxieties, undesirable speculative activity, or excessive
leads and lags in international payments;
B. To temper and smooth out abrupt changes in spot exchange
rates, and to moderate forward premiums and discounts
judged to be disequilibrating. Whenever supply or demand
persists in influencing exchange rates in one direction,
System transactions should be modified or curtailed unless
upon review and reassessment of the situation the Committee
directs otherwise;
C. To aid in avoiding disorderly conditions in exchange
markets. Special factors that might make for exchange
market instabilities include (1) responses to short-run
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increases in international political tension, (2)
differences in phasing of international economic activity
that give rise to unusually large interest rate
differentials between major markets, and (3) market rumors
of a character likely to stimulate speculative transactions. Whenever exchange market instability threatens to
produce disorderly conditions, System transactions may be
undertaken if the Special Manager reaches a judgment that
they may help to reestablish supply and demand balance at a
level more consistent with the prevailing flow of
underlying payments. In such cases, the Special Manager
shall consult as soon as practicable with the Committee or,
in an emergency, with the members of the Subcommittee
designated for that purpose in paragraph 6 of the
Authorization for System foreign currency operations; and
D. To adjust System balances within the limits established in
the Authorization for System foreign currency operations in
light of probable future needs for currencies.
3. System drawings under the swap arrangements are appropriate when
necessary to obtain foreign currencies for the purposes stated in
paragraph 2 above.
4. Unless otherwise expressly authorized by the Committee, transactions
in forward exchange, either outright or in conjunction with spot
transactions, may be undertaken only (i) to prevent forward premiums
or discounts from giving rise to disequilibrating movements of
short-term funds; (ii)to minimize speculative disturbances; (iii)
to supplement existing market supplies of forward cover, directly or
indirectly, as a means of encouraging the retention or accumulation
of dollar holdings by private foreign holders; (iv) to allow greater
flexibility in covering System or Treasury commitments, including
commitments under swap arrangements; (v) to facilitate the use of
one currency for the settlement of System or Treasury commitments
denominated in other currencies; and (vi) to provide cover for
System holdings of foreign currencies.
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AMENDMENTS TO THE FOREIGN CURRENCY DIRECTIVE SINCE JUNE 1966
Action taken: May 28, 1968
Effective date: May 28, 1968
Paragraph 4 was amended as a conforming change to the earlier
amendment, on November 14, 1967, of paragraph 1.C(1) of the
Authorization for System Foreign Currency Operations. These amendments
were required to authorize the Desk to warehouse foreign currencies for
the Treasury (no warehousing operations had been conducted up to this
time). As amended, paragraph 4 read as follows:
4. Unless otherwise expressly authorized by the Committee,
transactions in forward exchange, either outright or in
conjunction with spot transactions, may be undertaken only (i)
to prevent forward premiums or discounts from giving rise to
disequilibrating movements of short-term funds; (ii) to
minimize speculative disturbances; (iii) to supplement existing
market supplies of forward cover, directly or indirectly, as a
means of encouraging the retention or accumulation of dollar
holdings by private foreign holders; (iv) to allow greater
flexibility in covering System or Treasury commitments,
including commitments under swap arrangements, AND TO
FACILITATE OPERATIONS OF THE STABILIZATION FUND; (v) to
facilitate the use of one currency for the settlement of System
or Treasury commitments denominated in other currencies; and
(vi) to provide cover for System holdings of foreign
currencies.
Action taken: March 20, 1973
Effective date: March 20, 1973
Paragraphs 2.C and 2.D were amended to reflect the retitling of
the "Authorization for System Foreign Currency Operations" to
"Authorization for Foreign Currency Operations."
Action taken: February 19, 1975
Effective date: February 19, 1975
Paragraph 2.C was amended to reflect the elimination of the
position of Special Manager. Accordingly, in the two references to that
position the word "Special" was deleted.
Action taken: December 20, 1976
Effective date: December 28, 1976
The Foreign Currency Directive was broadly revised and
restructured to simplify and clarify the instructions to the Federal
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Reserve Bank of New York and to bring the document up to date in light
of changes under way in the international monetary system and its
functioning. The main substantive change was to omit the detailed
listing of basic purposes and specific objectives of System foreign
currency operations--many of which were anachronistic in the prevailing
circumstances--and to indicate instead that System operations were
generally to be directed at countering disorderly conditions in the
exchange markets. Other than a minor amendment made in 1979 and
indicated below, the Directive approved by the Committee on this date is
identical to the Directive as reaffirmed on February 6, 1990 (shown on
the next page).
Action taken: March 20, 1979
Effective date: March 20, 1979
Paragraphs 1 and 4.C of the Foreign Currency Directive were
amended to delete the word "proposed" preceding the references to IMF
Article IV, to reflect the fact that Article IV had been put in place
since the Committee had last conducted its annual review of its
continuing authorizations.
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FOREIGN CURRENCY DIRECTIVE
(Reaffirmed February 6, 1990)
1. System operations in foreign currencies shall generally be directed
at countering disorderly market conditions, provided that market
exchange rates for the U. S. dollar reflect actions and behavior
consistent with IMF Article IV, Section 1.
2. To achieve this end the System shall:
A. Undertake spot and forward purchases and sales of foreign
exchange.
B. Maintain reciprocal currency ("swap") arrangements with
selected foreign central banks and with the Bank for
International Settlements.
C. Cooperate in other respects with central banks of other
countries and with international monetary institutions.
3. Transactions may also be undertaken:
A. To adjust System balances in light of probable future needs
for currencies.
B. To provide means for meeting System and Treasury
commitments in particular currencies, and to facilitate
operations of the Exchange Stabilization Fund.
C. For such other purposes as may be expressly authorized by
the Committee.
4. System foreign currency operations shall be conducted:
A. In close and continuous consultation and cooperation with
the United States Treasury;
B. In cooperation, as appropriate, with foreign monetary
authorities; and
C. In a manner consistent with the obligations of the United
States in the International Monetary Fund regarding
exchange arrangements under IMF Article IV.
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APPENIX D
PROCEDURAL INSTRUCTIONS
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PROCEDURAL INSTRUCTIONS
(Adopted December 28, 1976)
In conducting operations pursuant to the authorization and
direction of the Federal Open Market Committee as set forth in the
Authorization for Foreign Currency Operations and the Foreign Currency
Directive, the Federal Reserve Bank of New York, through the Manager of
the System Open Market Account, shall be guided by the following
procedural understandings with respect to consultations and clearance
with the Committee, the Foreign Currency Subcommittee, and the Chairman
of the Committee. All operations undertaken pursuant to such clearances
shall be reported promptly to the Committee.
1. The Manager shall clear with the Subcommittee (or with the Chairman,
if the Chairman believes that consultation with the Subcommittee is
not feasible in the time available):
A. Any transaction which would result in a change in the
System's overall open position in foreign currencies
exceeding $100 million on any day or $300 million since the
most recent regular meeting of the Committee.
B. Any transaction which would result in gross transactions
(excluding swap drawings and repayments) in a single
foreign currency exceeding $100 million on any day or $300
million since the most recent regular meeting of the
Committee.
C. Any swap drawing proposed by a foreign bank not exceeding
the larger of (i) $200 million or (ii)15 per cent of the
size of the swap arrangement.
2. The Manager shall clear with the Committee (or with the
Subcommittee, if the Subcommittee believes that consultation with
the full Committee is not feasible in the time available, or with
the Chairman, if the Chairman believes that consultation with the
Subcommittee is not feasible in the time available):
A. Any transaction which would result in a change in the
System's overall open position in foreign currencies
exceeding $500 million since the most recent regular
meeting of the Committee.
B. Any swap drawing proposed by a foreign bank exceeding the
larger of (i) $200 million or (ii) 15 per cent of the size
of the swap arrangement.
3.
The Manager shall also consult with the Subcommittee or the Chairman
about proposed swap drawings by the System, and about any
transactions that are not of a routine character.
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Action taken: March 21, 1978
Effective date: March 21, 1978
Paragraph 1.B. was amended to read as follows:
B. Any transaction which would result in gross transactions
(excluding swap drawings and repayments AND PURCHASES AND
SALES OF ANY CURRENCIES INCIDENTAL TO SUCH REPAYMENTS), in a
$100]$200 million on any
single foreign currency exceeding[DEL:
$300] $500 million since the most recent regular
day or [DEL:
meeting of the Committee.
Action taken: June 20, 1978
Effective date: June 20, 1978
In order to make less cumbersome the consultation procedures
between the Desk and the Committee (or in some cases, the Foreign
Currency Subcommittee) paragraph 1.B. was amended to replace the limit
on gross transactions with a limit on changes in net positions in
individual currencies. In addition, a new paragraph 1.C. was inserted,
which called for clearance of any large-scale market operation in an
individual currency, and minor clarifying changes in language were made
to other paragraphs. The amended paragraphs read as follows:
l.A.
transaction]which would result in a change
Any OPERATION[DEL:
in the System's overall open position in foreign
currencies exceeding $100 million on any day or $300
million since the most recent regular meeting of the
Committee.
l.B.
transaction]which would result in A CHANGE
Any OPERATION[DEL:
IN THE SYSTEM'S NET POSITION [DEL:
gross transactions
(excluding swap drawings and repayments)]in a single
foreign currency exceeding $100 million on any day or
$300 million since the most recent regular meeting of the
Committee.
1.C.
ANY OPERATION WHICH MIGHT GENERATE A SUBSTANTIAL VOLUME
OF TRADING IN A PARTICULAR CURRENCY BY THE SYSTEM, EVEN
THOUGH THE CHANGE IN THE SYSTEM'S NET POSITION IN THAT
CURRENCY MIGHT BE LESS THAN THE LIMITS SPECIFIED IN 1.B.
1.D. [DEL:
C.] Any swap drawing proposed by a foreign bank not
exceeding the larger of (i) $200 million or (ii) 15 per
cent of the size of the swap arrangement.
2.A.
Any OPERATION [DEL:
transaction]which would result in a change
in the System's overall open position in foreign
currencies exceeding $500 million since the most recent
regular meeting of the Committee.
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3. The Manager shall also consult with the Subcommittee or the Chairman
about proposed swap drawings by the System, and about any OPERATIONS
[DEL:
transactions]that are not of a routine character.
Action taken: November 1, 1978
Effective date: November 1, 1978
In connection with the broad Government program to support the
dollar announced on November 1, Chairman Miller, in accordance with
authority delegated to him by the Committee the previous day, approved
the suspension of the intermeeting limit on changes in the System's
overall open position in foreign currencies specified in paragraph 2.A.
At the same time, the Foreign Currency Subcommittee approved
suspension--for the current intermeeting period--of the daily and
intermeeting limits on the change in the System's overall open position
and on the change in the System's net position in a single foreign
currency, as specified in paragraphs 1.A. and 1.B. respectively.
Action taken: December 19, 1978
Effective date: December 19. 1978
The Foreign Currency Subcommittee approved an indefinite
suspension of the daily and intermeeting limits specified in paragraphs
1.A. and 1.B.
Action taken: March 20, 1979
Effective date: March 20, 1979
The Committee decided to reinstate limits on paragraphs 1.A.,
1.B., and 2.A. The limits approved differed from those that had been in
effect prior to the suspension of the limits noted above. The amended
paragraphs read as follows:
1.A. Any operation which would result in a change in the
System's overall open position in foreign currencies
exceeding[DEL:
$100]$300 million on any day or[DEL:
$300]$600
million since the most recent regular meeting of the
Committee.
1.B.
Any operation which would result in a change ON ANY DAY
in the System's net position in a single foreign currency
exceeding[DEL:
$100 million on any day or $300 million since
the most recent regular meeting of the Committee] $150
MILLION, OR $300 MILLION WHEN THE OPERATION IS ASSOCIATED
WITH REPAYMENT OF SWAP DRAWINGS.
2.A.
Any operation which would result in a change in the
System's overall open position in foreign currencies
exceeding[DEL:
$500 million] $1.5 BILLION since the most recent
regular meeting of the Committee.
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Action taken: August 14, 1979
Effective date: August 14, 1979
To reflect changes in positions and titles relating to
management of the System Account, the procedural instructions were
amended as follows:
In the initial (unnumbered) paragraph, the reference to the
Manager was changed to read: "The Manager [DEL:
of the]FOR FOREIGN OPERATIONS,
System Open Market Account."
In paragraphs 1, 2, and 3, the phrase FOR FOREIGN OPERATIONS
was inserted after the word 'Manager'.
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PROCEDURAL INSTRUCTIONS
(Reaffirmed February 6,
1990)
In conducting operations pursuant to the authorization and
direction of the Federal Open Market Committee as set forth in the
Authorization for Foreign Currency Operations and the Foreign Currency
Directive, the Federal Reserve Bank of New York, through the Manager for
Foreign Operations, System Open Market Account, shall be guided by the
following procedural understandings with respect to consultations and
clearance with the Committee, the Foreign Currency Subcommittee, and the
Chairman of the Committee. All operations undertaken pursuant to such
clearances shall be reported promptly to the Committee.
1. The Manager for Foreign Operations shall clear with the Subcommittee
(or with the Chairman, if the Chairman believes that consultation
with the Subcommittee is not feasible in the time available):
A. Any operation that would result in a change in the System's
overall open position in foreign currencies exceeding $300
million on any day or $600 million since the most recent
regular meeting of the Committee.
B. Any operation that would result in a change on any day in
the System's net position in a single foreign currency
exceeding $150 million, or $300 million when the operation
is associated with repayment of swap drawings.
C. Any operation that might generate a substantial volume of
trading in a particular currency by the System, even though
the change in the System's net position in that currency
might be less than the limits specified in 1.B.
D. Any swap drawing proposed by a foreign bank not exceeding
the larger of (i) $200 million or (ii)15 percent of the
size of the swap arrangement.
2. The Manager for Foreign Operations shall clear with the Committee
(or with the Subcommittee, if the Subcommittee believes that
consultation with the full Committee is not feasible in the time
available, or with the Chairman, if the Chairman believes that
consultation with the Subcommittee is not feasible in the time
available):
A. Any operation that would result in a change in the System's
overall open position in foreign currencies exceeding $1.5
billion since the most recent regular meeting of the
Committee.
B. Any swap drawing proposed by a foreign bank exceeding the
larger of (i) $200 million or (ii)15 percent of the size
of the swap arrangement.
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3. The Manager for Foreign Operations shall also consult with the
Subcommittee or the Chairman about proposed swap drawings by the
System, and about any operations that are not of a routine
character.
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APPENDIX E
INFORMAL LIMITS ON HOLDINGS OF FOREIGN CURRENCIES
SEPTEMBER 1975 TO MARCH 1989
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INFORMAL UNDERSTANDINGS REGARDING LIMITS ON HOLDINGS OF FOREIGN CURRENCY BALANCES
(billions of dollars equivalent)
Limit on
total balances
Date
1975
1979
1980
1981
Limit on
total balances
excluding yen
Limits on individual currencies
All other
Yen
Marks
currencies
Sept. 16
.1
n.a.
n.a.
n.a.
n.a.
Dec.
16
.15
n.a.
n.a.
n.a.
n.a.
Feb.
6
.5
n.a.
n.a.
n.a.
n.a.
May
22
n.a.
1.0
(1/2 billion for
any single currency)
1.0
n.a.
n.a.
Oct.
21
n.a.
1.5
1.0
1.0
0.5
Nov.
7
n.a.
2.0
1.0
1.5
0.5
Dec.
18-19
n.a.
3.0
1.0
2.5
0.5
Feb.
2-3
n.a.
3.25
1.0
2.75
0.5
Mar.
31
4.25
n.a.
1.0
2.75
0.5
Aug.
18
4.5
n.a.
1.0
3.0
0.5
1982
Feb.
2
5.0
n.a.
1.0
3.5
0.5
1983
Mar.
28
5.5
n.a.
1.0
4.0
0.5
1984
Oct.
2
6.5
n.a.
1.0
5.0
0.5
1985
Oct.
1
10.0
n.a.
3.0
6.0
1.0
1987
Mar.
31
12.0
n.a.
3.0
8.0
1.0
1989
Mar.
28
Informal limits were terminated.
n.a. - No limit established.
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APPENDIX F
MEMRANDA RELATED TO SYSTEM FOREIGN EXCHANGE OPERATIONS
CIRCULATED TO FOMC, 1961 - 1989
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FOMC
MEMORANDA RELATED TO SYSTEM FOREIGN EXCHANGE OPERATIONS
NOTE:
In addition to the memoranda listed below, the
Manager for Foreign Operations (known as the
"Special Manager" prior to February 19, 1975)
provides detailed reports on foreign exchange
operations and related matters in weekly
memoranda to the Committee, intermeeting
summaries circulated prior to each meeting, and
annual reports to the Committee.
The Manager also prepares periodic reports
for publication on Treasury and Federal Reserve
foreign exchange operations. Four reports are
published each year. The first (covering the
period March 1961 - August 1962) appeared in the
September 1962 Federal Reserve Bulletin.
Distribution
Date
6/27/61
11/ 3/61
Federal Reserve Holdings of Foreign
Currencies
Young
International Cooperation of Central
Banks
Furth
System Operations in Foreign Currencies
Young
Paper No. 1: Proposed Actions by
Board of Governors
Paper No. 2: Proposed FOMC actions
Paper No. 3: Responsibility of the
Treasury and the Federal
Reserve for Foreign
Currency Operations (draft
for discussion with Treasury)
Paper No. 4: Guidelines for System Open
Market Operations in Foreign
Currencies
Paper No. 5: Aims and Scope of System
Foreign Exchange Operations
Paper No. 6: Legal Aspects of Proposed Plan
for Federal Reserve Operations
in Foreign Currencies (Hackley)
11/29/61
System Open Market Operations in Foreign
Currencies (Revised versions of papers
2, 3, 4, 5, and 6 circulated on 11/3/61)
Authorized for public release by the FOMC Secretariat on 1/31/2020
Young
-88-
System Operations in Foreign Currencies
(Revised versions of papers 1, 2, 4, and
5 circulated on 11/3/61 and a new paper
below)
Paper No. 7: Possible Amendments to Law
Young
Monetary Principles Underlying Federal
Reserve Holdings of Foreign Currencies
Thomas
1/ 8/62
Letter from Secretary Dillon to Chairman
Martin in support of System operations in
foreign currencies with enclosed copy of
related Dillon memo to the President
Dillon
1/ 8/62
Copy of opinion of Robert H. Knight,
General Counsel of the Treasury, re
the power under existing legislation of
the Federal Reserve to conduct operations
in foreign currencies
Young
1/19/62
FOMC Instructions Regarding Open Market
Transactions in Foreign Currencies
(Redraft and combination of papers 2
and 4)
Young
2/ 9/62
Young
New set of papers re proposed program for
System foreign currency operations:
1. Proposed FOMC action regarding
System operations in foreign
currencies
2. Proposed Guidelines for System
Foreign Currency Operations
3. Memorandum on understanding reached
between Treasury and FOMC staff
representatives on the scope and
character of initial foreign currency
operations of the System
4. (a) Proposed short-term program for
coordinated Treasury and System
operations in foreign currencies
(prepared by Treasury staff)
(b) Treasury memorandum on Treasury
and Federal Reserve foreign
currency operations and policies relationships and coordination
5. Proposed initial directive to FRB of NY
6. Treasury staff memorandum on "Treasury
Experience in the Foreign Exchange
Market"
7. Memorandum from Mr. Hackley on an
alternative approach to System foreign
currency operations (supervision by the
Board of Governors)
12/12/61
12/15/61
Authorized for public release by the FOMC Secretariat on 1/31/2020
Hackley
-89-
2/19/62
12/13/62
Statement of the Legal Authority for
Federal Reserve Foreign Exchange
Operations (furnished to Joint Economic
Committee and Chairmen of Senate and
House Banking and Currency Committees)
Hackley
Use of IMF Definition of a Convertible
Currency for Determining Whether to
Enter into Swap Arrangements
Furth
Request for Authorization of Forward
Exchange Operations
Coombs
10/17/63
Rationale of the System's Swap
Arrangements
Young,
Coombs
11/ 8/63
Request for Authorization of Spot
Purchases of Italian Lire and Other
European Currencies, and of Their
Simultaneous Forward Sales to the
U.S. Treasury
Coombs
Action on International Liquidity
Coombs
Commentary on Mr. Coombs' memo
Furth,
Young
7/28/65
Increases in Swap lines with German
Federal Bank and the BIS
Coombs
2/18/66
Proposed Reorganization of Instruments
Governing Foreign Currency Operations
Secretariat
3/21/66
Federal Reserve Operations in
Foreign Exchange, 1962-65
Baker
4/ 8/66
Commentary on Mr. Baker's memorandum
Coombs
4/27/66
Questions Relating to the System's
Foreign Exchange Operations
Furth
4/28/66
Revisions of Proposed New Instruments
Holland
2/26/63
5/20/65
Governing Foreign Currency Operations
5/ 9/66
Revision (see above) proposed by
Governor Mitchell
Holland
6/ 3/66
Sterling Balance Credit Package
Coombs
6/16/66
Text of Authorization for System Foreign
Currency Operations Adopted 6/7/66
Broida
Authorized for public release by the FOMC Secretariat on 1/31/2020
-90-
8/12/66
Disclosure of U.S. Official Foreign
Exchange Operations
Furth
8/18/66
Problems of Increasing Amounts of
Mutual Currency Arrangements
Furth
Contingency Planning re Sterling
and the Gold Markets
Coombs
2/ 1/67
Criteria for Increasing Membership
in the Federal Reserve Network of
Reciprocal Currency Arrangements
Staff
2/28/67
Application of Criteria (see above) to
Denmark, Mexico, Norway, and Venezuela
Staff
3/ 2/67
Record of Discussion on Publication
of Data on System Foreign Currency
Operations
Staff
4/28/67
Alternative Policies on the Disclosure
of System Operations in Foreign
Currencies
Staff
5/ 9/67
Swap Arrangements with Common Market
Countries: Discussions at Basle
May 6-7
Coombs
6/ 9/67
Maturity Dates of Swap Lines with
Common Market Central Banks
Coombs
Short-dated Sterling Swaps with U.S.
Commercial Banks
Coombs
2/28/68
Proposed Revisions in Authorization
for System Foreign Currency Operations
Secretariat
3/27/68
Recent Purchase of Swiss Francs at
Rate Other than Market Rate
Coombs
5/24/68
Proposed Revision of Foreign Currency
Directive
Secretariat
7/ 2/68
Legality of FR Participation in Proposed
Funding Arrangement for Sterling Balances
Hackley
6/ 3/68
Treasury Views Concerning "Backstopping"
of Federal Reserve Swap Arrangements
Staff
7/ 2/68
Legality of Federal Reserve Participation
in Proposed Funding Arrangement for
Sterling Balances
Hackley
12/ 5/67
Authorized for public release by the FOMC Secretariat on 1/31/2020
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7/15/68
Federal Reserve Participation in Proposed
Funding Arrangement for Sterling Balances
Holland
7/15/68
Draft letter from Secretary Fowler to
Chairman Martin concerning Treasury
backstop facilities for Federal Reserve
swap arrangements (actual letter, unchanged
from draft, was dated 7/23/68)
via Holland
1/31/69
Discussion of Questions Raised by Governor
Maisel Concerning System Foreign Currency
Operations
MacLaury
2/27/69
Proposed Technical Amendments to Authorization for System Foreign Currency
Operations
Secretariat
6/ 8/69
Request for a more Liberal Interpretation
of the $1 billion Warehousing Facility for
the Stabilization Fund
Coombs
Possible Increase in Swap Arrangements
with Austria, Denmark, and Norway
Coombs
1/26/70
Ireland as a Candidate for the Swap
Network
Coombs
3/23/70
Recommended Changes in Paragraphs 1B(4)
and 1C(2) of the Authorization for
System Foreign Currency Operations
Coombs
12/ 8/70
Proposed Modification of Procedures
to be Employed in Transactions under
Certain Swap Lines
Bodner
12/ 9/70
Dealing with the Overhang of Eurodollar Liabilities: Laissez-faire vs.
Taking Action to Discourage Outflows
Solomon
1/11/71
Euro-dollar problem: Federal Reserve
Matched Sale-Purchase Transactions
Staff
Legality of Matched Sale-Purchase
Transactions to Induce Banks to Retain
Euro-dollar Holdings
Hackley
1/18/71
Euro-dollar Reflow Problem
Coombs
1/29/71
Expression of Views on MSP Contingency
plan
Holland
5/ 4/71
System Drawings on Belgian Swap Line
Coombs
10/ 6/69
Authorized for public release by the FOMC Secretariat on 1/31/2020
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5/ 5/71
System Operations in Forward Marks
Coombs
8/16/71
Use of Swap Network
Solomon
1/ 5/72
System Losses on Foreign Exchange
Transactions in 1971
Bodner
3/13/72
Common Market Exchange Rate Policy
Coombs
3/20/72
Activation of Revaluation Clause in
Belgian Swap Arrangement
Coombs
4/17/72
Settlement of the Special Drawing
with Germany
Bodner
8/14/72
Letter from Secretary Shultz to Chairman
Burns (dated 8/8/72) confirming oral
understanding on use of System swap
facilities
via Broida
8/14/72
Letter from Fritz Leutwiler to C. Coombs
regarding swap-related transaction
via Broida
3/12/73
Proposed Changes in Titles of Committee
Policy Instruments and Amendments to
Foreign Currency Authorization
Secretariat
3/12/73
Recommendation that Committee Establish
Positions of Deputy Manager and Deputy
Special Manager
Holland
3/16/73
Foreign Official Holdings of United States
Treasury Debt--Issues and Problems
Staff, FRB
of NY
3/19/73
Staff
Foreign Official Holdings of United States
Treasury Debt--Issues and Problems (Comment
(Hersey,
Keir)
on 3/16 memo from New York Bank Staff)
3/30/73
Memo attaching list of Members and
Officers, Authorization for Domestic
Open Market Operations, Authorization for
Foreign Currency Operations, and Foreign
Currency Directive
Broida
4/23/73
Report on Banks' Operations during
Exchange Market Crisis Preceding
February 12 Devaluation
Staff
5/10/73
Reserve Requirements on CDs, Euro-dollars,
and Related Proposals
Divisions
of R&S & IF
Authorized for public release by the FOMC Secretariat on 1/31/2020
-93-
5/23/73
Certain Procedures with Respect to
Information on Federal Reserve and
Treasury Intervention in Foreign
Exchange Markets
Volcker
3/15/74
Designation of Alternates for FOMC
Broida
Subcommittee
Draft letter to Treasury Secretary re
possible use by Italy of the Federal
Reserve swap line
Burns
10/11/74
Considerations Underlying a Subcommittee
Decision Regarding Repayment of Belgian
Franc Swap Debt
Hayes,
Mitchell,
Wallich
11/ 5/74
Report on Foreign Official Investment
in U.S.--The Federal Reserve's Role
Meek
11/ 5/74
Report on FR Guarantee of Acceptances
Held for Foreign Accounts
Sternlight
2/10/75
Burns' Meeting with Leutwiler & Klasen
Broida
3/17/75
Review of Factors Underlying Recent
Dollar Decline and Implications for
Federal Reserve Intervention Policies
Pardee
4/11/75
System Intervention - Reuss & Burns
Broida
5/ 2/75
Exchange Market Implications of Recent
Changes in Valuation of OPEC Currencies
Kubarych
5/14/75
Foreign Account Repurchase Agreements
Handled by the Trading Desk
Cooper
6/24/75
Subcommittee on Foreign Currency
Instruments
Altmann
8/13/75
Possible Increase in Swap Line with
Board's IF
7/15/74
Bank of Mexico
Division
8/18/75
Doubling of the Swap Arrangement with
the Bank of Mexico and Possible Drawing
in Full by that Bank
Holmes
1/15/76
Loss Sharing Agreement with the Swiss
Holmes
National Bank
3/30/76
Recent Exchange Market Developments:
Analysis and Prospects
Authorized for public release by the FOMC Secretariat on 1/31/2020
Truman
-94-
4/15/76
Request for $360 Million Swap Drawing
Pardee
by Bank of Mexico
4/15/76
Recent Economic and Financial Developments
in Mexico and Prospects for 1976-77
(Attached to Pardee memo 4/15/76)
Maroni
8/18/76
Austrian Swap Line
Broida
10/27/76
Authorization Relating to Repayment of
Swiss Franc Debt
Broida
11/12/76
Report of Subcommittee on Foreign
Currency Instruments
Foreign
Currency
Subcommittee
12/14/76
Subcommittee Recommendations for Revised
Foreign Currency Instruments
Broida
12/17/76
Additional Subcommittee Recommendations
for Revised Foreign Currency Instruments
Broida
12/28/76
Adoption of Rewording of Paragraph 4 of
Foreign Currency Directive
Altmann
1/17/77
Background Information on System
"Warehousing" of Foreign Currency
Morton
1/17/77
Materials Relating to Official Sterling
Balances Facility
Broida
5/18/77
Procedures for Federal Reserve System
Foreign Currency Operations
Hopper
6/14/77
The Use of Repurchase Agreements for
Foreign Central Banks and International
Institutions
Volcker
6/15/77
The Use of Repurchase Agreements for
Foreign Central Banks and International
Institutions
O'Connell,
Gemmill,
Keir
6/15/77
Pros and Cons of System Matched-Sale
Purchase Transactions with Foreign
Accounts (attached to above memo)
Gemmill,
Keir
Foreign Currency Subcommittee Actions
Related to Countering Disorderly
Conditions in Foreign Exchange Markets
Broida
12/ 9/77
Authorized for public release by the FOMC Secretariat on 1/31/2020
-95-
The Federal Reserve Role in Providing
Short-Term Investment Facilities to
Foreign Central Banks and International
Institutions
Volcker
2/14/78
Agreement to Warehouse Foreign Currencies
for ESF
Truman
2/17/78
Notification of Foreign Currency Subcommittee Increase of the Limits on Open
Position and Gross Transactions in a
Single Currency for Intermeeting Period
from $300 to $500 Million
Broida
3/14/78
Agreement to Warehouse Foreign Currencies
for ESF
Truman
3/16/78
Report of Ad Hoc Subcommittee on Certain
Foreign Currency Matters
Wallich
4/ 3/78
Correspondence with Treasury re Swap
Lines with Bundesbank, ESF
Wallich
5/12/78
Status of Negotiations with Bundesbank
on Means of Repayment of Swap Drawings
Holmes
5/12/78
Increase in Foreign Currency Limit in
Intermeeting Period
Broida
6/15/78
Recommendations with Respect to
Procedural Instructions
Ad Hoc SubCommittee
on Foreign
Exchange
Materials Relating to Disorderly
Markets
Ad Hoc SubCommittee
12/13/77
on Foreign
Exchange
Some Observations on Disorderly Markets
(distributed in above package)
Smith
A Response to Governor Wallich's February
13 Note on Definition of Exchange Market
Disorder (distributed in above package)
Sleeper
7/10/78
System D-Mark Purchases in Connection with
German Government Payments to U.S.
Wallich
8/ 7/78
Revised Authorizations and Directives-Domestic, Foreign, and Procedural
Instructions
Altmann
Authorized for public release by the FOMC Secretariat on 1/31/2020
-96-
Swap Arrangements--Dr. Gleske's
Recommendations to Amend
Holmes,
Pardee
3/14/79
Limits on Foreign Currency Operations
Axilrod,
Holmes
3/16/79
Operations in Foreign Currencies
During 1978
Pardee
4/11/79
Holdings of Foreign Currency Balances
Axilrod,
Holmes
Holdings of Foreign Currency Balances
by the Federal Reserve (attached to
above memo)
Holmes,
Pardee
4/18/79
Price Adjusted Exchange Rate Index
Truman
5/17/79
Foreign Currency Holdings
Axilrod,
Holmes
7/ 3/79
The Mexican Swap Line
Pardee,
Truman
7/10/79
Potential Exchange-Market Impact of a
Lowering of the Fed-Funds Rate Target
Balles
8/ 7/79
Correspondence with Director General
of Bank of Mexico
Miller
8/10/79
Proposed Increase in Swap Arrangement
with the Bank of Mexico
Pardee
9/13/79
Suspension of Daily Limits in Foreign
Currency
Altmann
The Bundesbank's Foreign Exchange Swaps:
Recent Experience
Wilson
3/12/80
Renewal of Agreement to Warehouse Foreign
Currencies for ESF and the Treasury
Truman
5/19/80
Request by Swedish Riksbank for an
Increase in the Swap Line
Partee,
Caprio
10/10/80
&10/14/80
Background Material on Proposed Changes
in Terms on Federal Reserve Swap Drawings
Morton
12/12/80
Background Material on System Foreign
Currency Operations
Truman
10/ 3/78
12/18/79
Attachment A --
Foreign Currency Directive (3/18/80)
Authorized for public release by the FOMC Secretariat on 1/31/2020
-97-
Attachment B --
IMF Article IV - Obligations Regarding
Exchange Arrangements
Attachment C --
U.S. Holdings of Foreign Currency
Balances (4/10/79)
Morton,
Truman
12/18/80
Update of Table I to 12/12/80 Report
(listed above)
Truman
1/22/81
The New Approach to Monetary Policy-A View From the Foreign Exchange
Trading Desk
Greene
3/81
Operations in Foreign Currencies
During 1980
Staff
3/24/81
Proposed Changes in the FOMC's Foreign
Currency Instruments
Staff
3/25/81
Renewal of Agreement to Warehouse
Foreign Currencies for the ESF and
the Treasury
Truman
4/ 2/81
Special System Objective R-2, 1979:
Implications of a Floating Exchange
Rate Regime
Shafer
9/28/81
SDR-Denominated Deposit Facilities
for the IMF at the New York Bank
Adams,
Truman,
Schwartz
3/16/82
Renewal of Agreement to Warehouse
Foreign Currencies for the ESF and
the Treasury
Truman
3/15/83
Renewal of Agreement to Warehouse
Foreign Currencies for the ESF and
the Treasury
Truman
4/ 6/83
Holdings of Foreign Currency Balances
Steele
3/19/84
Renewal of Agreement to Warehouse
Foreign Currencies for the ESF and
the Treasury
Truman
Foreign Currency Subcommittee Action
Axilrod
System Investments of Foreign
Currency Holdings
Cross
10/17/85
2/10/86
Authorized for public release by the FOMC Secretariat on 1/31/2020
-98-
8/13/86
Proposed Bridge Financing Arrangements
for Mexico
Volcker
8/27/86
Bridging Arrangements for Mexico
Bernard
4/ 2/87
Operations in Foreign Currencies
During 1986
Cross
8/11/88
Increase in Intermeeting Limit on Changes
in Holdings of Foreign Currencies
Bernard
3/15/89
Formal and Informal Limits on System
Holdings of Foreign Currency Balances
Cross
7/26/89
Mexico (prospective FOMC participation
in financing arrangements)
Truman
8/18/89
Proposed Swap Drawing by Mexico for
Bridge Financing
Attachment: Update of Memorandum
on Mexico by Y. Maroni
Truman,
Cross
Authorized for public release by the FOMC Secretariat on 1/31/2020
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I-FOMC
March 9, 1990
(FR)
EVOLUTION OF U.S. EXCHANGE RATE POLICY
CONTENTS
I. Overview .................................................
1
II.
3
1958 to March 1973 ..............
Bretton Woods regime:
5
A. Broad objectives of U.S. exchange rate policy .......
6
B.
Operational objectives and tactics ..................
C. Major episodes and U.S. responses ................. 12
III.
Managed floating: March 1973 to date .................
A. Broad objectives of U.S. exchange rate policy .......
B.
Operational objectives and tactics ..................
C. Major episodes and U.S. responses ...................
17
21
24
26
* Prepared principally by Dianne Pauls, Divison of International Finance,
Board of Governors. Many colleagues provided useful comments; I
would like especially to thank Sam Cross, Margaret Greene, Ralph Smith,
and Edwin Truman.
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I-FOMC
I.
(FR)
Overview
This paper traces the evolution of U.S.
from 1958 to present.
the United States'
exchange rate policy
Under the Bretton Woods regime of fixed parities,
obligation was to stand ready to convert dollars into
gold for foreign monetary authorities at the official price of $35 per
ounce.
With this guarantee,
U.S.economy,
with gold,
and given the dominant position of the
the dollar was the principal reserve currency and, along
the principal reserve asset.
The overriding objective of U.S.
exchange rate policy under the
Bretton Woods regime was to maintain the value of the dollar as a leading
standard of value and the principal reserve currency.
Because the
dollar's value depended on the credibility of the offer to convert
dollars into gold for foreign authorities,
of U.S.
in
the key operational objective
policy was to protect the gold stock.
Direct U.S.
intervention
the market was extremely limited under the Bretton Woods system; U.S.
operations primarily consisted of redeeming official foreign acquisitions
of dollars into gold, or later into own foreign currencies in
lieu of
conversion into gold.
Eventually, pressures on the fixed parity system from divergent
economic policies,
structural changes in
the world economy,
and resulting
payments imbalances proved to be too great, and the system collapsed.
After attempts to restore the fixed rate system failed,
it
was replaced
on a de facto basis with generalized floating against the dollar in March
1973.
This mixed system (with major currencies floating,
individually or as a block,
either
and some other currencies being pegged) was
Authorized for public release by the FOMC Secretariat on 1/31/2020
the Second Amendment to the IMF's Articles of Agreement,
codified in
adopted in
-2-
(FR)
STRICTLY CONFIDENTIAL
CLASS I-FOMC
1978.¹
1976 and effective in
Since 1976,
the basic objective of U.S.
been to counter "disorderly market conditions".
For much of the time,
this objective was interpreted narrowly, and U.S.
one of very limited intervention.
defined,
low,
in
however,
in
exchange rate policy has
policy was basically
The objective was more broadly
1977-79 when the dollar was regarded as unacceptably
1985 when the dollar was deemed to be excessively high,
February 1987 when U.S.
and since
exchange rate policy has been guided by general
notions about the limits of tolerance for exchange rates agreed to at
Louvre and subsequent G-7 meetings.
Moreover,
during those periods,
the
the
level of the dollar was also a consideration in U.S. monetary policy
deliberations because of its
and,
in
1985,
implications for domestic price pressures
for the health of the manufacturing sector.
One frequently used gauge of intervention activity, is its
magnitude relative to the size of the U.S.
this metric,
substantial.
total intervention in
current account position.
1977-79 and 1987 was quite
Total net official purchases of dollars in
than twice as large as the U.S.
By
1978 were more
current account deficit of $15 billion
in
¹ The international exchange rate arrangements under which the United
States operates are part of U.S. law in the form of the Bretton Woods
Agreements Act that was first
enacted on July 31, 1945, establishing the
par value system, and was subsequently amended on October 19, 1976,
approving the Second Amendment of the IMF Articles of Agreement.
Initially, the par value of the dollar was defined by the President at
$35 per ounce of gold under the authority granted to him by the Gold
Reserve Act of 1934.
Congress modified the par value of the dollar to
$38 per ounce of gold in the Par Value Modification Act, passed in
February 1972.
This Act was subsequently amended in September 1973, to
redefine the par value as $42.22 per ounce of gold.
When the Second
Amendment to the Articles of Agreement was approved on October 19, 1976,
Congress repealed the Par Value Modification Act, but retained the value
of $42.22 per ounce of gold for the purpose of valuing the U.S. gold
stock so that the Treasury could monetize its holdings.
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I-FOMC
that year,
and in
1987,
(FR)
-3-
the central banks of major industrial countries
effectively financed more than two-thirds of the (much larger) U.S.
The U.S.
current account deficit of $144 billion.
official purchases amounted to $9.5 billion in
1987.
In
contrast,
U.S.
share of these
1978 and $8.5 billion in
intervention was the largest by far during 1989,
when net official U.S. sales of dollars totaled $22 billion.² Net
official foreign sales of dollars were more than $55 billion in
1989.
The paper divides the past 30 or so years into two regimes -Bretton Woods and managed floating.
The discussion of each regime begins
with a consideration of the broad objectives of U.S.
in
that regime,
tactics,
II.
exchange rate policy
followed by a discussion of operational objectives and
and a review of major episodes.
Bretton Woods regime:
1958 to March 1973
Although the Bretton Woods agreements were signed in 1945,
it
was not until the end of 1958, when most major foreign currencies were
convertible for the private sector into dollars for current account
transactions,
that the system of fixed exchange rates envisaged at
Bretton Woods became fully functional.
Under the Bretton Woods System,
par values were established for IMF member countries in terms of gold or
the U.S.
dollar of specified gold content.
Foreign monetary authorities
were obliged to intervene in reserve currencies to maintain the value of
their currencies within 1 percent of their parities.
countries,
this intervention occurred in dollars.
For major
The U.S.
Treasury
stood ready to buy or sell gold to or from foreign monetary authorities
² Since the central banks of the world, on net, made substantial sales
of dollars during 1989, while the U.S. current account deficit remained
quite large, private capital inflows into the United States during 1989
were massive.
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I-FOMC
-4-
(FR)
With this guarantee and given
at the official price of $35 per ounce.
the dominance position of the U.S.
economy,
the dollar was the principal
reserve currency and, along with gold, the principal reserve asset.
Sterling continued as a reserve currency, but only a minor one for
countries not part of the Commonwealth.
Because the responsibility for exchange market intervention was
with foreign authorities, direct U.S. intervention during the Bretton
During the period to August 15,
Woods era was extremely limited.
1971,
when official holdings of dollars were convertible into gold, U.S.
operations
largely were restricted to redeeming official foreign
of dollars for gold or,
acquisitions
later,
where
for own currencies,
such redemptions were financed through the Federal Reserve swap network
and Roosa bonds.
inconvertible
and still
It
was only after
the dollar had been declared
into gold, had been devalued in
was under downward pressure,
much intervention
in
the market
the Smithsonian Agreement,
that U.S.
authorities
began to do
(as opposed to redemptions of official
holdings of dollars).
The Treasury conducted its operations,
its
Exchange Stabilization Fund (ESF).3
which began in
Until 1962,
1961,
from
the System had no
3. The ESF was established by the Gold Reserve Act of 1934 with the
purpose of stabilizing
the exchange value of the dollar.
Its
initial
capital of $2 billion
derived from the proceeds of the revaluation of the
U.S. gold stock
from $20.67 to $35.00 per ounce.
Subsequently, the
Bretton Woods Agreements Act directed the Secretary of the Treasury to
from the ESF for the U.S. quota subscription in the IMF,
pay $1.8 billion
thereby reducing the ESF's appropriated capital to $200 million.
The ESF
grew over time through subsequent revaluations of gold, interest
receipts, and any profits resulting from foreign exchange operations.
Beginning in
1978, SDRs allocated by the IMF to the United States or
otherwise acquired by the United States became resources of the ESF, and
the ESF was authorized to issue SDR certificates
to the Federal Reserve
to help finance its
foreign currency operations.
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permanent basis for operations except as agent for the Treasury, though
operated on a very limited ad hoc basis in the forward
the System
exchange market in 1961.
(See Task Force papers "Evolution of Formal
for FOMC Oversight of System Foreign Exchange Operations" and
Procedures
"Legal Bases for Foreign Exchange Operations".)
A.
Broad objectives of U.S. exchange rate policy
establishing the Bretton Woods system, the IMF's Articles of
In
Agreement placed great stress on exchange rate stability,
in an effort
to
the kind of competitive devaluations that were viewed as
discourage
having contributed to economic and financial chaos in the 1920s and
1930s.
The Articles of Agreement permitted adjustment of a currency's
par value essentially only if a country's balance of payments was in
"fundamental disequilibrium".
practice,
it
This was an imprecise concept,
and,
in
came to mean that adjustment of exchange rates would be used
only as a last resort and in conjunction with policies to redress the
disequilibrium.
Given the widespread concern about competitive devaluations and
the goal of maintaining a system of fixed exchange rates, the overriding
objective of U.S.
value of the
exchange rate policy was the maintenance of a fixed par
dollar,
with the aim of providing a fixed center for the
world's monetary structure by keeping the dollar (along with gold) a
leading standard and store of value.
Revaluations of foreign currencies
against gold and the dollar were more readily accepted than devaluations,
which were
tolerated only if
seen as unavoidable.
Devaluation of the
dollar, even if it could be accomplished, was ruled out by most
policymakers as likely to have disturbing effects on the world economy by
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undermining confidence in
the fixed exchange rate system and increasing
the propensity to shift reserves out of dollars and into gold.
B.
Operational objectives and tactics
The convertibility by official holders of dollars into gold at a
fixed price was the linchpin of the Bretton Woods system.
However,
the
credibility of the offer to convert dollars into gold began to be
questioned
in
the early 1960s.
in
cumulate deficits
its
At that time,
the United States began to
balance of payments as U.S.
residents continued
to invest in the reconstruction of Western Europe and Japan, and those
economies enjoyed relatively larger gains in productivity and increased
competitiveness.
authorities
in
4
The dollars that were acquired by foreign monetary
as they intervened to maintain the value of their currencies
the face of growing U.S.
purchase gold from the U.S.
payments deficits increasingly were used to
Treasury,
after foreign authorities had
acquired what were regarded as adequate dollar balances.
were not immediately demanded,
demanded in the future.
there remained the threat that it
the dollar's role as a leading standard of
the protection of the U.S.
objective of U.S.
could be
To preserve the credibility of the offer to
convert dollars and, with it,
value,
Even if gold
gold stock became the key operational
policy.
4. Various concepts of the balance of payments were used. Analysis of
longer-run fundamentals tended to focus on the basic balance, which
consists of the current account plus net long-term capital.
From the
perspective of potential claims on the gold stock, however, the official
settlements basis -- the basic balance plus net private short-term
capital -- is the relevant concept.
5. Between 1957 and August 1971, the Treasury sold on net about $12-1/2
billion worth of gold, reducing its gold stock by more than 50 percent.
Sales to France and in the London gold market to stabilize the free
market price around the official price accounted for a large portion of
this total.
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A major policy response was to substitute credit facilities -the FR swap network,
Roosa bonds,
lending capacity of the IMF -or gold.
and a greatly expanded potential
for international settlements in dollars
In part because the resources of ESF were so meager, a network
of reciprocal currency agreements (swap facilities) was established by
the Federal Reserve with all the major foreign central banks and the BIS
after the FOMC authorized the System in
in
operations
was activated,
foreign currencies.
February 1962 to conduct
When such a standby swap arrangement
the Federal Reserve received foreign currency,
counterparty central bank received dollars.
Both parties agreed to
reverse the transaction on a specified date in
exchange rate
and the
the future at the same
via a simultaneous forward contract.
However,
if
the
foreign currency proceeds of the swap drawing had been disbursed,
would have
they
to be repurchased in the market or obtained from another
source before the original transaction could be reversed.
counterparty revalued its
currency in
be incurred by the drawing party.
If
the foreign
the interim, a potential loss would
Therefore,
the swap agreement also
included special provisions to protect the party that drew on the swap
line against this eventuality.
(No protection was provided for
situations
in
credit was
explicitly short-term,
which the drawing party devalued its
currency.)
Swap
and was intended to finance or
accommodate
short-term capital flows believed to be seasonal or
temporary.
It was not intended to be used in situations where the
balance of payments was thought to require more fundamental adjustment.
For its
part,
the Federal Reserve mostly used its
excess dollars held at foreign central banks,
swap drawings to mop up
thereby transferring
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Otherwise,
risk from them to the Federal Reserve.
exchange rate
those
dollars could have been converted into gold.
To obtain medium-term credit,
--
Roosa bonds
the Treasury issued so-called
medium-term bonds denominated in
foreign currencies --
to
official institutions of foreign countries intermittently from 1962 to
1971.
Roosa bonds were issued in marks,
and Austrian schillings.
Belgian francs,
also called Roosa bonds -rate provisions.
denominated in
Swiss francs,
Italian lira,
There were earlier issues -dollars with special interest
Both types of bonds were designed to be attractive to
foreign monetary authorities as an alternative to converting dollars into
gold.
Part of the foreign-currency proceeds from Roosa bonds was used to
extinguish
swap debt that otherwise would have lingered beyond the 1-year
limit set by the FOMC on swap drawings.
Finally, the Treasury also could obtain foreign currencies by
drawing on
its
credit facilities with the IMF.
However,
prior to 1961,
the IMF's supply of usable non-dollar currencies was limited by the small
size of the quotas of other members of the Fund.
In 1961,
States negotiated with the other Group of Ten (G-10)
the United
countries and
Switzerland an increased availability of their currencies to the IMF
under the General Arrangements to Borrow.
Nevertheless,
States was
reluctant to borrow from the Fund because it
subject its
economic policies to the Fund's conditions.
A
the United
did not want to
second tactic for protecting the gold stock was to try to
stabilize the private market price of gold around the official price of
$35 an ounce.
The United States was concerned that if
the market price
were allowed to rise appreciably above the official price,
foreign
central banks would want to convert their dollar holdings into gold.
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eliminate this potential source of pressure on U.S.
gold reserves,
in
1961 the United States and seven other countries formed the Gold Pool, a
consortium
to sell gold in the London market in order to keep the market
price of gold below $35.20 an ounce (roughly the cost of delivering loco
London gold purchased in New York).
The United States' nominal share of
Gold Pool sales was 60 percent, but, in fact, it was larger because some
central banks converted the dollar proceeds of their gold sales at the
gold window in order to replenish their gold stocks.
Although the Gold
Pool was later extended to be a gold-buying as well as selling syndicate,
the bulk of its transactions were sales, and, given the large U.S. share,
in the end
these played a major role in the decline in U.S. gold
reserves.
Ultimately, the Gold Pool was closed in March 1968, and a two-
tier market was adopted for gold with a fixed price for official
transactions and a flexible price in the private market.
The United
States continued to sell gold to foreign monetary authorities at $35 an
ounce, and
they, in turn agreed not to sell gold in the private market.
The amount of U.S. gold reserves that were "free" or available
for transactions with foreign monetary authorities was limited by the
legal restriction that U.S. authorities hold a portion of the gold stock
as backing
for domestic currency.
This 25 percent gold cover on currency
was repealed, also in March 1968, freeing up additional U.S. gold
reserves for international settlement.
The third tactic for protecting the gold stock was to redress
the payments deficit directly.
out by U.S.
Since devaluation of the dollar was ruled
policy and could not be accomplished unilaterally in any
case, and the deficit in the early 1960s was largely the result of
capital outflows -- American portfolio and direct investment abroad,
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particularly in Western Europe and Japan, and foreign borrowing in the
United States -sources of
three programs of capital restraints targeting the three
outflow were adopted.
initiated in
The interest equalization tax,
1963, was a reaction to the rising issuance of foreign bonds
in the United States as other countries failed to develop their markets
for these issues.
both bonds
The tax applied to purchases of foreign securities --
and stocks --
prohibitive.
in the U.S. market and was essentially
Lending abroad by banks and other financial institutions
was capped by the Federal Reserve's Voluntary Credit Restraint program,
established in 1965.
Direct foreign investment by U.S. corporations
was limited by the Commerce Department program, begun on a voluntary
basis in
1965,
but made mandatory in
1968.
While trying to remedy the payments deficit, U.S. policymakers
recognized
the need to provide a systematic means for growth in
international liquidity.
generate a
An expanding world economy could be expected to
secular increase in the demand for international reserves --
dollars and gold --
a demand that had been met by a build-up of official
claims on the United States as foreign monetary authorities intervened to
maintain the value of their currencies against the dollar.
This increase
in U.S. official liabilities, however, was not matched by a rise in the
U.S.
gold stock, and hence confidence in
the ability of the United States
to meet future calls on the gold stock declined.
Thus,
reliance on U.S.
liabilities to foreign official institutions as the sole source of an
6. Canada was exempted from both the interest equalization tax and the
Voluntary Credit Restraint Program on the understanding that Canada would
not serve as a conduit for capital flows to the rest of the world.
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increase in world reserves clearly was at odds with attempts to maintain
the convertibility of dollars into gold.
Two alternative proposals for alleviating this dilemma were
made.
The
first was an increase in the official price of gold against
all currencies, leaving exchange rates unchanged.
the United States on several grounds.
This was opposed by
U.S. authorities feared that once
they demonstrated a willingness to raise the price of gold, speculation
of further price increases would create strong buying pressure on gold,
and the system of fixed parities would collapse.
In addition, the United
States opposed various proposals for an increase in the price of gold on
equity grounds.
Such proposals would benefit countries that had
converted their dollar reserves into gold at the expense of countries
that had been cooperative in refraining from demanding gold, so-called
low gold-ratio countries.
Furthermore, for political reasons the United
States objected to a scheme that benefited the large gold producers,
South Africa and the Soviet Union.
As the U.S. balance of payments
continued to deteriorate in the late 1960s, the proposal to revalue gold
included a
devaluation of the dollar against other currencies.
In this
instance, not only would low gold-ratio countries lose relatively because
they had a
smaller proportion of gold in reserves, but they would also
lose absolutely because their dollar holdings would be devalued.
The
United States felt this would put it in a difficult position vis-a-vis
those countries that had been the most cooperative in not using the gold
window.
Rather than revalue gold, the United States proposed creating
another type of reserve asset whose supply could be systematically
increased as the world economy expanded.
This proposal resulted in an
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agreement to
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create the SDR (Special Drawing Rights on the International
Monetary Fund) through the First Amendment to the IMF Articles of
Agreement,
allocations
tend to blur
SDR
adopted in 1968 and effective the following year.
to IMF member countries are based on IMF quotas,
and thereby
distinctions between high and low gold-ratio countries.
value of the SDR initially
ounce of gold.7
was defined in
The
terms of gold at SDR 35 per
Following the establishment of the SDR, the United
States increasingly favored a reduction in
the role of gold as a reserve
asset in the international monetary system.
C.
Major episodes and U.S. responses
Given the strains that divergent macroeconomic policies,
structural
changes in the world economy, and resulting payments
imbalances
placed on the Bretton Woods system, currencies were devalued/
revalued or
allowed to float upon occasion when all else failed.
Revaluations were generally welcomed by the United States, and
devaluations were tolerated if
when sterling
States was
they were seen as unavoidable.
came under pressure intermittently in
1964-67,
However,
the United
concerned that the devaluation of the other major reserve
currency would prompt enormous market pressure on the dollar.
During the summer of 1964, the U.K. balance of payments
deteriorated sharply, largely the result of a stimulative fiscal policy.
7. After the move to widespread floating in 1973, the SDR's value was
initially the currencies
redefined in terms of a basket of currencies:
of the 16 countries that had a share in world exports of goods and
services in excess of 1 percent on average over the period 1968-72.
These were the currencies of the G-10 countries plus the currencies of
Australia, Denmark, Norway, Spain, Austria, and South Africa. The
currency composition and weights for the basket of 16 currencies was
revised in July 1978 to reflect export shares for 1972-76. Then, in
1981, the Fund decided to reduce the number of currencies in the basket
to the five most important currencies in world trade -- the currencies of
the United States, West Germany, Japan, France, and the United Kingdom.
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Following the Labor Party's victory in October 1964, selling pressure on
sterling intensified, as the new government's policies showed little
prospect for redressing the payments deficit.
The British government
strongly opposed the devaluation of sterling.
The United States endorsed
this position and increased the FR swap line with the Bank of England in
1964 and again in 1966 and otherwise participated in international credit
packages to bolster U.K. reserves.
IMF in the
The United Kingdom also drew on the
first use of the General Arrangements to Borrow.
When
sterling again came under downward pressure in the second half of 1965,
the Federal Reserve participated with a number of European central banks
and the Bank of Japan in purchasing sterling in the market, based on
agreements
with the Bank of England regarding guarantees of the sterling
they acquired.
After intermittent recoveries and bouts of selling
pressure, sterling came under persistent downward pressure beginning in
the spring
of 1967 as U.K. monetary policy eased, tensions mounted in the
Middle East culminating in war, and the U.K. trade position steadily
deteriorated, especially after the closing of the Suez Canal.
In an
effort to support sterling, U.S. authorities purchased sterling in the
market on a
swap basis (i.e., buying sterling spot against redelivery to
the market at a future date).
After several increases in the bank rate,
U.K. authorities gave way and devalued sterling in November 1967.
No
major country followed the United Kingdom with a devaluation of its
currency; nonetheless,
the devaluation of sterling brought into question
the basic premise of the Bretton Woods System that exchange rates of
major countries could be regarded as fixed.
By
late 1967, U.S. inflation was picking up and the balance of
payments was worsening as a consequence of the economic expansion
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associated with the Vietnam War.
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Continued rapid advances in Japan's
competitive position further contributed to the payments imbalance.
In
this context, selling pressure shifted to the dollar, as the United
States had
feared.
This took the form of record private purchases of
gold in London and shifts of private funds from dollars into continental
The United States unequivocally reaffirmed its commitment to
currencies.
maintain the official price of gold at $35 per ounce and, acting jointly
with other members of the Gold Pool, continued to stabilize the market
price of gold through sales in the London market.
The System also
enlarged its swap lines, which were used to absorb some of the dollars
flowing to
foreign central banks, and to a limited extent sold foreign
currencies
forward to the market.
members of
the Gold Pool tended to encourage speculative buying as market
However, heavy sales of gold by
participants came to expect that, given the implied gold loss, these
operations would be abandoned.
Indeed, the Gold Pool was abandoned in March 1968, and a twotier system for gold was established.
8
In supporting the two-tier
system, the United States was concerned that foreign monetary authorities
not exploit
arbitrage opportunities by selling official gold in the
private market, and such activity was explicitly banned.
Official
purchases of gold in the private market, while not banned outright, were
strongly discouraged because the United States was concerned that
purchases of gold in the market by foreign central banks would undermine
confidence
in
the Bretton Woods system.
Moreover, it felt that the
8. Under the two-tier system, all gold at the time in monetary reserves
was to remain there and to trade among monetary authorities at the
official price of $35 an ounce. All private gold and all gold to be
produced in the future was to remain outside official reserves and trade
at prices that fluctuated freely in the market.
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introduction of the SDR provided for adequate growth in international
and it wanted to promote a demonetization of gold.
reserves,
The dollar again came under selling pressure in 1971, prompted
by the relaxation of U.S. monetary policy after 1969 and the failure of
our balance of payments to strengthen.
U.S. authorities initially
responded with limited forward sales of foreign currencies and swap
drawings to mop up part of the increased flow of dollars to foreign
central banks.
Some foreign currencies, notably including the German
mark, abandoned their parities and began to float as early as May.
After
selling pressure on the dollar intensified and foreign central banks
stepped up
their demand for gold conversions, on August 15,
1971 the
Treasury suspended convertibility of dollars into gold or other reserve
assets for
foreign monetary authorities.
Use of the swap network also
was suspended.
Foreign authorities then had the choice of continuing to
pile
in
up dollars
their
official
or of revaluing their currencies.
reserves,
which were now inconvertible,
The United States made no effort to
support the dollar through intervention after convertibility was
By the end of August,
suspended.
franc were
floating.
all major currencies except the French
The use of capital controls was widespread, and
intervention by foreign central banks to slow the appreciation of their
currencies
was substantial, even though they were no longer defending
fixed dollar parities.
A
countries
system of fixed parities among the currencies of the G-10
plus
realignment
Switzerland was re-established through a general
of exchange rates in the Smithsonian Agreement of December
9. France adopted a dual exchange rate, and the value of the franc for
financial transactions was allowed to float.
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1971.
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The dollar was devalued in terms of gold to $38 per ounce; other
currencies were revalued against the dollar by varying amounts.
Recognizing that somewhat more flexibility in exchange rates was
desirable,
the G-10 authorities widened the margins for intervention to
2-1/4 percent to permit small adjustments in exchange rates without an
explicit change in central parities.
The United States had wanted a
larger devaluation based on its estimates of what would be required to
redress international payments imbalances, but other G-10 countries would
not agree.
sufficient.
Smithsonian
Nonetheless, it hoped that this realignment would be
The United States made no commitment to defend the
parity for the dollar through intervention or to restore the
convertibility of the dollar into gold; intervention was still left to
foreign monetary authorities if they wanted to maintain their new
parities.
The United States did agree to examine the case for a more
thorough reform of the international monetary system, which led to the
establishment in 1972 of the "Committee on Reform of the International
Monetary System and Related Issues" (the Committee of Twenty or C-20).
As
downward pressure on the dollar continued after the
Smithsonian Agreement, and the United States was not intervening to
defend the dollar, market participants began to doubt that foreign
monetary authorities would continue to buy inconvertible dollars.
Eventually,
the Treasury agreed to limited sales of foreign currencies to
defend the dollar, and the swap network was reactivated in July 1972.
The adoption of dual exchange rates by Italy and the floating of
the Swiss franc in early 1973, after sterling had been floating since
mid-1972, kindled new concerns about the durability of the Smithsonian
Agreement.
In this context, tightening of monetary policies abroad, the
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partial relaxation of U.S. wage-price controls imposed in August 1971,
and the sluggish response of our trade account to the dollar's
depreciation in the Smithsonian realignment contributed to renewed
downward pressure on the dollar.
devalued a
ounce.
In February 1973 the dollar was
second time, by 10 percent in terms of gold to $42.22 per
Nearly all other currencies accepted the full devaluation of the
dollar, and
the yen floated upward to an even higher level.
At the same
time the dollar was devalued, U.S. authorities stated their intention to
phase out all existing controls on capital outflows over the next two
years.
The United States expected that the devaluation would be
sufficient to remedy its payments deficit, but the market was not
persuaded.
The dollar continued to fall to its new floor against major
continental
European currencies, triggering massive intervention by
foreign central banks.
Ultimately, in March the system of fixed parities
was suspended, and the G-10 authorities de facto adopted generalized
floating.
III.
Managed floating:
March 1973 to date
Initially, the move to generalized floating was viewed as a
temporary means of coping with speculative pressures, rather than as a
permanent feature of the international monetary system.
The par value
system still was regarded as the "normal" regime, and the task of
monetary reform was viewed as one of improving the Bretton Woods system
so that it would operate, without frequent crises, and in a more
symmetrical
fashion than previously, to facilitate the continued
expansion of international trade and productive capital flows.
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Al though some issues were never completely resolved, the
Committee of Twenty described the broad features of a reformed monetary
system in its
(1)
Outline for Monetary Reform.
These features included:
An exchange rate regime based on stable but adjustable par values,
with the right
to float in particular circumstances.
(2) A greater
symmetry in
payments adjustments,
larger resp
nsibility than they had previously for correcting their
positions.
Under the old system, a country in deficit that was losing
such that countries in surplus had a
reserves was pushed to deal with its exchange rate problem
-- either
through demand management or devaluation -- more quickly than a surplus
country.
The United States in particular felt that by, in effect,
serving as
the residual country, other countries were allowed to maintain
undervalued
currencies and so accumulate payments surpluses, while the
United States ran deficits.
context of a
(3) Multilateral surveillance.
In the
par value system where convertibility could be suspended,
the United States favored the use of an international reserve indicator
as an objective gauge of whether a country's policies were consistent
with overall equilibrium in the balance of payments and adequate growth
in global liquidity (at the existing par values).
The use of this
indicator was thought to put more pressure on countries in surplus to
adjust than
before.
the lack of
mandatory convertibility of dollars under the Bretton Woods
system and felt
(4) Convertibility.
that if
European countries focused on
the United States were required to finance its
payments deficits with reserve assets (gold, SDRs,
i.e. restore convertibility),
policies to
it
and Fund drawings,
would have a greater incentive to adopt
eliminate its deficits.
The United States wanted to limit
the convertibility of dollars beyond a certain point for surplus countries
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as a means
imbalances.
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of encouraging a more symmetric adjustment of payments
One proposal in connection with the convertibility issue was
to establish a substitution account in which IMF member countries could
deposit dollar balances in exchange for SDRs.
In recognition of the U.S.
view, conversion through this account could be subject to certain limits.
(5) Better
international management of global liquidity, with the SDR
becoming the principal reserve asset, and the role of gold and reserve
currencies
being reduced.
Meanwhile, the increase in worldwide inflation in 1972-74,
associated with the run-up in oil prices in 1973, led to greater
divergence
in rates of inflation across countries, and increased strains
on countries' external positions -worldwide recession in 1975.
problems that were aggravated by the
Under these circumstances, a par value
system seemed even less viable than before.
Moreover, the world economy
had been functioning reasonably well under a mixed floating system for a
few years.
U.S. attitudes shifted during this period from favoring a
system of stable, but adjustable par values, with floating in particular
situations,
to an explicit advocacy of floating as an available long-run
option.
The Committee of Twenty recognized that the international
monetary system was in flux and that it might be particularly difficult
in the circumstances of the time to return to a par value system.
Accordingly , it concluded that an interim period was needed before final
agreement on reform.
However, it did recommend the immediate adoption of
"appropriate guidelines for the management of floating exchange rates"
during this
interim period.
These were in fact agreed to in 1974, though
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rest of the Committee's recommendations were not because
many of the
there was never a return to a par value system.
Floating was finally "legitimatized" in
Agreement of
to "deepen,
November 1975,
systematize,
which had two basic elements.
1976)
of the larger countries with regard
governing exchange arrangements,
to permit a member to choose its
including floating. 10
was
Second, Article IV of the IMF's
market intervention.
Articles of Agreement,
The first
and broaden" daily consultation among monetary
authorities , including central banks,
to exchange
the Rambouillet
was revised (in
own exchange arrangements --
As provided in Section 4 of the revised Article
IV, a return to a generalized par value system, if deemed appropriate,
requires an 85 percent majority vote, effectively giving the United
States veto power over such a move.
Section 1 of Article IV spells out the general obligations of
the Fund's members, which include (1)
financial policies toward .
.
reasonable price stability" (2)
"endeavoring to direct economic and
fostering orderly economic growth with
".
. . fostering orderly economic and
financial conditions and a monetary system that does not tend to produce
erratic disruptions" and (3)
"avoiding manipulating exchange rates or the
international monetary system in order to prevent effective balance of
payments adjustment or to gain an unfair competitive advantage over other
members".
Surveillance over the Fund's members to ensure effective
operation of the international monetary system and compliance with
10. According to Section 2 of Article IV these options included:
(1)
maintaining a stable value for a member's currency in
terms of the
SDR or another denominator, other than gold (2) cooperative arrangements
to maintain the value of members' currencies in terms of the value of
other members' currencies and (3) "other exchange arrangements of a
member's choice" (floating).
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members' general obligations listed above is provided for in Section 3 of
This provision calls upon the Fund to adopt "specific
Article IV.
principles
for the guidance of all members" with respect to their
exchange rate policies.
This new Article IV was incorporated along with
a significant number of other changes in the Second Amendment of the
IMF's Articles of Agreement that became effective April 1,
A.
1978.
Broad objectives of U.S. exchange rate policy
In conjunction with the decision in March 1973 to suspend the
to intervene in support of fixed parities against the dollar,
commitment
the G-10 countries issued a communique stating that intervention might be
useful at appropriate times to facilitate the maintenance of orderly
market conditions.
Then, as time passed and adjustment to the world oil
shock transpired smoothly with floating exchange rates, policymakers -including the Committee of Twenty -- came to see floating exchange rates
as inevitable, at least for a while.
By the time of the Rambouillet
Agreement in November 1975, it was generally agreed that market forces
could do a better job of setting a path for a country's exchange rates
consistent with its domestic and international policies than officials
could.
Accordingly, the statement about intervention in the Rambouillet
Agreement was changed to "countering disorderly market conditions" from
the 1973 formulation "to facilitate the maintenance of orderly market
conditions".
Principles
The Rambouillet formulation is repeated in the IMF's
for the Guidance of Members' Exchange Rate Policies, called
for by Article IV, Section 3b.11
11. IMF, Selected Decisions and Selected Documents, (Fourteenth Issue),
Washington, D.C., April 30, 1989. These principles specify that: "(1) A
member shall avoid manipulating exchange rates or the international
(Footnote continues on next page)
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This declaration, interpreted at times narrowly and at times
broadly, has guided U.S. exchange rate policy since.
The formal
statement of this policy is included in the U.S. notification to the IMF
of its exchange arrangements pursuant to Article IV, Section 2(a) of the
Articles of Agreement.
From 1978 through 1984, this notification stated
that the U.S. authorities intervene "when necessary to counter disorderly
market conditions in the exchange market".
This language also appears in
the System's Foreign Currency Directive, which dictates that "System
operations in foreign currencies shall generally be directed at
. . . "
countering disorderly market conditions
(See Appendix C of
Task Force paper "Evolution of Formal Procedures for FOMC Oversight of
System Foreign Currency Operations".)
September 1985,
Following the Plaza Agreement of
the U.S. notification to the IMF was amended to provide
for intervention ".
. . to counter disorderly market conditions, or when
otherwise deemed appropriate", thus providing more leeway for a broader
interpretation of our intervention policy.
The statement of U.S.
intervention policy contained in the notification to the IMF has not
changed since 1985.
The precise meaning of "disorderly market conditions" has never
been specified.
In a narrow sense "disorderly market conditions" has
been understood to mean very short-run market disruptions.
Along these
(Footnote continued from previous page)
monetary system in order to prevent effective balance of payments
adjustment or to gain an unfair competitive advantage over other members.
(2) A member should intervene in the exchange market if necessary to
counter disorderly conditions which may be characterized inter alia by
disruptive short-term movements in the exchange value of its currency.
(3) Members should take into account in their intervention policies the
interests of other members, including those of the countries in whose
currencies they intervene.
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lines probably the most detailed official elaboration on the nature of
disorderly
markets is
the one supplied by the Foreign Desk in
response to
a request by Rep. Reuss on the occasion of Congressional testimony by
former Chairman Burns in August 1973:12
exaggerated
Disorderly markets have certain features in common:
rate or price movements, wide spreads in quotations, a stifling
of the intermediary role of professional dealers, and an
unresponsiveness of prices and orders to the fundamentals
operating at the time. Disorderly markets are by their nature
unstable; in the absence of some stabilizing influence, disorder
can increase to the point at which the market ceases to function.
In a broader sense,
the phrase "disorderly market conditions" has
referred to episodes where market exchange rates are deemed by
policymakers to be clearly out of line with economic fundamentals.
In
his testimony before the Joint Economic Committee in January 1989,
Chairman Greenspan interpreted the phrase "countering disorderly market
conditions"
in the context of our current intervention policy as
fostering exchange rate stability, consistent with our understandings
with the foreign Group of Seven (G-7)
13
countries. 13
12. The 1973 Midyear Review of the Economy, before the Joint Economic
Committee, 93 Cong. 1 Sess. (GPO 1974)
13. Representative Hamilton:
"We are accustomed to hearing on this
committee in recent years that you only intervene if there are disorderly
markets. . . And yet it seems to me in recent years we have seen very
frequent and even massive intervention .
. That surely represents a
change of policy. . ."
Chairman Greenspan:
"I think it's
an issue of terminology.
That there
has been a change in policy, yes, there certainly has been. The reason
for the change is that it was perceived by the G-7 finance ministers and
central banks that exchange rate instability was creating adverse
consequences in the world and inducing potential destabilizing impulses
to the major economies, and it was the judgement of the G-7 that
stabilization was something which could and should be undertaken."
The 1989 Economic Report of the President, before the Joint Economic
Committee, 101 Cong. 1 Sess. (GPO 1989).
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Operational objectives and tactics
Since 1976,
the objective of "countering disorderly market
conditions"
generally has been construed by U.S. authorities narrowly and
U.S. policy
has been one of nonintervention in exchange markets.
Perhaps
the most extreme narrow interpretation of this objective was during the
first Reagan Administration when U.S. operations were minimal in line
with the administration's policy of limiting government interference in
markets generally.
conditions"
The objective of "countering disorderly market
was viewed more broadly in 1977-79 when the dollar was deemed
unacceptably low and again in 1985 when the dollar was unacceptably high,
and intervention in these episodes was substantial.
By far the most
extensive U.S. intervention operations, however, have taken place since
the Louvre Accord of February 1987, as the objective of countering
"disorderly market conditions" has been interpreted to mean fostering
exchange rate stability.
Throughout this period, other countries'
intervention policies have been more mixed, with some adopting a more
consistently active policy.
Although episodes of U.S. intervention were relatively
infrequent,
the amounts involved often were sizable.
Accordingly, the
United States took steps to increase foreign currency resources for
intervention, particularly at times when the dollar was under sustained
downward pressure.
The Federal Reserve swap network was enlarged and a
new swap facility between the Treasury and the Bundesbank was established
in early 1978.
1978.
The ESF also became an equal partner in intervention in
The Treasury sold SDRs for foreign currency, drew on its reserve
position at
the IMF, and issued foreign-currency denominated securities
in the private market ("Carter bonds").
In late 1980, U.S. authorities
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for the first time began to build-up substantial foreign currency
reserves through purchases in
the market and from other central banks,
after having first covered outstanding foreign currency liabilities.
During times when the dollar's exchange value raised
particularly great concern -a factor in
Furthermore,
in 1977-79, 1984-85, and 1987 --
it became
Federal Reserve decisions regarding monetary policy.
consultation and cooperation on macroeconomic policies by
the major industrial countries has increased over the floating rate era
amid a growing perception that the existing international monetary
arrangements have not provided as much stability and independence for
economic policies as had been expected.
have occurred,
Wide swings in exchange rates
contributing to large trade imbalances and pointing out
the need for more compatible policies among the G-7 countries.
So far,
these international agreements have at most involved loose statements of
intentions regarding fiscal policies.
policy have
years,
been made at any G-7 meetings,
changes in
in
though,
at times in
recent
official interest rates have been coordinated among
major industrial countries in
rates, and,
No commitments concerning monetary
in general,
individual countries'
order to minimize their effects on exchange
exchange rates have assumed a more important role
monetary policy deliberations.
General notions
about when the G-7 authorities should intervene to influence dollar
exchange rates also were decided in the Plaza and Louvre Accords,
along
with loose understandings about the amount of total intervention and each
country's share.
Following the U.S.
suspension of convertibility to gold in
1971
and the unwillingness of the United States and others to settle in gold,
the role of
gold in
the international monetary system gradually
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The SDR replaced the "gold dollar" as numeraire for accounts
in
line with the notion that the SDR was to become the
principal reserve asset (although de facto the dollar continues to occupy
this role,
and the yen and the mark have become important secondary
reserve currencies).
G-10 countries in
To further hasten the demonetization of gold, the
1975 abolished the official price of gold and lifted
the ban on sales to the private market.
The restrictions on gold
purchases under the two-tier gold system initially
few years,
insofar as the G-10 countries'
were extended for a
combined official stock of
gold, together with that of the IMF, was capped at the then current
level.
A portion of the gold held by the IMF was sold at its
price for the benefit of developing countries,
the Fund's
market
while another portion of
gold was reconstituted to members at the official price.
As of 1975, U.S. policy was to "treat gold like any other
commodity",
and the Treasury began auctioning gold to the market at about
the same time that U.S.
again.
residents were permitted to legally hold gold
When the dollar came under downward pressure in
1977-78,
the
Treasury stepped up its gold sales as another means of supporting the
dollar.
C.
Major episodes and U.S.
responses
Following the adoption of generalized floating, U.S.
intervened for the first
U.S.
time in
the summer of 1973.
authorities
Concern over rising
inflation, forecasts of vastly higher energy imports,
and the
potential ramifications of the Watergate affair weighed on the dollar,
while a tightening of German monetary policy supported the mark and
associated European currencies.
As the dollar fell, trading became
increasingly disorderly, with a number of banks refusing to quote rates.
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In these circumstances, U.S. authorities intervened to counter disorderly
conditions
in the narrow sense.
This narrow definition of disorderly market conditions in effect
was expanded a bit in subsequent operations to defend the dollar during
the winter of 1974-75.
At this time, inflation in the United States was
still worrisome, while price pressures in many other industrialized
countries were abating.
The recession, though worldwide, was far more
severe in the United States.
The Federal Reserve had begun to ease money
market conditions in the Autumn of 1974; other countries were more
circumspect and maintained restrictive policies until they saw more
evidence of progress in bringing down inflation.
With real interest
differentials between dollar and foreign currency assets eroding, the
dollar depreciated.
U.S. authorities intervened at first to cushion the
dollar's decline, which they regarded as "disorderly".
But by mid-
January 1975, they became more concerned with the dollar's progressive
slippage, and they stepped up intervention in support of the dollar in
concert with the central banks of Germany and Switzerland.
The first sustained period of U.S. intervention under the
floating rate regime, however, occurred in response to selling pressure
on the dollar in 1977-79.
During 1977, U.S. monetary policy was directed
towards furthering economic growth.
M1 expanded at a rate well beyond
the upper limit of its target range set by the FOMC.
By late 1977 rapid
growth in the U.S. economy, accompanied by an even sharper increase in
domestic demand, contributed to a deterioration of the U.S. external
accounts and a pick-up in inflation.
Even though short-term interest
rates in the United States rose during 1977, and the Federal Reserve
raised its discount rate twice by year-end, the perception in exchange
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These
that the Federal Reserve was "behind the curve".
markets was
economic conditions contrasted with those in Germany and Japan, where
economic growth was faltering as a result of early attempts to control
contributing to a surplus in
inflation,
these countries'
external
accounts.
the depreciation of the dollar intensified around the turn-
As
the Federal Reserve responded by raising its
of-the-year,
in January 1978 to 6-1/2 percent,
However,
markets.
trade
inflation continued to quicken in
by curbing oil imports also were relatively
deficit
unsuccessful.
The Federal Reserve accepted a modest firming in money
market conditions, but the growth of Ml still
and the dollar continued to fall.
range,
conditions
the Federal
in
Efforts to reduce the
abroad generally were coming down.
inflation rates
U.S.
the pace of U.S.
foreign exchange
reflecting the past depreciation of the dollar, while
in part
1978,
citing developments in
discount rate
exceeded its
targeted
Noting both disorderly
exchange markets and the serious U.S.
inflation problem,
Reserve raised its discount rate 1/2 percentage point further
to 7-3/4 percent in August.
This move and subsequent increases in
autumn provided only a temporary respite for the dollar.
the
In October,
president Carter announced a series of measures to fight inflation
including delays and reductions in
budgetary restraints,
the amount of scheduled tax cuts,
and voluntary wage-price guidelines.
On
November 1, a dollar defense package was announced, which included a
further hike in the discount rate by an unprecedented full percentage
point,
to a
package,
then historic high of 9-1/2 percent.
In unveiling the
president Carter stated that "the continuing decline in the
exchange value of the dollar is
clearly not warranted by the fundamental
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economic situation" and, "as a major step in the anti-inflation program,
it is now necessary to correct the excessive decline in the dollar
.
"Disorderly market conditions" in this instance were broadly
. ."14
defined to
include resisting a downtrend in the dollar's exchange value
in circumstances where that trend was perceived to be out-of-line with
economic fundamentals and threatening domestic objectives.
U. S. authorities also took steps to bolster resources for
intervention.
In December 1977, the President announced an explicit
undertaking to intervene in concert with other countries to support the
dollar.
In
henceforth
January 1978, the Treasury announced that the ESF would
be used as an equal partner in
new swap agreement with the Bundesbank.
15
intervention and announced a
Resources were further
increased in March through a doubling of the Federal Reserve's swap line
with the Bundesbank and sales of SDRs by the Treasury to the German
central bank in exchange for marks.
necessary,
The Treasury also indicated that, if
it was prepared to draw on its reserve position at the IMF in
order to acquire foreign currencies that might be needed for
intervention.
To lend further support to the dollar, the Treasury
announced that it, once again, would resume auctioning gold to the public
in May.
Finally, as part of the November 1, 1978 dollar defense program,
a $30 billion package of foreign-currency resources to finance U.S.
participation in coordinated intervention was put together.
This
consisted of an increase in Federal Reserve swap lines with Germany,
Japan and Switzerland, sales of SDRs and a drawing on the U.S. reserve
position at the IMF by the Treasury, and issuance of foreign-currency
14. Press release, White House, November 1, 1978.
15. Press release, Department of Treasury, January 4, 1978.
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denominated securities --
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so-called Carter bonds.
The latter were
denominated in marks and Swiss francs and issued publicly in the German
and Swiss capital markets between late 1978 and January 1980.
resources at
in concert
authorities
With these
hand, U.S. authorities intervened aggressively and sometimes
with other central banks.
Net official purchases by U.S.
in the market from October 1977 through the end of 1978
amounted to about $10 billion, while foreign authorities bought $37
billion, net.1 6
In the first half of 1979 the dollar recovered somewhat, but by
mid-June the dollar came under renewed selling pressure.
The second oil-
price shock in 1979 added substantial upward pressure to price levels
worldwide and contributed to reductions of output.
In the United States
these problems were particularly acute; inflation already was more
serious than in most foreign economies and new data on the economy
pointed to
a slowdown in economic activity.
In contrast, most foreign
economies had not yet begun to decelerate, their authorities having
committed themselves to stimulative fiscal packages at the Bonn economic
summit in the summer of 1978.
Policymakers in most foreign countries
responded to the hike in oil prices by tightening monetary conditions,
but with signs of weakness in the U.S. economy, the Federal Reserve took
only modest
steps in this direction, raising its discount rate 1-1/2
percentage points in three moves in the third quarter of 1979.
Nevertheless, growth of U.S. monetary aggregates remained well above
projected rates during the summer of 1979.
policy appeared to be in disarray.
Furthermore, U.S. energy
The subsequent acceptance of the
16. During this period, the United States also revived discussions of a
substitution account at the IMF, but no agreement was ever reached, and
it became a dead issue as the dollar strengthened in 1980-81.
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resignation of many members of the Carter Cabinet prompted political
concerns as well.
Under these circumstances, U.S. authorities intervened
substantially during the summer of 1979 to resist the dollar's decline.
The continued weakness in the dollar and other signs of rapidly
deteriorating inflation expectations (rapidly rising prices of gold and
other commodities) were important considerations in the adoption of new
monetary operating procedures by the Federal Reserve on October 6, 1979.
These procedures were intended to assure better control over the growth
of the monetary aggregates and, in general, help dampen inflationary
pressures.
The shift in operating procedures entailed a greater emphasis
on the control of bank reserves and less emphasis on short-term
fluctuations in the federal funds rate.
Also on October 6, the Federal
Reserve increased its discount rate a full percentage point to 12
percent.
Following the change in operating procedures, U.S. interest
rates rose
sharply, amid mounting inflationary expectations and anxiety
in financial markets about the Carter administration's economic policies,
including the imposition of credit controls in March 1980.
The dollar
moved up along with U.S. interest rates during the first quarter of 1980,
and U.S. authorities took advantage of the opportunity to acquire foreign
currencies
to repay debt incurred as a result of dollar support
operations
in 1978-79.
contracted
sharply in the second quarter of 1980 while, under the new
Then, as economic activity in the United States
operating procedures, the Federal Reserve adhered to its nonborrowed
reserves target,
plummeted.
short-term interest rates in the United States
Between April and July, the federal funds rate fell more than
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8 percentage points,
this period,
-32-
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prompting a sharp decline in
the dollar.
During
authorities intervened to slow the dollar's fall.
U.S.
By September 1980 the dollar began to strengthen markedly as the
performance
of the U.S. economy compared favorably with other economies.
Inflation in the United States had begun to wane,
countries,
especially the traditionally low-inflation countries of
Europe, were making little
progress against inflation, which remained
high relative to post-WWII experience.
resilience,
continued to
The U.S.
economy also showed more
bouncing back from the sharp downturn in
of 1980; output in
increased.
while several other
the second quarter
most European economies stagnated and unemployment
As the U.S. economy rebounded and the Federal Reserve
emphasize bank reserves rather than interest rates as a
means of controlling growth of the monetary aggregates,
interest rate
differentials moved sharply in favor of dollar assets.
Furthermore,
the
election of Ronald Reagan suggested a political commitment to bringing
Finally, the global pattern of external balances shifted
down inflation.
in
favor of the United States.
surplus in
The U.S.
the second half of 1980,
current account swung into
reflecting a strong improvement in
non-oil trade as a result of the past depreciation of the dollar.
At this time, U.S. monetary authorities still had outstanding
foreign currency obligations in the form of swap debt and maturing Carter
bonds to cover.
U.S.
As the dollar began to strengthen in the fall of 1980,
authorities were eager to purchase the needed foreign currencies and
did so when they judged that it would not put downward pressure on the
dollar.
However,
they also stood ready to sell foreign currencies to
counter disorderly market conditions if
selling pressure on the dollar
re-emerged.
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Once the outstanding obligations were covered, U.S. authorities
continued to purchase foreign currencies with the objective of building
up U.S. foreign currency reserves.
Prior to this time, the System and
Treasury had had essentially no long-term net position in foreign
U.S. authorities decided to acquire foreign currency
currencies.
avoid having to finance intervention by incurring debt with
balances to
reluctant foreign monetary authorities.
In addition, they judged that
the dollar's strength could well be temporary.
The dollar had been
supported primarily by unusually favorable interest differentials and, in
an environment of volatile interest rates, it was thought that these
might narrow, putting downward pressure on the dollar.
The System and Treasury intervened in this manner from October
1980 through mid-February 1981, purchasing nearly $7 billion equivalent
of German marks, about $6 billion equivalent of which was purchased in
the market and the remainder was purchased from other central banks.
U.S. authorities also bought about $100 million equivalent each of Swiss
francs and French francs in the market and from other central banks.
of February
As
1981, the combined System and Treasury net position in
foreign currencies (marks, yen, and Swiss francs) was $6 billion
equivalent.
This compares with net foreign currency liabilities that
peaked at $3.5 billion equivalent (also valued at February 1981 exchange
rates) in September 1979.
In
early 1981, the new Reagan administration decided to cease
the inherited intervention practices that it judged to have been
excessively
heavy.
This decision reflected the view that exchange rates
were the product of economic policies and that a "convergence" of the
latter was
the way to stabilize exchange rates, a view consistent with
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the administration's desire to minimize government interference in
markets generally.
May 4, 1981 ,
Testifying before the Joint Economic Committee on
then Undersecretary of the Treasury Sprinkel described the
new administration's exchange market policy as "a return to fundamentals"
by "concentrating on strengthening and stabilizing the domestic economic
factors which have undermined the dollar during the last decade or so."
In conjunction with the emphasis on economic fundamentals, Undersecretary
Sprinkel stated that the-administration intended to "return to the more
limited pre-1978 concept of intervention by intervening only when
necessary to counter conditions
went on to
of disorder in
the market".17
He then
suggest that, with the President's proposed program of tax
cuts to enhance incentives to work, save, and invest, and deregulation,
and the Federal Reserve's policy of gradually reducing money growth to
noninflationary levels, he anticipated little need for U.S. intervention
in in this
regard.
From 1981 through early 1985, the dollar continued to
strengthen.
U.S. monetary restraint in the context of a robust recovery
and prospects for continued large U.S. fiscal deficits with consequent
upward pressure on interest rates supported the dollar.
Meanwhile,
monetary authorities abroad initially were reluctant to raise interest
rates as their recoveries appeared more fragile.
Investment in the
17. Sprinkel, Beryl, "Statement before the Joint Economic Committee",
May 4, 1981.
In his statement, Undersecretary Sprinkel also described
the respective roles of the Treasury and the Federal Reserve in exchange
market policy:
"The Secretary of Treasury is the chief financial officer
of the United States.
In close cooperation with the Federal Reserve, he
establishes U.S. exchange market intervention policies.
Both the
Treasury and the Federal Reserve engage in exchange market operations in
close coordination to ensure consistency with overall U.S. international
monetary and financial policy. The Federal Reserve Bank of New York acts
as agent for both the Federal Reserve System and the Treasury when
exchange market intervention occurs."
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United States boomed,
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(FR)
including foreign investment,
attracted by the
Reagan economic policies and the increasingly favorable business climate.
In addition,
dollar-denominated assets were sought as a "safe haven"
following the onset of the international debt crisis and amid
apprehensions about the political situations in
U.S.
some European countries.
intervention operations from April 1981 through 1984 were very
limited, occurring on only 20 days,
in
line with the administration's
view that the strong dollar was an indication of the robust U.S.
and not a cause for concern.
the urging
Moreover,
economy
most of these operations were at
of foreign monetary authorities.
On net, U.S.
authorities
sold $750 million against marks and yen during this period.
Some European monetary authorities who favored more active
management
of exchange rates objected to the U.S.
nonintervention.
on June 4-6,
In
policy of
G-7 officials, meeting in Versailles
this context,
1982 agreed to establish a working group (the Jurgensen
Group) to study the effectiveness
of intervention in
foreign exchange
markets.18
By mid-1984, however, the dollar had risen nearly 60 percent
from its
level in
a concern for U.S.
strength had become
the fourth quarter of 1980, and its
monetary policy.
In particular,
in
FOMC meetings
18. The Jurgensen report concluded that "intervention had been an
effective tool in the pursuit of certain exchange rate objectives -notably those oriented towards influencing the behavior of the exchange
rate in the short run. . . There was also broad agreement that sterilized
intervention did not generally have a lasting effect, but that
intervention in conjunction with domestic policy changes did have a more
durable impact.
At the same time it was recognized that attempts to
pursue exchange rate objectives which were inconsistent with the
fundamentals through intervention alone tended to be counterproductive."
For a review of the background studies prepared for the Working Group see
the Task Force paper "Foreign Currency Operations:
An Annotated
Bibliography".
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concern was
(FR)
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expressed about the implications of the strong dollar for the
U.S. manufacturing sector, and the potential consequences for inflation
should the
dollar drop precipitously.
These considerations were among
the arguments leading to an adoption of an easier monetary stance in mid1984.
As
to reverse
the dollar continued to rise, the Reagan administration began
its policy of nonintervention in currency markets.
Group of
Five (G-5) officials, meeting on January 22, 1985, issued a statement
reaffirming
their commitment to promote convergence of economic policies,
to remove structural rigidities, and (as agreed at the Williamsburg
summit of April 1983) to undertake coordinated intervention in exchange
markets as
banks, U.S.
necessary.
In coordinated operations with other central
authorities sold about $650 million between January and March
1985.
Although the dollar had started to decline by late February,
protectionist sentiment in the United States mounted as the trade deficit
swelled to
$120 billion at an annual rate in the summer of 1985.
to deflect
protectionist legislation, U.S. officials arranged a meeting
In part
of G-5 officials at the Plaza Hotel on September 22 with the purpose of
ratifying an initiative to bring about an orderly decline in the dollar.
In their statement, G-5 officials drew attention to the significant
progress that already had been made in promoting favorable economic
performance
along a path of steady noninflationary growth.
Yet, they
observed, "recent shifts in fundamental economic conditions among their
countries, together with policy commitments for the future, have not been
fully reflected in exchange markets."
Large imbalances in external
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positions were noted, along with the potentially "mutually destructive"
protectioni sm they might engender.
The statement concluded:
The Ministers and Governors agreed that exchange rates should
play a role in adjusting external imbalances. In order to do
this, exchange rates should better reflect fundamental economic
conditions than has been the case. They believe that agreed
policy actions must be implemented and reinforced to improve the
fundamentals further, and that in view of the present and
prospective changes in fundamentals, some further orderly
appreciation of the main non-dollar currencies against the dollar
is desirable. They stand ready to cooperate more closely to
encourage this when to do so would be helpful.
This recognition that exchange rates were out-of-line with economic
fundamentals represented a sharp reversal of the U.S. administration's
previous stance, and reflected the change in incumbency in the office of
Secretary of
Treasury.
Al though intervention in exchange markets was not explicitly
mentioned, the last sentence of the G-5 statement quoted above
encompassed
it.
At the Plaza meeting, the United States suggested an
upward adjustment of non-dollar currencies on the order of 10 to 12
percent, though no explicit target was ever agreed to.
552 U.S.C. (b)(4)
552 U.S.C. (b)(4)
During this period, official sales of dollars by G-5 authorities amounted
to nearly $9 billion, of which the United States sold $3.3 billion.
With respect to policy intentions, the communique said little
that was new. Each country included as an attachment a statement of
present policy intentions.
policy.
No commitments were made regarding monetary
Since the imbalance in external positions reflected, to some
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extent,
specific programs to reduce
the misalignment of fiscal policies,
fiscal stimulus in
in
-38-
(FR)
the statements,
abroad were included
the United States and increase it
but these suggested no departure from existing
The United States promised to "implement fully the deficit
policies.
the Gramm-Rudman-
reduction package for fiscal year 1986" specified in
This package was intended to reduce the budget deficit
Hollings bill.
for FY 1986 by more than 1 percent of GNP.
In addition, U.S.
authorities
intention to implement revenue-neutral tax reform.
indicated their
agreed to increase investment by local governments,
individual
circumstances of each region.
stated its
intention to continue its
tax cuts due to take effect in
Japan
conditional on the
The West German government
ongoing process of tax reform, with
1986 and 1988.
The United Kingdom and
France each promised to curb public expenditure and to reduce tax
burdens.
In reaction to the G-5 statement and subsequent intervention,
the dollar fell
sharply.
Monetary tightening in Japan in
provided further downward impetus for the dollar,
late October
so that by year-end the
dollar had fallen 16 percent against the yen and 14 percent against the
mark from its
levels just prior to the Plaza meeting.
Throughout this period,
the Federal Reserve emphasized that,
given the dependence of the United States for the time being on large
capital inflows,
maintained.
underlying confidence in the dollar needed to be
It was concerned that a precipitous fall in the dollar,
though perhaps a remote possibility, could lead to sharply higher
interest rates and inflationary pressures,
thereby threatening the
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19
financial system and the economy.
Based on these considerations, the
decisions to lower the Federal Reserve's discount rates in March and
again in April 1986 were carefully coordinated with similar moves by
other central banks.
The March move coincided with reductions in
official rates in Japan, Germany, France, and the Netherlands.
Subsequently, the United Kingdom cut its official rates, as did several
other of Germany's EMS partners.
In April, the United States and Japan
lowered their discount rates in tandem.
Formal procedures to improve the G-7 policy coordination process
and strengthen multilateral surveillance were agreed to at the Tokyo
economicsurmmit in May 1986.
In particular, a framework for the
systematic consideration of national policies and performance was
adopted, involving the use of economic indicators.
According to the
summit declaration, the purposes of improved coordination "should
explicitly include promoting noninflationary growth, strengthening
market-oriented incentives for employment and productive investment,
opening the
international trading and investment system, and fostering
greater stability of exchange rates."
Although the United States
supported improved coordination of macroeconomic policies to foster
increased stability in exchange rates, the dollar's continued decline in
1986 per se
was regarded as orderly and not cause for concern, and U.S.
authorities
did not intervene in exchange markets in 1986.
The Bank of
Japan, however, became quite concerned about the yen's appreciation,
particularly in the run-up to the national elections in Japan, and
19. FOMC policy record, October 1, 1985 meeting.
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intervened
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(FR)
quite heavily in support of the dollar in the spring and
summer of 1986.
The dollar declined to seven-year lows in early 1987, amid signs
that the U. S. economy might be weakening while the U.S. trade deficit
continued to grow.
Furthermore, various press statements attributed to
administration officials were interpreted in exchange markets as
indicating
a lack of concern about the ramifications of a further decline
in the dollar.
In these circumstances, U.S. monetary authorities at the
end of January intervened on one occasion in support of the dollar for
the first time since mid-1980 (except for small operations when President
Reagan was
shot in 1981 and during the Continental Bank crisis in 1984)
in coordinated operations with the Bank of Japan.
On February 22, the G-7 officials met at the Louvre in Paris.
They concluded that "substantial exchange rate changes since the Plaza
Agreement will increasingly contribute to reducing external imbalances
and have now brought their currencies within ranges broadly consistent
with underlying economic fundamentals".
In addition, they expressed
concern that "further substantial exchange rate shifts could damage
growth and
adjustment prospects in their countries."
Therefore, they
agreed to "cooperate closely to foster stability of exchange rates around
current levels" (i.e. around levels of February 20).
Because of innumerable hypothetical circumstances that could not
be fully anticipated, the agreement on intervention was in general terms
and not pinned down too closely.
552 U.S.C. (b)(4)
552 U.S.C. (b)(4)
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552 U.S.C. (b)(4)
552 U.S.C. (b)(4)
intervention
after the Louvre Accord was substantial, with the G-7 and other central
banks effectively financing most of the U.S. current account deficit for
that year.
The U.S. share of net official purchases in 1987 amounted to
$8.5 billion, while the other G-7 countries' share was $82 billion.
No
Louvre, and
commitments regarding monetary policy were made at the
only two aspects of the agreements on fiscal policy
represented new initiatives.
Japan promised that "A comprehensive
economic program will be prepared after the approval of the 1987 budget
by the Diet , so as to stimulate domestic demand, with the prevailing
economic situation duly taken into account."
20.
Germany agreed to "propose
552 U.S.C. (b)(4)
552 U.S.C. (b)(4)
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to increase
the U.S.
side,
fiscal 1988
(FR)
-42-
the size of the tax reductions already enacted for
1988
."
the commitment to "policies with a view to reducing the
deficit to 2.3 percent of GNP from its estimated level of 3.9
percent in fiscal year 1987" was consistent with the Gramm-RudmanHollings target, which was not reached.
As
552 U.S.C.
(b)(4)
552 U.S.C. (b)(4)
the dollar fell
G-7 authorities,
meeting in April 1987,
552 U.S.C. (b)(4)
552 U.S.C. (b)(4)
Despite heavy intervention, the dollar declined sharply in the
second half
October.
of 1987, particularly after the stock market crash in
Record U.S. trade deficits and perceptions of disarray among
G-7 officials as foreign authorities pursued their own domestic
objectives sparked the initial dollar selloff.
The dollar's decline
gathered momentum once the Federal Reserve moved more aggressively than
its foreign
On
counterparts to supply liquidity in the aftermath of the
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stock market crash.
-43-
The Federal Reserve's actions in this regard led
market participants to believe that the Federal Reserve would emphasize
domestic objectives, if necessary, at the cost of any objective for the
dollar.
these circumstances, G-7 officials reconvened by telephone at
In
year-end and the result was
552 U.S.C. (b)(4)
552 U.S.C. (b)(4)
552 U.S.C. (b)(4)
In their public statement, G-7
concurred that "either excessive fluctuation of exchange
authorities
rates, a further decline of the dollar, or a rise in the dollar to an
extent that
becomes destabilizing to the adjustment process, could be
counterproductive by damaging growth prospects in the world economy."
They then reaffirmed their commitment to "cooperate closely on exchange
markets".
In
contained in
addition, the agreements on fiscal policy measures
the Louvre Accord were extended to include policy for 1988.
During 1988 and early 1989, G-7 finance ministry deputies and,
552 U.S.C.
on two occasions, their central bank counterparts met to consider
(b)(4)
552 U.S.C. (b)(4)
552 U.S.C. (b)(4)
more concrete as part of a broader
consideration of ways of strengthening the international monetary system
552
552
that was called for by
officials. U.S.C. (b) also wanted to
U.S.C.
(4)
(b)(4)
integrate in to the G-7 process
closer consultation on monetary policy
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action.)
In
(FR)
-44-
the event, G-7 officials were unable to reach an agreement
on ways and means of strengthening the G-7 coordination process.
During both 1988 and 1989, the dollar strengthened over the
first part of the year as monetary conditions in the United States
tightened more than those abroad and U.S. external accounts improved.
As
relative monetary stances were reversed and external adjustment stalled
during the latter part of both years, the dollar eased back somewhat.
For 1988 as
a whole, the dollar appreciated moderately and net
intervention by the United States was light.
However, when the dollar
continued to strengthen in 1989, reaching a 2-1/2 year high against the
mark and threatening to undermine progress on external adjustment, U.S.
authorities
intervened more actively.
In September 1989, G-7 officials issued a communique stating
that they "considered the rise in recent months of the dollar
inconsistent with longer run fundamentals" and "agreed that a rise in the
dollar above (then) current levels or an excessive decline could
adversely affect prospects for the world economy.
In this context, they
agreed to cooperate closely in exchange markets."
The release of this
statement was followed by several weeks of coordinated intervention with
the initial
objective of lowering the dollar and the later objective of
keeping the
dollar lower.
552 U.S.C. (b)(4)
For 1989 as a whole, U.S. authorities sold $22 billion net,
while other G-7 countries made net sales of $43 billion.
Chiefly as a
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result
in
of these
foreign
"U.S.
Official
operations,
currencies
1989 (valued
(FR)
at
-45-
the combined System and Treasury net position
swelled to $42 billion
December 29,
equivalent at the end of
1989 exchange rates).
Holdings of Foreign Currencies"
(See Task Force paper
for details.)
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References
Board of Governors of the Federal Reserve System, Annual Report, 1984,
1985, 1986.
Burns, Arthur, "Statement before the Joint Economic Committee" in The
1973 Midyear Review of the Economy, Hearings, 93 Cong.
1 Sess., Washington: GPO 1974
Coombs, Charles, The Arena of International Finance, New York: John
Wiley and Sons, 1976.
Cross, Sam,
"Treasury and Federal Reserve Foreign Exchange Operations,"
Federal Reserve Bulletin, various issues.
Federal Reserve Bank of New York, "Operations in Foreign Currencies"
(annual reports), various issues.
From the Plaza to the Louvre,
Funabashi, Yoichi, Managing the Dollar:
Institute for International Economics: Washington, 1988.
Greene, Margaret L., U.S. Experience with Exchange Market Intervention;
January-March 1975, Staff Studies 125, Washington: Board of
Governors of the Federal Reserve System, 1984.
, U.S. Experience with Exchange Market Intervention:
September 1977-December 1979, Staff Studies 128, Washington:
Board of Governors of the Federal Reserve System, 1984.
, U.S. Experience with Exchange Market Intervention:
October 1980-September 1981, Staff Studies 129, Washington:
Board of Governors of the Federal Reserve System, 1984.
Greenspan, Alan, "Statement before the Joint Economic Committee" in The
Economic Report of the President, Hearings, 101 Cong. 1
Sess., Washington: GPO 1989.
International Monetary Fund, Annual Report:
Exchange Arrangements and
Exchange Restrictions, various issues.
, Articles of Agreement, Washington, 1982.
, "The Gold Pool", Annual Report, 1964,
pp. 131-132.
"The Role of the SDR in the International
Monetary System", Occasional Paper #51.
, Selected Decisions and Selected Documents,
(Fourteenth Issue), Washington, April 30, 1989.
Polak, J.J. , Valuation and Rate of Interest of the SDR, International
Monetary Fund: Washington, 1974.
Report of the Working Group on Exchange Market Intervention, March 1983.
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(FR)
-47-
Solomon, Robert, The International Monetary System, 1945-1976, New York:
Harper and Row, 1977.
Sprinkel, Beryl, "Statement before the Joint Economic Committee", May 4,
1981.
U.S. Treasury Department, Exchange Stabilization Fund, Report of Audit,
various issues.
, Maintaining the Strength of the United States
Dollar in a Strong Free World Economy, January 1968.
, Press Release, January 4, 1978.
, Treasury Bulletin, various issues.
The White House,
Press Release,
November 1,
1978.
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Historical Review of
System Objectives and the Use of Intervention *
A.
Overview
1
B.
U.S. Intervention under the Bretton Woods System
6
C.
U.S. Intervention during the Breakup of the Bretton Woods System,
August 1971 - March 1973
12
D.
Implementation of the Policy Framework for U.S. Intervention
under a System of Managed Floating Exchange Rates, March 1973 December 1974
15
E.
U.S. Intervention Operations: January - March 1975
17
F.
Countering Declining Confidence: September 1977 -December 1979
21
G.
U.S. Intervention Operations: April - July 1980
34
H.
U.S. Foreign Exchange Operations to Repay Debt and to Replenish
Reserves, 1971 to 1981
35
I.
U.S. Intervention Operations: March 1981 - Early 1985
39
J.
September 22, 1985: the Plaza Agreement
42
K.
U.S. Intervention Operations since the Louvre Accord
44
59
L. Tables
I. U.S. Foreign Exchange Operations during the Early Floating Rate Period, March
1973 - August 1977
II. U.S. Foreign Exchange Operations, September 1977 - December 1979
III. U.S. Foreign Exchange Operations, January 1980 - August 1985
IV. U.S. Foreign Exchange Operations, September 1985 - Present
V. Summary of U.S. Foreign Exchange Operations, March 1973 - Present
* Prepared by Chris Rude, with assistance from Cathy Weintraub, Foreign Exchange
Department, Federal Reserve Bank of New York.
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This paper discusses the objectives and uses of U.S. foreign exchange
intervention operations from the early 1960s to the present. It describes the
basic reasons why the U.S. authorities have intervened in the foreign exchange
market--what the operations attempted to achieve--and comments on the
nature and the extent of the intervention operations themselves, including
some of the tactical approaches used to achieve our objectives.
A. Overview
Under the Bretton Woods system, U.S. foreign exchange intervention was
light because the United States had another responsibility under that system-to maintain the convertibility of officially held dollar liabilities into gold. In the
period immediately after the advent of generalized floating in 1973, U.S.
intervention remained light, at least relative to the use of this policy tool by
other countries. Subsequently, there have been periods of more sustained
and heavier operations--in the years 1977 to 1981; the fall of 1985; and the
post-Louvre period, February 1987 to the present.
In a world of extensive capital mobility and floating exchange rates, the U.S.
monetary authorities have generally accepted the premise that the underlying
economic fundamentals should and ultimately will determine dollar exchange
rates. They have taken the view that, under these circumstances, capital and
exchange controls would be largely ineffective. These concepts underlie the
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2
basic policy framework that has governed and still governs U.S. foreign
exchange operations, a framework which was largely developed during the
period between the move to generalized floating in March 1973 and the
completion of the Jamaica Amendment to the IMF Articles in January 1976.
Early experience with floating during 1973, however, indicated that shortterm phenomena might overshadow underlying economic fundamentals. The
U.S. authorities have long recognized, therefore, that intervention may be
appropriate, indeed necessary, at times to deal with these phenomena and to
restore market conditions that would more likely permit the underlying
economic fundamentals to reassert themselves. Accordingly, the United
States has throughout the years accepted the need for intervention to deal
with "disorderly markets."
Over the years, the phrase "disorderly markets" has been interpreted at
times narrowly and at times broadly. That phrase has been used to cover
operations ranging from modest efforts designed to achieve the relatively
limited objective of containing day-to-day or very short-run market dysfunction,
to large-scale efforts which sought to influence exchange rate levels or trends
over prolonged periods when current market conditions were perceived as not
consistent with underlying fundamentals.¹
¹ See the accompanying paper on "Historical Review of the Reciprocal Currency
Arrangements."
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3
--From time to time, in the mid-1970s, the U.S. authorities intervened in
modest amounts to deal with "disorderly markets" in the more narrow sense of
the term.
--Subsequently, in the period from September 1977 to December 1979, the
U.S. authorities made a major and sustained effort to influence the dollar
exchange rates and sought to counteract a severe undervaluation of the dollar,
an action based at least partly on the grounds that such a misalignment was
itself a cause of market disorder.
--In the following year, 1980, still under the "disorderly market" rubric, we
intervened on the opposite side of the market, selling dollars in substantial
amounts to cover outstanding debts and build up balances.
--An effort similar to the September 1977-December 1979 exercise began
with the Plaza Agreement in September 1985, when the U.S. authorities placed
priority on increasing the value of the other Group of Five (G-5) currencies
relative to the dollar.
--Beginning with the Louvre Accord in February 1987, the U.S. authorities
worked in cooperation with other Group of Seven (G-7) industrial countries to
foster greater exchange rate stability, roughly around the then-current
exchange rates. This objective was to be achieved through greater economic
policy coordination, supported by cooperation in exchange rate intervention.
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--That G-7 commitment to foster greater stability has continued since,
amplified by successive G-7 statements indicating at times the need for rate
stability, and at other times suggesting that further moves of the dollar in one
direction or another would not be helpful to international adjustment and a
strong world economy.
All U.S. intervention during the floating rate period through 1985 was
undertaken under a policy, as formally notified to the IMF, of intervening "when
necessary to counter disorderly market conditions in the exchange markets."
At the end of 1985, the phrase was added "or when otherwise deemed
appropriate."
The basic techniques used to intervene today were developed in the 1960s
and 1970s. By the end of the period of relatively heavy intervention 1978 to
1981, the U.S. authorities had employed all of the techniques used today:
visible and discreet operations, alone or in cooperation with other central
banks, at home in the United States or in other foreign exchange markets,
during the New York trading day or around the clock. The absolute size of the
operations has increased in recent years, but this should be seen against the
background of the size, sophistication, and globalization of the market. In
1989, total intervention by the United States was perhaps somewhat larger
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5
than the level of activity of an earlier, active period 10 years ago; but the
growth of the market during the same period has been much larger.2
The U.S. monetary authorities have maintained a fairly passive policy toward
reserve acquisition throughout most of the period of this review, more or less
accepting the consequences for reserves of any intervention operation
directed toward market conditions or exchange rates. From the advent of the
floating period until November 1978, the swap network was the primary
mechanism through which the U.S. monetary authorities obtained the foreign
balances necessary for any significant intervention operation to support the
dollar. Since intervention operations were essentially financed through shortterm borrowing, the authorities had to reverse operations reasonably quickly to
repay market-related debt or reconstitute the small level of reserves the U.S.
authorities had, or else obtain the needed balances from other sources.
Although the U.S. authorities still maintain a fairly passive policy toward
reserves, the operations designed to limit the dollar's rise over the past year
have led to a large buildup in U.S. foreign exchange reserves. This relatively
new situation has helped to provide greater flexibility to the U.S. authorities and
has enabled the United States to be less dependent on other countries in
There is no reliable measure of the size of market imbalances, or the open position of the
private sector, but based on the Federal Reserve Bank of New York's Turnover Survey of the U.S.
2
foreign exchange market, the size of the U.S. market increased from an estimated average daily
turnover of $18 billion in 1980 to $129 billion in 1989.
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6
discussions and policies concerning the exchange value of our currency. In
other words, if the dollar should come under severe downward pressure, the
U.S. authorities will not so quickly be faced with the choice of having either to
introduce major policy changes that may not be compatible with domestic
needs, or to seek financing from others which might be subject to unpalatable
conditions.
In summary, over the nearly thirty years of the period under review, there
has been a consistent theme in the thinking of the U.S. authorities of primary
reliance on economic fundamentals and market forces as main determinants of
exchange rates. Nonetheless, within that framework there have been
significant changes in U.S. attitudes and practices with respect to intervention,
reflecting: a) modifications of the international monetary system; b) evolution
of the structure of the U.S. and global economies and capital markets; c)
shifting official views about the character of exchange markets as well as the
cost, benefits, and effectiveness of intervention with changing Administrations
and philosophies; and d) the changes in current economic and financial
conditions.
B. U.S. Intervention under the Bretton Woods System
Under the Bretton Woods System, the United States was formally
committed to buying and selling gold at $35 an ounce without limit at the
request of governments that were members of the International Monetary Fund
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(IMF). In turn, foreign authorities were formally committed to keep their
exchange rates from moving by 1 percent above or below par against the
dollar. Thus, the U.S. monetary authorities were not formally committed to
maintaining the market value of the dollar against foreign currencies. This
responsibility, in effect, fell upon foreign authorities, an obligation which they
fulfilled by intervening, primarily in dollars or other useable currencies. The
United States was instead committed to maintaining the convertibility of
officially held dollars into gold at $35 an ounce. U.S. "intervention," in this
sense, was indirect and passive.
The Bretton Woods system was constructed under conditions of a dominant
U.S. economy with a near monopoly of gold--which could perform the "nth"
currency function, provide the residual counterpart of all international payments
imbalances, and supply the liquidity needed for a growing world economy. In
time these premises eroded, with the recovery of Europe and the development
of Asia. The Bretton Woods system proved incapable of bringing about the
needed policy adjustments by member nations, and came under intolerable
strains as growing official dollar liabilities rose relative to a declining U.S. gold
stock.
As foreign central banks began to accumulate large dollar reserves--as the
"dollar shortage" of the late 1940s gave way to the "dollar overhang" of the
1960s--U.S. foreign exchange policy focused on protecting the U.S. gold stock
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8
and preserving the status of the two major reserve currencies, the dollar and
sterling, whose fixed par values were thought to be the linchpin of the system.
In particular, the U.S. authorities sought to maintain the dollar's value
measured in gold in order to maintain confidence in the dollar and in the
monetary system. The U.S. authorities also believed that any loss of
confidence in sterling's role could jeopardize confidence in the dollar, thereby
prompting foreign monetary authorities to rush to the Treasury's gold window
to convert their dollars into gold.
The U.S. authorities developed a variety of strategies to protect Treasury's
gold stock.³ A gold pool was formed whereby foreign central banks shared in
the U.S. authorities' efforts to contain the dollar price of gold in the major free
markets for gold, mainly in London. The Treasury issued foreign currencydenominated bonds (Roosa bonds), and the Federal Reserve drew on the
reciprocal currency arrangements to acquire currencies to, in effect, assume
other countries' exchange-rate risk on a portion of their dollar reserves. The
operations were all designed to discourage foreign monetary authorities from
using their dollar holdings to buy gold. Nonetheless, the U.S. gold stock still
continued to fall substantially.
³ See the accompanying paper "Evolution of U.S. Foreign Exchange Rate Policy" for more
details on these measures.
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In addition to various measures to protect the gold stock, the U.S. monetary
authorities also intervened in foreign exchange markets during this period to
ameliorate pressures on the dollar as well as to assist other countries in
defending their own Bretton Woods parities. The U.S. Treasury intervened on
some occasions, beginning in March 1961, more often in the forward market,
and the Federal Reserve intervened, beginning in June 1962, more often in the
spot market. The Treasury's operations in the forward market were designed
to encourage stabilizing, and discourage destabilizing, speculation. By
operating in the forward market, the Treasury did not have to have foreign
currency balances to buy dollars, but it was exposed to exchange rate risk
because it had to buy the currency spot when it came time to honor its
forward transactions. The System's occasional operations were typically in the
spot market and at times undertaken to help foreign authorities support the
value of their own currencies against the dollar. The System assisted the Bank
of England in its defense of sterling against the waves of speculative selling
that occurred in the 1960s and which finally culminated in sterling's devaluation
in November 1967. The U.S. authorities also assisted the Bank of France in its
defense of the franc from speculative selling pressures in 1968.
Intervention operations for both the Treasury and the System were executed
by the Foreign Exchange Desk at the Federal Reserve Bank of New York.
Spot transactions were usually executed by using commercial banks as agents
in the New York brokers market. Forward transactions were executed directly
with U.S. banks known to specialize in forward transactions.
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10
Under the Bretton Woods system, the U.S. authorities, lacking significant
foreign currency reserves, financed almost all of the spot transactions through
the use of the System's swap network. Since the maturities of the swap lines
were relatively short (typically 3 months), any operation implied that the U.S.
authorities would generally have to reenter the market shortly in order to repay
the debt or to cover the liability by some other means. Over time, the swap
network became the primary mechanism by which the authorities in both the
United States and elsewhere could obtain the reserves necessary for defensive
foreign exchange operations, and negotiations to set up larger bilateral swap
networks came to play a key role in central bank cooperation.4
Two individual operations by the U.S. authorities during this period bear
mentioning: the Desk's operations on the day of President Kennedy's
assassination on November 22, 1963, and the sterling "bear squeeze" on
September 10, 1965. The operations undertaken following the news that
President Kennedy had been shot were undertaken for System account and
on Federal Reserve initiative to counter what would later be called "disorderly
market conditions." Acting through a bank as agent, the Desk offered to buy
dollars against marks at the rate which prevailed just prior to the unsettling
4 See the accompanying paper on "Historical Review of the Reciprocal Currency
Arrangements."
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news. By the end of the day, the Desk had purchased $23 million; the Bank of
Canada joined in by purchasing another $27 million.
The "bear squeeze" operation, two years later, was designed to counter the
negative sentiment against the British pound that had persisted for some time.
Specifically, it was aimed at generating a rise in sterling against the dollar at a
time when many market participants had sold sterling in the expectation of a
fall in its price. The operation was undertaken on System account; the
strategy was designed by the Federal Reserve. The Desk abandoned its
normal practice of intervening discreetly through brokers and, instead,
simultaneously placed offers for dollars against sterling totaling $30 million
directly with all of the major New York banks in what was the first significant
case of overt operations by the Desk. Not only was the size of the total bid
large for the market at the time, but the intervention technique itself was seen
in the market as a startling change from the usual central bank tactic of
supporting an exchange rate quietly, if not secretly, through the agency of a
commercial bank. As market participants scrambled to cover previously
established short-sterling positions, sterling moved immediately upward. The
Desk pursued the rate with new and lower offers to sell dollars. By the end of
the day, the Desk had sold $13 million against pounds. This operation was
coordinated with the Bank of England, a number of continental central banks,
and the Bank of Japan.
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C. U.S. Intervention during the Breakup of the Bretton Woods System,
August 1971 - March 1973
With the end of gold convertibility on August 15, 1971, the U.S. authorities
no longer conducted operations with the purpose of protecting the gold stock.
This period was characterized by attempts to reconstitute a system of fixed
parities: a new constellation of exchange rates was established as part of the
Smithsonian agreement in December 1971; the European Economic
Community (EEC) authorities decided to narrow the margins for their
currencies and agreed to maintain their exchange rates within 2.25 percent of
each other (the IMF rules permitted a range of 4 1/2 percent) to form the EEC
5
"snake" in the Smithsonian "tunnel" in March 1972; and the dollar was
unilaterally devalued in February, 1973, in an environment in which a number
of currencies were floating de facto. Even so, the exchange markets were
subject to recurrent pressures on exchange rates. Many central banks
continued to intervene to limit the rise of their currencies against the dollar,
even though, with the suspension of gold convertibility, they were exposing
themselves to exchange risk.
Intervention operations by the U.S. monetary authorities to influence dollar
exchange rates, by contrast, were modest and essentially limited to two
episodes. The first was during summer 1972, after pressure against the dollar
5 The EEC "snake" was a precursor for the European Monetary System (EMS) regional joint
float mechanism.
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intensified following sterling's abandonment of its Smithsonian parity in the face
of a wave of speculative selling. The move by the U.K. authorities cast the
entire Smithsonian framework into doubt, and the U.S. authorities entered the
foreign exchange market to intervene, purchasing a total of $31.5 million.
Swap drawings, which had been suspended since August 15, 1971, began
again, following a change in Treasury Secretaries, and the Federal Reserve
offered marks in the foreign exchange market beginning on July 19, 1972. At
the time, Chairman Burns described the intervention operation as a move by
the U.S. authorities to restore order in the foreign exchange markets in
keeping with the Smithsonian agreement. The Treasury commented that "the
action reflects the willingness of the United States to intervene in the exchange
markets upon occasion when it feels it is desirable to help deal with
speculative forces." During the following month, the System also purchased
dollars against Belgian francs, and the franc moved well below its ceiling level
against the dollar.
The second episode of intervention was in early 1973, when the viability of
the Smithsonian Agreement, which had never fully recovered from the 1972
developments, was called into question again, leading to the effective demise
of the Smithsonian parities. The dollar, along with pound sterling and then the
Italian lira, came under successive waves of selling pressure in an increasingly
uncertain and nervous environment amid growing concerns about price and
external performance in these countries. In late January-early February, the
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U.S. authorities, in cooperation with the Bundesbank, entered the foreign
exchange market to intervene. Initially, intervention purchases of dollars
against marks and guilders were all undertaken for Federal Reserve account.
However, once Federal Reserve mark balances were depleted and the System
had to draw on its swap line with the Bundesbank to finance continued
intervention, Chairman Burns became concerned that the Federal Reserve not
be caught with an exchange rate exposure at a time when the Treasury was
negotiating a new exchange rate realignment. He insisted that any further
dollar purchases against marks be undertaken for the U.S. Treasury account
out of Treasury's existing balances. By this action, he confirmed the principle
that the Federal Reserve could control the use of its own balances and
liabilities.
On February 12, 1973, the dollar was devalued for the second time in 14
months in an environment in which a number of Group of Ten (G-10)
currencies were floating de facto or utilizing exchange controls to establish an
exchange rate system to help shield their trade and economies from the
effects of speculative capital flows. Market participants were unconvinced that
stable rates would be soon restored, however, and by March 16, 1973, there
was generalized floating of the dollar.
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D. Implementation of the Policy Framework for U.S. Intervention under a
System of Managed Floating Exchange Rates, March 1973 - December
1974
On March 16, 1973, the Group of Ten (G-10) countries (plus Switzerland)
decided to abandon the commitment to intervene in support of fixed parities
against the dollar. They issued a communiqué stating that intervention might
be useful at appropriate times to facilitate the maintenance of orderly market
conditions. Each country agreed to be prepared to intervene at its own
initiative in its own market in consultation with the countries whose currencies
were being traded. This agreement represented the initial policy framework for
any U.S. intervention that might be regarded as necessary or desirable under
the system of floating exchange rates for the major currencies.
In the immediate aftermath of the March 16, 1973, meeting, the U.S.
authorities interpreted the concept of "disorder" narrowly and abstained from
intervention. Some foreign monetary authorities, in contrast, did engage in
modest intervention as the dollar continued to move lower.
First Intervention of Floating Rate Period
During May-July 1973, selling pressure on the dollar intensified, and the
U.S. monetary authorities intervened for the first time during the floating rate
period. During this period, trading was becoming increasingly one-sided, with
spreads between bid and asked rates widening substantially, and many
corporate customers withdrew from the market. Gold prices rose as the dollar
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and U.S. securities prices declined sharply. By July 6, several New York
banks refused to quote rates and suspended all foreign exchange
transactions, even in major currencies. In response to the near paralysis of
the foreign exchange market, the Federal Reserve started to intervene on July
10. These operations were accompanied by a joint statement of the Chairman
of the Federal Reserve Board and the Secretary of the Treasury indicating that
the U.S. monetary authorities would intervene at whatever times and in
whatever amounts were appropriate for maintaining "orderly market
conditions."
During July 1973, the Federal Reserve purchased $273.5 million in the
market--$220.5 million against marks, $47.0 million against French francs, and
$6.0 million against Belgian francs (see Table One). 6 The Desk entered the
market on 12 days during the month, or on 57 percent of the trading days, to
purchase an average of $23 million on each day that it was in the market.
These operations were financed by drawings under the swap arrangements
with the respective central banks.
6Table One and the subsequent tables report all U.S. operations undertaken in the foreign
exchange market by the U.S. Treasury and the Federal Reserve. The tables exclude transactions
with customers and off-market transactions conducted directly with foreign central banks. They
include both the U.S. foreign exchange market operations designed to influence market conditions
and exchange rates--intervention--and the operations undertaken in the market to acquire the
foreign currencies necessary to repay market-related swap debt or otherwise to reconstitute
reserves. The number of days of the operations, the frequency of the operations, and the average
size of the daily operations reflect both "active" intervention as well as reserve-related operations.
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Through the remainder of 1973 and 1974, the dollar was occasionally
buffeted by releases of unfavorable U.S. economic data, speculation of a
revaluation of the mark within the new European Community "snake"
arrangement, and financial market uncertainty in the wake of the closures of
Bankhaus I.D. Herstatt and Franklin National Bank. During this period, U.S.
intervention was moderate, and no major innovations in intervention
techniques were introduced. Between August 1973 and December 1974, the
Desk intervened in the market on occasion to support the dollar by purchasing
a total of $1,345.4 million and on occasion to stem the dollar's rise by selling a
total of $203.2 million. These operations were generally conducted for System
account.7
E. U.S. Intervention Operations: January - March 1975
The first major episode of U.S. intervention in concert with other central
banks during the floating rate period occurred in the first quarter of 1975. The
United States, Germany, and Switzerland had been intervening beginning in
late 1974 to moderate the dollar's decline and to counter disorderly market
conditions. Not until February 1975, however, did they adopt a large-scale,
concerted approach to intervention and publicly confirm that change in
approach.
7Between March 1973 and January, 1978, there was one episode of U.S. Treasury intervention,
intervention during February and March, 1974 in which the Treasury purchased $42.6 million
against marks and Belgian francs.
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The intervention had been initiated by these countries at a time when the
industrialized countries generally were beset by inflation, recession, and the
continuing dislocations of the first oil crisis. The inflationary pressure were
moderating more quickly in many of the other industrial countries than in the
United States, and moreover, the United States was in a far deeper recession.
As U.S. economic policy shifted more decisively to support the economy,
interest rate differentials that had previously been strongly in favor of the dollar
narrowed quickly in late 1974 and again in January 1975. The other countries
wanted to avoid the deflationary consequences of appreciation. The U.S.
authorities were concerned that, with market participants already expressing
concern that the direction of U.S. monetary policy was inconsistent with
fighting inflation, a deterioration of confidence in the dollar would further
undermine their ability to contain inflation over time.
Although the Desk had acted several times to check sharp dollar-exchange
rate declines on individual days late in 1974, the dollar's overall trend had not
changed. By early January 1975, the dollar had declined by 10 percent
against the German mark and by 16 percent against the Swiss franc from its
highs of four months before, and the market's expectations continued to be
bearish. The Desk remained prepared to operate in early January on a
modest scale to cushion, but not to prevent, the dollar's day-to-day declines.
Thus the Desk approached the market indirectly and on a small scale. It
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operated in the brokers market using commercial banks as agents, in amounts
typical of the New York market of the period, usually at progressively lower
dollar exchange rate levels, to purchase for the Federal Reserve a total of
$178.1 million against German marks and Swiss francs during January. But by
late January 1975, the dollar had declined another 5 percent.
Under these circumstances, the U.S. authorities sought to reverse the
deteriorating conditions in the market, the continuing slippage of the exchange
rate, and the deepening pessimism toward the dollar. They tried to increase
the coordination of central bank intervention and adopt a more forceful
approach to the market. By early February, the Federal Reserve had reached
agreement with the Bundesbank and the Swiss National Bank on a new
approach. On February 3, the central banks of both Switzerland and Germany
entered the market shortly after the European open to buy dollars visibly. The
Desk on behalf of the Federal Reserve entered the market even before the
usual 9:00 a.m. opening in New York to bid for sizeable amounts of dollars
against marks and Swiss francs to set the tone of strong dollar demand for the
day. It did so openly in the interbank market by placing bids directly with
commercial banks. The Desk supplemented these operations by bidding to
buy dollars against Dutch guilders and Belgian francs.
As the dollar turned upward, the Desk kept bidding for dollars against these
four currencies at progressively higher dollar rates to demonstrate the U.S.
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authorities' willingness to support the dollar's recovery. The dollar's rise
accelerated late in the morning after the wire services reported that Chairman
Burns had confirmed that the Federal Reserve was intervening to maintain
orderly markets. Spokesmen for the other central banks also confirmed the
operation. By the end of the day, the Desk had purchased $112.3 million
against marks, Swiss francs, Dutch guilders, and Belgian francs in what was
then by far the largest single-day operation since the United States began
intervening again in July 1973. This operation represented a broadening of the
interpretation of activities that might be regarded as appropriate for dealing
with "market disorder." The Desk purchased an additional $27 million on
February 4.
Although exchange market conditions tended to stabilize following this twoday round of concerted intervention, the dollar continued to move lower on
balance during February as a number of events continued to reinforce the
concerns that still weighed against it, including a further easing in U.S.
monetary policy, release of sharply higher unemployment figures in the United
States, and an apparent tapering off in the rise in unemployment in Germany.
Although the Bundesbank eased its stance somewhat, the additional evidence
that the recession was more severe in the United States than elsewhere
tended to confirm the view that any decline in German interest rates would lag
behind one in U.S. rates. In this atmosphere, the Desk remained ready to
intervene in order to avoid disorder in the market, but not to hold the rate at
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any particular level. In fact, it intervened to support the dollar on 12 out of the
16 business days remaining in February in operations coordinated with the
Bundesbank and the Swiss National Bank, although the scale of operations on
those days was relatively modest.
In March 1975, the dollar began to firm in response to a favorable shift in
interest rate differentials; dollar interest rates firmed somewhat due to a move
toward relative U.S. monetary restraint, while interest rates on assets
denominated in other currencies continued to fall. The Desk continued to
intervene at times to resist any reversal in dollar rates, but as the dollar's rise
solidified, the Desk's intervention operations tapered off. The cumulative total
of the Desk's dollar purchases during February and March amounted to
$740.4 million. The bulk--$551.9 million--was against marks, with the
remainder against Swiss francs, guilders, and Belgian francs.
F. Countering Declining Confidence: September 1977 - December 1979
The period from September 1977 to December 1979 saw a multi-faceted
effort to resist deteriorating confidence in the U.S. economy and resist an attimes precipitous decline in the dollar, which was thought to be both
inconsistent with underlying fundamentals and itself a source of market
disorder. The effort comprised the full range of intervention techniques:
adjustments in monetary policy, including several rounds of Federal Reserve
discount rate increases; enhanced coordination with other governments; and
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initiatives to address structural weaknesses in the economy. During this
period the U.S. authorities undertook the most protracted, intense, and
sustained intervention operations to date, and developed and utilized the
techniques still used by the authorities today (see Table Two). The downward
pressure on the dollar began gradually to subside during early 1979. The
change in Federal Reserve operating procedures in October 1979 and the
subsequent rise in dollar interest rates contributed to a further rise in the dollar
against the yen and helped stabilize the dollar/mark rate.
By late 1977, a number of problems began to undermine the Carter
Administration's economic strategy--to promote vigorous growth in the United
States so as to provide the engine of expansion for the world as a whole, while
simultaneously containing domestic inflation and conserving energy. The U.S.
economy was growing rapidly. But the strength of demand had led to a
serious deterioration in the U.S. trade deficit that could no longer be excused
simply on the grounds that it offset the contractionary effects of the continuing
current account surpluses of oil producing countries. Moreover, economic
recovery still eluded Germany and Japan, despite U.S. demand for these
countries' exports. Thus, the prospect was fading that expansion could
quickly or easily be transmitted from the United States to other industrialized
countries. Market participants grew skeptical that the growing U.S. current
account deficit could be reversed without either a significant curtailment of
demand at home or dollar depreciation. Faced with this choice, they believed
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the Administration would be more willing to accept depreciation, even though
the movement in the exchange rate would result in further deterioration in price
performance. In response to these concerns, the dollar was moving steadily
lower in the exchange markets, even as interest rate differentials moved in
favor of the dollar.
To counter disorderly markets in a fairly narrow sense of the term, the Desk,
acting on behalf of the Federal Reserve, first entered the foreign exchange
market in late September 1977. Using largely a discreet approach to the
market, it placed bids for dollars in the brokers market through banks acting
as agents and in amounts in keeping with the normal market practice.
Between September 30 and December 20, the Desk purchased $676.5 million
against German marks. But the operations were not intended to stop the
general trend then underway, and the dollar continued to weaken. Market
participants, watching the dollar decline nearly every day, interpreted the
limited nature of the operation as evidence of a lack of concern by the U.S.
authorities. By December 20, the dollar was 6 percent below the level at which
the Desk had first intervened, trading at DM 2.10.
By the end of 1977, the Administration began to show some concern about
the dollar. It believed that, if the immediate market pressures could be
contained, before long the overall strategy would be seen as bearing fruit.
Following conversations between the Federal Reserve and the Treasury,
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President Carter announced, on December 21, an explicit undertaking to
intervene in concert with other countries. At that point, the Desk started
operating for both Treasury and Federal Reserve account and increased the
size of its intervention activities, although it continued to intervene in a discreet
manner. On that day, the Desk also operated on behalf of other central
banks. In the final days of December, the U.S. monetary authorities
purchased $173.7 million against marks.
With the Administration now publicly associated with the efforts to resist
pressures against the dollar, market participants wondered whether the United
States had the resources needed to finance intervention on the scale needed
to reverse the dollar's decline. 8 Whereas the Federal Reserve had recourse to
its swap arrangements with other central banks to borrow the currencies
needed to sell in the market, the Treasury's access to currency was not well
known. Moreover, both agencies were understood still to have significant
obligations outstanding that dated back to August 15, 1971. In these
circumstances, market participants believed the United States had little scope
for waging significant resistance against selling pressure and would be quick
to take advantage of any let up in pressure to sell dollars in order to repay
either recently incurred or long-standing debt. In other words, the market
8 See the accompanying paper "Historical Review of U.S. Holdings of Foreign Currencies."
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believed there to be little risk that the dollar would go up even if the
intervention succeeded in stemming the dollar's decline.
Meanwhile, the Federal Reserve and the Treasury were making
arrangements to share in the financing of joint intervention operations on an
ongoing basis. As acting Treasury Secretary, Solomon agreed that the United
States "should act to counter disorderly market conditions in our foreign
exchange markets that may develop from time to time" and gave Chairman
Burns the Treasury's full approval of Desk's operations since late September.
The Treasury also agreed that "the exchange value of the dollar will be
determined by underlying economic and financial conditions in the U.S.
economy, and that the basic strength of the dollar will depend on our ability to
maintain a strong and non-inflationary economy."9 He also informed the
Chairman that Secretary Blumenthal approved the initiation of consultations
between the Treasury and the Federal Reserve, on the one hand, and the
Congressional Committee chairmen, on the other "with regard to the possibility
of [Treasury's Exchange Stabilization Fund (ESF)] participating with the
Fed[eral Reserve] in financing U.S. exchange market intervention."10
9 Letter from Under Secretary Solomon to Chairman Burns, December 28, 1977.
10Covernote from Under Secretary Solomon to Chairman Burns.
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On January 4, 1978, to address these concerns, the Federal Reserve and
the U.S. Treasury issued a joint statement that the U.S. Treasury's ESF would
henceforth be actively used together with the Federal Reserve's swap network
system. In addition, it was announced that Treasury had established a swap
arrangement with the Bundesbank, although the size of the arrangement was
purposefully never disclosed so as to avoid giving a sense of limitation. Then
on January 6, the Federal Reserve increased its discount rate to 6 1/2
percent, while allowing federal funds rates to rise to 6 3/4 percent.
But the dollar continued to come under selling pressure, and the Desk
increased its foreign exchange operations. During the first half of January, the
Desk purchased $773.5 million against marks. The Desk intervened on 78
percent of the trading days, dealing at times both with banks directly and in
the brokers market using banks as agents. On one occasion, the Desk
quoted a bid and offer simultaneously to narrow spreads and achieve more
orderly market conditions in the first use of two-way prices as an intervention
technique.
For the balance of the first quarter of 1978, the Desk continued to intervene
on occasion. (For the quarter as a whole, the Desk intervened to purchase a
total of $2,102.1 million and operated on 62 percent of all trading days.) In
addition, on March 13, to demonstrate determination to address the situation
once more, the authorities announced further increases in facilities to finance
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intervention. The Federal Reserve's swap arrangement with the Bundesbank
was doubled, and the Treasury indicated its willingness to sell Special Drawing
Rights (SDRs) to the Bundesbank against the purchase of marks. For its part,
the German government reaffirmed its commitment to support economic
recovery at home. The dollar continued to decline and toward the end of the
month, the dollar traded around the psychologically important level of DM 2.00
against the mark, down another 4 percent.
Pressure against the dollar ebbed and flowed for the next few months, and
the U.S. authorities continued to intervene to support the dollar in varying
amounts. Foreign central banks, however, remained quite active. Meanwhile,
anxiety deepened that U.S. macroeconomic policies and the pace of economic
expansion were incompatible with price stability, a return to external balance,
and a stable dollar. Data being released at the time showed U.S. labor prices
rising more rapidly than those in Germany and Japan as well as the declining
dollar exchange rates being reflected in rising domestic prices for imports and
import substitutes. As a consequence, the pace of U.S. inflation accelerated,
while inflation rates abroad were generally coming down. To make matters
worse, efforts to curb the U.S. trade deficit primarily by reducing oil imports
faltered.
Against this background, downward pressure on the dollar reemerged in
August 1978, and the U.S. authorities stepped up their dollar-support
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operations. As the dollar fell through the DM 2.00 level against marks, dealers
expressed dismay that the U.S. policy makers were not more prepared to
resist the dollar's weakness. None of the actions taken so far had relieved the
market's anxieties about the inconsistencies in U.S. economic policy. Talk was
widespread in the market that large holders of dollar assets--OPEC countries
and central banks all over the world--were actively seeking to diversify their
portfolios so as to reduce their dollar exposures. In this context, the overhang
of foreign-held dollars appeared huge relative to the resources of the United
States available to finance intervention. As a result, trading became
increasingly hectic as the dollar's decline gathered momentum, and substantial
intervention by the U.S. authorities, as well as other countries, failed to stem
the tide.
Since the beginning of this period in September 1977, the U.S. monetary
authorities had employed numerous approaches to the exchange markets,
ranging from high profile announcements of cooperative efforts with other
governments to persistent discreet operations. It used a variety of diverse
operating techniques in terms of counterparties and market of operation. For
example, the Desk timed some of its operations to coincide with the opening
and the closing of the foreign exchange futures market on the International
Money Market (IMM) in Chicago. In addition, the U.S. government announced
numerous other economic policy steps, trying to arrest the decline in
confidence in the United States and in the dollar. The discount rate was
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increased again in August 1978 and twice in September 1978. In August 1978
the Treasury announced measures to address the U.S. trade deficit and in
September the Senate approved a long-awaited energy bill. Nevertheless,
these efforts were perceived by the market as too little and too late. After each
initiative, dollar rates were only briefly bid up. In short, the market's extreme
pessimism did not fade.
On the evening of October 24, 1978, President Carter announced a new
anti-inflationary program that proposed wage-price guidelines and a tax-based
incomes policy. But market participants expressed such skepticism about the
repeated failure of previous programs to produce meaningful results in terms
of stabilizing prices that the dollar came under intense selling pressure in the
Far East even before the President had finished speaking. To contain these
pressures, the Desk operated for the first time in the Far East. It purchased
$75 million against marks though U.S. banks in Hong Kong and Singapore,
dealing with the foreign branches of commercial banks with whom it already
had formal trading relations in New York. The market was well aware of these
operations, but the dollar continued to decline, moving well below the DM 1.80
level by the end of the day.
During the last week of October, the selling of dollars reached near-panic
proportions and the dollar fell to record lows against several currencies. The
Desk intervened more heavily in an effort to moderate the dollar's decline and
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to reestablish a greater sense of two-way risk. Then, as the Administration
considered more policy moves to deal with the dollar exchange rates and
other more fundamental issues, the Desk pulled out of the market. The dollar
dropped to a low of DM 1.7050 on October 31, 17 percent below its earlyAugust level.
The November 1. 1978 Package
On November 1, 1978, President Carter, the U.S. Treasury, and the Federal
Reserve announced various measures to "correct the excessive decline in the
dollar". Simultaneous announcements were made in Germany and Japan.
The program featured an increase in the Federal Reserve's discount rate by an
unprecedented 1 percentage point to an historic high of 9 1/2 percent--and an
unprecedentedly large $30 billion package of foreign currency resources to
finance U.S. participation in coordinated intervention in the foreign exchange
markets.
The Federal Reserve's contribution to the $30 billion package was made
through a doubling of its swap arrangements with the central banks of
Germany, Switzerland, and Japan to a total of nearly $16 billion. The Treasury
announced that it would draw $3 billion equivalent of foreign currencies under
the U.S. reserve position in the IMF and sell $2 billion of SDRs to acquire
marks, Swiss francs, and yen. The Treasury also announced that it would
issue up to $10 billion in securities denominated in foreign currencies.
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The dollar moved up immediately following the announcement of this
program as traders around the world sought to cover their short-dollar
positions. The Desk was authorized to operate in close coordination with
other central banks to reinforce the dollar's recovery with active and forceful
intervention in marks, Swiss francs, and yen. Through commercial banks it bid
aggressively for dollars in the brokers market in all three currencies. The Desk
acted throughout the day to prevent the dollar from falling and took advantage
of any rise in the dollar to purchase dollars aggressively at progressively
higher rates. By the end of the day, the dollar was up 7 to 10 percent from its
lows of the previous day, and the Desk had purchased $609.3 million, mostly
against marks.
In subsequent weeks, as the dollar kept gaining ground, the Desk continued
to operate in cooperation with other central banks. By early December, the
dollar was trading at DM 1.94 against the mark, 14 percent higher than its lateOctober low. But then the dollar's rise ran out of steam. Market participants
remained skeptical about U.S. economic policy, and the dollar was vulnerable
to the political and economic shocks that occurred around mid-December:
political upheaval in Iran and the 14.5 percent increase in oil prices following
the OPEC price-fixing meeting at the end of the year. The U.S. authorities,
joined on occasion by other central banks, intervened persistently and in
substantial amounts to blunt the selling pressures. Their largest intervention
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operation so far for a single day--more than $1 billion--was done on December
11, 1978, undertaken on their own behalf and for other central banks. The
currencies used for these operations were drawn in part by the Federal
Reserve under its swap arrangements and in part by the Treasury from
balances that had been obtained from the U.S. drawings on the IMF and out
of proceeds of the Treasury's first issuance of mark-denominated securities.
U.S. operations during November and December were substantial by any
measure--and certainly compared with the historical experience of the United
States. In these two months, the Desk purchased $6,647.6 million, including
$5,705.8 million against marks, $734.7 million against Swiss francs, and $207.4
million against yen. The Desk purchased dollars on 60 percent of the trading
days in November and 80 percent of the trading days in December. The
Desk's operations for the two months greatly exceeded the dollar purchases
by any other country; its share in the total dollar purchases by the U.S.,
German, Swiss, and Japanese authorities was about one-half. Including very
modest purchases of foreign exchange for reserve-related purposes, the U.S.
authorities entered the market on 78 percent of the trading days during
November and December; the average size of its daily operations was $220
million. The dollar closed the year at DM 1.8175 against the mark.
Coming into 1979, many market participants had anticipated that the dollar
would again come under selling pressure. But the persistent determination of
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the U.S. authorities in following up the November 1 package had apparently
proved sufficient to blunt negative sentiment towards the dollar. As the market
began to respond more favorably to U.S. economic policy, pressure on the
dollar subsided, and U.S. intervention operations to support the dollar tapered
off (although reserve-related transactions were undertaken). By March,
sentiment had clearly tilted in the dollar's favor, and during most of the first half
of 1979, the authorities of Germany, Switzerland, and Japan intervened heavily
to sell dollars. These operations were largely motivated by the foreign central
banks' desire to absorb some of the domestic liquidity created by earlier
interventions, but had the effect of limiting the dollar's rise.
The dollar again came under selling pressure in the last half of 1979, as the
energy situation and monetary policies of the United States and other
countries no longer appeared uniformly to favor the dollar. On various
occasions through the summer and early fall, the U.S. monetary authorities
sold substantial amounts of foreign currencies to resist the decline. In June,
around the time of the Tokyo Summit, with the dollar once again coming down
to test the psychologically important level of DM 1.80, the Desk operated
around the clock on most business days, purchasing over $5 billion, mostly
against marks. Again, in late August and September the Desk intervened in
sizable amounts, largely in a defensive action, as the dollar fell from the DM
1.83 level of late August back towards to DM 1.80. By late September,
however, the Desk judged that the pressures against the dollar were too large
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to be contained by intervention alone, and scaled back its operations. On
October 2, the dollar traded as low as DM 1.7250.
On October 6, 1979, the Federal Reserve announced a major change in its
operating procedures for monetary policy, through a series of actions to
assure better control over money and credit growth and thereby to curb
inflation. In the exchange markets, traders at first reacted cautiously to the
change in the Federal Reserve's operating procedures. As dollar interest rates
moved up sharply, interest rate differentials moved strongly in favor of dollardenominated assets. But the dollar did not strengthen decisively. The U.S.
authorities continued to purchase dollars to maintain orderly markets through
early February 1980, but the scale of these operations tapered off (see Table
Three). With inflationary expectations fueling the demand for money and
credit, the Federal Reserve moved to restrain the growth of money, and shortterm dollar interest rates started to move up sharply to levels that clearly
discouraged speculative position-taking against the dollar. Then in late
February and March, as the dollar began to move sharply higher, the Desk
intervened to sell dollars to moderate the dollar's rise and repay debt.
G. U.S. Intervention Operations: April - July 1980
By April, with the announcement of President Carter's special credit restraint
program, the scramble for funds in the United State had run its course,
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economic indicators indicated economic activity was starting to slow, and
dollar interest rates began to decline.
Under these circumstances, the U.S. authorities expected and were willing
to see some decline in dollar exchange rates. However, the Federal Reserve
was concerned that, given the fragility of confidence about the dollar and U.S.
domestic economic policy more generally, the exchange rate not come under
such intense selling pressure as to have an adverse effect on domestic money
and capital markets. The Foreign Exchange Trading Desk timed its operations
to coincide with those of the Open Market Desk, in order to signal to the
market that, although the monetary policy actions were being taken to add
bank reserves, another free-fall in the dollar would be resisted. In addition,
when the credit restraint programs were then eliminated in May and June, the
authorities wanted to indicate that the Federal Reserve was not giving up on its
anti-inflation efforts. Although the dollar had relinquished its first-quarter gains
by early July, the decline was kept orderly. In total, during this period, the
Desk purchased $3,688.8 million against marks, Swiss francs and French
francs.
H. U.S. Foreign Exchange Operations to Repay Debt and to Replenish
Reserves, 1971 - 1981.
Throughout much of the period of floating exchange rates, the U.S.
authorities undertook operations in the foreign exchange market to repay debt
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and replenish reserves. There were two types of debt to be covered--that
arising from operations conducted prior to August 15, 1971, the so-called "pre1971 debt", and that arising from subsequent operations, "market-related
debt".
As for pre-1971 debt, outstanding System swap commitments were $3,045
million and Treasury obligations were $1,998.2 million at the time the
convertibility of the dollar into gold was suspended. Negotiations concerning
how these obligations were to be met were conducted with the central banks
of issue. In some cases, these negotiations extended over a period of years.
The understandings that were reached included how the Desk would acquire
the needed currencies and the time frame for liquidation of these obligations.
The currencies were purchased either in the market or directly from the issuing
central bank. In some cases the foreign central bank required the Desk to
consult with it frequently, as often as daily, to work out whether market
conditions permitted our purchase and if so the amount. In some cases the
foreign central banks agreed to sell the United States currency directly on a
regular schedule, or to be prepared to do so if market conditions did not
permit us to buy in the market.
As for the later, market-related debt, the Desk used a variety of techniques
in order not to exert unnecessary downward pressure on the dollar which, in
any event, was under selling pressure during much of the time:
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--The Desk bought the currencies in question, especially German marks,
from central banks other than the Bundesbank that acquired marks either as a
result of their own intervention operations, transactions with customers, or
transactions among governments.
--It arranged to buy a number of currencies through the agency of the BIS
or another central bank in a foreign market, so that the U.S. authorities would
not, in effect, be announcing that they were selling dollars in the exchange
market.
--It took advantage of opportunities it had to buy currencies in the New York
market for the Federal Reserve Bank's customers to "piggy back" on these
operations. In this way the Desk sought to minimize the possibility that the
market would draw policy conclusions from these operations.
--The Desk looked for moments when the dollar was rising to buy
currencies discreetly in the U.S. market, acting similarly to the way it conducts
other discreet intervention operations.
--It bought currencies in the forward market, because the Treasury believed
that such operations would put less pressure on the fast-moving spot market
and thereby be less likely to be detected.
--The Desk also invited the commercial banks with whom it dealt to offer to
sell to the Federal Reserve currencies that the banks' customers were selling.
It thereby put itself in the position of reacting to, rather than initiating,
proposals to buy currencies. This approach had several advantages: The
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Desk remained free to accept or reject a proposed transaction and no
institution had enough information to know the size of any one day's
operations.
In general, the banks came to the Desk with offers to sell
currencies when there were few other buyers--such as when the dollar was
moving up sharply or after the volume of trading had subsided for the day--or
when they had an order they felt was too large for the market to absorb.
-As last
a
resort, the Desk was prepared to take advantage of conditions
attached to the System's swap arrangements with some central banks to buy
the currency directly from the central bank if market conditions did not permit
timely repayment of the swap.
In addition, the U.S. authorities at times purchased currencies openly in the
market to repay market-related debt when U.S. exchange market objectives
and reserve management needs coincided. The largest amount of these open
operations occurred in late 1980 and early 1981. The dollar was strengthening
first in response to a renewed tightening of U.S. monetary policy once the
dislocations of the credit restraint program had passed. Later on, the dollar
drew strength from political developments within the United States that
suggested the fight against inflation had widespread support and would be an
important policy objective for a new Administration. In its final months, the
Carter Administration wanted to take advantage of the dollar's resurgence to
repay debt, build up resources to finance further intervention so as to place
the United States in a position less dependent on borrowed funds, and to
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prevent an erosion of the competitive gains achieved as a result of the dollar's
earlier depreciation.
These open operations, together with those indicated above were, during
the ten years, sufficient to cover all of the System's and Treasury's obligations
and to provide balances on an outright basis by early December 1980.11
I. U.S. Intervention Operations: March 1981 - early 1985
From early 1981 to early 1985, the U.S. authorities limited their intervention
to a very few instances where there was a clear perception that market
disorder had emerged which warranted intervention. The new Administration
held strong views that it was generally inappropriate to intervene to influence
exchange rates and that there should be a very strong presumption in favor of
allowing exchange rates to be determined by the market without government
intervention. Therefore, although the basic policy of intervening to counter
disorderly market conditions still prevailed, this policy was clearly intended to
call for minimal involvement in the foreign exchange market. With respect to
monetary policy, at least in the years from 1981 to 1984, it was generally
agreed that the overriding priority had to be to squeeze inflation out of the
domestic economy, and to restore long-term confidence to the economy and
in the credibility of the monetary authorities.
11 See the accompanying paper "Historical Review of U.S. Holdings of Foreign Currencies."
Also, refer to the accompanying paper "Profits and Losses in U.S. Foreign-Currency Operations."
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This was a period where growth in Europe languished, and by comparison
the U.S. economy was booming under the impetus of fiscal stimulus,
deregulation, declining inflation, and renewed confidence. The dollar became
an attractive investment. It rose 49 1/4 percent against the mark and
21 percent against the yen between March 1981 and December 1984. The
Desk operated to buy or sell dollars on 21 occasions during the four years, or
on only 2 percent of the business days. Most of these operations took place
in very specific circumstances. For example, the Desk intervened to counter
disorder and reassure financial markets generally following the assassination
attempt on President Reagan and the political uncertainties which resulted.
Another occasion was when the Desk bought dollars at the time of the
Continental Bank crisis, an event that instilled concern worldwide over the
stability of the U.S. banking system.
By early 1985, U.S. officials were becoming concerned that the dollar had
risen since 1980 to levels that were so clearly out of line with underlying
economic fundamentals as to cause severe economic consequences and
pose serious political risks. The economic consequence was a major loss of
U.S. competitiveness, showing up in a decline in activity in the U.S.
manufacturing sector, a de-industrialization of much of our economy and shift
of capacity to overseas producers, and large payments deficits financed by a
massive build-up in foreign debt. The political risk was that the Congress
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would try to prevent a further loss of U.S. manufacturing jobs by imposing
severely protectionist trade measures, a move which might undermine
international trade, not only important to the United States but also vital to a
prosperous global economy and the efforts to help relieve the debt burdens of
the LDCs. At the same time, other nations, in the G-5 and elsewhere, grew
increasingly concerned and more restive about the impact of the strengthening
dollar on their own currencies, on their own price performance, and on the
structure of trade and payments.
Under these circumstances, after a January 1985 meeting of the G-5, a
communiqué was issued which suggested perhaps a modest easing of the
U.S. opposition toward intervention, in response to the complaints of the other
G-5 members. Indeed, following initiatives of several other industrialized
countries, the United States on several days in January-early March 1985
joined in to sell a moderate amount of dollars in order to encourage a decline
in dollar rates. Over the eight business days of this operation, the U.S. sold
$659.2 million against marks, yen, and pounds, accounting for 7 percent of the
total $10 billion sold by the G-10 countries. The intervention at first did not
dispel the market's enthusiasm for the dollar, which touched its highest levels
in the floating rate period of DM 3.4780 on February 26 and Y 263.65 on
February 25. But by early March, the weight of the combined intervention,
together with evidence of stronger economic growth in Europe, began to be
reflected in a gradual easing of dollar rates that carried on for a few months.
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In these circumstance, the Desk refrained from intervening actively in the
foreign exchange market until later in the year. By late summer 1985, the
dollar had eased 29 3/4 percent and 24 1/4 percent against the mark and the
yen, to DM 2.4420 and Y 199.80, respectively.
J. September 22, 1985: the Plaza Agreement
The dollar's decline seemed to peter out in early September just as the
United States was ready for a clear policy commitment and coordinated effort
to encourage a further reduction in the exchange rate. The Ministers and
Governors of the G-5 industrial nations caught the markets by surprise when,
on September 22, they announced they had agreed, at a special meeting at
the Plaza Hotel in New York, to a U.S. initiative that "some further orderly
appreciation of the main non-dollar currencies against the dollar [was]
desirable" so that exchange rates would better reflect fundamental economic
conditions. Each of the G-5 agreed to intensify individual and cooperative
efforts to achieve sustained non-inflationary expansion, as a framework for the
exchange rate moves.
The U.S. authorities intervened during the six weeks following the Plaza
Agreement to help achieve their goals. The aim was to bring the dollar lower-or euphemistically, to encourage an appreciation of the other G-5 currencies
relative to the dollar. The United States' G-5 partners were willing--at times too
willing--to sell the dollar even in a falling market. At least within the Federal
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Reserve there was concern that the Desk avoid giving the market an
impression that the United States was trying to hammer the dollar down, lest
the operation get out of control. Memories were still fresh of the U.S.
experience of the late 1970s when the market's impression that the United
States wanted a depreciation of the dollar was firmly entrenched and
consequently difficult to change. The Administration was using tactics other
than intervention--public comments, trade policy, and so forth--to communicate
its desire for a lower dollar and an improved competitive environment. And
many members of Congress were introducing legislation to pursue their own
ideals by way of trade protectionism to gain a "fairer" environment for U.S.
industry. With so many potentially powerful tactics employed to influence
exchange market conditions and sentiment, the Desk took the approach of
resisting upward pressure on the dollar at progressively lower dollar rates. It
sold dollars in the spot market in New York. Sometimes it conducted its
operations through an agent bank which in turn, operated in the futures
market, the agent bank taking the risk of dealing spot with the Desk and
futures on the floor of the IMM. On one occasion, the Desk dealt spot with
banks in Canada when inclement weather had forced many banks in New
York to let their dealers go home during regular business hours.
The intervention after the Plaza Agreement was significant in many ways. It
represented the first episode in which the United States sold dollars when the
dollar exchange rate trend was down (U.S. dollar sales in 1980-81 occurred as
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the dollar generally rose). The amount--over $3 billion by the United States-was sizeable, at that time second only to the short period NovemberDecember 1978 when the United States' ability to intervene in large volume
was first being tested. And the operations were both fairly consistent in
approach and carefully coordinated among the major participants: the rest of
the G-5 sold $5 billion and other G-10 countries sold an additional $2 billion.
But the frequency with which the Desk operated in the market was consistent
with earlier intervention operations (see Table Four).
The effect of these operations was to convince the market of the G-7
authorities' determination to bring about the desired change in the dollar
exchange rate. After six weeks, the dollar had declined by approximately
8 1/2 percent against the mark, 12 3/4 percent against the yen, and 8 percent
on a trade-weighted average from pre-Plaza rates. Thereafter, the United
States did not believe it was necessary to intervene (except for one operation
to buy dollars against yen during late January 1987) for the subsequent 14
months, until the Louvre Accord in February 1987.
K. U.S. Intervention Operations since the Louvre Accord
By the time of the Louvre Accord, February 22, 1987, the dollar had been
on a downward trend for two years (the trade-weighted average having
declined by 31 percent from the early 1985 peaks and by 25 percent from the
Plaza levels). Although the decline had been reasonably orderly, the extent of
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the fall and the levels the dollar had reached against most currencies were
causing anxiety in the markets and among officials, particularly abroad where
there was fear of a "super-competitive" dollar. Meanwhile, the yen was being
bid up relative to all currencies, reflecting the widespread view that a larger
upward adjustment was needed for the yen than for other non-dollar
currencies to reduce the huge Japanese surplus. But the Japanese authorities
were worried that the speed and the extent of the yen's rise was having a
serious deflationary effect on the domestic economy, and were intervening, at
times heavily, to contain the yen's appreciation.
The essential bargain at the Louvre was an agreement by the United States
to cooperate in seeking a greater stability of exchange rates around thencurrent levels, and agreement by Germany and Japan to introduce some
stimulative fiscal measures to their domestic economies. Accordingly, the G-7
monetary authorities shifted their objective from one of encouraging an
appreciation of the non-dollar G-7 currencies to one of fostering greater
stability of exchange rates. The G-7 Accord looked forward to a strengthening
of macroeconomic policy coordination supplemented by exchange market
intervention. There was agreement that intensified economic policy
coordination would promote more balanced global growth and would facilitate
the reduction of existing external imbalances. Given their policy commitments
at the time of the Louvre, the G-7 authorities stated that their currencies were
"within ranges broadly consistent with underlying economic fundamentals." In
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particular, the Louvre Accord maintained that, given the dollar's orderly decline
since the Plaza agreement, "further substantial exchange rate shifts among
[major] currencies could damage growth and adjustment prospects" and
therefore the governors and ministers agreed "to co-operate closely to foster
stability of exchange rates around current levels."
During the nearly three years since the policy shift reflected in the Louvre
Accord, from dollar depreciation to greater dollar stability, there have been
several periods of sustained intervention on the part of the U.S. authorities,
including periods in which the authorities intervened to resist downward
pressures on the dollar and also periods in which they intervened to resist
upward pressures.
Intervention in the First Year after the Louvre Accord: February 22 - December
1987
The dollar, which had been on a long downward trend, moved higher in the
days immediately following the Louvre Accord, especially against the mark.
This movement reflected the market's initial acceptance of the concept that the
G-7 authorities were no longer actively seeking to lower the dollar. Market
participants were willing to believe that the G-7 authorities were prepared to
keep the dollar around the then-current levels while giving the economies of
the major industrial nations time to adjust to the significant depreciation of the
dollar that had occurred since 1985. As this initial reaction boosted the dollar
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in the exchange markets, questions arose in the market about how much of a
recovery in the dollar the G-7 authorities would tolerate. Therefore, on March
11, when in keeping with the agreement the Desk entered the market to sell
$30 million against marks when the dollar/mark rate was at DM 1.8715, this
operation drew immediate market attention. The market concluded that it had
discovered the upper limit of the unannounced G-7 target ranges and quickly
returned to testing the downside of the dollar. The dollar then started to move
lower, especially against the yen, and was periodically under downward
pressure for much of the rest of the year.
A major test occurred after the dollar fell through the Y 150.00 level against
the yen. To many market participants, especially in Japan, the Y 150 level had
been perceived as the lower limit of the Louvre accord. Indeed Y 150 had
been regarded as an important psychological level by the Japanese well
before the Louvre, and there had been widespread reports that the Japanese
authorities had encouraged the view that level would not be breached. When
the dollar did decisively break below Y 150, Japanese institutions sold dollars
heavily not only to cover their dollar exposures but also to seek alternative
investments, while prices of U.S. bonds and equities fell and prices of precious
metals and of bonds denominated in other currencies rose.
In these circumstances, pressures against the dollar persisted from late
March to early May 1987. The U.S. monetary authorities intervened more
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forcefully to resist, if not reverse, the downward direction of the dollar's
exchange rate movements. Monetary policy was also adjusted somewhat to
help stabilize the dollar. At its March 31, 1987, meeting, the Federal Open
Market Committee agreed that open market operations needed to be
especially sensitive to any tendency for the dollar to weaken significantly, and
generally firmer reserve conditions were subsequently maintained. But it was
not until mid-April, when Treasury Secretary Baker, in a speech to the Japan
Society in New York, pointed to ways other than exchange rate adjustment
that the United States could improve its external performance vis-a-vis Japan
that the selling pressure against the dollar subsided. Subsequently, when the
leaders of the G-7, at the mid-June Venice summit meeting, reaffirmed the
Louvre Accord and adopted plans for increased multilateral surveillance aimed
at improving policy coordination and economic performance among the G-7,
the dollar rose. In early August, the U.S. authorities intervened to resist the
upward pressure.
During late 1987, the dollar again came under persistent downward
pressure amid concerns about the large U.S. external imbalances and
continuing large U.S. budget deficits. Press reports suggested there were
major policy disputes among the G-7, in particular Germany and the United
States. Further, in the wake of the October 1987 break in equities prices, fears
of a possible recession in the United States intensified, and many market
participants perceived that the scope for a tightening in U.S. monetary policy
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was limited. In these circumstances, on December 22, 1987, the G-7 issued a
statement that went beyond the Louvre call for exchange rate stability, stating
that a further decline of the dollar could be counterproductive. The initial
market response was quite negative. The dollar continued to decline in thin,
holiday trading as market participants expressed disappointment that the
communiqué offered no explicit new economic policy initiatives to stop the
dollar's fall and redress international imbalances. There was heavy and
sustained intervention by the U.S. authorities in the days following the
December 1987 G-7 meeting. Although the dollar continued to decline to
reach its record lows early on the first business day of the new year, January
4, 1988, the intervention served to put the dollar technically in an oversold
position in very thin year-end markets.
During the period from February 22, 1987, to the end of the year, the Desk
entered the market on 23 percent of the trading days either to buy or sell
dollars. The Desk purchased a total of $9,194 million and sold $661 million; its
gross operations amounted to $9,855 million.
U.S. Intervention Operations in 1988
On January 4, 1988, after the dollar hit its lows of DM 1.5615 against the
mark and Y 120.20 against the yen in Australian trading, market perceptions of
official commitments to support the dollar changed dramatically. Telephone
calls by the Desk to Far Eastern markets to ask for exchange rate quotations,
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together with intervention by the Japanese authorities, gave market
participants the impression that a concerted and aggressive intervention
operation was about to be embarked upon to turn the dollar around. As
traders clamored to cover their short positions, the dollar bounced up against
all the major currencies. The U.S. and other G-7 authorities did intervene to
reinforce the dollar recovery, and traders continually struggled to cover short
positions as the dollar moved to progressively higher levels. Once the
immediate scramble for dollars had passed, and the market recognized that
the dollar was considerably above the levels prevailing at the time of the
December G-7 statement, market participants came to believe that the U.S.
monetary authorities were seriously committed to supporting the dollar.
Beginning in March, U.S. trade figures also began to show impressive
improvement. In these circumstances, the dollar continued generally to
advance for much of the spring and summer.
For the rest of 1988, the U.S. authorities intervened at times to buy and at
times to sell dollars. To resist brief periods of downward pressure, the U.S.
authorities intervened on several occasions in March and April to buy dollars.
But soon the dollar took on a stronger tone. During the spring some other
central banks began to sell dollars in order to trim back their foreign currency
reserves. During the summer, the U.S. authorities also entered the market to
resist the upward pressure by selling dollars. Market participants did not
appear to be too concerned about the central banks selling dollars since, for
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the most part, they expected that the central banks would resist sharp
movements in the dollar ahead of the Presidential election.
But, as the election approached in the United States, many market
participants began to reflect again on the severity of the U.S. budget and
balance of payment deficits, and to wonder whether a new administration
would be as concerned about and as committed to fostering exchange rate
stability. Many observers believed that the change in administration would
provide an opportunity for the United States to seek another depreciation to
enhance competitiveness; others expressed concern that, with a possibly
increased Democratic majority in Congress, budget negotiations with the
administration would become more contentious. In these circumstances, the
U.S. authorities once again entered the market to resist the dollar's fall and to
reassure market participants of their continued commitment to the Louvre
agreements to foster exchange rate stability.
During 1988, the Desk purchased $4,133 million and sold $5,066 million,
operating on 19 percent of the trading days in the year. Its gross operations
were $9,199 million; the Desk's operations averaged $192 million on each day
that it was in the market.
U.S. Intervention Operations during 1989
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During 1989, U.S. intervention operations were all on the side of containing
rises in the dollar in the face of several waves of dollar buying pressure, most
heavily in May and June, and to a lesser extent in September and early
October. In each instance, the dollar was buoyed by strong investment and
commercial demand. In part, market attitudes toward the dollar may have
reflected increased market confidence based on experience since the Louvre
that the G-7 officials would firmly resist too sharp a decline in the dollar.
Investors and commercial interests seemed to have become more convinced
that the dollar would not depreciate greatly, and showed greater confidence in
both increasing the share of dollar assets in their overall portfolios and
reducing the hedged proportion of their dollar assets.
The strength of the dollar took place in spite of a large reduction in the
dollar's interest rate advantage over other major currencies between April and
December 1989 of 400 basis points against the yen and 200 basis points
against the mark--to the extent that the dollar's margin over yen and mark
assets virtually disappeared. At times, the relative attractiveness of the dollar
was improved by concerns about political developments abroad--in China,
Japan, and Europe--which spurred bursts of strong demand for the U.S.
currency. Although the U.S. current account deficit remained large, and did
not show as much improvement in 1989 as in the previous year, there was
little apparent market concern about the deficit since it was being so easily
financed--indeed overfinanced--by private capital flows.
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The U.S. authorities adjusted their intervention approach to respond to the
varying degrees of intensity of market pressures on the dollar. As the dollar
rose in mid-May to approach earlier highs of the Louvre period, the authorities
stiffened their resistance. On two days, May 18 and May 19, 1989, the U.S.
authorities sold a total of $2 billion, mostly in visible and concerted intervention.
On several occasions, the Desk placed bids or offers in several commercial
banks simultaneously in close coordination with similar operations by other
central banks. As May progressed, the Desk began to supplement these
visible operations with discreet ones in order to reduce the predictability of the
Desk's actions and thereby increase a sense of greater two-way market risk.
At one time, during the summer, the Desk coordinated "rolling" discreet
operations whereby the U.S. and foreign monetary authorities would enter the
market in successive turns to sell dollars discreetly.
The May-June period was the time of the heaviest U.S. intervention, almost
$12 billion for the two months. In this period, the dollar rose to its highest
rates of the post-Louvre period--to DM 2.0476 against the mark and Y 151.90
against the yen. In the summer months the dollar eased back moderately,
and there were much smaller amounts of intervention. But in late August and
September, there was a resurgence of upward pressure on the dollar, partly
reflecting evidence of a stronger-than-expected U.S. economy. U.S.
intervention again grew larger, leading up to the G-7 meeting on September
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23. As the date approached many market sources were anticipating a
renewed, major coordinated effort by the central banks to stop the dollar's
upward momentum.
At that meeting, the G-7 Finance Ministers and Governors confirmed these
expectations and issued a statement concluding, among other things, that the
dollar's rise in recent months was "inconsistent with longer-run economic
fundamentals" and that a further dollar rise above then current levels, or an
excessive decline, could adversely affect the world economy. The Ministers
and Governors reiterated their intention to cooperate closely in the exchange
markets.
Following the release of the September 23 G-7 statement, the dollar moved
sharply lower. Coordinated intervention by the U.S. and other G-7 authorities
to sell dollars at successively lower rates helped to reinforce the market view
that there was strong official determination to deal effectively with the rising
dollar. In order to encourage that view, the United States, Japan, and
Germany all operated during the first few days in other foreign exchange
markets--a very unusual though not unprecedented practice. Thus the United
States operated in Tokyo, Singapore, and Sydney (some of it on Sunday night
in New York), and Germany and Japan operated in similar ways.
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In these intervention activities after the September 23 statement, the U.S.
and other G-7 authorities were of the view that it would be necessary to
operate more aggressively than before in order to change market attitudes and
to break the strong upward momentum in the trend of the dollar that had
developed.
In operations earlier in the year, the U.S. authorities had tended to
resist upward pressure by selling dollars at progressively higher levels--a kind
of gradual retreat, in order to avoid being seen to be forcefully driving the
dollar down with sales in a falling market. The problem with such an approach
was that, in the strong and rising dollar market that existed at that time,
position-takers had an incentive to hold on to and increase their long-dollar
positions. If the official intervention failed to stop the dollar's rise, the positiontaker gained; if the intervention succeeded in stabilizing the dollar, the positiontaker neither gained nor lost, but was hardly discouraged from trying again the
next day. In late September, it was felt that containing the dollar's rise was not
enough--it was necessary to try to reduce the dollar's level, so as to cause the
position-takers to suffer losses on their long-dollar positions and cut those
positions. That was the approach followed in the days after the September 23
communiqué.
The aim was to restore a two-way market, and encourage
greater stability over the medium term, by breaking the dollar's upward
momentum.
The U.S. and other G-7 countries (mainly Japan) intervened in
substantial amounts until October 12.
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For the last 2 1/2 months of 1989, there was virtually no U.S. intervention
(dollars were sold against yen on only 2 occasions, totalling $150 million). In
addition to whatever effects the late-September-early-October intervention had,
there were further interest rate changes in Germany, Japan, and the United
States all of which tended to continue to reduce the dollar's margin of
attractiveness relative to the other major currencies. Also, changes in Eastern
Europe and other factors buoyed the German mark against other currencies.
The dollar closed the year below the June 1989 peaks by about 17 percent
against the mark, though down by only about 4 percent against the yen.
In total, U.S. intervention during the waves of upward dollar pressure and
intervention during 1989 totalled nearly $22 billion for the year as a whole.
This amount was larger than U.S. intervention in the prior years of the Louvre
Accord--in 1987 total U.S. intervention was $9.8 billion (gross dollar purchases
and sales) and in 1988 it was $9.2 billion. But that did not reflect a different
intervention policy or approach than was followed in those prior years. Hence,
the United States did not, for example, sell dollars at lower levels than in 1987
or 1988. The larger amounts of intervention in 1989 reflected heavier
exchange market pressures on the dollar and the effect of following the same
general approach at a time when market pressures were more intense.
The decision to resist the upward pressure on the dollar to the extent the
United States did in 1989 was taken in light of the U.S. understandings with the
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other members of the G-7. It reflected the view that further sharp upward
movements of the dollar, beyond the rises that had already been registered,
would worsen the already large U.S. payments deficit and be harmful to the
effort to bring about international adjustment. A higher dollar was seen 1) as
being unsustainable over an extended period, 2) as leading to potentially
greater instability, uncertainty, and volatility in the foreign exchange market,
and thus, 3) importantly, as a potential source of instability for other U.S.
financial markets with possibly disturbing and dangerous consequences.
Finally, it is worth looking at the size of operations during 1989, and more
generally since the Louvre Accord, in comparison with those undertaken in
earlier periods of strong pressure in the exchange markets, especially during
the period September 1977 to December 1979 (see Table Five). During the
earlier period, the U.S. authorities were in the market on 61 percent of the
trading days compared with 27 percent for the post-Louvre period as a whole
and 39 percent in 1989. To be sure, the average daily operations during the
1977-1979 period were smaller--$82 million compared to $207 million and $226
million, respectively. But the growth in the average daily operations should be
viewed in the context of the greatly increased size of the U.S. foreign
exchange market. 12 There has been much publicity about the extent to which
12 Based on the Federal Reserve Bank of New York's turnover survey of the U.S. foreign
exchange market, the market increased from an estimated average daily turnover of $18 billion
in 1980 to $128 billion in 1989.
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U.S. official dollar purchases have "financed" the U.S. current account deficit in
recent years. But official U.S. dollar purchases in the 1977-1979 period were
nearly identical to the estimated current account deficit for the same period--or
about $23 billion. Comparing the size of all operations--intervention plus
operations to repay debt and adjust balances--for the (almost) three-year
period since the Louvre with the three-year period 1978-80:
--Gross operations since the Louvre were $41 billion (of which $13 billion
was dollar purchases and $28 billion dollar sales).
--Gross operations during 1978-80 were $43 billion (of which $27 billion was
dollar purchases and $15 billion dollar sales).
The heaviest single year of intervention since the Louvre was 1989, with $22
billion (all dollar sales), while the heaviest single year in the earlier period was
1980, with $16 billion (two-thirds of which was dollar sales, and one-third dollar
purchases).
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Table One: U.S. Foreign Exchange Operations ¹
During the Early Floating Rate Period, March 1973 - August 1977
AMOUNT OF OPERATIONS
(Millions of dollars)
Purchases
Sales
PERIOD
DIRECTION
OF PRESSURE
ON DOLLAR
Intervention
Intervention
Repay debt &
Reconstitute
Reserves
FREQUENCY OF
AVERAGE SIZE
OF DAILY
OPERATIONS
(Percent of
Trading Days)
OPERATIONS
(Millions of
dollars)
NUMBER OF
DAYS OF
OPERATIONS
March to
June 1973
Downward
0.0
0.0%
July 1973
Downward
273.5
57.1%
22.8
August 1973
to
December 1974
Downward
1345.4
-203.2
-1285.5
36.2%
22.0
Downward
928.7
0.0
-130.3
68.3%
24.6
April 1975
to
August 1977
Mainly
Downward
1059.6
0.0
-1977.7
42.3%
TOTAL
PERIOD
Downward
3607.2
-203.2
-3393.5
38.9%
January to
March 1975
Mainly
¹ This table reports all U.S. operations conducted in the foreign exchange market by the U.S. Treasury and Federal Reserve.
It excludes transactions done with customers and off-market transactions conducted directly with foreign central banks. It
includes both the U S. foreign exchange operations designed to influence market conditions and exchange rates--intervention-and
operations undertaken in the market to acquire the foreign currencies necessary to repay market-related debt or otherwise
to reconstitute reserves. The number of days of operations, the frequency of operations, and the average size of the daily
operations reflect both "active" intervention as well as reserve-related operations.
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16.3
Table Two: U.S. Foreign Exchange Operations¹
September 1977 - December 1979
AMOUNTOF OPERATIONS
(Millions of dollars)
Purchases
Sales
PERIOD
DIRECTION
OF PRESSURE
ON DOLLAR
Intervention
Intervention
AVERAGE SIZE
Repay debt &
Reconstitute
Reserves
NUMBER OF
DAYS OF
OPERATIONS
FREQUENCY OF
OPERATIONS
(Percent of
Trading Days)
OF DAILY
OPERATIONS
(Millions of
dollars)
September to
Downward
850.0
0.0
-11.5
March 1978
Downward
2102.1
0.0
April to
July 1978
Mixed
258.4
August to
October 1978
Downward
November to
December 1978
Downward
December 1977
34
42.0%
25.3
-69.3
61.9%
55.7
0.0
-1042.3
52.9%
28.9
2492.8
0.0
-224.7
50.0%
84.9
6647.6
0.0
-190.7
77.5%
220.6
January to
January to
Mainly
June 14, 1979
Upward
852.1
0.0
-3808.5
65.0%
61.3
Downward
10173.5
0.0
-696.0
75.6%
106.6
Downward
23376.5
0.0
-6043.0
61.4%
81.9
June 15, 1979 to
December 1979
TOTAL
PERIOD
¹ This table reports all U.S. operations conducted in the foreign exchange market by the U.S. Treasury and Federal Reserve.
It excludes transactions done with customers and off-market transactions conducted directly with foreign central banks. It
includes both the U.S. foreign exchange operations designed to influence market conditions and exchange rates--intervention--and
operations undertaken in the market to acquire the foreign currencies necessary to repay market-related debt or otherwise
to reconstitute reserves. The number of days of operations, the frequency of operations, and the average size of the daily
operations reflect both "active" intervention as well as reserve-related operations.
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Table Three: U.S. Foreign Exchange Operations ¹
January 1980 - August 1985
AMOUNT OF OPERATIONS
(Millions of dollars)
Purchases
PERIOD
DIRECTION
OF PRESSURE
ON DOLLAR
Intervention
Sales
Intervention
Repay debt &
Reconstitute
NUMBER OF
DAYS OF
Reserves
OPERATIONS
FREQUENCY OF
AVERAGE SIZE
OF DAILY
OPERATIONS
(Percent of
Trading Days)
OPERATIONS
(Millions of
dollars)
January to
March 1980
Mixed
800.7
April to
July 1980
Mixed
3688.8
August 1980
to
February 1981
Upward
363.3
March 1981
to
December 1984
Upward
January to
August 1985
TOTAL
PERIOD
-582.7
-1195.4
76.6%
52.6
-937.3
62.4%
87.3
-2805.4
-4991.5
78.6%
71.6
209.4
-889.1
-25.0
2.2%
53.5
Mainly
Downward
0.0
-659.2
4.7%
82.4
Mainly
Upward
5062.2
-4936.4
20.8%
70.0
-7149.2
¹ This table reports all U.S. operations conducted in the foreign exchange market by the U.S. Treasury and Federal Reserve.
It excludes transactions done with customers and off-market transactions conducted directly with foreign central banks. It
includes both the U.S. foreign exchange operations designed to influence market conditions and exchange rates--intervention--and
operations undertaken in the market to acquire the foreign currencies necessary to repay market-related debt or otherwise
to reconstitute reserves. The number of days of operations, the frequency of operations, and the average size of the daily
operations reflect both "active" intervention as well as reserve-related operations.
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Table Four: U.S. Foreign Exchange Operations ¹
September 1985 - December 1989
AMOUNT OF OPERATIONS
(Millions of dollars)
Purchases
Sales
PERIOD
DIRECTION
OF PRESSURE
ON DOLLAR
Intervention
Intervention
Repay debt &
Reconstitute
Reserves
FREQUENCY OF
NUMBER OF
DAYS OF
OPERATIONS
OPERATIONS
(Percent of
Trading Days)
AVERAGE SIZE
OF DAILY
OPERATIONS
(Millions of
dollars)
September to
November 1985
Downward
0.0
December 1985 to
January 1987
Downward
50.0
February to
December 1987
Mainly
Downward
9194.1
1988
Mainly
Upward
1989
TOTAL
PERIOD
TOTAL
SINCE
LOUVRE ACCORD
-3300.9
36.1%
150.0
0.3%
50.0
-661.0
23.0%
185.9
4133.0
-5066.0
19.0%
191.6
Upward
0.0
-21957.0
38.5%
226.4
Mixed
13377.1
-30984.9
20.3%
200.7
Mainly
Upward
13327.1
-27684.0
27.0%
207.1
22
¹ This table reports all U.S. operations conducted in the foreign exchange market by the U.S. Treasury and Federal Reserve.
It excludes transactions done with customers and off-market transactions conducted directly with foreign central banks. It
includes both the U.S. foreign exchange operations designed to influence market conditions and exchange rates--intervention--and
operations undertaken in the market to acquire the foreign currencies necessary to repay market-related debt or otherwise
to reconstitute reserves. The number of days of operations, the frequency of operations, and the average size of the daily
operations reflect both "active" intervention as well as reserve-related operations.
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Table Five: Summary of
Foreign Exchange Operations
March 1973 - December 1989
AMOUNT OF OPERATIONS
(Millions of dollars)
Purchases
Sales
PERIOD
DIRECTION
OF PRESSURE
ON DOLLAR
Intervention
Intervention
Repay debt &
Reconstitute
Reserves
NUMBER OF
DAYS OF
OPERATIONS
MEMO ITEMS
FREQUENCY OF
AVERAGE SIZE
OF DAILY
OPERATIONS
(Percent of
Trading Days)
OPERATIONS
(Millions of
dollars)
APPROXIMATE
SIZE OF U.S.
FOREIGN
EXCHANGE MRKT
(Avg. daily
turnover,
Millions of
dollars)
BASED ON
F.R.B.N.Y
TURNOVER
SURVEYS
CONDUCTED IN
THE FOLLOWING
YEARS
March 1973
to
August 1977
Downward
3607.2
-203.2
-3393.5
September 1977
to
December 1979
Downward
23376.5
0.0
-6043.0
61.4%
81.9
18000
1980
January 1980
to
February 1981
Mixed
4852.8
-3388.1
-7124.2
73.5%
71.1
18000
1980
Mainly
Upward
209.4
-1548.3
-25.0
2.6%
61.5
26000
1983
September 1985
to
November 1985
Downward
0.0
-3300.9
36.1%
150.0
58500
1986
December 1985
to
January 1987
Downward
50.0
0.3%
50.0
58500
1986
Mainly
Upward
13327.1
-27684.0
198
27.0%
207.1
128900
1989
45423.0
-36124.5
1268
31.8%
77.4
March 1981
to
August 1985
February 1987
to
Present
TOTAL
FLOATING RATE
PERIOD
-16585.7
443
38.9%
I. Sec footnote ¹ on other tables.
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Review of
Approaches and Tactics of Intervention
in the Context of
Changing Market Conditions, Policy and Objectives*
Overview ...............................
1
II.
Structure of the Foreign Exchange Market .......
1
III.
Objectives and Tactics .....................
6
IV.
Monitoring Market Conditions ................
8
V.
Coordination with Other Central Banks .........
VI.
Financial and Other Constraints ..........
VII.
Various Approaches to the Market ............
VIII.
Differences in Approaches of Foreign
Exchange Desk and Open Market Desk .......
18
Evaluating the Results of Particular
Intervention Operations ....................
20
I.
IX.
10
... .
11
.13
* Prepared by Meg Browne, Foreign Exchange Department, Federal
Reserve Bank of New York.
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Overview
This paper deals with the execution of intervention policy and not the
formulation of such policy. It discusses how the Desk tries to implement the
decision, whatever it may be, once the U.S. monetary authorities have
reached agreement on what the United States should try to do in the
exchange market.
The techniques used by the Foreign Exchange desk for intervening have
been developed against the background of the particular structural
characteristics of the foreign exchange market, and reflect, among other
things: the objective or strategic aim of the intervention operation; market
conditions at the time, that is, the main forces and psychology, the tactical
environment; the nature and degree of coordination with other central banks
and governments; and whatever constraints there may be on available
financing or other limits. These factors are discussed below, followed by a
description of the differences between the operating techniques of the
Foreign Exchange Desk and those of the Open Market Desk. A final section
discusses how the desk assesses the results of its operations.
Structure of Foreign Exchange Market
The desk's intervention operations are undertaken in an exchange market
which is large in size, worldwide in scope, and virtually twenty-four hours in
duration with interlocking exposures linking financial centers. No one knows
the exact size of the worldwide market, but estimates are that turnover is
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perhaps $650 billion per day. Only about one fifth of these transactions take
place in the U.S. market. The U.S. market is not regulated as such, though
many or most of the participating institutions (other than the brokers) are
regulated by bank supervisors or the SEC.
The Foreign Exchange desk perceives itself as being only one of a
number of large and potentially influential players in the foreign exchange
market. There are many private sector entities which can be quite active,
from time to time, and whose activities are hard for the desk to monitor,
either because of the nature of the institution or its location. Moreover,
unlike the Open Market desk, the Foreign desk is not the only official
institution intervening in its market. In fact, there are many other central
banks that play a role in the foreign exchange market for dollars, executing
their own exchange rate policies and reserve management strategies as well
as meeting other operational objectives.
In addition, the desk has much less "hard" data or information available to
it than does the Open Market desk when designing a strategy for conducting
a foreign exchange market intervention. It has virtually no way of knowing
precisely what institutions have been most active, what their operations have
been, why they have conducted them, or what the consequences are for
their exchange rate exposures. There is no reporting system for United
States-based institutions that provides such information on a timely enough
basis to be of any use for this purpose. And, of course, information about
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offshore institutions is never available. There is an effort to exchange some
information among central banks, both about transactions executed in their
own markets and their own operations. But this exchange is also quite
limited. The central banks that nominally participate in this exercise are no
more than about 20, compared to the total number of IMF members of 152,
and the participating central banks do not always report even all of their own
operations.
Working within these constraints, the desk has sought to develop effective
relationships with other market participants which voluntarily discuss with the
desk what they see taking place in the markets and their own attitudes and
expectations. In addition, those working on the desk need to develop some
"market sense" of their own in order to evaluate the commentary they
receive from others and independently make judgments about the
receptiveness of the market to certain types of tactics that the desk may
employ to execute an intervention operation. The type of factors that the
desk keeps track of to maintain this "market sense" has evolved over time
as the market has grown and changed in character.
In the 1950s and early 1960s, there was no true "international" market for
foreign exchange, just a series of isolated national markets. Also, exchange
rates were fixed, capital transfers were generally restricted, and international
capital flows were more or less limited to financing current account
imbalances. Traders working on the desk were expected to pay close
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attention to the major countries' trade and current account positions, as well
as the level of their official reserves.
As the growth of world trade and capital flows increased, as capital
controls were relaxed, and as communications technology improved, global
foreign exchange and other markets began to develop in the late 1960s.
The real expansion in foreign exchange trading volume in the United States
took place in two stages. The first was in the late 1970s when international
brokering was introduced and international dealing therefore became a
reality. Foreign exchange turnover, as measured by the Federal Reserve
Bank of New York's triennial surveys, increased nearly five-fold from roughly
about $5 billion per day in April 1977 to $23.4 billion per day in March 1980
(or $18 billion adjusted to eliminate double counting). The second stage
was after 1983 when daily average turnover adjusted to eliminate double
counting went from $26 billion in April 1983, to $58.5 billion in March 1986,
and to $128.9 billion in April 1989. This second phase coincided with a shift
from trade-financing to predominantly investment financing, the adoption of a
wide variety of new products and new techniques, the absorption of major
improvements in technology and communication, and a broadening of the
inter-bank market to include some investment houses. In this environment,
those who work at the desk are expected to develop good understandings
of all the major financial markets around the globe as well as some of the
major commodity markets, new trading techniques (such as "charting" and
program trading) and new instruments. Desk coverage has also been
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extended. As a matter of routine it is manned from 3:30 a.m. until 5:30 p.m.
with at least one dealer covering the markets during the evening from home.
During times of turbulence the desk is manned and can be active around
the clock.
The growth in the size of the foreign exchange market has been parallel
by an increase in the volume of heavy interventions conducted by the United
States. Looking back over the record of U.S. operations as presented in the
periodic reports to Congress, one can see that, in the early days of
intervention, an operation that amounted to $50 million in a day might have
been described as "active" or "heavy." The first $1 billion dollar day for the
desk for our own account did not occur until May 1989.
But the growth in the market does not mean that all operations have to
increase proportionally in order to be effective. This is because central bank
intervention operates on the margin, when there is great uncertainty or an
imbalance between demand and supply. Such an imbalance at any point of
time may be very small, even in a market that has the capacity to be quite
deep. Indeed, the historical record shows that when the desk came into the
market on March 11 to intervene for the first time after the Louvre Accord of
1987, the desk's sale of $30 million was sufficient to reverse a 2 1/2 week
advance of dollar rates.
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Objectives and Tactics
Fundamental to any intervention operation is the question of what is the
desired strategic objective. As described in other Task Force papers, it is
possible to identify over the past 12 years five (partly overlapping) periods in
which the United States had different strategic objectives with respect to
intervention:
to support the dollar and push it
1. Nov. 1978 to July 1980
up.
2. April 1979 to Feb. 1981
to take market opportunities as
they occurred to acquire foreign
exchange for repaying debt and
building up balances.
3. Feb. 1981 to Sept. 1985 -
to limit intervention strictly to
countering "disorderly market"
conditions, narrowly defined.
4. Sept. 1985 to Feb. 1987 -
to encourage appreciation of other
G-7 currencies relative to the
dollar.
5. Feb. 1987 to present
-
to foster exchange rate stability.
Put another way, our intervention operations have been aimed primarily at:
a) dealing with short-term flare-ups that could disrupt markets; b) acquiring
foreign currency balances for repaying debt; and c) moving dollar rates, up
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or down, or maintaining stable rates, in line with what are regarded as
"fundamentals."
Obviously the different objectives call for different tactical approaches.
The need to calm a disorderly market may require prompt, bold actions,
perhaps highly visible, perhaps discreet, conceivably entering the market on
both the buy and sell sides simultaneously in very exceptional
circumstances.
Accumulating or restoring balances may be best accomplished by modest
purchases over time on a daily or other gradual basis, possibly discreetly,
with operations timed in a way so as to minimize market disruption or
attention.
Encouraging the currency to follow a particular medium-term trend--be it
up, or down, or stable--can be particularly sensitive, and tactics must be
fashioned to the particular circumstances. When the authorities are trying to
encourage a medium-term trend--such as on November 1, 1978, or
September 1985, and most of the post-Louvre period--the desk has been
more inclined than at other times to intervene openly, in order to take
maximum advantage of the "announcement" effects of intervention. This
technique can be powerful, when combined with other announcements or
actions (such as occurred on November 1, 1978 and with the Plaza
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statement of September 1985). But because it is so potentially powerful it
carries particular dangers when used to push a currency down. That is
why, during the period after the Plaza, when the policy guideline was to
encourage appreciation of the G-7 currencies relative to the dollar, the desk
tried as much as possible to allow the dollar to move downward when
market forces tended in that direction, and to resist (with varying degrees of
firmness and at progressively lower levels) when market forces tended to
move the dollar back up. The desk sought to avoid any impression that we
wanted to "hammer" the dollar down. This asymmetrical approach helped to
encourage a gradual, substantial, and certainly helpful correction of the
dollar's very high level.
Monitoring Market Conditions
Since the dollar was floated in 1973, the U.S. monetary authorities have
undertaken to intervene if necessary to deal with "disorderly conditions" in
the exchange market and, more recently, at other times that may be
appropriate.
As a result of this mandate, the desk watches for evidence that disorderly
conditions may exist or be developing. It also evaluates market conditions
on an ongoing basis in order that, if intervention operations are considered
appropriate for other reasons, it can take account of those conditions in
recommending a tactic that is most likely to accomplish the desired results.
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Elements of a disorderly market include: exaggerated rate movements,
wide spreads in quotations, a stifling of the intermediary role of the
professional traders, and near total unresponsiveness to the fundamentals
operating at the time. A market that is in such a disorderly state as to show
all of these characteristics is by its nature unstable. If left to its own
devices, it can deteriorate further, leading eventually to a kind of paralysis of
the market place. Such a paralysis actually occurred--in July 1973 in an
episode that convinced the authorities that, even in a floating exchange rate
regime, intervention is sometimes appropriate.
Since the Louvre Accord the United States has intervened even though
evidence of market disorder in that narrow technical sense was not present.
These operations have had the objective of trying to foster greater exchange
rate stability, usually by resisting a rise or a decline in the dollar that was
thought to be excessive and potentially counterproductive to international
adjustment. Sometimes in these circumstances, the intervention operations
have been fairly straightforward. The market was looking for evidence that
the current movement in rates was causing official concern. All that the
intervention needed to accomplish was to reassure market participants that,
indeed, there was enough concern for the central banks to do something
about it. But at other times, such as in the spring of 1989, the pressures
the desk was confronting were very strong. Under these circumstances, the
desk finds it more difficult to come up with strategies that will appear
credible, particularly over a sustained number of days. Therefore, the desk
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may simply change its strategy in order to regain an element of
unpredictability or temporarily adopt a more aggressive mien.
Whenever the desk is trying to devise its tactics, it tries to take into
account: the current position (long or short) of the largest intra-day positiontaking entities, the current position (again long or short) of more "strategic"
position takers, the level of activity, expectations about the near-term course
of exchange rates and other relevant prices, the strength of conviction about
those expectations, "chart" points, and anything else that might influence
exchange market conditions during the time span of the operation (such as
press releases, economic data, political events, operations of the Domestic
desk--the list is endless). Since these are qualities of market performance
which are unmeasurable or unknown at the time an operation is being
planned, much is based on a combination of judgment and experimentation.
It may happen, for example, that the desk starts out with one strategy, but
revises the strategy when it sees how the operation is going.
Coordination with Other Central Banks
Another factor affecting the approach to be taken in intervention
operations is the degree and form of coordination with other central banks.
All U.S. intervention is in some sense "coordinated" under present
circumstances. The general policy issues are discussed by the G-7
Ministers and Governors. The overall framework for U.S. intervention
operations is presented to the desk by the Treasury. The desk tries to work
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out a strategy for the operation that is consistent with that framework,
acceptable to the Federal Reserve, and agreeable to if not supported by the
central bank responsible for the counterparty currency. Nowadays we
generally coordinate in ways that go much farther than that: recognizing
that markets are much impressed by concrete evidence of close operational
harmony and coordination (and also quick to exploit even the most
minuscule hint of intra-G-7 disagreement), we frequently try to act jointly, at
the same time and in the same manner, or, as the clock moves, to pass the
baton from one central bank to the next in a way which indicates uniformity
of view and consistency of purpose.
Financial and Other Constraints
The effectiveness of intervention is enormously enhanced if the operation
can be conducted at the appropriate time. A missed opportunity to influence
the market can often mean that to achieve the same effect, a much larger
operation than was initially envisaged becomes necessary. The Foreign
Exchange desk's task is to try to determine when the market's dollar
position, psychology and technical factors are right for intervening to achieve
the desired objective. But to take advantage of the most opportune time,
the desk has to have the appropriate authorization and quantity of funds. It
can happen that the desk's scope of action is limited by not having timely
authorization, not having authorization of sufficient size to achieve the
objective in the most efficient manner, or other constraints.
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The problems of timeliness and size of authorization, when they occur,
reflect essentially the decision-making process (see Task Force paper on
"Federal-Reserve Treasury Coordination").
In recent years the Treasury has
insisted that it authorize the funds to be available for intervention on a daily
basis, and sometimes the Treasury's plans are for very limited amounts. It
is the desk's practice then to review the authorization within the Federal
Reserve, seeking FOMC guidance when called for under the Procedural
Instructions, before initiating any operation. Working in this way, an
opportunity to be most effective can be lost. The desk does not know the
extent to which additional authorization will be forthcoming if the need should
arise, and therefore cannot really budget the resources as effectively as it
ought. Furthermore, if the desk does request additional authorization, the
request often requires concurrence or approval by the most senior Treasury
officials who may be unavoidably unavailable or inaccessible on short notice.
This decision-making process may also lead to situations in which the
market senses inconsistencies in carrying out intervention strategies from
one day to the next. Such a perception can be costly. If, for example, the
desk is successful in pushing the dollar through an important technical level
on one day but the desk does not reappear to intervene on the following
day when the dollar returns to that same technical level, market participants
may assume the desk has given up and/or that participants have license to
push the dollar even further away from the goal of the policymakers.
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At times the desk may also feel constrained from acting as strongly as it
might to pursue a U.S. policy objective in the exchange market, out of
concern that doing so would put pressure on other countries' currencies or
otherwise compromise other countries' approach to the exchange market.
When using the German mark or another continental currency as its
intervention currency, for example, the desk is mindful that its actions could
have an impact on exchange rate relationships within the EMS and tries to
avoid aggravating pressures that may already exist there.
Various Approaches to the Market
Depending on market sentiment and other conditions at the time, the desk
may operate directly in the interbank market. In this approach, which the
desk utilized extensively in the past year or so, the desk asks banks for
prices on standardized amounts. The desk deals with the bank as an equal
partner--a direct counterparty to the trade--and the other partner has the
option to deal with the information of our trade as he sees fit--just as we do.
Accordingly, a bank with which we operate in this fashion may inform the
news services, other participants, or bank customers of the fact that they
have dealt with the Federal Reserve. Normally, information that the Federal
Reserve is undertaking such transactions gets around the market quickly
(although there are frequently reports of such transactions when none have
taken place). This technique is useful if the operation's effectiveness is
enhanced by the market's knowing either that we are intervening and/or the
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market conditions and approximate exchange rates at which we are
operating.
In many situations, however, the desk has sought to avoid an
"announcement effect" for its operations for either policy or technical reasons
and to enhance the effectiveness of the operations. In such an operation,
the desk may ask one or more banks to act as its agent to place bids or
offers in the brokers market. In this situation the desk approaches a bank
just as any customer would approach his own banker, and we expect the
same privileges of customer service, including that our agent business not
be reported to the news media or other customers. The desk does not ask
or accept any special treatment by virtue of being the Federal Reserve.
The brokers market may at times be more appropriate because the
interbank market is thin and the brokers market presents greater
opportunities, sometimes the only opportunities, for actually executing trades.
(In the afternoons, after the European markets have closed, activity in U..S.
markets usually declines sharply, and most transactions are executed
through brokers.) Alternatively, we may use the brokers market because it
is judged that the transactions conducted in a more unobtrusive manner
would be more successful in achieving our objective. There are times when
the credibility of the central banks in the market is very strong and other
times when it is not--and that can influence our views on whether to operate
openly or discreetly. The brokers market can enable us to test the strength
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of dollar pressures without getting deeply engaged, and without giving
signals to the market that could be misleading. It provides a way to
intervene and have more control over the amount spent in volatile market
conditions. Furthermore, when our desk carries out intervention for foreign
central banks, we are often instructed to do so in a discreet fashion. The
use of a more discreet approach is by no means a new or recent
innovation. Indeed for most of our experience with intervention during the
period of floating exchange rates--namely throughout the years from 1973 to
1985--the U.S. monetary authorities typically wished the desk to avoid using
any technique that might generate expectations in the market that the United
States was seeking to establish a particular level or range of exchange rates
for the dollar. Having the market know the exchange rates at which we
were operating was believed to raise the risk that market participants would
interpret the authorities as responding to a movement in the exchange rate
to an "undesirable" level when in fact they were responding to a deterioration
of exchange market conditions.
Over the years, the desk had developed a number of approaches to the
market that have fallen into relative disuse more recently.
During the 1960s and again in the early 1980s, the desk did a fair amount
of operations in the forward market. During the fixed-exchange rate regime
of Bretton Woods, the desk at times thought it useful to curb speculation
about a change in parity by trying to influence forward rates when the
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forwards had moved well beyond the intervention points for spot rates.
Also, there were a number of operations that were predicated on the idea-an idea that was never fully tested--that forward rate operations have a
different effect than spot-market operations. Forward operations can also be
conducted at a time when the cash resources needed to finance spot
transactions are not available. The last time the desk conducted forward
operations for the United States was when it bought foreign currency for the
account of the Treasury in 1980 to cover the Treasury's foreign currency
obligations. (However, exchange rates that looked attractive at the time the
Treasury negotiated the trades did not look so attractive by the time of the
value date. Treasury incurred an immediate loss when the transaction was
completed, which attracted the attention of Treasury auditors.)
During much of the late 1970s and early 1980s, the desk also conducted
"two-way" price operations. In this approach, the desk contacts a bank
directly and offers simultaneously both to buy (at one price) and to sell (at
another price) dollars against a specific currency. Acting this way, the desk
approaches a commercial bank in precisely the same professional manner
that other banks deal directly among themselves. (Market makers always
quote both bid and offered rates.) The range of rates quoted may be
shaded either on the high side or the low side, depending on the desk's
desire to buy or sell. This technique was developed in the first instance to
restore order to a disorderly market where the spread between bid and
offered rates had gotten unusually wide. By quoting a spread that was
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narrower, the desk could restore more normal trading conditions without
indicating that it wanted to encourage either a rise or fall in dollar exchange
rates. Over time, the desk came to use this technique to influence the
direction of exchange rates at times when it perceived risks in being visible.
Also, the desk used this technique to buy (provide support) for the dollar at
moments of weakness while still taking advantage of moments of strength to
sell (acquire foreign currencies to repay debt). Whenever this technique was
used, the market responded constructively, taking reassurance in the fact
that the desk knew how to meet its sometimes conflicting objectives without
disrupting the market.
Another technique that the desk used in the late 1970s was to develop
the practice of letting banks with whom it dealt call in whenever those banks
had large customer orders. The tactic gave the desk the opportunity, but
not the obligation, to conduct trades in currencies and at rates it so chose.
The idea was that the desk might be able to buy foreign currency it needed
to repay debt, and at the same time smooth any short-term disturbance to
exchange rates of a large deal-particularly late in the trading session-without declaring itself a seller of dollars to the market as a whole. A
corollary benefit of this technique was that the desk obtained a lot more
information than normal about the large transactions of banks operating in
the United States, since banks had an incentive to share this information
with the desk.
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Differences in Approaches of Foreign Exchange Desk and Open Market
Desk
It is noteworthy that the operating techniques of the Foreign Exchange
desk differ in key respects from those used by the Open Market desk,
because of basic differences in the character of the two markets, as well as
differences in policy objectives.
In the case of domestic open market operations, the objective of the
Federal Reserve is primarily a quantitative one--to add or subtract bank
reserves, although of course, the domestic desk expects thereby to influence
credit conditions and does have views about the level of Federal funds
associated with particular transactions. The Federal Reserve operates on the
level of Federal Reserve balances, controls the supply and is effectively the
only source over time that can increase or reduce such balances. As a
result, the Federal Reserve's authority within that market is unique. A
primary aim of the brokers and dealers in that market is to know--as soon
as, if not sooner, than anyone else knows--what the Federal Reserve is
going to do, so as to be able to anticipate possible market responses to the
Federal Reserve's actions and to trade in the same direction. In these
circumstances, the Federal Reserve's operations are typically carried out by
offering to buy/sell in a market "go-around" in which contact is made virtually
simultaneously with virtually all 40-odd primary dealers.
The Foreign Exchange desk's role in the foreign exchange market differs
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from that of the Open Market desk in the domestic markets in key respects.
The Foreign Exchange desk does not have the unique position of control; as
noted above it is only one of a number of potentially large participants in the
foreign exchange market, and represents only one of a number of central
banks that can supply or absorb dollars (effectively in the form of dollar
denominated-securities) from the private sector. Moreover, the Foreign
Exchange desk's objective is not quantitative: it has never set as an
objective to inject or withdraw a predetermined amount from the worldwide
pool of dollars. Instead, it tries to influence views, attitudes, and asset
preferences of market participants in order to attain the desired objective-e.g., to foster stability in exchange rate relationships and market conditions.
Partly as a result of these differences, the Foreign Exchange desk's
operations are not intended and are not able to determine uniquely
movements in exchange rates. Federal Reserve/Treasury intervention is an
important but by no means an exclusive factor in moving exchange rates;
the other factors may be complementary or contradictory.
The Foreign Exchange desk's intervention operations are generally a
fraction of the Open Market desk's operations on a daily basis, and subject
to much wider variation in amount. The two desks do maintain close
contact, and the Open Market desk is kept fully informed of Foreign
Exchange desk operations so that the domestic desk can make any
necessary adjustments to its own operations. Another difference is that,
whereas the Federal Reserve is operating only on behalf of the FOMC in
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domestic markets, our exchange market intervention, as noted above, is
carried out pursuant to decisions that are not only carefully worked out with
the Treasury, but usually in close coordination with other central banks and
governments under policies approved by the G-7. These operations take
place in a foreign exchange market that is global rather than national, has
widespread participation by extremely diverse types of institutions, and has
become accustomed to operating with considerably more rate variability than
normally exists in the domestic Federal funds market.
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Evaluating the Results of Particular Intervention Operations
As is clear from the Task Force papers on "Evolution of U.S. Exchange Rate
Policy" and "System Objectives", intervention can be viewed from a variety of
perspectives and evaluated against a wide range of objectives, time frames and
circumstances. The counterfactual situation, or what would have happened if the
authorities had not intervened, is particularly difficult to ascertain given the lack of
understanding over how exchange rates are determined. Since intervention
operations in recent years have normally been conducted at times of market
pressure, it is especially difficult to disentangle their effects from those resulting from
the initial pressures in the markets and to assess the results on the basis of
exchange rate movements. In many cases, exchange markets may still display
undesirable conditions, or exchange rates may show undesirable moves, although
perhaps less so than would otherwise have occurred. Moreover, the objectives of
particular operations may vary or be multiple, and the time frame over which
intervention operations are conducted or show their effects can range from minutes
to days or weeks, or even to years, as in the periods of the declining dollar in 198587 (after the Plaza), or the effort beginning at the Louvre in February 1987 to foster
increased stability of the dollar and other exchange rates in the context of enhanced
policy coordination.
From the desk's viewpoint the aims of particular operations can usefully be
arrayed from those related to (a) immediate market conditions, through (b) efforts to
complement the overall thrust of economic policy, to (c) efforts to affect market
dynamics over more extended periods. Some examples are shown below.
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a. Objectives Related to Exchange Market Conditions
1.
Reinforce/diminish resistance at specific (technical) levels: Certain of the
intervention operations in September-October 1985 after the immediate
effects of the announcement of the Plaza agreement wore off were
intended to prevent a rebound of the dollar/yen and dollar/mark rates.
2.
Narrow bid/offer spreads: A tactic used frequently during the late 1970s
and early 1980s to calm markets at times of unsettling announcements or
news, as, for example, in January 1978, when, with the dollar continuing to
come under selling pressure despite a range of initiatives, market
conditions became disorderly.
3.
Restore better order to disorderly or frozen markets: Reagan
assassination attempt (March 1981).
Success or failure is relatively easy to determine in terms of these objectives,
even if the results may not have clear significance in terms of broader policy. The
desk can directly observe a narrowing of bid/offer spreads, or a shift in market
momentum or order flow in the brokers' market associated with its operations, and
draw strong inferences as to the success of its activity. If the desk judges that its
efforts are meeting with only minimal success, measured in these terms, it may
discontinue the operations or change its approach.
To the extent that the desk can achieve its immediate objective in individual
operations, it can pursue similar operations in an attempt to shape the subsequent
evolution of exchange rates over a somewhat longer period.
b. Complementary Policy Objectives
4.
Calm other financial markets: At the time of the Continental Bank problem
in 1984; in the weeks following the stock market break of October 1987.
5.
Indicate a change/no change in policy: When we signalled continued
commitment to anti-inflation efforts during April - July 1980; when
Chairman Volcker announced his departure in June 1987; when Secretary
Brady was appointed in mid 1988.
6.
Buy time until other policies are implemented or become effective:
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Around the time of the implementation of new Federal Reserve operating
procedures in October 1979.
7.
Demonstrate support for other countries or the coordination process:
Various times since the Plaza Accord; in March 1990, when we operated
in support of Japanese and German efforts to resist weakness in their own
currencies.
This second class of objectives is focussed not on the foreign exchange rate or
market directly, but rather on the broader economic policy context. In some cases,
such as demonstrating support for other countries and their policies, intervention
may be successful by definition -- it is the effort itself that is important in this context,
whatever may be the ultimate results of the operation. In other cases, where the
objective is to affect the perception of economic policy or reassure markets by using
intervention in an almost symbolic way, the question of success or failure is not
easily assessed.
A controversial objective is that of "buying time". Some would argue that buying
time is a euphemism for costly delay, and no one would contest the idea that
operations should not impede timely implementation of policy actions. In practice,
however, occasions arise, as in late summer 1979, when time may be required to
identify, implement and realize the impact of other policy measures. In such
circumstances intervention can be a useful tool in mitigating the deterioration in
exchange market conditions which might otherwise occur. The measure of success,
then, is not so much what happens to exchange rates but, rather, whether better
economic policies ultimately are put in place.
c. Objectives Related to Market Dynamics
8.
Deflate speculative bubbles: The upward spike in dollar exchange rates in
January-February 1985; the dollars downward spiral and turnaround in
December 1987 and January 1988.
9.
Resist/encourage the dollar's fall/rise/stability: Encourage a rise of the
dollar following unveiling of November 1, 1978 package; encourage
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decline in dollar in January-February 1985 and again following the Plaza
Agreement in September 1985; encourage greater stability in the dollar
following the February 1987 Louvre Accord.
Sometimes the success or failure of an operation can be better assessed as the
results of individual operations cumulate. The intervention in late 1987, at a time of
concern about the fragility in financial markets after the October stock market break,
helped stop the dollar's downward spiral by early January 1988. Other episodes,
when the cumulative effect of individual operations may have resulted in a change in
market dynamics over extended periods, have occurredin January-February 1985
and during both the Plaza and the post-Louvre periods.
It is particularly difficult to assess in a precise way the results of intervention in
influencing market dynamics over an extended period. Certainly, if one looks at a
chart of exchange rate movements during the period 1985 to February 1987, when
the aim was to reduce the level of the dollar relative to the other major industrial
country currencies, the dollar did indeed decline very substantially.
Similarly, if one looks at a chart of exchange rate movements since the Louvre
Accord in February 1987, there has certainly been more rate stability than in the rest
of the 1980s. To the extent that the G-7 objective since the Louvre has been to
"foster greater exchange rate stability", that result has in that sense been achieved,
even though rates did not for very long remain within the specific ranges discussed
at the Louvre.
In such cases it is not possible to determine the extent to which these results
were attributable to intervention or other factors. A good example of the difficulty of
assessment is the experience in 1989, when the world's demand for dollars was very
strong. Not only did the United States supply the rest of the world with dollars
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amounting to $110 billion through its current account deficit, but intervention by the
G-10 central banks also provided another $70 billion. Moreover, monetary policy in
the United States and abroad markedly reduced the relative attractiveness of the
dollar as interest rate differentials narrowed during the last three quarters of the year.
In the end, the dollar closed the year very close to where it opened it, with both
monetary policy and intervention yielding only that limited result.
Little can be said by way of overall assessment other than rather general
statements -- that intervention can be helpful in working with other factors to
influence exchange rates, but that it cannot accomplish much if other policies are
operating in the opposite direction. Intervention can be an important part of the
arsenal, but is most effective when consistent with overall macro-economic policies.
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Federal Reserve - Treasury Coordination *
I.
II.
Overview
.............
Key Citations ........
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
Martin, 1962 .......
Shultz - Bums, 1972-73
Volcker, 1973 ......
Burns, 1973 .......
Burns, 1976 .......
Simon, 1976 ..... .
Simon - Burns, 1976 .
Solomon - Burns, 1977
Volcker, 1976 . ....
III.
The General Policy Framework: U.S. Exchange
Arrangements and International Agreements .....
IV.
The Consultation Process ..................
V.
Summary
VI.
Attachments ..................
1.
2.
3.
4.
.............................
...........
14
Summary of Martin Testimony .. .
Shultz-Burns Correspondence ....
Rees-Burns Correspondence .....
House Banking Committee Report .
5. Simon-Burns Correspondence ....
6. Solomon-Burns Correspondence .
7. Gibbons-Volcker Correspondence ..
8. U.S. Notification to the IMF ......
* Prepared by Paul DiLeo, Foreign Exchange Department, Federal Reserve
Bank of New York.
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Overview
The Task Force paper "Review of Approaches and Tactics of Intervention"
discusses the execution of intervention policy; this paper comments on the
policy formulation process.
As noted in the Task Force paper "Legal Authority for Foreign Exchange
Operations," the Federal Reserve has consistently held that it has
independent authority to undertake foreign exchange transactions, and that
authority has not been seriously challenged. However, the record of the
past 30 years is replete with communications between the Federal Reserve
and the Treasury, and indications of Congressional reliance on these
communications, that the Federal Reserve will in undertaking any foreign
exchange operations act in close collaboration with the Treasury. Indeed,
the FOMC's Foreign Currency Directive requires that operations shall be
conducted "in close and continuous consultation and cooperation with the
United States Treasury."
Key Citations
Some key citations are as follows:
A. In 1962, Chairman Martin, in Congressional testimony at the time the
Federal Reserve was resuming operations in foreign exchange, gave
assurances that "the System will, of course, coordinate its foreign exchange
operations with those of the Treasury Stabilization Fund" (Statement to
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House Committee on Banking and Currency, February 28, 1962). These
assurances were repeated when Congressman Reuss expressed concerns
that much of the Federal Reserve's proposed activities seem " to duplicate
the foreign exchange stabilization operation that the Secretary of the
Treasury has very properly undertaken pursuant to the Gold Reserve Act of
1934" (see page 102 of Hearings), and that those foreign exchange activities
appeared to be "an usurpation of the powers of Congress."
The House Banking Committee, in its report to Congress on these
hearings, indicated its expectation that in order to avoid the possibility of
conflicts between the Federal Reserve operations and the foreign financial
policies of the United States, "(1) that the President and the Secretary of the
Treasury will take full responsibility for defining the foreign financial policy of
the Unite States as it relates to the conduct of foreign financial operations;
(2) that if any instance should arise where the Federal Reserve System fails
to conform its activities to the foreign financial policies of the United States
as set forth by the President or the Secretary of the Treasury, the Secretary
will inform the proper Congressional committees..."
(Attachment 1.)
B. In 1972 and 1973, letters between Secretary Shultz and Chairman
Burns confirm that the Federal Reserve and Treasury are in agreement that
market operations by the Fed will be conducted "in close day-to-day
consultation with the Treasury." (Attachment 2.)
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3
C. On March 6, 1973, in testimony before the House Banking Committee
on the legal basis for Federal Reserve intervention, then Under-Secretary
Volcker was asked by Congressman Gonzalez what would happen if there
were "a run on the dollar, and the question of intervention arises, and there
is a difference between the Federal Reserve managers and Treasury, and is
it possible for Federal Reserve to intervene independently of Treasury?..."
Mr. Volcker replied: We cooperate very closely on these matters and
basically I think in the last analysis the foreign monetary policy of the
United States, the foreign financial policies of the United States, is directed
by the President of the United States through the Secretary of the
Treasury.
But on this issue we cooperate very closely with the Federal
Reserve.
Mr. Gonzalez
You don't see any possibility of the Fed acting
independently?
Mr. Volcker:
I do not.
Mr. Gonzalez:
To intervene?
Mr. Volcker:
No.
Mr. Gonzalez:
Without some joinder with Treasury?
Mr. Volcker:
No, sir.
Mr. Gonzalez:
That has been bothering me. Thank you.
D. On June 27, 1973, in testimony before a subcommittee of the Joint
Economic Committee, Congressman Reuss asked Chairman Burns:
"Having in mind the independence of the Federal Reserve under our
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4
constitutional system and further the wealth of historical statements over
the last years on coordination of policy, in the event that the Federal
Reserve under a given set of circumstances deemed it desirable to
intervene in exchange markets, and the executive branch deemed it
undesirable, I take it that the Federal Reserve would abide by the wishes,
right or wrong, of the executive branch. Is that a correct political science
observation on my part?"
Chairman Burns replied: "It is correct for one time, one time only.
By that I mean that if we could not really reconcile our differences in that
case, then the Federal Reserve would abide by the wishes of the
administration. But if I thought that we had done something that was
wrong, we would have a constitutional problem and, as I told you at the
Gonzalez hearing, if such a problem arose, I would come to the Congress
immediately and raise the constitutional issue.
I do not think that will happen. We have worked together. There
have been differences, but in the process of reasoning and deliberation,
we have always worked out our differences. I do not think that the
likelihood of a genuine difference arising is at all significant, therefore, I do
not think we have a problem."
E. On June 15, 1976, in response to a letter requesting comments on
proposed legislation to prohibit the Fed from engaging in foreign exchange
dealings specifically disapproved by the Secretary of the Treasury, Chairman
Burns wrote:
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5
"The proposed amendment is clearly unnecessary. Both the Federal
Reserve and the Treasury have indicated on previous occasions that
Treasury and Federal Reserve officials work together very closely to
ensure that Federal Reserve dealings are in furtherance of and at all times
are consistent with the international financial policy of the United States.
There is no problem in this area that calls for Congressional action.
When a co nsultative relationship, such as has long existed between the
Treasury and the Federal Reserve, works well, no statute is needed. It
would indeed be a mistake to attempt to rigidify that relationship within a
statutory framework.
If, in the future, a problem were to arise between the Federal Reserve
System and the Treasury regarding the foreign exchange dealings of the
system, the appropriate Committee of the Congress would be immediately
notified. However, such a problem has not arisen in the past and the
Board considers it highly unlikely that it will ever arise." (Attachment 3.)
F. Secretary Simon also responded that the proposed legislation
appeared unnecessary, since officials of the Federal Reserve "have always
worked in close collaboration with the Department of the Treasury to assure
that System dealings in foreign exchange...are in furtherance of and
consistent with the international financial policy of the United States..." In its
report, the House Banking Committee noted the comments of the Chairman
of the Board and the Secretary of the Treasury, and indicated that it
expected the "international financial transactions of the Federal Reserve
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6
System will continue to be fully consistent with the international financial
policies of the United States as determined by the President and the
Secretary of the Treasury." While the proposed amendment was not
adopted, the Committee stated that "if any instance should arise where the
Federal [Reserve] System fails to conform its activities to the foreign financial
policies of the United States as set forth by the President or the Secretary of
the Treasury, the Secretary will inform the proper Congressional
committees;..."
(Attachment 4.)
G. Subsequent correspondence confirms the understandings between the
Federal Reserve and the Treasury on exchange market operations
undertaken by the FOMC. Sec. Simon's letter of January 23, 1976 to
Chairman Burns, states:
"Our policy recognizes that intervention in foreign exchange markets
may be appropriate to maintain orderly markets by countering erratic
fluctuations.
This can best be achieved by continued Federal Reserve
coordination of its foreign exchange activities with the Treasury. In
particular, our day-to-day consultations on foreign exchange operations
ought to ensure, as in the past, the effective implementation of the U.S.
policy." (Attachment 5.)
H. Acting Secretary Anthony Solomon wrote a letter dated December 22,
1977, to Chairman Burns which was requested by Chairman Burns in order
to have a public record showing that Federal Reserve intervention was
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consistent with Treasury policy. The letter states:
"Since last October the Federal Reserve has intervened in an amount
of nearly $800 million for that purpose. Those intervention operations
have been undertaken in close consultation with Treasury and with our full
concurrence. It is my view that the Federal Reserve should under present
conditions continue to intervene to counter disorderly conditions, and we
would expect to continue consultation as to the extent that seems
appropriate." (Attachment 6.)
I. Finally, on May 7, 1976, in a letter responding to an inquiry from
Congressman Gibbons about budget procedures for Treasury's Exchange
Stabilization Fund (ESF), then President of the FRBNY Volcker, in presenting
his personal reflections on the need for both the Federal Reserve and the
ESF to have operational authority in foreign exchange, stated that
"consultation and cooperation--day by day and sometimes hour-by-hour--has
necessarily been close." He said further:
"It is appropriate, in my judgment, for the broader ranging (but
smaller) operations feasible for the ESF to be conducted by the Treasury
itself, since it is the Secretary of the Treasury who is primarily and directly
responsible to the President and the Congress for formulating and
defending international financial and monetary policy, for assessing the
position of the United States in the world economy, and for conducting
international negotiations on these matters. At the same time, since
exchange markets are closely linked to money markets and questions of
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monetary policy, there is a distinct role and responsibility for the Federal
Reserve to work in cooperation both with foreign central banks, which are
operating in their own markets, and with the Treasury. The fact that both
agencies have operating responsibilities in the area, forces them to work
closely together on operational decisions and to take full account of the
various considerations bearing upon operational decisions. There is the
strongest kind of motivation to reach a full meeting of minds in engaging
in operations, because any operations at cross purposes would be
virtually immediately apparent, highly confusing, and totally
counterproductive. I know of no instance of that kind." (Attachment 7.)
Volcker's comments immediately above describe well the logic of the
present arrangements between the Federal Reserve and Treasury, and how
the process should and generally does function, within the framework that
Federal Reserve activities in this area always have been, and are understood
by the Congress and the public to be, closely coordinated with and in
conformity with the foreign financial policy of the United States.
The General Policy Framework:
International Agreements
U.S. Exchange Arrangements and
The Secretary of the Treasury, as representative of the President, is
responsible for the international or foreign financial policies of the United
States. He has political accountability for any commitments or
understandings which the United States undertakes with other nations or
international institutions, and which provide the general framework for U.S.
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9
FOMC
intervention operations.
As a formal matter, the Secretary of the Treasury, as U.S. Governor of the
IMF, notifies the IMF of the exchange arrangements applied by the United
States pursuant to Article IV, Section 2(a), of the IMF Articles of Agreement.
In recent years, exchange rate policy has been seen as being effected to an
important extent by the various undertakings of the Group of 7 (G-7). The
Federal Reserve plays a role in both the IMF and G-7 processes. Any
changes in the notification of exchange arrangements to the IMF are
normally preceded by extensive discussions between the Federal Reserve
and Treasury, and the Chairman of the Board of Governors of the Federal
Reserve System participates in meetings of G-7 Ministers and Governors.
For many years following the move to floating rates and the adoption of
the Second Amendment of the IMF Articles of Agreement, the U.S.
notification to the IMF stated, with respect to intervention, that the U.S.
authorities intervene "when necessary to counter disorderly conditions in the
exchange market"--an approach which was adopted when the dollar first was
permitted to float. The phrase "disorderly conditions" has always been an
elastic concept. At a minimum, it relates to the technical aspects of market
conditions--size of spreads, volatility, and the like--which might prompt U.S.
intervention.
But it has also been interpreted much more broadly to cover
sustained and extensive operations to influence the exchange rate or to
acquire balances such as occurred in the period from 1978 to early 1981.
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On December 31, 1985, following the Plaza Agreement of the G-5, the U.S.
notification was expanded to provide for intervention "...to counter disorderly
conditions in the market or when otherwise deemed appropriate", thus
providing greater leeway if any were needed. (Attachment 8.)
The understandings of the G-7, with some notable exceptions, do not
customarily call for precise actions in well-defined circumstances. The
understandings are usually rather broad and general, indicating directions
and, at times, presumptions with respect to intervention, and may sometimes
be subject to differing interpretations by the various parties particularly with
the passage of time. This is a description of the process, not a criticism of
it; some G-7 participants have strongly resisted efforts to make G-7
commitments more precise, stressing the difficulties of trying to "program"
automatic or mechanical responses over an extended period to rapidly
changing market conditions and economic circumstances.
In either the earlier or current form, U.S. intervention policy is stated within
such broad parameters that even within the context of G-7 undertakings
there is a considerable scope for day-to-day consultation and decision
making on possible intervention operations.
The Consultation Process
Over the past 30 years, the Federal Reserve's relationships with Treasury
on intervention operations have varied greatly, depending on policy views,
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economic conditions, personalities, and other considerations. There have
been periods when those in authority in Treasury have more or less
delegated all operational decisions to the Federal Reserve on a broad scale,
and periods when even the most minor details were tightly monitored and
controlled by the most senior Treasury officials. Also there have been times
when policy views of the two institutions were quite similar or diverse.
As a broad generalization, during the period of general floating starting in
1973, the Federal Reserve has served usefully as a kind of "balance wheel"
to Treasury policy shifts, tending to lend a stabilizing influence to the
process. Thus, in the mid-1970s, when the Treasury was very reluctant to
intervene, the Federal Reserve tended to favor somewhat greater activity; in
the late 1970s, when Treasury had moved to heavy intervention, the Federal
Reserve urged more restraint; in the first half of the 1980s, the Federal
Reserve thought the Treasury was too inclined to stay out of the markets; in
recent years, we have again been a restraining influence on intervention
during certain periods.
The process of lively discussion and coordination with the Treasury
certainly continues at present. The process normally starts with desk
conversations with Treasury staff and Board staff well before the New York
market opens, based on reports that the desk has picked up from other
central banks, the market, and the media. The Manager or another officer
will usually make a recommendation to the Treasury and the Federal
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Reserve for whatever action or non-action seems appropriate, given the
general policy approach being followed and in light of the market conditions
and overnight developments. If Treasury and the Chairman agree, then all is
well. If Treasury presses for an approach that seems inadvisable to the
Federal Reserve, there can be extensive discussions to try to resolve
differences. If the differences are serious enough, this can lead to
conversations at progressively higher levels--ultimately involving the Chairman
and the Secretary--until an approach is agreed to or at least accepted.
Independent of these discussions, there are other regular meetings between
the Chairman and the Secretary to exchange general views on market
matters where broad areas of agreement or disagreement can be identified.
This consultative process does lead to a decision, one way or the other,
to deal with the immediate situation. Where there are deep-seated
differences of view, the decision usually represents a compromise. Over
time no one party consistently wins or loses the entire debate. But usually
there are few fundamental disagreements. Indeed for long periods, most
participants in the process see eye to eye on the basic approaches. Much
of the debate that does occur essentially reflects little more than discussions
about the best tactics to follow, based on different sensitivities of the
Treasury, the Federal Reserve, and the market technicians at the desk. The
process of consultation assures that all of these points of view are taken into
account, and, although time consuming, it is probably necessary and
desirable because the process leads to a broader-based and better-
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grounded decision than would otherwise occur.
When a decision has been reached and an operation is to be undertaken,
typically both Treasury and Federal Reserve resources are used. In recent
years, operations have in the great bulk of cases been shared on 50/50
basis. Treasury can not commit Federal Reserve's resources against the
Federal Reserve's will. However, it is useful to recall that the decision by the
Federal Reserve in 1962 to resume foreign currency operations was
motivated by a desire to augment the Treasury's limited resources. In light
of this history, a decision of the Federal Reserve not to participate could
have important implications--in significantly reducing the Federal Reserve's
role and influence in these matters, and in conveying a major rift in policy
with potentially severe adverse effects on financial markets.
Summary
In summary, in matters of intervention policy, the Federal Reserve has an
influential role.
Though it may have an "independent" legal authority to
undertake foreign exchange operations, in practice it must and does operate
in close consultation with Treasury consistent with the Secretary of the
Treasury's responsibility for the international financial policies of the United
States. The Federal Reserve brings to the consultative process a technical
competence in financial matters, a background in and knowledge of
monetary developments, an ability to participate in the financing of any
operations, and very importantly, an independence and authority in monetary
policy.
Authorized for public release by the FOMC Secretariat on 1/31/2020
H.R.
ATTACHMENT 1:
Report No. 1484, 87th Congress, 2d. Session
WOODS AGREEMENTS ACT
ountry which made loans to the Fund but
intered a balance-of-payments need, it is
obtain prompt repayment from the Fund.
are to enter into force upon completion of
uirements enabling formal adherence of at
ith commitments totaling $5.5 billion. The
er into force, therefore, without the adherwith a commitment greater than $50
is France, Germany, Italy, the United
States. The arrangements are to remain
may be extended for an additional period
ments cannot be amended without the unaniicipants.
BY THE UNITED STATES AND U.S. DRAWING
TS ON THE FUND
proposed arrangements cannot be operaon of the United States. Participation
of $2 billion, and in no lesser amount;
ssary to renegotiate the entire arrangements
vernments.
wever, that the United States would have to
to lend to the Fund in the foreseeable future
ed in the testimony of the Secretary of the
ments are intended to make it possible for
ipating countries having serious balance-ofosing reserves by permitting the Fund to
ountries with payments surpluses and inthe present U.S. balance-of-payments cirFund still has almost $2½ billion available
ing U.S. quota), it is regarded as extremely
States could be called upon to lend to the
future.
new arrangements would be of great impores should the need ever arise to request a
H.R. 10162 assures the United States of the
needed, in the event a U.S. drawing should
United States has never drawn on the Fund
ing rights.
United States are of real interest, and may
be drawn on a virtually automatic basis,
billion readily available, and with larger
ious situations and in furtherance of U.S.
ect a balance-of-payments deficit situation.
is moment, it lacks the resources in gold
which could be used by the United States
United States as a member would be
in time of need. At the close of 1961, the
the currencies of the major industrial
United States and the United Kingdom-
BRETTON WOODS AGREEMENTS ACT
(1962)
7
the latter has recently required large assistance from the Fund.
The Fund also had available $2.1 billion in gold reserves. Against
these resources, however, the Fund had outstanding commitments
under standby arrangements with the United Kingdom and other
members amounting to $1.4 billion.
In his message of February 6, 1961, on balance of payments, the
President also referred to our drawing rights in the International
Monetary Fund and said that U.S. access to Fund's resources must
be regarded as part of our international reserves available to be drawn
upon as necessary. The proposed arrangements authorized by H.R.
10162 furnish added assurance that the Fund could obtain the currencies which would be needed in the event the United States should
ever request a drawing. For this reason, the arrangements will be
to the advantage of the United States and the position of the U.S.
dollar even if it is never necessary for the United States to call upon
the Fund for such assistance.
Finally, the knowledge that the major industrial nations of the free
world are agreed in strengthening further the large resources in gold
and other assets which now stand behind the dollar, with a large
supplementary pool of usable foreign currencies through these new
Fund borrowing arrangements, will act as a strong deterrent to any
speculation against the U.S. dollar. For that matter also, the position of the other major world currencies, and of the entire free world
monetary system, will also inherently benefit from the presence of
these new and additional resources in the International Monetary
Fund.
In the course of his testimony in support of H.R. 10162, William
McChesney Martin Jr., Chairman of the Federal Reserve Board,
indicated that the Federal Reserve System had initiated foreign exchange operations to acquire convertible foreign currencies for the
primary purpose of safeguarding the value of the dollar in the international exchange markets. This step will not, of course, solve the
basic problems of the deficit existing in our balance of international
The Federal Reserve System actions are
payments accounts.
principally aimed at discouraging speculation against the dollar.
Chairman Martin, under questioning, testified that this new foreign
exchange program was established with the full approval or the Secretary of the Treasury and the National Advisory Council on International Monetary and Financial Problems. Additionally, in reply
to questioning regarding the legal aspects of engaging in such foreign
exchange operations, Mr. Martin stated they had been reviewed and
concurred in by the General Counsel of the Federal Reserve System,
the General Counsel of the Department of the Treasury, and the
Attorney General of the United States. Chairman Martin testified
also that the foreign exchange operations would supplement the operations of the Stabilization Fund of the Treasury, as well as complement
the arrangements for the International Monetary Fund contemplated
by H.R. 10162.
Your committee expects that the System's arrangements with foreign reserve banks will be confined to normal banking transactions
incidental to the establishment and use of reciprocal balances and will
in no wise involve matters normally negotiated through Executive
agreements.
In order to avoid the possibility of conflicts between System operations and the foreign financial policies of the United States, your com-
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BRETTON WOODS AGREEMENTS ACT
8
mittee further expects (1) that the President and the Secretary of the
Treasury will take full responsibility for defining the foreign financial
policy of the United States as it relates to the conduct of foreign financial operations; (2) that if any instance should arise where the Federal
Reserve System fails to conform its activities to the foreign financial
policies of the United States as set forth by the President or the Secretary of the Treasury, the Secretary will inform the proper congressional
committees; and (3) that the Secretary of the Treasury will inform
the proper congressional committees concerning any significant "cooperative arrangements between Foreign Central and Reserve banks."
CONCLUSIONS AND FAVORABLE RECOMMENDATION ON H.R. 10162
The National Advisory Council on International Monetary and Financial Problems, under the chairmanship of the Secretary of the
Treasury, includes in its membership the Secretaries of State and
Commerce, Chairman of the Federal Reserve Board, and the President
of the Export-Import Bank. Their report on special borrowing arrangements of the International Monetary Fund, January 1962, discussed the financial climate and pressures which contribute to fluctuations in the balances of payments of the leading industrial countries
having convertible currencies. In this special report the National
Advisory Council points out that it is in the interest of the intercircumstances from impairing
national community to prevent such
the stability of the international monetary system. In commenting
upon the arrangements which are embodied in H.R. 10162 the Advisory Council indicated they are* * * well adapted to dealing with the monetary system
that has emerged in recent years and will contribute significantly to the maintenance of sound international monetary
conditions.
The President, in his letter to the Speaker of the House of Representatives, dated February 2, 1962, urging draft legislation (intro10162) to implement the recommendations of the
duced as H.R.
National Advisory Council stated:
The new proposals would strengthen the position of the
dollar as the world's major reserve currency. They would
also provide new armament for the defense of the currencies
of the free world and for reinforcing the entire international
monetary system.
• The Secretary of the Treasury, in his testimony to your committee,
stated that it is "essential to us and to other countries that the dollar
be maintained as a sound and reliable currency at its present parity,"
and he describes in detail the extreme importance for the United
States represented in the provision of these additional resources to the
International Monetary Fund. The resources involved in this legislation would greatly reinforce the Fund's ability to assist the United
States should that ever become necessary. The legislation will provide an additional means of assistance to the United States in handling itsbalance-of-payments problem.
Your committee is in full accord with these conclusions and favorably recommends H.R. 10162 as a highly desirable step in supporting
the stability of the U.S. dollar and a strong international monetary
system.
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Attachment 2:
Shultz-Burns Correspondence
G
THE SECRETARY OF THE TREASURY
WASHINGTON
Dear Mr.
Chairman:
I want to confirm our understanding in conversations on and before July 18, 1972, with respect to
intervention in fdreign exchange markets.
Such market intervention by the Federal Reserve
will require resources of foreign exchange that can
most readily be obtained from recourse to use of the
existing swap network. On August 15, Secretary
Connally requested the suspension of the virtually
automatic use of your swap network for the purpose
of converting dollars into other currencies, while
noting the future operation of these and other mutual
credit facilities will be determined in the light of
emerging developments.
I have agreed the planned
Federal Reserve intervention in exchange markets will
require use of the swap facilities for that purpose.
In undertaking these operations, we agreed that
market operations will be conducted in close day-today consultation with the Treasury, and I noted the
Exchange Stabilization Fund might, when convenient
and desirable, engage in such intervention on behalf
of the Treasury.
Sincerely yours,
George P.
Shultz
The Honorable
Arthur F. Burns
Chairman, Federal Reserve Board
Washington, D. C. 20551
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July 9, 1973
Dear George:
As you know, I feel that prompt intervention on the
part of the United States in the foreign exchange markets
has become essential. My colleagues at the Federal Reserve
share this view. On the basis of recent conversations with
you and Paul, I believe that this is also the Treasury's judgment.
On August 8, 1972 you sent me a letter confirming the
understanding that we had reached in conversations held on and
before July 18, 1972 with respect to intervention in foreign
exchange markets. It would be helpful to have a similar letter
from you with regard to the Federal Reserve's use of its swap
facilities in the current circumstances.
Sincerely yours,
Arthur F. Burns
The Honorable George P. Shultz
Secretary of the Treasury
Department of the Treasury
Washington, D. C.
AFB:ccm
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THE SECRETARY OF THE TREASURY
WASHINGTON
5:39
10
AUG
1973
AUG 8 1973 OFFICE OF THE REC'd
CHAIRMAN
Dear Mr. Chairman:
In response to your letter of July 9, I would like
to confirm the understanding we reached in conversations
held during the time of and after the recent meeting of
central bankers in Basle that intervention by the Federal
Reserve in foreign exchange markets would be appropriate
in current circumstances in pursuance of the general
approach agreed to at the meeting of the Group of Ten with
the European Economic Community in March of this year.
We have agreed that, in undertaking these operations,
the Federal Reserve will remain in close day-to-day
consultations with the Treasury.
Operations will be conducted in the interests of orderly markets and will not
undertake to preserve any particular relationship between
the dollar and any specific foreign currency.
I also
noted that the Exchange Stabilization Fund might, when
convenient and desirable, engage in such intervention on
behalf of the Treasury.
Sincerely yours,
George P. Shultz
The Honorable
Arthur F. Burns
Chairman, Federal Reserve Board
Washington, D. C. 20551
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Correspondence
Rees-Burns
3:
Attachment
U.S. HOUSE OF REPRESENTATIVES
COMMITTEE ON BANKING, CURRENCY AND HOUSING
NINETY-FOURTH
CONGRESS
2120
BUILDING
OFFICE
HOUSE
RAYBURN
WASHINGTON,
D.C.
20551
June 15, 1976
Burns,
F.
Arthur
Mr.
Chairman
Board of Governors
Federal Reserve System
Constitution
Avenue
Washington, D.C. 20551
Dear
Mr. Chairman:
The Subcommittee
Monetary
and
Investment,
Trade,
International
on
Policy of the
Housing is considand
Currency,
Banking,
on
Committee
House
ering
Act.
Reserve
Federal
he
tot
amendment
an
The
language of thisamend-
ment,
revised
as
by Federal
Reserve
counsel,
reads as fo11ows:
Secton 6.
A FederalReserve
Bank may not engagein dealings,
in foreign
exchange
which are specifically disapproved by the
Secretary of the Treasury.
This new section 6 would be inserted on page 3, 1ine 22, after section 5.
The current number 6 would be renumbered as section 7.
In order that the Subcommittee
may judiciously and promptly
this proposed amendment, could you please
communicate
to me as
as possible the opinion of the Board on the
language.
above
condider
soon
u
Sincerely,
S
Thomas
Tra
b
c
d
M.Rees, Chairman
ommittee
e,
Investment,
on
International
and
Monetary
Policy
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Questions Regarding Proposed Amendment to Section 14(c) of the Federal
Reserve Act Which Would Add A New Sentence reading:
A Federal Reserve Bank may not engage in any dealings in
foreign exchange under this section which are specifically
disapproved by the Secretary of the Treasury.
In my judgement legislation
that has emerged or that is
emerged between the Federal
York Federal Reserve Bank's
this amendment necessary?
should only be proposed to correct a problem
Has such a problem
in real danger of emerging.
Reserve and the Treasury as regards the New
If not, why is
dealing in foreign exchange?
To the best of your knowledge has there ever been a problem between the
Federal Reserve and the Treasury arising from the New York Federal Reserve
Bank's dealing in foreign exchange?
It is my understanding that the FED
and the Treasury have always worked closely together as regards the foreign
Do you have a different underexchange transactions of the New York FED.
standing?
It is my understanding that Chairman Burns has stated on a previous occasion
that if a problem were to arise between the Federal Reserve and the Treasury
regarding the foreign exchange dealings of the New York FED, that the appropriate Committees of the Congress would be immediately notified and if
Isn't this procedure an adequate
necessary remedial legislation requested.
one making unnecessary the amendment which you are proposing?
What
it
is
the exact purpose of your amendment and what problem or abuse does
seek to correct?
Have the formal views of the Federal Reserve Board been requested on this
amendment to the Federal Reserve Act? Shouldn't they have been?
( note--There has been staff contact between the House Banking Committee
staff
and the Federal Reserve staff at the technical level, but no formal
communication has been received requesting the views of the Board)
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CHAIRMAN
GOVERNORS
BOARD
THE
OF
RESERVE
FEDERAL
SYSTEM
D.C.
WASHINGTON,
20551
June 15, 1976
The Honorable Thomas M. Rees
Chairman
Subcommittee
on International
Trade,
Investment,
Police
Monetary
and
Committee on Banking, Currency and
House of Representatives
Washington, D. C.
Housing
Dear Mr. Chairman:
15
requesting the
Thank you for your Iletterof June
Board's comments on an amendment,
as follows, which may
be proposed to H.R.13955:
may not
6. A Federal Reserve Bank
engage
in dealings in foreign
exchange
which
are specifically disapproved by the Secretary
of the Treasury."
"Section
unnecessary.
The proposed amendment is clearly
Both
indicated
have
Treasury
and
Reserve
Federal
the
Federal Reserve
and
that Treasury
onprevious
occasions
officials work together very c1osely to ensure that Federal
of
arein furtherance
in foreign exchange
dealings
Resever
international financial
the
with
consistent
are
times
all
at
and
policy of the United States. There is no problem in this area
a consultative
When
action.
for
calls
Congressional
that
existed between the Treasury
long
has
as
relationship, such
needed.
no statute
is
and
well,
works
Reserve,
Federal
the
It would
that
rigidify
attempt
to
amistake
be
indeed
relationship
within a statutory framework.
If, in the future, a problem were
between
arise
to
and the Treasury regarding the
the Federal
System
Reserve
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The Honorable Thomas M. Rees - Page 2.
foreign exchange dealings of the System, the appropriate
Committees of the Congress would be immediately notified.
However, such a problem has not arisen in the past and the
Board considers it highly unlikely that it will ever arise.
Sincerely yours,
Arthur F.
Burns
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Attachment 4:
H.R. Report No. 1234, 94th Congress,
2d. Session (1976)
1. RATE
OBLIGATIONS
EXCHANGE
The Committee the
expects
administration to honor scrupulously
the obligations of Article IV of the amended Articles, to collaborate
with
Fund in the development of the "specific principles for the
the
guidance mentioned in section 3(a), and to represent
members"
all
of
other members, as appropriate, the importance we attach to the
obligation of all members to
Avoid manipulating exchange rates or the international
system
monetary
in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage
over other
members.
The Committee expects the administration to keep it informed
through timely consultation of its efforts to promote international
cooperation and coordination of exchange rate policies, and practices.
to
II.
LIQUIDITY
INTERNATIONAL
The Committee
urges
the Administration to give special attention to
the task of managing the growth of international liquidity, in
collaboration with the International Monetary Fund. It is the sense of this
Committee that, as the role of gold declines, every effort should be
made to promote the role of Special Drawing Rights as the primary
reserve asset of the international monetary system. As SIDR's move to
the center of the system, it will be necessart to ensure that the creation
are
SDR's
new
of
distribution
and related to the growth of world
trade and investment, and the evolution of the international payments
system, in a manner that satisfies the need for liquidity without inducing, inflation.
In the course of deliberations on H.R. 13955, the opinion was, expressed that the development of a substitution account within the
IMF, which would permit members to exchange other reserve assets
SDR's,
for
might be a feasible approach to the objectives of SDR enhancement and
the non-inflationary management
of international
liquidity. The Committee notes that consideration of this subject by,
the
Directors
Executive
was recommended by the Interim Committee
in its communique
of
January 8, 1976. It the
urges
administrationto
cooperate with the IMF inconsidering such anacccount for the
purposes of promoting SDR's and controlling liquidity.
III. TREASURY
RATE
EXCHANGE
OF
COORDINATION
RESERVE
FEDERAL
AND
POLICY
In the course of examining the fundamental reforms of the InternaMonetary
system described above, your committee considered
whether it would be appropriate to specify, by statute, the respective
responsibilities of the Treasury and the Federal Reserve system in
supervising
and
implementing,
coordinating,
formulating,
the execution of the innternational financial policies of the United States. The
committee understands that while, in practice, the Federal Reserve
System,
the Congres, and other Executive agencies contribute to the
formulation of international monetary policy, the final executive retional
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sponsibility for decision and implementation rests with the President
and
Treasury.
of
Secretary
the
The Federal Reserve System, through its ability to intervene in exinterrole in
implementing
important
an
change markets, also plays
national financial policy. An Amendment to the Federal Reserve Act
was offered to prohihit any Federal Reserve Bank from engaging in
dealings
in foreign exchange which are specifically disapproved by the
Secretary of the Treasury. When asked for their opinions on this
amendment, both the Board of Governors of the Federal Reserve System and the Treasury Department responded that, as a practicalmatter, the amendment was unnecessary. The Secretary of the Treasury
responded that the amendment reflected "the fact that it is the responsibility of the Secretary of the Treasury as chief financial officer of
the United States. U.S. Governor to the IMF and Chairman of the
National Advisory Council on International Monetary and Financial
Policies to direct and coordinate U.S. exchange market intervention
policy."
In his response to Chairman Thomas M. Rees of the Subcommittee
on International Trade, Investment and Monetary Policy. Chairman
Arthur F. Burns of the Board of Governors of the Federal Reserve
System said:
Treasury and Federal Reserve officials work together very
closely to insure that Federal Reserve dealing in foreign exchange are in furtherance of and at all times are consistent
with the international financial policy of the United States.
Secretary of the Treasury William E. Simon responded in a letter
to Representative J. William Stanton, ranking minority member of
the Subcommittee, s follows:
The officials of the Federal Reserve system have always
worked in close collaboration with the Department of the
Treasury to assure that System dealings in foreign exchange-whether through swap arrangements ordirect foreign exchange intervention-are in furtherance of and consistent with the international financial policy of the United
States, and would not run counter to any actions undertaken
by the Secretary of the Treasury for the account of the Exchange Stabilization Fund.
This committee expects that the international financial transactions
of the Federal Reserve System will continue to he fully consistent
with the internationAl financial policies of the United States as determined by the President and the Secretary of the Treasury.
To this end it is appropriate to call attention to and reaffirm certain
comments made in Report No. 1484 offered to the House of Representatives on March 22, 1962, to accompany H.R. 10162.
Your committee expects that the System's arrangements with foreign reserve banks will be confined to normal banking transactions
incidental to the establishment and use of reciprocal balances and will
in no wise involve matters normally negotiated through Executive
agreements.
In order to avoid the possibility of conflicts between System operations and the foreign financial policies of the United State&, your
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9
committee further expects (1) that the President and the Secretary
of the Treasury will take full responsibility for defining the foreign
financial policy of the United States as it relates to the conduct of
foreign financial operations; (2) that if any instance should arise
where the Federal System fails to conform its activities to the foreign
financial policies of the United States as set forth by the President or
the Secretary of the Treasury, the Secretary will inform the proper
(3)that the Secretary of the Treasury
and
congressionalcommittees;
will inform the proper congressional committees concerning any significant "cooperative arrangements between Foreign Central and Reserve banks."
IV. CONSULTATION ON IMF GOLD
IMF
The Committee notes that the proposed amendments to the
Articles will empower the Fund to disposeof its remaining gold holdings in a variety of ways, including restitution to members, or sales
to the private market. Decisions to dispose of gold holdings under the
amended Articles will require an 85 per cent majority vote, and thus
be subject to a veto by the United States. The Committee feels that
the Congress should be consulted, prior to the casting of the United
States vote, by the U.S. Governor of the Fund, and should have ample
opportunity to register its views on the proposed disposion of IMF
given his
gold. Secretary of the Treasury William E. Simon, has
assurance, in a letter to Chairman Reuss, dated June 17 , 1976, that
there will be ample consultations with the Congress on this issue. That
letter reads, in part,
I understand
your concerns about possible future restitution and your desire that there be an opportunity for membersofCongress to register their views prior to decisions
to
restitute any part of the IMF's gold beyond that already
agreed. Accordingly, I want to assure you that, in the event
the U.S. were to consider agreeing to further restitution.
you and your colleagues would be given ample opportunity
to consult with the Treasury and register your views on the
proposal.
STATEMENTS
REQUIRED IN ACCORDANCE WITH HOUSE RULES
In accordance with clauses 2(1)(2)(B).2(l)(3), and 2(l) (4) of
Rule XI and clause 7(a) of Rule XIII of the Rules of the House of
Representatives, the following statements are made:
H.R.13955 was
Committee Vote (Rule XI, clause 2(l)(2)(B)):
reported out of Committee by a rollcall vote on June 17, 1976, with 24
votes cast for and 1 vote cast against reporting the bill.
Oversight Findings (Rule XI, clause 2(1)(3)(A) and Rule X.
clause 2(b) (1)) : The Committee has held hearings on the subject
matter contained in H.R. 13955 and based upon the evidence presented concludes that the provisions of H.R. 13955, as amended, are
necessary to authorize the United States, to accept amendments to the
Articles of Agreement of the International Monetary Fund, to consent to an increase of the quota of the United States in the Fund,
and to enact consequential changes in United States statutes:
H. Rept. 94-1284
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THE SECRETARY OF THE TREASURY
WASHINGTON
Attachment 5
20220
JAN 2 3 1976
Dear Arthur:
I am writing to reaffirm with you and the other
members of the FOMC our common understandings with
respect to foreign exchange market operations undertaken
on behalf of the Committee.
Our policy recognizes that intervention in foreign
exchange markets may be appropriate to maintain orderly
This can
markets by countering erratic fluctuations.
best be achieved by continued Federal Reserve coordination of its foreign exchange activities with the Treasury.
In particular, our day-to-day consultations on foreign
exchange operations ought to ensure, as in the past, the
effective implementation of the U.S. policy.
In addition to daily consultations, there will be
cooperative exchanges of relevant information between our
agencies pursuant to the U.S.-French Memorandum of Understanding. The language of the Memorandum that states
"They (Deputies) would convey their conclusions to their
central banks" refers to such exchanges of information
with central banks and does not imply directives to
central banks.
The Treasury and
activities, as in the
have maintained close
I look forward to our
future.
Federal Reserve, in foreign exchange
area of domestic economic activities,
and harmonious working relations.
continued close cooperation in the
With best wishes,
Sincerely yours,
E. Simon
William
The Honorable Arthur F. Burns
Chairman
Federal Reserve Board
Washington, D.C.
20551
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Attachment 6
The Under Secretary of the Treasury
for Monetary Affairs
December 28, 1977
Arthur
I have checked with Secretary
Blumenthal and he approves this
letter.
He also approves Steve and I
initiating
consultations with the
Congressional committe chairmen with
regard to the possibility of ESF participation
with the Fed in financing
U.S. exchange market intervention.
Tony
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THE SECRETARY OF THE TREASURY
WASHINGTON
20220
Dear Mr. Chairman:
I am writing to clarify our understandings with
respect to exchange market operations.
We are in full agreement that the exchange value
of the dollar will be determined by underlying economic
and financial conditions in the U.S. economy, and that
the basic strength of the dollar will depend on our
ability to maintain a strong and non-inflationary
economy.
Within this framework we agree that the U.S. should
act to counter disorderly conditions in our exchange
markets that may develop from time to time.
Since last
October the Federal Reserve has intervened in an amount
of nearly $800 million for that purpose.
Those intervention operations have been undertaken in close consultation with Treasury and with our full concurrence.
It is my view that the Federal Reserve should under
present conditions continue to intervene to counter
disorderly conditions, and we would expect to continue
consultation as to the extent that seems appropriate.
I know that the Federal Reserve and Treasury will
continue to work closely together in this matter, as in
the past.
Sincerely,
Anthony M. Solomon
Acting Secretary
The Honorable
Arthur Burns
Chairman
Federal Reserve Board
20th & Constitution Ave.,
Washington, DC 20551
NW
CONFIDENTIAL
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29
Attachment 7:
Gibbons-Volcker Correspondence
NINETY-FOURTH
CONGRESS
HOUSE
U.S.
REPRESENATIVES
OF
COMMITTEE
BUDGET
THE
ON
WASHINGTON,D.C.
20515
March 3, 1976
Mr. Paul A. Volcker
President
Federal Reserve Bank of
New York
New York, New York 10045
Dear
Mr. Volcker:
One of the responsibilities of the House Budget Committee's
Task Force on Tax Expenditures and Off-Budget Agencies is to
determine whether off-budget agencies should continue to be treated
outside of the budget.
The first agency that we are examining is
the Exchange Stabilization Fund and the Task Force held a hearing
on it on February 18.
At the hearing Mr. E. H. Bernstein and
Mr. M. Bradfield testified as independent consultants and Under
Secretary of the Treasury Edwin H. Yeo, III presented the Treasury's
point of view.
Since many of the foreign exchange stabilization activities are
conducted by the Federal Reserve Bank of New York we are also very
interested
in your views on the current status of the Fund.
One
of the issues we are interested in is the respective tasks performed
by the Federal Reserve Bank of New York and the Exchange Stabilization
Fund.
There are some serious questions concerning the continuing
United States
thethe
of
most
that
need for the Fund considering fact
Federal Reserve
the
out
foreign exchange transactions are carried by
Furthermore, the use of the
Bank of New York using its own reserves.
were adopted
rates
Fund has
been negligible since floating exchange
appreciate hearing your views on the question of
would
ini 1973. We
be capable of
would
whether the Federal Reserve Bank of New York
States.
the United
of
activities
exchange
foreign
all
over
taking
What would the impact be of such a change?
Also, in view of your extensive experience as a Treasury official
responsible for the Fund's activities, we would be very interested
in
anythoughts
administrative expenses
the
whether
on
have
may
you
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-2-
of
the
Fund
be
should
The Treasury prefers
included in the budget.
keeping those expenses off-budget saying that it
provides them
with flexibility needed to handle unexpected crises in the foreign
exchange markets.
However, we have been unable to identify any
reason why the personnel payed for by the Fund should not be
included in the budget like other Treasury personnel and the
people working for the State Department.
Sincerely yours,
Sam M.
Gibbons
Chairman
Task Force on Tax Expenditures
and Off-Budject Agencies
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May 7, 1976
The Honorable Sam M. Gibbons
Chairman
Task Force on Tax Expenditures
and Off-Budget Agencies
Committee on the Budget
U.S.
House of Representatives
Washington, D. C. 20515
Dear Sam:
I must apologize for not writing sooner on the question you
raised with me concerning the appropriate budgetary treatment of the
Exchange Stabilization Fund.
My delay reflects no lack of interest.
As you noted, I had certain responsibilities for the ESF in the Treasury,
and in my
present position, I see the functions from a somewhat different
angle.
In any case, while I am glad to comment, you should consider
this in
the nature of personal reflections rather than a statement of
official position--either Federal Reserve or Treasury.
As you know, under the Cold Reserve Act of 1934, Congress gave
the Secretary of the Treasury general responsibility for maintaining the
To carry out these responsibilities,
value of the dollar internationally.
the ESF was also established, provided with sizable resources, and given
broad authority under the exclusive control of the Secretary to deal in
gold and foreign exchange as well as other credit instruments.
It was
thereby given a status which enabled it to operate with flexibility,
Congress directed the use of ESF funds for
speed and confidentiality.
the initial
U.S. subscription to the IMF substantially, depleting the
While transactions with the IMF are
ESF's cash resources at that time.
those transactions may give rise to
conducted by the Treasury itself,
foreign currency balances or requirements that are channelled through the
ESF.
Although the Federal Reserve Bank of New York has acted as agent
exchange operations and in certain other respects since
for the ESF in its
its
inception, the Federal Reserve System did not engage in exchange
At that time, as our balance of
operations on its own account until 1962.
payments position came to be a matter of chronic concern and some questions
began to arise about the ability of the U.S. to maintain its policy of
freely buying and selling gold at $35 an ounce to maintain the stabilityexchange rate, the Treasury discussed with the Federal Reserve
of the dollar
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the possibility of the latter supplementing the ability and capacity of
the ESF to engage in exchange market operations. It was concluded that
the Federal
Reserve
should establish a series of mutualcredit aggrements
with some foreign centra1 banks--the so-called "swap arrangements"--in
order to obtain foreign currencies as needed.
These arrangement are
essentially bilateral credit facilities under which each participating
central bank agrees to exchange its currency for that of the other up to
a maximum amount for a limited period of time, enabling our partners or
ourselves to obtain funds to deal with passing balance of payment or
market
exchange
disturbances.
Those credit arrangements subsequently were
substantially enlarged, and the Federal Reserve in fact has carried out the
great bulk of the U.S. operations in the exchange markets since that time.
The specific
controlling
guidelines
the precise
type
of transactions
entered
be
to
into by the Federal
Reserve
are set forth by the
Federal Open
Market
Committee in its directive to the Federal Reserve
Bank of New York, which actsas
agent for the Federal Open Market Committee
operations
these
in
as it does for the
ESF.
From the start, it has also
been understood
that
operations in this area would be conducted in close
consultation
Treasury
the
with
in recognition of its general responsibilities
Obviously,
the operational responsibilities of the Federal Reserve
and
overlap,
ESF
the
in concept the question can be raised as to whether
it is desirable for the U.S. Government to have two instrumentalities for
conducting exchange market operations and arranging
short-term
credits.
In
my
judgment,
there are both substantive and policy grounds for an
unambiguously positive answer to that question.
The Federal Reserve, in time of need, can bring very substantial
resources to bear, as reflected in the present size of the established lines
of credit, amounting
some
to
Bank for International
Settlements.
that would
justify
or
require
aggregate, the ability
currency or
time of need
$20 billion with 14 foreign countries and the
While I cannot now imagine circumstances
full utilization of these facilities in their
to marshall large amounts of resources in one
another through those Federal Reserve swap arrangements at a
remains important
in dealing with specific problems an they
However, while Federal Reserve resources are large, another distinguishing feature of the swap arrangements, consistent with central bank
traditions and in some cases legal powers, is their short-term nature.
Swaps are drawn for three-month intervals; they may be renewed at maturity
but, except for quite unusual cases, they have been repaid within, one year.
Normal practice has been, in fact, to effect repayment within six months.
This in consistent with the general philosophy that mutual central bank
assistance should be short-term in nature and designed to deal only with
temporary payments imbalances that are expected to be reversible. The
arrangements are also 1imited to a relatively small group of foreign central
banks.
arise.
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-3-
5/7/76
In these respects, Federal Reserve operations are more limited
than the potential operations of the ESF. The ESF, although its resources
are much smaller, can respond in a greater variety of ways to contingencies
not envisaged in guidelines for Federal Reserve operations. The ESF can,
for instance, engage in transactions with countries that may not be included
in the System's overall swap network. SinceESF financings can more easily
be arranged on an ad hoc basis instead of as part of an overall network of
credits, as is the case for the Federal Reserve, the ESF can respond more
flexibly to unusua1 or special circumstances, attaching such conditions and
specifications
to these financings as may be appropriate to each operation.
The ESF has also been assigned a number of significant functions with
respect to SDR's. It can undertake operations to deal with unusual market
situations
which
might entail a longer-term exposure than in appropriate
for the System under the swap arrangements.
And, it can potentially
supplement the amount of financing that is available to any one country
under System swap arrangements.
Because of some of these differences, the flexibility with which
been enhanced
has
sometimes
its own way.
in
situation
participate
ESF
particular
the
approach
Systema and
could
both the
having
the U.S.
by
Conceivably, the Federal Reserve might be given and accept
broadened
authority to engage
in
all these types of transactions,
or
alternatively, the resourccs of the ESF could be very substantially
enlarged.
In
a sense
either result would appear "neater" than present arrangements.
But
the
"neatness" would sacrifice some very important, if intangible, advantages
in the current arrangement.
Specifically, I believe that, in the end, any
appearance of divided authority of cumbersomeness implicit in the present
division of (overlapping) responsibilities is justified by the "checks and
balances" implicit in the current approach.
It
is appropriate, in my judgment, for the broader ranging (but
smaller) operations
for feasible
the ESF to be conducted by the Treasury
itself, since it is the Secretary of the Treasury who in primarily and
directly
formulating
for
Congress
and
President
the
to
responsible
defending international
financial and monetary policy, for
assessing the
the United States in the world
economy,
andfor
interconducting
national negotiations
onthese
matters.
At the same
exchange
since
time,
questions
and
markets
policy
of
markets are closely linked to money monetary
there is a distinct role and responsibility for the Federal Reserve to work in
foreign central banks, which are operating in their
cooperation both
with
own markets, and with the Treasury. The fact that both agencies have
the area,
forces
them to work closely
together
operating responsibilites in
on operational decisions and to take full account of the various considerations
position of
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5/7/76
-4-
misc.
bearing upon operational decisions.
There is the strongest kind of
motivation
to reach a fullmeeting of minds in engaging in operations,
because any operations at crons purposes would be virtually immediately
I know of no
apparent, highly confusing, and totally counterproductive.
instance of that kind.
Reserve,
I
Having been with both the Treasury and the Federal
can
testify
that lively discussions do sometime take place about the
I can also testify that, in
appropriate scale and nature of operations.
the end, these discussions in the process of developing an agreed approach
have been useful and constructive in bringing to bear on the decision
varying considerations and viewpoints. Consultation and cooperation-dau-by-day and
sometimeshour-by-hour--has necessarily been close.
On an operational basis, because the exchange
market
operations
at
this Bank, full coordination can be, and is, readily achieved. Both agencies
are fully and continuously informed of the activities of the other, and the
equally
have
decisionmakers
prompt access to full information about emerging
market
developments.
of both the
are
ESF
the
and
Reserve
Federal
people
same
the
by
executed
Under the particular conditions of recent years, the need for
operations
ESF
the
by
to supplement those of the Federal Reserve have not
operations
market
exchange
matter
practical
a
as
and
great,
been
have been
left
almost
entirely
o the latter.
While I personally
advantages
see
can
in
the
more
in
a
as
these
ESF
frequently
operations
participating
continuing
symbol of the close cooperation between the agencies, that
is
not a crucial
matter.
It does seem to me essential, however, that, in view of the rapid
financial markets around the world, the United
changes
that
can
take
place
in
States
capacity
the
retain
to respond promptly and flexibly to emerging
developments, and that the Secretary of the Treasury not be deprived of all
operational capacity to influence events in this area. The ESP
access to
me vital if this capacity
is
to be retained, even though the Federal Reserve
is
available to handle the great hulk, or even all, of the operations that
into
fall
a more established mold.
With respect to the budgetary treatment of the ESF, there is no
exchange
undertaken
operations
market
that the credit and
indoubt
mind
my
by the ESF by their nature, are not appropriate, for inclusion in the budget.
Those operationsdo not involve government expenditures
in
any ordinary sense
cash
management
to
akin
more
are
they
instead
word;
the
of
balances or
other exchanges of
assets. The volume of operations
bound to swing
is
widely
in a n e s s entially unpredi c table fashion, and tho s e swings in no sense should
to the amending of
administrative
equated
be
in
economic or sense,
government funds for the purchase of goods or services or for transfer payments.
The
of
usefulness
the ESF is, in the last analysis,
dependent
upon
th flexibility, and often the confidentiality, with which it can act.
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-5-
typically)
(more
well
as
loss
of
are
Of course, there risks
prospects for gain.
The amount of loss that
without the need for Congressional action is
which was initially set by the Congress.
In
in that respect similar to certain insurance
5/7/76
as
can be horne by the FSF
reflected in its capital,
a sense, this situation
is
and guarantee programs.
As you know, apart from its operations, certain expenditures
arising in the administration of the ESF, and in the related international
responsibilities of the Treasury, are funded out of ESF earrings and
excluded from the budget. Policy and practice in this area are long
standing, and have been concurred in by the Congress.
These expenditures
are more comparable to other budgetary expenditures, and the precise line
between those expenditures funded through theESF and those funded through
somewhatarbitrary at the
usual appropriation processes is necessarily
margin.
In my period
at
the Treasury, carefu1 guidelines were developed
concernting those positions and activities that might appropriately be
financial
by theESF
with the introduction of the audit by the GAO of such
expenditures in 1970, those guidelines can be, and were, subjected to
independent
review outside the Treasury.
The important points of substance in this
respect seems
to me
that
the ability of the Treasury to respond flexibly to rapidly changing
needs be preserved
and that necessarily
confidentiality
be maintained.
has,
Congress
I believe, consistently recognized the legitimacy of both
points,, specifically in the review in 1970 that resulted in the GAO audit.
In passing
that legislation, the Congress
specifically
noted that upon
occasion certain administrative expenditures may be internationally
sensitive
and, in effect,
may in that respect be
indistinguishable from
In recognition of that reality, those administrative expendioperations.
tures which the Secretary might determine to be "internationally significant"
from time to time were specifically excluded from GAO audit. At the same
time the more routine use of ESF funds for certain related adminstrtive
expenditures of the Treasury was implicitly confirmed. Whatever the
line to be drawn between
judgmentof the Congress may be as to the pracise
the ESF and budgetary expenditures, I
would urge that the necessary
flexibility
and
for certain of those expenditures be
confidentiality
recognized and retained.
Sincerely,
(sgd.)
Paul
Paul A. Volcker
PAV/ar
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Attachment 8 :
U.S. Notification to IMF
UNITED STATES
(Position on December 31. 1985)
Exchange Arrangement
The currency of the United States is the U.S. Dollar.
The U.S. authonties do not maintain margins in respect
of exchange transactions, and spot and forward exchange
rates are determined on the basis of demand and supply
conditions in the exchange markets. However, the
authorities intervene when necessary to counter disorderly conditions in the exchange markets or when
otherwise deemed appropriate. There are no taxes or
subsidies on purchases or sales of foreign exchange.
The United States formally accepted the obligations of
Article VIII.
Sections 2, 3, and 4, of the Fund Agreement as from December 10, 1946.
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Review of Organization of
Foreign Currency Operations in
Other G-7 Countries and Switzerland*
I.
II.
Overview
..............
.. ..
.....
.
...
...
Country Profiles ......................
Canada ............
Japan ...........
Switzerland ....
....
........
United Kingdom .......
European Monetary System
France ..............
Germany ............
Italy
...............
Tables
Policy Framework for Foreign Currency Operations ....
Organization of Foreign Currency Operations ........
Foreign Currency Operations in 1989 .............
Techniques of Foreign Currency Operations ........
* Prepared by Paul DiLeo, Foreign Exchange Department, Federal Reserve
Bank of New York.
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OVERVIEW
This paper reviews exchange rate policy and intervention in the other G-7
countries and Switzerland. The focus is on identifying how policymakers view
exchange rates and how they pursue their objectives for their own currency,
with particular focus on the use of exchange market intervention. Some sense
of the institutional and operational frameworks for these operations is also
provided.
The range of practices and approaches for the group of countries reviewed
are summarized below and in the tables which follow. More detailed treatments
of each country follow.
Views of Exchange Rates -- The range of views within the group on the
importance of exchange rate developments, and the relative weight of exchange
rate considerations in policy determination, varies a great deal superficially
(Table I). On the one hand, there are a number of countries which explicitly
identify the exchange rate as a or the primary instrument in their pursuit of
economic objectives. Canada, for example, cites the exchange rate as a key
instrument in its pursuit of price stability; Japan sees exchange rates as a tool
in the pursuit of external adjustment. On the other end of the spectrum is
Switzerland,
which in recent years has adopted something of a "hands-off"
attitude towards exchange rates, focussing instead almost exclusively on the
evolution of the monetary base. Toward the same end of the spectrum, though
not so extremely, is Germany which places a primary focus on the achievement
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of domestic
2
monetary and economic goals, but will, albeit reluctantly,
temporarily subordinate these goals to exchange rate considerations at times
of severe market pressures.
Somewhere between these extremes fall the
United Kingdom, France and Italy. In these three cases, exchange rate policy
and monetary policy are difficult to distinguish, with the authorities tending first
to identify objectives and then to select an instrument on the basis of tactical
or strategic considerations.
Notwithstanding the divergence in stated objectives, the differences in views
among countries is less pronounced in practice. The focus of any one of the
authorities can shift to the exchange rate if developments in the exchange
market appear likely to undermine domestic stabilization objectives seriously.
An example
at the moment is Switzerland which is placing considerable
emphasis on preventing a further depreciation of the Swiss franc in order to
achieve stabilization of prices and the economy.
Policymaking Process -- The policymaking process, and in particular, the
roles of the Finance Ministries and central banks in setting exchange rate and
intervention policy, differ widely (Table II). In Switzerland and Germany highly
independent central banks have more or less exclusive control over exchange
rate policy, with the exception of the most fundamental decisions, such as
whether to alter fixed rates against other currencies, as in the ERM mechanism
of the EMS.
In these countries, consultations with government Ministries cover
exchange rate policy in only the broadest terms, and information on day-to-
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day activities or decisions is not necessarily routinely shared.
In Italy, the
central bank also operates with more or less complete independence in
exchange rate policy. However, unlike Switzerland and Germany, consultation
and coordination with the Finance Ministry tends to be much more frequent and
substantive.
In most other cases, the involvement and influence of other parts
of the government, and particularly Finance Ministries, is much greater.
In
Japan, the Ministry of Finance wields more or less total control over policy, in
both general and day-to-day terms.
In Canada, the United Kingdom, and
France, the Finance Ministries have ultimate control over exchange rate policy,
although in practice, the central banks have significant influence in the design
of overall policy and a very substantial degree of influence over day-to-day
decisions.
Despite this wide
range
in the
policy-making models,
operational
responsibility for intervention is in all cases the province of the central bank.
This operational role tends to magnify the central bank's influence in the policymaking process,
by providing
it with unique expertise in terms
of
implementation and tactics, and a unique asset and role in terms of market
intelligence.
The structure of ownership of reserves used for intervention purposes varies
widely among countries. In those countries, such as Switzerland and Germany,
with highly independent central banks exercising more or less total control over
exchange rate policy and intervention, reserves are owned by the central bank.
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In Italy, reserves used for intervention purposes are owned by the central bank;
the bulk of reserves are held by a separate entity which, although nominally
administered jointly by the Bank of Italy and the Finance Ministry, is effectively
part of the central bank. In the other countries, reserves are owned by the
Finance Ministries, but typically managed by the central banks.
Intervention -- Views on intervention among the countries coincide to a large
degree. In the most narrow "disorderly markets" sense, all countries explicitly
assert the utility of intervention in preventing the intensification of "speculative
bubbles" or "bandwagon effects" which, if unchecked, could have negative
implications for the real economy (while in recent years Switzerland has backed
away from this type of operation, it had previously been relatively active in this
regard). Several countries, in particular Canada and Italy, cite intervention as
an important tool in "smoothing" the movement of the currency along its long
run path. Japan and the United Kingdom would appear to ascribe the most
influence to exchange market intervention, principally because they view it as
an
influential
means
of affect
market
expectations
understanding of the views of the authorities.
and
participants'
Nevertheless, none of the
countries ascribes much influence to intervention beyond the short term unless
it is supported by consistent monetary and other policies.
Some evidence of these various attitudes towards intervention can be
discerned in data on the frequency as well as gross and net volumes of
intervention operations in 1989 (Table III). In Canada and Italy, for example,
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where "smoothing" of rate movements is an important goal, intervention is
relatively frequent, in terms of days in the market, and gross operations greatly
exceed "net" operations.
In other countries, such as Japan and the United
Kingdom, which assign intervention an important role in achieving economic
objectives, there was little difference between gross and "net" intervention.
Sterilization -- Most countries report a general commitment to "sterilization" of
intervention operations. Germany most closely adheres to both the letter and
the spirit of sterilization, with the impact of foreign exchange market operations
for domestic monetary aggregates fully offset and monetary and exchange rate
policies generally viewed as separate instruments directed towards different
goals.
Most of the other countries sterilize more or less routinely, offsetting
intervention as part of their regular monetary programming exercises, or
automatically sterilizing, in the case of Canada, as a consequence of the
structure of the government's reserve holdings. However, in many of these
countries monetary policy itself is determined with the exchange rate as the or
a primary objective, and not infrequently may be modified to address exchange
rate considerations, and the concept of sterilization may be somewhat less
meaningful.
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TABLE I
Policy Framework for Foreign Currency Operations
Exchange Rate Policy/
Intervention Goals
Intervention
Sterilized
CANADA
Contain price pressures.
Smooth rate movements.
Avoid "bandwagon" effects with negative
impact on real economy.
Automatic.
JAPAN
Reduce external surplus.
Avoid excessively rapid movements.
Routine.
SWITZERLAND Focus is on evolution of monetary base;
exchange rate is usually not an objective.
UNITED
KINGDOM
FRANCE
Routine. Foreign exchange swaps
are used to control money growth.
Balance between reducing inflation and
preserving competitiveness.
Intervention is used as first response to
deviations of rate from desired path, and to
give market official view of fundamentals.
Routine.
Reinforce fiscal discipline.
Encourage price stability.
Routine. Monetary program may be
adjusted to ensure achievement of
exchange rate objectives.
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TABLE I (continued)
Policy Framework for Foreign Currency Operations
Exchange Rate Policy/
Intervention
Goals
Intervention
Sterilized
GERMANY
Focus is on monetary policy, maintaining
purchase power of mark.
Intervention used to deflate/prevent
speculative bubbles.
Routine.
ITALY
Reinforce fiscal discipline.
Combat inflation.
Smooth speculative and seasonal
movements.
Routine. Monetary program
may be adjusted to ensure
achievement of exchange rate
objectives.
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TABLE II
Organization of Foreign Currency Operations
Policy
Authority
Operations
Information
Control of
Release
Reserves
CANADA
Shared
Bank
Minimal
Ministry
JAPAN
Ministry
Bank
Minimal
Ministry
SWITZERLAND Bank
Bank
Partial
Bank
UNITED
KINGDOM
Ministry
Bank
Minimal
Ministry
FRANCE
Ministry
Bank
Partial
Ministry
GERMANY
Bank
Bank
Minimal
Bank
ITALY
Bank
Bank
Minimal
Bank
Note: "Bank" denotes the central bank. "Ministry" denotes the Finance Ministry or Treasury.
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TABLE III
Foreign Currency Intervention in 1989
Days in
Market*
Total Gross
Operations
(percent) ($ mil)
$/Loc
Composition
$/Oth
DM/Loc Oth/Loc Oth/Oth
(percent)
Net**
Operat
($ mil)
552 U.S.C. (b)(4)
CANADA
JAPAN
SWITZERLAND
UNITED
KINGDOM
FRANCE
GERMANY
ITALY
MEMO:
United States 38
21957
n.a.
n.a.
n.a.
n.a.
n.a.
21957
Notes: This table includes only those operations reported as intervention. A number of countries conduct a large
volume of other operations in the market.
Under "Composition", "Loc" refers to local currency, "Oth" to non-dollar, non-DM, non-local currency.
* Based on an estimated 255 trading days in 1989.
** In the "Net" Operations estimate, opposite transactions in the same currency pair have been offset.
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TABLE IV
Techniques of Foreign Currency Operations
Visible/
Discreet
Instruments
Approaches
Central Bank
FX Traders
CANADA
Both
Spot
Banks/Brokers
IMM Futures
4
JAPAN
Both
Spot
Banks/
Brokers
9
SWITZERLAND
Both
Spot/Swaps
Banks
6
UNITED
KINGDOM
Both
Spot/Forward
Swaps
Banks/Brokers
Investment Bnks
FRANCE
Mostly
Discreet
Spot
Banks
GERMANY
Mostly
Visible
Spot/Forward
Banks/
Brokers
ITALY
Both
Spot
Banks
United States Both
Spot
Banks/
Brokers
MEMO:
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CANADA
I. Official Views of Exchange Rate Policy¹
Canadian policymakers tend to view the evolution of the exchange rate (the
Canadian dollar/U.S. dollar rate) in Canada -- a small, open economy -primarily in terms of its possible impact on inflation, and to the extent that
movements in the rate could undermine the achievement of price stability, they
are considered a matter of concern.
In the 1986 Bank of Canada Annual
Report, it was noted that "[e]xchange rate depreciation always involves an
upward push to domestic prices and is never easily accepted because this rise
in prices undermines the purchasing power of wages and salaries. If people
are already fearful of inflation, these additional price pressures only exacerbate
their fears." In addition, policymakers hold the view that short-term volatility of
the exchange rate can initiate "bandwagon effects" with negative implications
for trade, real output, capital flows, and investment, and are particularly sensitive
to the possibility of sharp movements in the exchange rate in light of the
relatively small and concentrated Canadian foreign exchange market. At the
same time, it is believed that intervention will be most effective in the short run,
and will have little or no effect on the level of the exchange rate over a period
of a quarter or longer.
In light of these views, Canadian exchange market intervention has adopted
a tendency to "lean against the wind." The Department of Finance indicated in
¹ This and other sections of this paper on Official Views of Exchange Rate Policy is
based largely on public statements by the authorities in the various countries, and in particular
on a 1988 BIS compilation, entitled "Exchange Market Intervention and Monetary Policy".
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1982 that over the period of floating rates "official operations in the foreign
exchange market by the Canadian authorities have been directed towards
smoothing out erratic movements in the Canadian dollar/US dollar rate of
exchange and avoiding disorderly market conditions."
It is not the aim of
intervention to achieve or maintain a specific rate, or to have any particular
long run influence, although upon occasions, movements which appeared to
carry the rate far out of line with fundamentals have been vigorously resisted.
In general, the Canadian authorities respond to short-term movements in the
exchange rate. They are more likely to intervene, and the amounts are greater,
the larger is the day-to-day movement in the spot rate. Operating in this way,
they expect their interventions to net out over time, so that they do not feel the
need for either large foreign currency reserves or official financing facilities to
finance intervention.
In the event Canadian intervention requires substantial
financing, the authorities expect to borrow the needed funds in private markets,
an avenue easily available to them because the bulk of their foreign currency
sales are U.S. dollars, and they have established ready access to this market.
All intervention activity is automatically "sterilized" because exchange reserves
are held by the Federal government; foreign exchange purchases and sales
affect the Canadian dollar deposits which the government holds at banks and
have no effect on the central bank's books. In any event, policymakers do not
perceive much scope for intervention operations to conflict with monetary policy
objectives because the objective of intervention operations is to smooth
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movements rather than to affect the level of the exchange rate over time. The
scope for intervention operations to neutralize at least partially bandwagon
effects and
speculative bubbles is viewed as reducing the need for and
providing time to implement necessary interest rate adjustments.
II.
Policy Determination
The Bank
Department
of Canada executes exchange rate policy on behalf of the
of Finance (DOF).
The DOF focusses primarily on strategic
considerations, while the Bank of Canada has both a significant amount of input
into these strategic deliberations as well as undertaking much of the day-today activity associated with intervention, and asset and liability management.
Within the general policy framework, the Advisor to the central bank Governor
is responsible for the conduct of exchange market operations, subject to formal
clearance by the Deputy Minister at the DOF.
In practice central bank
proposals for intervention are rarely overruled.
Information on reserve holdings is released monthly. In addition, the central
bank Governor testifies from time to time to various parliamentary committees,
and may choose to discuss exchange rate policy at that time. In a 1989 audit
of the Department of Finance, the Office of the Auditor General recommended
that the DOF should provide more complete information to Parliament on the
operations of the Exchange Fund Account, with primary emphasis on the
information
required to evaluate the costs and profits associated with
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intervention and the maintenance of reserves. The DOF indicated that it would
consider the recommendation.
III. Policy Implementation
The Bank of Canada establishes a "trading program", providing for target
amounts of currency to be bought or sold for each 10 basis point move within
a 100 basis point range in the U.S. dollar/Canadian dollar exchange rate. As
a general matter, intervention is initiated only after the rate has moved some
distance within the range. The intensity of intervention -- in terms of the volume
of transactions per basis point move -- tends to increase the further the
movement within the range. Within the program, central bank traders have a
fair amount of discretion to deviate from the predetermined amounts.
For
example, if the exchange rate appears to be moving decisively out of the range,
the traders may decide to withdraw from the market temporarily.
Under these operational procedures, overall intervention is frequent. The
amounts can vary from small to large.
Over short periods of time, the
monetary authorities may find themselves both buying and selling US dollars as
pressures on the Canadian dollar shift.
The Bank
of Canada administers the Exchange Fund Account for the
Department of Finance, from which operations are financed. Until recent years,
Canadian holdings of foreign currency reserves were minimal, and when the
Canadian dollar came under pressure, intervention activity needed to be
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financed through a variety of means. These included lines of credit the Bank
of Canada had in place with various Canadian banks and U.S. banks with
branches in Canada; such lines totalled $7.5 billion in the early 1980s.
In
recent years, and particularly in late 1989, these lines were reduced and now
total $3 billion. In addition, a "Canada Bills" program is utilized, whereby the
U.S. commercial paper market can be accessed to raise dollars for intervention
purposes.
With the strengthening Canadian dollar over the past few years,
Canadian reserves have grown rapidly, and these financing arrangements have
not been needed, although outstandings under the Canada Bills program have
been maintained on the order of $1 billion.
IV. Operational Issues
The Bank of Canada traditionally operates in the spot market for intervention
purposes and generally buys or sells US dollars.
It has, on occasion, also
operated on the organized futures exchanges in Chicago, buying or selling
Canadian dollar futures contracts through commission houses or investment
banks.
In addition, the Bank of Canada, in order to avoid conflict with
operations being undertaken by the U.S. authorities, has at times in the past
few years operated in German marks or Japanese yen when those countries
were amenable.
The Bank of Canada approaches banks both directly and through the
brokers market in its own name.
conducted discreetly.
Bank of Canada operations are normally
However, since the Bank of Canada operates in a
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predictable fashion, market participants can frequently determine when the BOC
is likely to be active.
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JAPAN
I. Official Views of Exchange Rate Policy
In recent years the authorities have been concerned about reducing Japan's
huge external surpluses without exerting an excessively deflationary impact on
the domestic economy.
Under these circumstances, the authorities permit
trends in the exchange rate to take their course insofar as they appear
consistent with continued adjustment of imbalances.
They use intervention
either to minimize disruptive or excessively rapid movements in the desired
direction or discourage undesired movements in exchange rates that do not
appear to reflect economic fundamentals.
Policymakers believe that forceful intervention is often effective in calming
market sentiment when disorderly conditions develop. They are less convinced
of the effectiveness of intervention when it aims at correcting the level of
exchange rates or at stabilizing the exchange rate in the longer run. However,
it is believed that intervention, when perceived to be supported in a coordinated
fashion by other policies such as monetary and fiscal policies, can be highly
effective, particularly in influencing market sentiment.
The BOJ routinely sterilizes its foreign currency intervention operations,
including intervention along with other factors contributing to surpluses or
shortages of funds in the money market in determining what operations are
necessary to control the money supply and to ensure that the market is
confident about its controllability.
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II.
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Policy Determination
The Ministry of Finance has the sole authority to intervene in foreign
exchange markets and holds all Japanese reserves in the "Foreign Exchange - Special Account". The MOF instructs the BOJ when to intervene and in what
amounts, while taking counsel from the BOJ on market conditions.
No information on intervention activities per se is formally published, and no
parliamentary testimony on the subject is given. Observers can try to infer the
scale of intervention from information on the reserve holdings, published
monthly.
In addition, many market participants allege that it is possible for
banks in Japan, especially large Japanese banks, privately to obtain information
about the monetary authorities' operations and intentions.
The Foreign Exchange -- Special Account of the MOF is managed by a
Deputy Director in the Foreign Exchange Markets Division of the MOF.
All
investment decisions are made in the MOF; the BOJ acts as agent.
III.
Policy Implementation
The Foreign Exchange Markets Division of the MOF is in frequent contact
with the BOJ Foreign Operations Bureau throughout the day, beginning with a
call at about 8:30 am to review market conditions. Normally, the MOF will give
the BOJ instructions on how much intervention to undertake, and at what level
or at what time. It would leave to the BOJ's discretion issues of tactics.
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IV. Operational Issues
The BOJ deals with banks directly and through the brokers market in its own
name.
It operates both visibly and in a discreet manner.
Operations are
conducted in the spot market, primarily in US dollars, although other currencies
may be used in certain circumstances.
The BOJ has recently broadened its intervention techniques to intervene on
occasion in Far Eastern markets while the Tokyo market is closed.
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SWITZERLAND
I. Official Views of Exchange Rate Policy
The Swiss National Bank currently is concentrating on the evolution of the
monetary base, taking the view that the domestic money market will work to
stabilize the
franc and smooth out short term fluctuations.
However, it
recognizes that at times these stabilizers may not succeed in preventing
excessive swings in exchange rates.
If exchange rates movements appear
large enough to cause significant conflict between policy objectives, the
authorities are prepared to alter the thrust of policy so as to stabilize the
exchange rate. In particular, when excessive exchange rate movements have
threatened to damage the domestic economy, the authorities are prepared to
deviate from, or temporarily abandon, the money stock target.
The Swiss authorities believe that sterilized intervention is useful for giving
signals to the foreign exchange market, but not for dealing with extreme
aberrations in rates, and consequently have not relied much on sterilized
intervention in recent years.
II. Policy Determination
Foreign exchange policy is the responsibility of the Swiss National Bank
(BNS). As noted above, the BNS's principal focus in recent years has been on
the development of the monetary base, and, at least until quite recently, foreign
exchange considerations were subordinate to this goal. Currently, however,
monetary policy is directed at achieving an appreciation of the Swiss franc
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against the DM.
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The conclusion of foreign currency swaps is the primary
instrument employed in monetary control operations.
The BNS will not volunteer information about intervention operations to the
public, although in recent years it has sometimes confirmed that operations
have occurred, without giving amounts.
The BNS has recently initiated a quarterly report in which it discusses its
operations. BNS officials do not, however, testify about operations before any
parliamentary bodies.
III.
Policy Implementation
The decision to intervene is taken by the Director General in charge of the
Monetary Operations Department.
He is under no obligation to consult with
any part of the Federal Government.
The dollars purchased in the market are kept in the BNS's portfolio in the
form of U.S. money market investments. The BNS also holds limited amounts
of assets in other currencies.
IV. Operational Issues
The BNS operates through banks in Switzerland.
For domestic monetary
control purposes it frequently uses foreign exchange swap or forward
transactions.
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UNITED KINGDOM
I. Official Views of Exchange Rate Policy
The views of policymakers towards exchange rate policy have shifted during
the last decade. Recently, the focus has been on the need for policy to find
a balance between the implications of exchange rate developments for inflation
and for competitiveness.
Policymakers evaluate developments in exchange
rates in light of the causes and expected duration of any movements, and the
relative impact of domestic conditions and external developments on the
exchange rate before determining the appropriate response. If some official
response is considered appropriate, intervention is normally the first instrument
If necessary, in light of developments more generally, intervention
to be used.
may be followed by changes in interest rates.
Operations in the money and exchange markets are closely coordinated.
There is no hard and fast rule about whether the authorities intervene or adjust
interest rates.
Instead the decision will depend on the particular circumstances
and tactical considerations, although changes in money market intervention
rates are infrequent relative to intervention operations.
In addition, the British authorities believe that speculators in the foreign
exchange market as well as the growing volume of capital flows can generate
substantial movements in exchange rates which are often unwarranted by
economic fundamentals. In this context, they believe that the role of exchange
rate management, and the scope for intervention, goes beyond smoothing short
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term fluctuations in exchange markets, and includes the need to give the
market a clear understanding of the official view of economic fundamentals.
Sterling bought or sold in exchange market intervention is included in
calculations used to determine the daily money market operations of the Bank
of England, and its effect on banks' operating balances at the Bank, and on the
monetary base, is routinely sterilized.
More broadly, the authorities are
committed to a "funding rule" which implies that the effect of intervention on
broad money is also sterilized over some period, although this period may
extend beyond the end of the current fiscal year.
It is believed that even
sterilized intervention can have an impact on exchange rate movements, so
long as the rate which the authorities are endeavoring to protect lies within a
range considered by market participants to be consistent with economic
fundamentals.
II. Policy Determination
Management of foreign exchange reserves is governed by the Exchange
Equalization Act. Reserves are owned by the Treasury. Through an exchange
of letters between the Treasury and the Bank of England, the Bank is appointed
manager of the reserves, and is charged with investing balances held by the
Exchange Equalization Account.
However, the ultimate responsibility for
exchange rate policy remains with the Treasury, which is answerable to
parliament.
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Each month, exchange rate policy, along with interest rate policy, are
discussed at a meeting of the Chancellor of the Exchequer and the Bank's
Executive Director in charge of the Markets Division, which covers both foreign
exchange and domestic market operations; the central bank Governor may
occasionally attend. In addition, ad hoc meetings would be held in the event
of any need for a policy review or change.
Some information about exchange rate policy and operations is provided in
the Bank's Quarterly Report, however, the discussion tends to be relatively
guarded.
II. Policy Implementation
The policy determined by the Chancellor and the Bank's Executive Director
in charge of Markets is translated into operational guidelines, which govern the
activities of the trading room. For example, the guidelines might specify how
much the traders are permitted to sell during a certain period or if exchange
rates move beyond specified levels.
Any changes in the guidelines are typically dealt with at the Executive
Director level; his counterpart is one of the three Permanent Secretaries of the
Treasury. In the event of his absence, consultations would be carried out by
the Head of the Foreign Exchange Division. There is a great deal of contact
and sharing of information between the Treasury and the two managers in the
Bank's foreign exchange area. There is no contact between the dealing room
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25
itself and the Treasury.
All intervention is financed through the Exchange Equalization Account.
IV. Operational Issues
The Bank
operates in the markets directly with banks and through the
brokers market in its own name; the latter route is used when quick and wide
public dissemination of the information on the operation is desired. Intervention
operations are normally conducted in the spot market, and mainly in US dollars,
although operations are also occasionally undertaken in marks and yen.
However, the Bank conducts operations in forwards and sometimes extensively
in swaps, in
order to manage the extent to which its operations are reflected
in monthly reserve data. The Bank of England also conducts extensive (almost
daily) foreign
government,
exchange operations to cover the currency needs of the British
including the armed services.
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MONETARY SYSTEM EXCHANGE RATE MECHANISM
EUROPEAN
The remaining three countries to be considered in this review -- France, the
Federal Republic of Germany and Italy -- are all members of the Exchange Rate
Mechanism (ERM) of the European Monetary System (EMS).
Membership in
the ERM implies certain obligations with respect to exchange rate policy and
intervention.
In particular, each member country agrees to fixed but adjustable
exchange rates in which each participating currency is tied to each of the other
participating currencies by bilateral central rates. Around the bilateral central
rates, fluctuation margins of 2.25 percent (6 percent in the case of the Spanish
peseta) have been established that determine the bilateral intervention points
for each currency against each of the other currencies.
At these points,
intervention in the partner currency concerned is obligatory and potentially
unlimited in amount. The necessary funds for carrying out such intervention,
to the extent the country involved cannot draw on reserves, are supplied by the
respective partner central banks under mutual credit lines, under the "very short
term financing facility" of the European Monetary Cooperation Fund (EMCF).
Within this context, different participating countries at times have had different
views with regard to the desirability of full use of the fluctuation margins. Some
believe the flexibility provided by the margins serves as a cushion available to
absorb some external shocks without the need for policy adjustments.
In
addition, they believe full use of the margins helps limit the need for
intervention. Others, however, adopt the view that greater stability of rates may
better serve the objective of domestic monetary stability and avoid the buildup
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of momentum for exchange rate movements.
Consonant with this view, a
number of EMS central banks have adopted a strategy of keeping their
exchange rates well within the band and minimizing movements against the key
currency, the German mark. At times this has necessitated both substantial
intervention as well as the maintenance of higher interest rates than might
otherwise have been desired. When intervening "intramarginally", participating
countries do not have recourse to the very short term financing facility of the
EMCF.
Over the years, the use of "intramarginal" intervention has increased. Such
operations are viewed as a first line of defense to counteract tensions, and as
useful to gain time and obtain a more precise picture of the sources of
disturbances, as well as proving effective in smoothing short term fluctuations
due to occasional mismatches of supply and demand.
Under the EMS
Agreement, the holding of currencies of other participating countries in excess
of working balances, and the use of these currencies in intervention, requires
the consent of the central bank of issue.
The central bank most often
approached in this connection is the Bundesbank, issuer of the main EMS
intervention currency.
552 U.S.C. (b)(4)
, has become an important intervention currency with the EMS.
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FRANCE
I. Official Views of Exchange Rate Policy
The French authorities believe that the obligations of a fixed exchange rate
desirable because they impose constraints on government policy
regime are
making in a way that makes it easier for the government to accept and then
adhere to appropriate stabilization policies. In the current context, the French
authorities ascribe their desire to prevent a depreciation of the franc -particularly against the DM -- to the need to encourage price stability by
maintaining pressure on firms to restrain costs. This objective is pursued by
membership
in the ERM of the EMS as well as by participation in various
coordination
efforts, such as the Plaza Agreement and the Louvre Accord.
The policy-making framework in France explicitly incorporates intervention
policy into overall stabilization policies. The Bank of France, after consultation
with the Ministry of Finance, adopts a target or objective for monetary or credit
growth thoug ht to be consistent with forecast growth of the real economy and
financing requirements of the balance of payments.
If during the year, the
Bank of France intervenes to support the franc by more than was expected,
based on
current account projections, the Bank of France provides
correspondingly less credit to the domestic economy -- either to finance the
fiscal deficit or private sector expenditures. In an earlier regime when credit
controls were an important tool of monetary policy, this rationing of credit was
done, after negotiation with the government, through various ways the Bank of
France influenced the allocation of credit. More recently, this process has been
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performed using interest rates, and indeed interest rates in France have been
changed during the past several years far more frequently than before in direct
response to exchange market developments. Similarly, if intervention results in
taking in more reserves than expected, the Bank of France provides either
more credit to the economy or lowers interest rates. In this way, the policy
framework in place in France provides for foreign exchange market intervention
to serve as the mechanism for making short-term adjustments to the medium
term strategy.
In the view of the French authorities, disturbances in the exchange market
normally take the form of spontaneous and rapid fluctuations in spot rates,
generally with no immediately obvious, convincing explanation.
Such
fluctuations may generate uncertainties which can develop into movements
more difficult and costly to contain, particularly as full use of the ERM
fluctuation margin may lead market participants to believe that a realignment is
imminent.
Consequently, the French authorities respond to unexpected
exchange rate fluctuations by acting to prevent speculative movements from
gaining momentum.
The French authorities consider the effectiveness of exchange market
intervention to be indisputable, at least in the short run. Intervention, in this
view, is an adaptable and flexible instrument which is well-suited to episodes
of unexpected upward or downward pressure whose origin is not immediately
apparent. In addition, coupled with appropriate interest rate policy, intervention
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can prevent even more severe tensions from turning into crises. Nevertheless,
even if coupled with appropriate interest rate changes, there is no substitute for
the adjustment measures necessary to correct excessive imbalances.
It is
certainly not advisable to lean without limit, or for too long, against the general
market trend.
The Bank of France routinely sterilizes intervention, attempting to maintain
a level of interest rates consistent with domestic and external objectives. The
franc counterpart of purchases or sales of foreign currencies is taken into
account along with all the domestic factors which might affect the banks'
liquidity. If the overall net balance of francs is estimated to be consistent with
the desired development of interest rates no action is taken; if not, action is
taken to absorb or supply liquidity, as necessary.
II. Policy Determination
The Finance Ministry has the lead role in policy issues related to exchange
rate policy.
But the Governor of the Bank of France, though he serves at the
pleasure of the government, can use his influence in monetary policy, together
with financing requirements to support the franc, to exert a restraint on fiscal
policy.
French reserves are formally held in the Fonde de Stabilization de Change
(Exchange Stabilization Fund), a Finance Ministry account managed by the
Bank of France. The Fonde was created in 1936 to help obscure intervention
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operations.
31
However, in practice, the Fonde has very small resources, and
holds only about 5 percent of reserves. The remainder is swapped with the
Bank of France.
Once a week, before publication of the Bank of France
balance sheet, reserves are transferred off balance sheet. These swaps are not
done to offset intervention operations franc for franc, but rather to smooth
movements in published reserve data.
Both the Bank and the Fonde publish information on gross reserves.
No
information is published on Fonde liabilities or on off balance sheet items of the
Bank.
There is no formal parliamentary discussion of Bank of France
intervention operations.
Ill. Policy Implementation
Intervention operations are executed by the Bank of France which is in the
market frequently, operating for customers, intervening, and taking positions.
Typically, when pressure emerges on the DM/franc rate, an objective is set in
terms of a ce rtain level to defend with a specified amount of reserves. Levels
can be shifted as intervention operations proceed, with a view to trying to
soften movements. The initiative for these operations can be taken within the
central bank's dealing room without further review unless the pressure persists.
The trading room is also given the authority to take positions, up to explicit
limits. If the pressure against the franc becomes significant, the head dealer
would report the situation to senior management of the Bank.
In cases of
particularly intense or sustained pressure the Ministry would be informed.
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Class I - FOMC
The Bank and the Ministry carry roughly equal weight in discussions of the
appropriate stance towards the market when pressure is not great, or if it
appears to reflect technical considerations. If the pressure is intense, or if the
policy implications appear significant, the Ministry's weight in the discussion
increases substantially.
IV. Operational Issues
The Bank of France holds a daily fixing, at which by law it must fix rates for
more than 20 currencies. Small customer orders are typically executed at the
fixing, which normally accounts for a small fraction of total market turnover.
The Bank deals with about 50 or 60 bank counterparties in Europe and
North America; no brokers are used. The Bank seeks to have at least two
counterparties willing to deal each currency covered at the fix. About 25-30
banks are used for marks and US dollars, about two-thirds of which are outside
of France.
The Bank has an understanding with its counterparties that all operations are
strictly confidential, and has made clear that transactions will be immediately
halted if this understanding is breached.
This confidentiality is reportedly so
rigorously observed by counterparties that on those occasions when the Bank
has wanted its operations to receive more notice in the market, it has had
difficulty persuading counterparties to abandon the normal practice.
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33
The Bank operates mostly in FF/DM and $/FF, and on a few occasions
$/DM, and typically operates in the spot market. The Bank of France also
conducts frequent operations on behalf of the French government, greatly
increasing its volume of activity in the market.
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GERMANY
I. Official Views of Exchange Rate Policy
Monetary management in Germany is predominantly geared towards the
achievement of domestic monetary and final economic goals by means of
publicly announced annual targets for the growth of the money stock.
Nevertheless, in pursuing these objective, the authorities always take account
of exchange rate developments.
There is considerable scope for transitory
exchange market pressures to be reflected in domestic money market
conditions or in short-run variations in monetary growth. Furthermore, in cases
of abnormal appreciation or depreciation pressure on the mark, the authorities
are willing to tolerate a lasting overshooting of annual monetary objectives in
order to mitigate the repercussions of lasting exchange rate aberrations on the
domestic economy. Policymakers focus on movements in the effective rate of
the mark to determine when exchange rate aberrations warranting corrective
action have occurred.
However, the authorities do not necessarily respond
immediately to extreme fluctuations in the effective exchange rate, but rather
are inclined to wait until it appears that undesirable exchange rate movements
threaten seriously to disrupt domestic economic objectives.
Policymakers view the primary purpose of intervention in the mark/dollar
market as the maintenance of orderly market conditions through short-run
"smoothing" operations and efforts to dampen over- or under-shooting of the
mark in relation to its warranted long run trend. The authorities aim to counter
disorder resulting from political shocks, the emergence of "bandwagon" effects,
or apparent "speculative" bubbles, which might be dampened by the creation
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of two way risk for speculators.
Intervention is normally fully sterilized, and monetary management and
exchange market intervention are regarded as two separate policy instruments
aimed at different intermediate operating objectives. The authorities believe that
largely neutralized exchange market intervention exercises only a limited and
transitory influence on exchange rate movements. Official purchases and sales
of foreign exchange are permitted to affect the monetary base under the
Bundesbank's short term monetary operating procedures only to the extent that
it is consistent with the Bundesbank's objectives in this regard.
Excess
reserves or reserve shortages of the banking system resulting from exchange
market intervention are offset completely.
II. Policy Determination
The government, in particular the Finance Ministry, determines the very broad
parameters of German exchange rate policy:
whether to follow a fixed or
floating regime, to join a regional currency arrangement, such as the ERM, or
to change the DM's central rates in the ERM. Within these basic parameters,
the Bundesbank (DBB) has essentially total control over policy and operations.
On a day-to-day basis, the DBB operates with complete independence, and
does not necessarily inform the government of any operations it may undertake.
On a more medium term basis, exchange rate policy is discussed within the
context of overall economic policy. These discussions might occur in one of
two forums.
First, the Finance and Economy Ministers are entitled under the
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36
Bundesbank Law to take part in the fortnightly Council meetings, as non-voting
participants, and do so 3-4 times each year, often in response to a request
from the DBB. The second, and more significant, forum is the various technical
committees of parliament, such as Finance and Budget, in which the President
and Vice President of the Bundesbank participate.
Participation in these
committees does not constitute testimony before parliament; the DBB does not
testify before parliament, and any questions which deputies may have on the
conduct of the DBB must be directed to the government.
The DBB
publishes monthly and annual reports, which give minimal
information on intervention operations; it publishes reserve data fortnightly.
Other sources of information on policy and operations are speeches by the
President of the DBB in which he may, at his own discretion, discuss such
matters.
At the beginning of each fortnightly Council meeting, the DBB Director
responsible for foreign exchange operations reports to the Council, composed
of the Bundesbank President and Vice President, up to eight Directors and the
Presidents of the 11 state banks, on the foreign exchange operations
conducted and any other relevant issues.
III.
Policy Implementation
The decision to intervene and in what amounts is typically taken by the
member of the DBB Directorate charged with responsibility for foreign exchange
policy. This decision would then be communicated to the Head of the Foreign
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Department of the DBB and from there to the Head of the Foreign Exchange
Division. The Foreign Exchange Division would have most of the responsibility
for operational decisions: how many and which banks or brokers to contact,
the size of transactions, etc.
The DBB owns and manages all German reserves.
IV. Operational Issues
The DBB intervenes primarily through commercial banks, and occasionally,
when it wishes to draw an extraordinary amount of attention to an operation,
through the brokers market in its own name.
In principle, the DBB always
operates visibly, although there have been exceptional occasions when it has
operated more discreetly.
Except for operations mandated by membership in the ERM, intervention by
the DBB has been largely confined to US dollars. The DBB nearly always
operates in the spot market, although it has operated extensively in the forward
market on occasion when it wishes to influence exchange market conditions but
postpone the money supply effects. Other exchange market activities may be
undertaken but are not considered instruments of active exchange rate
management,
such as swap transactions or foreign exchange transactions
under repurchase agreements, in order to "fine-tune" domestic money market
conditions.
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ITALY
I. Official Views of Exchange Rate Policy
The Italian authorities, like those in France, have accepted the intervention
obligations of the ERM, largely for domestic macro-economic management
In recent years they have emphasized the implications of
purposes.
movements
in the exchange rate for combating inflation at the expense of
ensuring price competitiveness for industry. Having accepted the proposition
that Italy should give up the wider, 6 percent band applicable to the lira in the
ERM since its inception, the Bank of Italy has used intervention and monetary
policy to try to exert pressure on the government to deal meaningfully with its
fiscal problems. Under these circumstances, the lira remained mostly within the
narrow margins of the ERM during the latter part of the 1980s, and formally
adopted the 2.25 percent band in January 1990.
Intervention in recent years has occurred primarily within the margins with the
objective of smoothing exchange rate changes against the DM and countering
speculative and seasonal pressures.
A few foreign exchange restrictions, mainly to discourage capital outflows,
remain in place, but have been gradually lifted in recent years and are much
less binding.
Nevertheless, specific restrictions have been reintroduced from
time to time to counter speculative attacks on the lira viewed as inconsistent
with economic fundamentals and a threat to the process of disinflation.
Money market and exchange market operations are coordinated on a daily
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basis, with both types of operations taken into account in analyzing and
forecasting the short run behavior of the monetary base, assessing the likely
effects on banks' reserves, and planning the appropriate operations for
subsequent days.
II. Policy Determination
Policy is set, implemented and financed by the Bank of Italy. The Bank
controls about 10% of reserves with the remainder controlled by the Ufficio
Italiano dei Cambi (UIC).
The Ufficio was originally a joint Bank - Treasury
office, but has effectively, if not formally, been absorbed into the Bank with
some independent responsibilities (for example pertaining to the administration
of exchange controls).
The Governor of the bank of Italy also serves as
President of the Ufficio. There is some talk of formally absorbing the UIC into
the Bank, although it is not seen as a pressing issue.
IIl. Policy Implementation
While the UIC holds the bulk of foreign exchange reserves, the Bank holds
the most liquid portion, and all intervention activities are financed out of these
holdings.
In those cases where the Bank requires access to additional
reserves, the UIC supplies the needed funds.
IV. Operational Issues
A feature of the Italian exchange market is the daily fixing, which begins each
day at 1:15prn, although its importance is reportedly declining. The fixing is
effected by means of a three way conference call linking the Bank with staff on
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the Rome and Milan stock exchanges.
Eighteen currencies are fixed in a
session which generally takes between 60 and 90 minutes; the dollar, mark,
and French franc are usually fixed first. The most relevant price information for
determining day-to-day intervention is the mark/lira rate and, to a lesser extent,
the U.S. dollar/lira and French franc/lira rates. The Bank of Italy may intervene
to facilitate the process of fixing exchange rates, and such operations are
visible. In addition, the Bank may intervene extensively outside the fixing. Such
operations normally are not officially reported or confirmed.
In its foreign exchange dealings, the Bank operates exclusively through
commercial banks; no non-banks or brokers are used. The Bank operates in
the spot market. Only banks registered in Italy are used for these operations;
Italian branches of foreign banks are included.
Intervention in the market
usually involves lira sales and purchases; cross currency transactions are
occasionally conducted with the aim of changing the currency composition of
reserves.
When the senior management of the Bank decides to intervene in the foreign
exchange market, the foreign exchange desk, with 5-7 traders, is given the
discretion to operate up to some authorized amount.
The Desk has direct
access to the most senior levels of the Bank, and routinely reports market
conditions during the course of intervention operations.
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CLASS I - FOMC
Historical Review of
U.S. Official Holdings of Foreign Currencies*
I.
II.
page
1
O verview ........................................
Foreign Currency Holdings and Exposures .............
A. The Sixties .....................................
B.
C.
D.
E.
1971 - 1977 ..................................
1978- February 1981 ............................
March 1981 - September 1985 .....................
September 1985 to the Present .....................
6
6
9
10
13
15
III. Investment of Foreign Currency Reserves ..............
A. Investment Facilities Established in the late Seventies ....
B. Investment Facilities Established in the Eighties .........
C. Rates of Return ................................
17
18
21
23
Appendix -- W arehousing
24
..............................
Charts
1. Gross Foreign Currency Balances and
Net Open Positions (1962 - 1989) ....................
2. Composition of Official Reserves .......................
3. Official Foreign Reserves Cover of Imports ...............
4. U.S. Foreign Currency Holdings and Liabilities (1962 5. U.S. Foreign Currency Holdings and Liabilities (1971 6. U.S. Foreign Currency Holdings and Liabilities (1978 7. U.S. Foreign Currency Holdings and Liabilities (1981 8. U.S. Foreign Currency Holdings and Liabilities (1985 Tables
I.
II.
III. a.
b.
c.
IV.
V. a.
b.
*
1970)
1977)
1980)
1984)
1989)
Rates of Return on U.S. Foreign Currency Balances ......
U.S.Foreign Currency Reserves and Open Positions ......
Composition of U.S. Foreign Currency Reserves .........
Federal Reserve Balances (1962 - 1989) ...............
U.S.Treasury Balances (1962 - 1989) .................
Forward Commitments ...........................
New Issues and Redemptions of Treasury Foreign
Currency Denominated Securities .................
Outstanding Issues of Treasury Foreign Currency
Denominated Securities at Year End ...............
1
2
3
7
10
12
14
15
23
26
27
28
29
30
31
32
Prepared principally by Thad Russell, Foreign Exchange Analysis Staff,
Foreign Exchange Department, FRBNY, with the help of Eddie Wolf and
other members of the Foreign Currency Accounts Management Division
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U.S. Foreign Currency Holdings
CLASS I - FOMC
I.
Overview
During most of the period since 1962, U.S. holdings of foreign
currencies were low or virtually nonexistent. Until 1980, those holdings the
U.S. monetary authorities did have were outweighed by foreign currency
liabilities so that, on a net basis, the open position* of the United States in
foreign currency was actually strongly negative (see Chart 1 below). There
were only three periods -- 1980-1981, 1985, 1988-89 -- when there were
substantial increases in U.S. net foreign currency reserves. The rise in U.S.
foreign currency holdings was particularly rapid in 1989 when the United States
intervened heavily to sell dollars to resist the dollar's rise.
Chart 1
Gross Foreign Currency Balances
and Net Open Positions
$Millions
Equivalent
15,000
10,000
5,000
0
(5,000)
62
64
66
68
70
72
74
76
78
80
82
84
86
Year-end figures on the basis of original costs. See Table II for supporting data.
* For the purposes of this review, the U.S. open position has been defined as
gross foreign currency holdings less foreign currency liabilities arising from
swaps, forward sales, and foreign currency-denominated securities.
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March 7, 1990
U.S. Foreign Currency Holdings
-2-
The level of U.S. foreign currency reserves, about $40 billion at the
end of 1989, is the fourth highest after Taiwan, Japan, and Germany.
Although among the world's largest in absolute terms, the level is still low
according to various relative measures. For example, while foreign
exchange has come to account for a record 59 percent of all U.S. official
reserves, this is a small proportion compared against the composition of
other countries' international reserves (see Chart 2 below). The United
States therefore remains unique in the extent to which it holds its official
reserves in gold and IMF-related assets.
Chart 2
Composition of Official Reserves
United States
(as of December 31, 1989)
14.8 pct
Non-Oil
Developing Countries
(as of November 30, 1989)
Other
Industrialized Countries
(as of November 30, 1989)
Source: International Financial Statistics.
* Gold valued at $42.22 per ounce.
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U.S. Foreign Currency Holdings
-3
-
More importantly, the size of U.S. foreign currency holdings is
relatively modest when foreign currency reserves are viewed against the size
of the U.S. and other economies. A common gauge of the size of a country's
international reserves is the number of days the central bank could finance the
economy's imports. According to this measure, most other industrial countries
could use their foreign currency holdings and other non-gold reserves to cover
at least two months of their trade. For the United States, these reserves could
finance just one month of trade (see Chart 3 below).
Chart 3
Official Reserves' Cover of Imports
of Goods and Services (# of days)
0
20
40
60
80
100
DAYS
Source: International Financial Statistics
Imports: Calculations based on trade figures forQ1 - III of 1989 for the United
States, Germany and Japan and for 1988 for other countries.
Reserves: As of end December 1989. Includes holdings of foreign exchange,
SDRs, and other IMF-related assets.
*
IFS group, not including the United States, Germany, and Japan.
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- 4-
In today's environment, of course, the United States would not be
called upon to draw on its foreign currency reserves to finance its trade
directly. The U.S. authorities could, however, decide to use those reserves to
resist a fall in the dollar in the exchange markets, and the speed with which the
United States has accumulated reserves suggests the speed with which it
might lose reserves.
This capacity to intervene with reserves without, at least initially,
having to finance operations by borrowing from other countries or in the credit
markets gives the United States somewhat greater policy flexibility and control
over its own financial environment. This is because borrowing foreign
currencies to finance intervention, whether through the swap arrangements or
in foreign credit markets, may be conditioned on taking certain policy actions.
This has often been the case in the past. In the late seventies, for example,
the German authorities became reluctant to extend additional marks to the
United States on the swap line in the absence of U.S. policy actions to deal
with the current account deficit. For their part, the U.S. authorities have made
the extension of credit contingent on following IMF programs or meeting other
conditions. While U.S. and foreign monetary authorities work together
cooperatively, differing perceptions of underlying economic conditions as well
as differing national interests may mean that credit for intervention will not
always be available when desired or on acceptable terms.
In the early sixties, when the System first resumed foreign exchange
operations, it was felt that the central bank was the appropriate institution to
deal with speculative short-term capital flows. The Treasury, as part of its
broader responsibilities for the government's international financial policies,
was the entity to provide longer-term financing in the case of continuing
imbalances. This distinction was reflected in the types of operations that were
conducted by the System and the Treasury, through the Exchange
Stabilization Fund (ESF). But over the years, the operational distinctions in
carrying out U.S. intervention operations have virtually disappeared. The
System and Treasury currently have approximately the same foreign currency
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resources and generally share equally in financing foreign exchange
operations conducted on their behalf by the Federal Reserve Bank of New
York.
Another important development associated with the growth of U.S.
foreign currency reserves has been the establishment of new investment
facilities for U.S. foreign currency holdings. These facilities were developed to
meet U.S. requirements for market-related rates of return, safety, and liquidity.
While the arrangement of these facilities has been complicated by foreign
central banks' statutory and operational limitations, instruments were devised
so that the United States now earns market-related rates of return on virtually
all of its holdingsof foreign currencies.
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-6
-
II. Foreign Currency Holdings and Exposures
A. The Sixties
At the time the Federal Reserve resumed foreign exchange
operations in 1962, the United States had little reason, and little opportunity,
to hold or acquire foreign currency reserves (see "Policy" and "Objectives"
papers). Under the Bretton Woods system of fixed exchange rates then in
place, the United States did not assume any responsibility to intervene in
the exchange markets to buy and sell foreign currencies, a responsibility
that other industrialized countries assumed. Instead, under the Bretton
Woods system, the United States undertook to redeem dollars held by other
countries' monetary authorities into gold at the fixed price of $35 an ounce
The United States, therefore, had only modest balances of foreign
currencies (see Tables Ill.b and Ill.c) and kept the bulk of its reserves in
gold. Other countries gained or lost foreign currency reserves in the
conduct of their intervention operations to maintain fixed exchange rates.
Since the principal reserve currency and the dominant transaction currency
was the dollar, almost all of these foreign-held currency reserves were held
in the form of dollars. But increasingly during the sixties, many central
banks became wary of holding large amounts of dollars rather than the
traditional reserve asset, gold. These central banks came to perceive their
dollar reserves as subject to the risk of a fall in value from either a
revaluation of their own currencies or a devaluation of the dollar as declines
in the U.S. gold stock and rapid increases in the amount of dollars in foreign
official hands raised doubts about the dollar's future convertibility.
During the period from 1962 to the suspension of gold convertibility
on August 15, 1971, the United States could obtain currency balances
generally in four ways:
First, in order to protect the country's gold stock, the U.S.
authorities borrowed foreign currency from the foreign central bank of issue.
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Chart 4
U.S. Foreign Currency Holdings* and Liabilities
$ Millions
(1962 - 1970)
Equivalent
Assets
4,000
2,000
Swaps
(2,000)
(4,000)
Forwards
(6,000)
(8,000)
Liabilities
(10,000)
1962
1963
1964
1965
1966
1967
1968
1969
1970
Year-end figures on the basis of original costs. See Table II for supporting data
* System balances include foreign currencies warehoused for the Treasury.
The U.S. authorities used the borrowed currency to conduct some foreign
exchange transactions directly with other central banks in a way that
effectively transferred the exchange rate risk of holding some of their dollars
from these central banks to the U.S. authorities. That is, the U.S. authorities
would use the foreign currency which they had borrowed to purchase
dollars from the foreign central bank which otherwise might have been
turned in for gold. The foreign currency value of the amount borrowed was
guaranteed by the United States, thereby eliminating the exchange rate risk
to the foreign central bank of a possible dollar devaluation. In this way,
other countries were dissuaded from using their dollar holdings to buy gold
from the United States. (In the jargon of the day, the United States
provided "cover"for other central banks, which as a result held "covered"
dollars in their reserves.) These borrowings, if undertaken by the Federal
Reserve, were executed under the Federal Reserve reciprocal currency (or
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"swap") arrangements which required repayment in three months, subject to
renewal, but no longer than one year (see Table II and "Swaps" paper). If
undertaken by the Treasury, the borrowings took several forms of which the
most important was the issuance to foreign monetary authorities of foreigncurrency denominated, non-marketable medium-term securities, the socalled "Roosa" bonds (see Tables V.a and b). At times, the proceeds of
these securities were used to repay System swap debt when market
conditions prevented the purchase of currencies to liquidate the swaps
within one year, in keeping with understandings that swaps should be used
only for short-term financing.
Second, the U.S. authorities acquired currency as a direct result of
credit operations they extended to bolster the Bretton Woods system of
fixed exchange rates. These credit operations generally took the form of
the Federal Reserve lending to other central banks, most importantly the
Bank of England, under the swap arrangements. In other words, the
Federal Reserve provided dollars to the borrowing central bank in exchange
for currency issued by that central bank. The currency so acquired was
purchased on a spot basis, with a corresponding obligation to deliver the
same amount of currency back to the borrowing central bank at the same
exchange rate at a predetermined maturity date--again usually three months
after the transaction. Of course, U.S. holdings of foreign currencies arising
from such transactions could not be used since their sale would counter
what the borrowing central bank had been trying to accomplish.
Third, the U.S. earned interest on its credit operations. The
amounts of interest were generally pretty small, amounting to less than
$300 million equivalent during this period, and the proceeds were frequently
left deposited in accounts the Federal Reserve Bank of New York
maintained at the relevant central banks for this purpose.
Fourth, the U.S. had the authority to exchange assets--to sell gold
or another reserve asset to a foreign central bank for foreign currency. This
option was avoided since the exchange of assets was viewed by the U.S.
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authorities as an admission that concern about the size of U.S. dollar
liabilities to official foreign monetary institutions was warranted and the
underlying situation would never be reversed.
The exchange of assets, along with the earning of interest, were
about the only ways the United States acquired foreign currency balances
during the fixed exchange rate period on an outright basis--that is, without
the obligation to repay.
B.
1971 - 1977
With the suspension of gold convertibility on August 15, 1971, the
United States no longer felt it appropriate to provide cover to foreign central
banks for their holdings of dollars. The Federal Reserve did, however,
borrow under the swap agreements to obtain the funds needed to finance
intervention in the exchange markets on a few occasions in 1972 and early
in 1973 after the dollar had been devalued, and then again later in 1973
after the start of the floating rate regime (see "Swaps" paper). The amounts
drawn were equal to the amounts sold in the exchange market on a daily
basis, so that currencies so borrowed never showed up in outstanding
balances.
Meanwhile, the authorities engaged in lengthy and difficult
discussions with their counterparties abroad over how to unwind the
extensive liabilities the United States had left outstanding at the end of the
Bretton Woods regime. These amounted to slightly more than $3 billion
equivalent in swap debt for the System and almost $2 billion equivalent in
foreign-currency denominated securities for the Treasury. These were
gradually reduced, in large part through foreign currency purchases from
the foreign central banks which held the claims, to $1.7 billion by the end of
1977.
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Chart 5
U.S. Foreign Currency Holdings and Liabilities
(1971 - 1977)
$ Millions
Equivalent
Assets
Assets
2,000
Treasury
System
0
(2,000)
Securities
(4,000)
(6,000)
Liabilities
1971
1972
1973
1974
1975
1976
1977
Year-end figures based on original costs. See Table II for supporting data.
During the mid-seventies, U.S. holdings of foreign currencies were
even lower than in the sixties. By the end of 1977, the combined balances
of the Federal Reserve and the Treasury stood at less than $10 million.
Meanwhile, post-1971 liabilities had been assumed which at the end of 1977
stood at $800 million. Together with pre-1971 debt, these obligations
resulted in a net open position of a negative $2.5 billion as of the end of
1977.
C.
1978 - February 1981
As part of the November 1, 1978 package to support the dollar, the
United States took a series of measures to shore up its foreign currency
balances--both by borrowing at various maturities and by exchanging
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assets. While the dollar had fallen to levels the U.S. authorities felt were
clearly undervalued, selling pressure in the exchange market persisted
nonetheless. For its part, the Federal Reserve had begun to run out of
room to borrow under its swap arrangements with the major creditor
countries as the limits of the facilities were approached and creditor
countries (especially Germany) had become reluctant to provide additional
swap financing in the absence of other actions by the United States to
adjust its economic policies. Under these circumstances, the U.S.
authorities came to believe that new actions were necessary to provide
credibility to a new U.S. balance of payments adjustment and financing
program.
Accordingly, in late 1978, the United States drew foreign currencies
from the IMF totaling $3 billion, exchanged SDRs for foreign currency
balances in the amount of $1.4 billion, and announced its willingness to float
foreign currency bonds publicly in foreign markets up to $10 billion. The
U.S. Treasury issued these securities (the so-called "Carter bonds") in
German marks and Swiss francs, in amounts that ultimately totalled
$6.4 billion equivalent (see Tables V.a and b). At the same time, the central
banks of Germany, Japan, and Switzerland agreed to increases in their
reciprocal swap lines with the Federal Reserve by a total of $9.6 billion.
Boosted by these actions, gross U.S. foreign currency balances
totaled more than $4 billion equivalent by the end of 1978; $5 1/2 billion by
the end of 1979; and $8 1/2 billion by the end of 1980 (see Chart 6 on next
page). However, despite the Treasury's exchange of IMF assets for foreign
currencies, the negative open position of the United States in foreign
currencies still amounted to well over $4 billion for a time in the late
seventies (see Table II). And at the start of 1979, net indebtedness in
foreign currencies of the Federal Reserve by itself to foreign central banks
reached an all-time peak at more than $5.5 billion equivalent.
As the dollar began to recover in late 1980, U.S. authorities acted to
buy currencies in the foreign exchange market to meet their liabilities. They
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Chart 6
U.S. Foreign Currency Holdings* and Liabilities
(1978 - 1980)
$ Millions
Equivalent
10,000
5,000
0
(5,000)
(10,000)
1978
1979
1980
Year-end figures based on original costs. See Table II for supporting data.
* System balances include foreign currencies warehoused for the Treasury.
began these operations very tentatively, so as not to add any downward
pressure on the dollar that might limit the scope for future currency
purchases. As the dollar gained strength, U.S. authorities became bolder in
their approach to the market. In covering their liabilities, the Federal
Reserve and Treasury agreed that short-term obligations, such as those
under swap lines, should be addressed first. Since all the System's liabilities
were short-term, its debt was fully repaid by October 15, 1980. The
Treasury's foreign currency-denominated bonds were repaid as they
matured, the last being in July 1983, but these liabilities were fully matched
(either with remaining proceeds of the "Carter" bonds or foreign currency
purchases in the market) by December 5, 1980. After the matching of
liabilities was achieved, the System and the Treasury decided to continue to
build up some foreign currencies on an outright basis at a time when the
authorities in any case were willing to resist a rise in the dollar's exchange
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rate. When these operations ended at the end of February 1981, the
combined open positions of the Federal Reserve and the Treasury had
increased to a positive $6.1 billion.
Meanwhile, U.S. authorities began to seek more attractive
investment instruments for their foreign currency balances. The Federal
Reserve requested and was granted the authority in the Monetary Control
Act of 1980 to invest its foreign currency balances in securities issued or
guaranteed by foreign governments. Previously, all Federal Reserve
balances had been invested in deposit accounts at foreign central banks or
the BIS, and some of these central banks did not have the authority to pay
interest on such accounts. The Federal Reserve Bank of New York had
already initiated negotiations with the relevant central banks to improve the
investment opportunities for the U.S. monetary authorities. In the early
eighties, progress in achieving market-related rates of return on the Federal
Reserve's foreign currency assets, while at the same time assuring liquidity
and safety, was achieved by access to new instruments. Most of the
investments used today were arranged at this time. These are described
briefly in Section III of this paper.
D.
March 1981 - September 1985
Between end-February 1981 and the Plaza Agreement of
September 1985, the sources of increases in balances and in the open
position were interest earnings on previously acquired balances and a small
amount of intervention. Gross interest earnings alone added $3.0 billion to
balances during this period. U.S. intervention was minimal for most of this
period, especially before 1985. The largest purchase of currency occurred
early in 1985, when the U.S. authorities intervened in cooperation with the
authorities of several other industrialized countries to try to resist the dollar's
rise. The net increase in U.S. balances during the 4 1/2 year period before
September 1985 arising from intervention amounted to another $1.3 billion.
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Chart 7
U.S. Foreign Currency Holdings* and Liabilities
(1981 - 1984)
$ Millions
Equivalent
15,000
Assets
10,000
Treasury
5,000
0
Securities
(5,000)
Liabilities
1981
*
*
1982
1983
1984**
Year-end figures based on original costs. See Table II for supporting data.
System balances include foreign currencies warehoused for the Treasury.
Liability as of end 1984 reflects counterpart to swap drawing by Argentina.
Balances were used by the U.S. authorities to pay interest and
principal on the Carter bonds and to make a partial payment of the increase
in the U.S. quota to the IMF as part of a general increase in IMF quotas in
1983. A total of $5.0 billion equivalent of balances was paid out for these
purposes during the period from February 1982 to the Plaza Agreement of
September 1985. Since the repayments of Carter bonds extinguished both
an asset and a liability, these repayments did not affect the open position,
which strengthened on balance during this period. In fact, by mid-1983,
most foreign-currency obligations had been repaid (see Chart 7) so that the
net U.S. open position nearly equaled gross balances.
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D.
September 1985 to the present
The period between the Plaza Agreement and the Louvre Accord
was characterized by an increase in balances acquired through intervention
in exchange markets and interest earnings. With U.S. authorities intervening
during late 1985 balances rose by $3.3 billion by the end of that year.
There was no intervention during 1986, so that the change was the result of
interest earnings. For the 1 1/2 years between September 1985 and
February 1987, intervention accounted for a net $3.25 billion increase in
balances and interest earnings for a net $400 million increase.
Chart 8
U.S. Foreign Currency Holdings* and Liabilities
(1985-1989)
$ Millions
Equivalent
Assets
40,000
Treasury
30,000
System
20,000
Swaps
10,000
Liabilities
1985
1986
1987
1988
1989**
Year-end figures based on original costs. See Table II for supporting data.
* System balances include foreign currencies warehoused for the Treasury.
** Liability as of end 1989 reflects counterpart to swap drawing by various countries
The period since the Louvre Accord is the one with the largest
swing in foreign currency balances. Initially during 1987 there was
considerable intervention to resist the decline in the dollar, and $8.6 billion
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equivalent of foreign currency balances were expended by the end 1987.
Subsequently, intervention operations gave rise to a very large increase in
balances since the bulk of the operations in 1988 and 1989 were to sell
dollars --i.e., buy foreign currencies-- in order to resist the dollar's rise.
From early 1988 to the end of 1989, the total increase in balances arising
from intervention operations was $22.9 billion, bringing the net increase
from intervention alone since the Louvre Accord to $14.4 billion.
Also, after early 1988, when yen reserves had been drawn down to
$400 million equivalent as a result of operations since the Louvre Accord*
resources to finance future intervention were supplemented in four ways.
The U.S. authorities sold dollars to the Bank of Japan for yen in the amount
of $3.0 billion, sold SDRs in the amount of $1.1 billion, received earnings
from the IMF in foreign currency in the amount of $300 million, and bought
$200 million equivalent of foreign currencies from customers.
*
Reserves of all foreign currencies amounted to $8 billion equivalent at
the time.
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III.
-
Investment of Foreign Currency Reserves
With the increase in U.S. foreign currency holdings of marks, yen,
and Swiss francs in the late seventies, new investment arrangements began
to be negotiated with the central banks of issue. These arrangements have
enabled the United States to earn interest on virtually all of its foreign
currency holdings. The only non-interest bearing holdings are small
amounts held in transactions accounts at the Bank of Canada, the Bank of
England, and the Bank of Japan.
In the late seventies, the placement of funds in foreign money
market instruments was not considered an option, both because of the lack
of suitable instruments in terms of safety and liquidity as well as because
foreign central banks felt that such large investments could create problems
for their management of domestic liquidity. However, over the next few
years, new investment facilities were designed to provide market-related
rates of return while at the same time satisfying U.S. requirements for a very
high degree of safety and liquidity as well as other countries' concerns over
monetary control.
Previously, interest rates on balances for the most part were
determined by the arrangements through which the balances were
acquired. Balances obtained from reciprocal swaps earned the three-month
U.S. Treasury bill rate as provided by the terms of the swap arrangement of
the time. (In 1980, the swap arrangements were changed to provide that
the interest on foreign currency balances be based on a money market rate
of the country of issue.) Balances held outright were left on deposit with the
central bank. If that central bank was empowered to pay interest on
deposits, the rate paid was often tied to an administered rate such as the
central bank's discount rate, rather than a market rate. If the central bank
did not have the authority to pay interest on deposits, the funds were either
transferred to the Bank for International Settlements (BIS) or left uninvested.
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18 -
Investments placed as interest-bearing time deposits with the BIS
generally have been made either to ensure interest earnings or to
accommodate foreign central banks' desires to keep the funds in the
market for monetary policy considerations.
As new facilities were established to meet U.S. investment needs for
its reserves, different instruments were often developed in keeping with the
operational requirements and statutory limitations of the foreign central
552 U.S.C. (b)(4)
bank.
In yen, balances were invested in a
money employed account based on commercial bill rates. In Swiss francs,
a repurchase agreement-swap facility was created.
A. Investment Facilities Established in the Late Seventies
552 U.S.C. (b)(4)
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German Mark Schuldscheine
552 U.S.C. (b)(4)
Japanese Yen Money Employed Account
Yen balances were invested in money employed accounts at the
Bank of Japan. Balances earned interest based on commercial bills
"notionally allocated" to U.S. accounts. While the bills remained the
property of the Bank of Japan, the interest from the bills was credited to the
U.S. authorities.
Swiss franc Repurchase Agreement-Swap Facility
The "repo-swap" facility in Swiss francs was a combination of a
currency swap and securities repurchase agreement.
552 U.S.C. (b)(4)
The swap involved a System spot sale of francs against dollars to
the Swiss National Bank and the simultaneous forward purchase of francs,
usually for 14 days. The dollars from the spot transaction were used by the
Federal Reserve to purchase U.S. Treasury bills held by the Swiss central
bank at the Federal Reserve Bank of New York. These securities were then
sold back to the Swiss National Bank on the same date that the swap was
unwound. Prevailing interest and exchange rates were applied to all
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transactions, though the forward part of the swap was adjusted for the
interest rate on the repurchase agreement. While the swap network used
the Treasury bill rate to determine the amount of interest earnings, the repo-
swap facility was unique in that it involved the actual purchase of a domestic
instrument to earn interest on foreign assets.
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B. Investment Facilities Established in the 1980's
With the authority of the Monetary Control Act empowering the
Federal Reserve to invest in foreign currency-denominated securities*, U.S.
authorities diversified their investment instruments.
German Mark Repurchase Agreements
U.S. authorities have kept DM 1 billion invested in repurchase
agreements in mobilization and liquidity paper since 1981. These securities,
which are structured like U.S. Treasury bills, are sold by the Bundesbank
principally to German commercial banks in order to assist in the central
bank's management of domestic liquidity. The United States also currently
holds DM 750 million in repurchase agreements in German government
bonds, although holdings have totaled as much as DM 2.5 billion at times.
552 U.S.C. (b)(4)
, all of these repurchase agreements have 3-month
maturities and earn interest based on the German interbank rate less
25 basis points. In the event of the liquidation of these investments by the
United States ahead of maturity, there is no charge. However, a profit or
loss may be incurred depending on the level of German interest rates and
the cost of refinancing compared to the interest rates on the investments
being liquidated.
German Long-Term Bonds
Although German government and Federal agency bonds
historically have been a fairly large source of investments for the System
and Treasury, U.S. authorities presently hold only nominal amounts of these
obligations. This reflects the 1-year maturity limitation** on investments and
* Unlike the System, the ESF had not been restricted from investing
in foreign currency-denominated securities.
** FOMC Authorization for Foreign Currency Operations (Section 5).
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the virtual unavailability of German government bonds with remaining
maturities of one year or less as investors generally choose to hold these
securities to maturity.
Japanese Treasury Bills
In 1981, the Federal Reserve began to place some of its yen
reserves in Japanese Treasury bills, as the U.S. Treasury had done since
552 U.S.C. (b)(4)
1978.
552 U.S.C. (b)(4)
Swiss Money Market Certificate
The Swiss National Bank currently auctions and sells on a discount
basis approximately SF 200 million per month of 3-month obligations of the
Swiss Confederation. The System's bids at recent auctions have not been
accepted, so the System currently does not hold any of these securities.
*
552 U.S.C. (b)(4)
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Since this past summer, the auctions' accepted prices generally have
produced yields below the alternative investment rate in Swiss franc time
deposits at the BIS.
C.
Rates of Return
The United States has obtained market-related rates of return on its
foreign currency holdings in recent years. Differentials between Eurocurrency rates and returns on these holdings have generally been fairly
narrow. The annual average rates of return since 1982 for U.S. holdings of
yen, marks, and Swiss francs, the principal U.S. foreign currency reserve
assets, are shown on the table below. Also shown are three-month Eurocurrency deposit rates and the differentials between the portfolio's rates of
return and these market rates.
Table I
Rates of Return on U.S. Foreign Currency Balances
(1982 - 1989)
Japanese yen
Rate
DifferEuro
of
Return yen entials
1982
1983
1984
1985
1986
1987
1988
1989
6.83
6.58
6.33
6.32
5.36
3.97
3.92
4.50
6.93
6.54
6.32
6.40
5.40
4.15
4.35
5.07
-0.10
+0.04
+0.01
-0.08
-0.04
-0.18
-0.43
-0.57
Swiss francs
Rate
Euro Differof
Return Swiss entials
5.47
3.45
3.74
4.62
3.82
3.47
2.91
6.05
5.81 -0.34
4.03 -0.58
-0.44
4.18
5.01
-0.39
4.21 -0.39
3.80
-0.33
2.84 +0.07
6.23 -0.18
German marks
Rate
of
Euro
DifferReturn
mark
entials
9.00
5.88
5.73
5.27
4.35
3.86
3.89
6.40
9.02 -0.02
5.63 +0.25
5.79 -0.06
5.36 -0.09
4.51 -0.16
4.06 -0.20
-0.14
4.03
6.59 -0.19
Euro currency rates are for 3-month maturities.
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APPENDIX -- Warehousing
Since U.S. authorities resumed foreign exchange operations in the
early sixties, the Federal Reserve has "warehoused" foreign currencies for
the Exchange Stabilization Fund of the U.S. Treasury on several occasions.
(See Table IV for amounts outstanding at the end of each year.)
Warehousing is a temporary exchange of foreign currency for dollars. In
carrying out a warehousing operation, the Federal Reserve buys the foreign
currency in a spot purchase from the Treasury and simultaneously
undertakes to sell it back to the Treasury at a future date. Interest earnings
on the foreign currencies being warehoused accrue to the System. Since
the spot and forward transactions are done at the same rate and therefore
for the same amounts, neither party incurs any foreign exchange rate risk
as a result of the transaction. The ESF may realize a previously unrealized
foreign exchange profit or loss when the warehousing is undertaken and
remains exposed to valuation gains and losses on the foreign currencies
being warehoused. Warehousing transactions are reversed when the
Treasury repays the dollars and the Federal Reserve repays the foreign
currencies.
The ESF is the Treasury's vehicle for foreign exchange activity.
Since the use of the ESF's funds is not subject to the appropriations
process, the ESF provides the Treasury with flexibility and discretion for
exchange market operations. However, the ESF's capacity to purchase
foreign currencies is limited. When its limits have been reached,
warehousing has served to give the ESF the room to undertake additional
purchases by temporarily selling some of its foreign currencies to the
System for dollars. The Bank's authority to warehouse foreign currencies
for the Treasury is provided under the Federal Open Market Committee's
Authorization for Foreign Currency Operations, Section 1.A and B and in the
Foreign Currency Directive, Section 3.B (see "Procedures" and "Legal
Bases" papers).
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The first warehousing transaction was conducted in 1963 and
enabled the Treasury to purchase $100 million equivalent of lire from Italy's
finance ministry. In the late sixties, sterling was warehoused, to permit the
Treasury to participate in the international support packages for that
currency, as well as French francs and lire.
Warehousing was not used again until 1978 when the mechanism
facilitated-the Treasury's handling of the proceeds of its foreign currencydenominated securities. In this case, as authorized by the FOMC in
December 1978, the System provided the warehousing directly to the
Treasury, not to the ESF. The warehousing was done for the Treasury's
General Fund since the Treasury wished to obtain dollars but did not wish
to sell the foreign currencies and transfer the associated foreign exchange
rate risk to the ESF.
Currently (as of March 8), the Federal Reserve is warehousing
$8 billion equivalent of German marks which have enabled the ESF to
participate in additional sales of dollars as part of U.S. intervention
operations. The upper limit on the facility is now $10 billion equivalent.
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- 26 TABLE II
US
FOREIGN CURRENCY
RESERVES
AND
OPEN POSITIONS
(1962 --- 1989)
(in $ millions equivalent)
End Of
FOREIGN CURRENCY BALANCES
OUTSTANDING SWAP LIABILITIES
NET FORWARD COMMITMENTS
(FWD SALES & WARESHOUSING)
SYSTEM
TREASURY
TOTAL
YEAR
SYSTEM
1962
1963
1964
1965
808
1526
2949
6290
186
590
370
1420
994
211.6
3319
771.0
2650
4690
5450
7000
00
00
00
1113
2650
469.0
5450
811.3
00
00
-988
-4867
-516.0
-2079
-1542
-10000
-516.0
-207.9
-253.0
-1486.7
1966
1967
1968
1969
1970
8747
16053
20605
19661
257.3
4088
7384
14648
813.5
371.9
12835
23437
5253
2779 6
629.2
8800
32160
20996
9800
810.0
1300
5150
7500
5500
0.0
10100
37310
28496
15300
810.0
-5329
-5575
-725
-975.0
0.0
-11012
-15800
-2136.3
4250
0.0
229
225.1
248.0
3045.0
0.0
3045.0
0.0
1971
1972
1973
1974
1975
170
1923
43
17
80.2
2580
48.5
3.3
3.7
0.0
2750
2408
7.6
5.4
80.2
2855.0
15850
1426.8
1462.2
1464.6
00
00
00
00
0.0
28550
1585.0
14268
1462.2
1464.8
1976
1977
1978
1979
1960
1706
184
1529.2
23843
32462
1500
0.0
2805.0
3183.0
5477.2
320.6
18.4
43342
5567.3
8723.4
12159
1306.6
5484.3
31502
0.0
16500
00
889.4
0.0
00
1981
1982
1983
1984
1965
5505.2
63886
45966
49429
7152.0
5382.3
51913
3186.3
3958.2
5618.4
10887.5
11579.9
77829
8901.1
12770.4
00
7398
00
00
0.0
1986
1987
1988
1989
7640.7
52734
7750.6
275756
6071.4
3490.9
6948.3
125493
13712.1
8764.3
146989
40124.9
989
0.0
00
741.8
8/15/71
TREASURY
TOTAL
SYSTEM**
TREASURY
TOTAL
TREASURY
FOR. CURR.
SECURITIES
NET OPEN POSITION *
SYSTEM
TREASURY
298.3
780.3
1086.0
1207.8
-184.2
-316.4
-348.9
-557.7
-795.7
-909.2
-1203.2
-2177.1
-979.9
-1225.6
-1552.1
-2734.8
-1634.1
-2137.5
-2206.8
-550.0
0.0
859.5
1199.6
2229.7
2089.9
1365.7
-538.2
-2168.2
-111.6
11.1
-552.7
-1681.9
-2566.2
-3651.2
-1401.4
-993.8
-2220.1
4724.4
-3762.8
-1390.3
-1546.5
0.0
0.0
1906.2
-3022.1
-1773.1
4795.3
00
00
0.0
0.0
0.0
00
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
2145.2
1711.2
1566.6
1500.3
1599.3
-2838.0
-1392.7
-1422.5
-1460.5
-1384.6
-1887.2
-1662.7
-153.3
-1595.6
-1599.3
4725.2
-3055.4
-3005.8
-3056.1
-2963.9
1365.9
1306.6
6373.7
31502
0.0
00
0.0
-1487.3
-2105.5
-3107.1
0.0
00
1487.3
2105.5
3340.0
0.0
0.0
0.0
0.0
232.9
1545.7
1168.9
2195.6
5266.7
6436.6
-1045.3
-1288.2
-5442.4
-2871.4
139.1
-1545.7
-1168.9
1207.3
19.8
2380.6
-2591.0
-2457.1
4235.1
-2851.6
2519.7
00
13536
100
500.0
00
00
2093.4
100
500.0
0.0
-1931.8
-14648
0.0
00
0.0
1931.8
1464.8
00
0.0
0.0
00
00
0.0
0.0
0.0
4000.8
1733.7
0.0
0.0
0.0
3573.4
4184.0
4596.6
4942.9
7152.0
3233.3
3568.8
3176.3
3458.2
56184
6806.7
7752.8
7772.9
8401.1
12770.4
992
0.0
477
502.8
198.1
00
477
12446
00
0.0
00
-70000
00
-182.0
0.0
70000
0.0
-182.0
00
0.0
0.0
0.0
0.0
0.0
7541.8
5273.4
7750.6
19833.8
59722
3308.9
6900.6
19046.5
13514.0
8582.3
14651.2
38880.3
*Open position = Balances - (swap liabilites) + (net forward commitments) - (foreign currency securities).
**Outstanding pre-1971 swap debt at end year 1971 - 2855.0 1972 - 1585 0, 1973 - 1426 8, 1974 - 1240 3 1975 - 1464 8 (revaluaton), 1976 - 1051.0, 1977 - 506.3 1979
- 157.3, 1980 - 0.
All data are reported on the basis of original costs except as not e d and are as of year end. See TablesIII-V for more detaled Information
regarding Balances (III). ForwardCommitments(IV),
and Foreign Currency Securities (V). See Reciprocal Currency Arrangements paper for more Information on swaps.
Authorized for public release by the FOMC Secretariat on 1/31/2020
TOTAL
March 7, 1990
U.S. Foreign Currency Holdings
STRICTLY CONFIDENTIAL
CLASS I - FOMC
- 27 -
TABLE Ill.a.
COMPOSITION OF U.S. FOREIGN CURRENCY RESERVES *
(in millions of dollars equivalent)
December 29, 1989
SYSTEM
GERMAN MARKS **
JAPANESE YEN
SWISS FRANCS
STERLING
OTHER MAJOR CURRENCIES ***
LDC CURRENCIES +
TOTALS
U.S. TREASURY
TOTAL
19,966.7
6,443.1
380.2
15.8
28.0
741.8
4,682.2
7,325.9
22.9
15.5
0.0
502.8
24,648 9
13,7690
403.1
31.3
28.0
1,244.6
27,575.6
12,549.3
40,124.9
* Reserves based on original acquisition cost.
** Warehoused funds included in System balances.
*** Includes Netherlands Guilders, Belgian Francs, French Francs,
and Canadian Dollars.
+ Includes Mexican Pesos, Bolivian Bolivianos, and Polish Zlotys
representing counterpart to swap drawings.
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I - FOMC
March 7, 1990
U.S. Foreign Currency Holdings
- 28 -
TABLE III. b.
FEDERAL RESERVE BALANCES (1962 - 1989)
(in millions of dollars equivalent)
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
GERMAN
MARKS
SWISS
FRANCS
JAPANESE STERLING
YEN
BALANCE
BALANCE
BALANCE
27.0
1.1
1.1
33.8
216.3
412.5
165.0
59.8
98.4
2.1
164.5
0.1
0.5
51.6
10.7
1.0
1,515.6
983.5
1,483.2
4,523.1
4,474.9
3,698.1
3,996.8
5,397.9
5,662.0
4,774.3
6,574.7
19,966.7
4.0
0.4
0.0
0.3
2.9
2.4
2.6
3.6
4.2
7.9
6.3
3.0
0.0
13.2
0.4
4.6
0.2
1,186.5
1,312.0
541.8
663.2
303.0
311.2
321.1
333.6
346.3
359.6
380.2
0.0
0.0
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
200.7
435.2
422.5
492.7
575.6
614.1
1,402.1
1,512.1
116.5
777.0
6,443.1
OTHER
TOTAL
BALANCE
BALANCE
BALANCE
0.3
9.6
234.1
534.3
593.6
1,140.6
1,443.6
1,574.7
153.6
3.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
9.1
10.5
11.8
13.4
15.8
49.5
141.5
58.8
59.6
61.0
48.9
448.4
327.1
0.2
2.9
20.4
0.1
0.1
4.3
158.4
11.7
12.3
13.4
15.6
17.6
757.6
19.7
20.6
21.8
121.9
24.5
25.9
769.8
80.8
152.6
294.9
628.9
874.7
1,605.3
2,060.5
1,966.1
257.3
17.0
192.3
4.3
1.7
70.2
170.6
18.4
1,529.2
2,384.3
3,246.2
5,505.2
6,388.6
4,596.6
4,942.9
7,152.0
7,640.1
5,273.4
7,750.6
27,575.6
"Other" currency balances principally reflect the foreign currency counterpart of swap
drawings by foreign monetary authorities.
Balances include foreign currencies warehoused for the Treasury.
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I - FOMC
March 7, 1990
U.S. Foreign Currency Holdings
- 29 -
TABLE III. c.
U.S. TREASURY BALANCES (1962 - 1989)
(in millions of dollars equivalent)
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
GERMAN
MARKS
SWISS
FRANCS
JAPANESE STERLING
YEN
OTHER
TOTAL
BALANCE
BALANCE
BALANCE
BALANCE
BALANCE
1.9
2.9
8.2
16.8
0.9
17.3
90.8
225.7
218.7
257.4
45.7
0.3
0.1
0.0
0.0
0.0
1,171.5
0.0
3,586.0
3,413.7
1,757.0
1,413.8
1,598.8
2,902.3
3,052.1
2,987.1
5,493.9
4,682.2
13.2
0.6
0.5
2.3
12.0
0.2
0.0
0.1
0.2
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
1,502.6
111.8
88.1
78.0
18.1
18.6
19.3
20.1
20.6
21.6
22.9
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
1,633.5
1,680.4
1,779.4
1,880.5
2,002.7
1,744.4
1,840.8
2,687.7
2,889.7
471.6
1,371.9
7,325.9
BALANCE
0.0
5.8
27.6
121.8
363.7
716.0
1,372.1
578.7
152.8
0.1
2.6
2.8
3.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
9.1
10.3
11.6
13.2
15.5
3.5
49.7
0.7
1.1
32.2
4.9
1.9
9.5
0.2
0.5
0.2
0.2
0.6
0.0
0.0
0.0
0.0
0.0
0.0
0.0
1,353.6
10.0
500.0
0.0
99.2
0.0
47.7
502.8
18.6
59.0
37.0
142.0
408.8
738.4
1,464.8
814.0
371.9
258.0
48.5
3.3
3.7
0.0
0.0
0.0
2,805.0
3,183.0
5,477.2
5,382.3
5,191.3
3,186.3
3,958.2
5,618.4
6,071.4
3,490.9
6,948.3
12,549.3
"Other" currency balances principally reflect the foreign currency counterpart of swap
drawings by foreign monetary authorities.
Balances do not include foreign currencies being warehoused with the Federal Reserve
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I - FOMC
March 7, 1990
U.S. Foreign Currency Holdings
- 30 -
TABLE IV
FORWARD COMMITMENTS
(in millions of dollars equivalent)
FORWARD SALES
SYSTEM TREASURY
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987*
1988
1989
0.0
0.0
-98.8
-486.7
-532.9
-557.5
-72.5
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
-516.0
-207.9
-154.2
-1000.0
-1101.2
-1580.0
-2136.3
-550.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
232.9
0.0
0.0
0.0
0.0
0.0
0.0
-182.0
0.0
0.0
WAREHOUSING
SYSTEM TREASURY
0.0
0.0
0.0
0.0
0.0
0.0
0.0
-975.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
-1487.3
-2105.5
-3107.1
-1931.8
-1464.8
0.0
0.0
0.0
0.0
0.0
0.0
-7000.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
975.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
1487.3
2105.5
3107.1
1931.8
1464.8
0.0
0.0
0.0
0.0
0.0
0.0
7000.0
*Represents spot sale of Japanese yen transacted in 1987 for settlement in 1988.
All data as of year end.
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I - FOMC
March 7, 1990
U.S. Foreign Currency Holdings
- 31
TABLE V.a
NEW ISSUES AND REDEMPTIONS OF TREASURY
FOREIGN CURRENCY DENOMINATED SECURITIES
(in millions of dollars equivalent)
GERMAN MARKS
ISSUE REDEEM
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1978
1979
1980
1981
1982
1983
0.0
275.2
402.4
0.0
0.0
250.4
750.7
124.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
(75.4)
(251.5)
0.0
(50.3)
(199.6)
(542.0)
0.0
(459.0)
(325.4)
0.0
0.0
0.0
0.0
0.0
0.0
1,595.2
0.0
2,470.5
0.0
1,168.0
0.0
0.0 (1,611.4)
0.0 (2,347.0)
0.0 (1,275.2)
SWISS FRANCS
ISSUE REDEEM
98.8
106.4
121.6
23.2
0.0
60.3
288.5
144.6(
0.0
1,572.0
0.0
63.6
127.3
0.0
0.0
0.0
0.0
0.0
0.0
1,203.0
0.0
0.0
0.0
0.0
OTHER
ISSUE REDEEM
ROOSA BONDS
0.0
199.5
80.4
0.0
0.0
0.0
0.0
175.2
(46.2)
0.0
0.0
60.4
0.0
165.9
0.0
53.2)
0.0
(54.7)
0.0
(940.5)
0.0
0.0
(62.2)
0.0
0.0
(127.3)
0.0
0.0
0.0
(53.6)
(376.8)
0.0
0.0
(568.5)
(600.4)
0.0
CARTER BONDS
0.0
0.0
0.0
0.0
0.0
0.0
(744.5)
0.0
0.0
0.0
(458.5)
0.0
0.0
0.0
(199.5)
0.0
(50.4)
(30.2)
(126.1)
(150.5)
(125.4)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
TOTAL
ISSUE REDEEM
298.3
462.0
524.0
198.4
0.0
371.1
1,205.1
268.9
0.0
1,572.0
0.0
63.6
127.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
(199.5)
(75.4)
(348.1)
(30.2)
(176.4)
(403.3)
(722.1)
(940.5)
(459.0)
(387.6)
(127.3)
0.0
(53.6)
(376.8)
(568.5)
(600.4)
0.0
1,595.2
0.0
3,673.5
0.0
1,168.0
0.0 (2,355.9)
0.0 (2,347.0)
0.0 (1,733.7)
Other includes issues and redemptions of se curities denominated in Austrian schillings,
Belgian francs, Italian lire and Dutch guilders.
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL
CLASS I - FOMC
March 7, 1990
U.S. Foreign Currency Holdings
- 32 -
TABLE V.b
OUTSTANDING ISSUES OF TREASURY FOREIGN
CURRENCY DENOMINATED SECURITIES AT YEAR END
(in millions of dollars equivalent)
GERMAN
MARKS
SWISS
FRANCS
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
0.0
275.2
678.7
602.1
350.7
601.2
1,301.4
1,219.5
675.1
765.0
306.0
0.0
0.0
0.0
0.0
0.0
0.0
98.8
205.2
326.9
349.9
303.5
362.9
652.4
745.0
690.6
1,380.2
1,405.2
1,586.6
1,599.3
1,599.3
1,545.7
1,168.9
600.4
ROOSA BONDS
0.0
0.0
50.3
30.1
50.3
30.1
100.7
30.2
50.3
30.2
50.3
60.4
50.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
1978
1979
1980
1981
1982
1983
1,595.2
4,065.7
5,233.6
3,622.3
1,275.2
0.0
0.0
1,203.0
1,203.0
458.5
458.5
0.0
CARTER BONDS
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
AUSTRIAN
SCHILLINGS
BELGIAN
FRANCS
ITALIAN
LIRE
TOTAL
199.5
199.5
0.0
124.8
124.8
124.8
225.6
125.4
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
298.3
760.3
1,086.0
1,207.7
859.5
1,199.6
2,229.7
2,089.9
1,3657
2,145.2
1,711.2
1,586.6
1,599.3
1,599.3
1,545.7
1,168.9
600.4
Note: Outstanding issues + New Issues - Redemptions might not equal issues
outstanding for the following year due to revaluations.
No securities of this type have been outstanding since July, 1983.
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1,595.2
5,268.7
6,436.6
4,080.8
1,733.7
0.0
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CLASS I FOMC
Historical Review of the
Reciprocal Currency Arrangements
(or "Swap" Network)*
page
I.
O verview ................................
III.Provisions and Mechanics of Reciprocal
Currency Arrangements ....................
..... 3
III.
Changes in Terms and Condition ............ ...... 5
VI.
Establishing the Federal Reserve Swap Network
V.
Use of the Reciprocal Swap Arrangements .....
..... 9
Federal Reserve Swap Arrangements with BIS ..
..
VII.
ESF Swap Arrangements ...................
....
VIII.
Assessment of the Use of Swaps ............ .... 15
VI.
.
12
13
Table s
1.
2.
3.
4.
5.
6.
Current Principal Terms and Conditions .......... .... 20
Changes in Swap Limits, 1962 - 1989 ...........
.... 24
Drawings and Repayments, 1962 - 1973 ......... .... 25
Drawings and Repayments, 1974 - 1980 .........
.... 27
Drawings and Repayments, 1981 - 1989 .........
.... 29
Drawings and Repayments by Mexico and LDCs
Under Treasury Special Swaps, 1982 - 1989 .....
.... 30
* Prepared principally by Danilo G. Dungca, Foreign Currency Account
Management Division, Foreign Exchange Department, FRBNY. With
acknowledgment to E. Wolf, T. Kiriposki and D. Charles.
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HISTORICAL REVIEW OF THE
RECIPROCAL CURRENCY ARRANGEMENTS (OR "SWAP" NETWORK)
Overview
The network of Federal Reserve System's reciprocal currency arrangements (or
"swap" arrangements) was developed in the early 1960s to supplement the resources of
the U.S. monetary authorities needed to carry out the Treasury's responsibility under the
1934 Gold Act "to support the dollar internationally". The United States, with all of its
reserves held in the form of gold, possessed no foreign exchange with which to intervene
in the exchange markets. Thus, one of the objectives of establishing the swap network
was to develop a mechanism to provide the United States with such currencies.
A
second objective was to provide the international monetary system indirectly with at least
a moderate degree of short-term liquidity not dependent on U.S. balance of payments
deficits. Moreover, the establishment of the network served to strengthen confidence in
the system by showing the world that the monetary authorities of the major nations were
prepared to cooperate to deal with pressures on the system.
Initially, the Federal Reserve drew on its swap facilities most often to protect the
U.S. gold stock. Currency operations involving the swaps provided foreign central banks
with an alternative to exchanging "excess" dollar holdings for the Treasury's gold reserves.
It was not until the floating rate period that the Federal Reserve used swaps primarily as
a means of financing U.S. intervention operations. After the dollar was floated the use of
swaps became less frequent in general. Also, the tendency developed for the creditor
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central bank to exert more pressure than before on the borrowing country to adjust
monetary and/or other policies in response to pressures in the exchange market. These
pressures were stronger, the more the swap facility was utilized and the longer drawings
were outstanding. Since 1980, the Federal Reserve has not initiated any swap drawings,
as official sales of foreign currencies have been paid out of reserve balances.
The swap facility as used in the 1960s had several useful features.
currency could be obtained quickly.
Foreign
All that was required was the approval of the
counterpart central bank, an approval that could be obtained in one phone call, so as to
allow central banks to react to market events as they occurred. Also, swap drawings in
general were not usually conditional (although there were important exceptions). The
central banks viewed the swap arrangements as the first line of defense after their foreign
currency balances to finance intervention to support their currency. The financing was
expected to be short term and accessible to contain temporary disruptions to exchange
markets. As a result, neither party to a swap drawing expected to engage in negotiations
over economic measures to be taken by the borrowing country, a characteristic reserved
for medium-term, conditional financing. Third, the use of swaps usually worked in the
sense that drawings were reversed without recourse to other arrangements. Proceeds
from drawings were directed at combatting "disequilibrating forces" in the short-term. To
the extent that pressures on the dollar and other foreign currencies were more
fundamental and persistent so that a drawing could not be repaid in a timely fashion,
pressures increased for the borrowing country to seek recourse from longer-term facilities
such as the IMF.
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Inrecent times, as U.S. foreign currency balances have grown, the Federal Reserve
has not had to rely on the swaps to finance currency sales but, instead, has been able
to use its own currency holdings. In part, this has enabled the U.S. authorities to maintain
control of its foreign exchange operations and avoid conditions on swap drawings. Still
the swap network remains in place.
It is considered a useful mechanism and an
important expression of international cooperation. In recent years, Federal Reserve and
ESF swaps have been important components of multilateral financing packages for
developing and Eastern European nations. These swaps have thus become associated
with longer term financing by multilateral official institutions and have been an essential
part of policy efforts aimed at structural reform.
Provisions and Mechanics of Reciprocal Currency Arrangements
Reciprocal currency arrangements between two central banks are facilities whereby
each of the banks agrees to exchange its currency for that of the other up to a
prearranged maximum amount and agreed period of time. The prearranged maximum
represents the "limit" or size of the facility. Generally, both parties commit to the terms of
the arrangement for one year.¹ An actual drawing on a facility usually has a term of three
months, but can be renewed by mutual agreement. Traditionally, central banks were
expected to repay after six months (that is, not request a second renewal) and every
¹ Although warehousing operations between the Federal Reserve and Treasury bear
similarities to swap arrangements, discussion of such warehousing operations can be
found in a separate paper, "Historical Review of U.S. Official Holdings of Foreign
Currencies".
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effort was made to prevent a facility from being in continuous use for as long as a year.
A drawing on one of these facilities takes the form of a simultaneous spot purchase
and forward sale of one currency against another for a stated (usually three-month)
maturity. When a drawing is made, the central bank that initiates the drawing incurs an
obligation to sell back the currency. The exercise of this forward commitment in effect
reverses the original transaction, liquidating the drawing. Consultations between the two
parties are required to initiate or roll over a swap drawing. Two days' notice is required
prior to a drawing. The exchange rate used is usually the spot rate prevailing in the
market, as agreed by the parties at the time the drawing is agreed, normally two days
prior to the value date. This exchange rate serves also as the basis for the rate used to
liquidate the swap. When the Federal Reserve used the swaps to finance its intervention
during the 1970s it established the amount, exchange rate and value date of a swap
drawing to coincide with those of the intervention transaction being financed.
On value date, the Federal Reserve Bank of New York (FRBNY) credits the foreign
central bank with dollars. In turn, the foreign central bank credits the FRBNY account on
its books with its respective currency. The drawer may intend to use the currency
obtained from the swap to finance intervention in the exchange market. In that case, the
drawer is exposed to exchange rate risk as a consequence of selling the borrowed
currency in the exchange market. It has an obligation to sell the currency back to the
central bank of issue at the rate agreed to when the drawing was made, but does not
know at which rate it can buy the currency back in the market.
Unused balances obtained from swap drawings are typically invested. Thus,
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investment facilities are an integral part of the swap arrangements. The central bank that
acts as the creditor almost always invests the currency obtained during the entire term of
drawing. If the Federal Reserve System initiates a swap, the central bank counterparty
may invest the dollar balances in a non-transferable certificate of indebtedness that the
Treasury has agreed to offer for this purpose at a market rate. (See page 7.)
If the
foreign central bank initiates the swap, the System invests the foreign currency balances
with the host central bank. Inthe original agreements established during the early 1960s,
these foreign currency balances earned the equivalent of the U.S. Treasury bill rate. The
interest was usually paid in foreign currency either through a direct credit of interest to the
System's account prior to liquidation, though sometimes interest was paid by adjusting
the forward exchange rate.
Changes in Terms and Conditions
The standard terms and conditions of the swap arrangements have been modified
over time. In addition to changes in the swap limits, changes have been made in the
exchange rate and interest rate provisions of the swaps.
The exchange rate risk on reciprocal swap arrangements has been handled in two
basic ways. The first swap arrangements included a mechanism providing an exchange
rate guarantee -- within the framework of the Bretton Wood's par value system of
exchange rates -- to protect the borrower from exchange losses that would have resulted
if the creditor country revalued its currency.
The swap arrangements included a
"revaluation clause" which provided that, if a borrower had disbursed part or all of its
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drawings, the borrower could purchase from the creditor country that country's currency
at the rate in effect prior to the revaluation up to an amount sufficient to replenish
outstanding drawings on the swap. This provision was exercised on only one occasion - in May 1971 -- in connection with a Federal Reserve drawing on its swap line with the
Netherlands Bank. These clauses offered no protection in the event that the exchange
rate system changed or, individual currencies were floated. Consequently, for U.S. swap
drawings outstanding as of August 15, 1971, the System incurred all the losses due to
revaluations and the subsequent floating of exchange rates on Belgian franc, sterling and
German mark commitments. After negotiation, the Swiss National Bank agreed to absorb
a portion of losses from Swiss franc swaps. (For further discussion, see the paper "Profits
and Losses in U.S. Foreign Currency Operations").
With the advent of the floating rate regime in the spring of 1973, exchange rate risk
was handled in a different way. Foreign central banks continued to intervene heavily at
times to restrain rises in their currencies. Meanwhile, the U.S. authorities initially abstained
from intervention even when the dollar continued to fall sharply. In a meeting at the Bank
for International Settlements (BIS) in July 1973, several foreign central banks agreed to
include a risk-sharing clause on the swap provisions as an inducement for the Federal
Reserve to undertake more active intervention in the exchange market. This clause -negotiated with Germany, Belgium, France, the Netherlands and Switzerland -- provided
that when the Federal Reserve drew on the swap arrangements for intervention purposes,
any profit or loss that resulted at the time the foreign currencies were repaid was to be
shared equally between the Federal Reserve and the creditor central bank. This risk-
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sharing procedure did not apply when the other central banks drew on their respective
swaps with the Federal Reserve.
In December 1980, this risk-sharing procedure, as well as any remaining
revaluation clauses, were removed from the terms of the agreements. Subsequently, the
U.S. authorities, like their counterparties in the swap agreements, agreed to take the full
exchange rate risk on their own swap drawings in exchange for changes in the interest
rate provisions indicated below.
The interest rate at which the System earns or pays interest on foreign currency
balances from swaps has also changed over the years. Originally, the interest rates on
all swap operations were "flat" -- i.e., the interest rate was the same on holdings of both
currencies. The actual rate used for all transactions was a dollar-based rate, specifically,
the average rate of discount at the latest auction of three-month U.S. Treasury bills.
With the advent of dollar floating, these provisions remained for a time for practical
reasons. Many of the foreign countries lacked an instrument comparable to U.S. Treasury
bills on which to base an interest rate. By 1980, however, comparable instruments had
become more readily available abroad and questions had arisen as to whether the United
States should continue, in effect, to pay its relatively higher interest rates when borrowing
low interest rate currencies such as the mark.
Therefore, when the United States
authorities agreed in December 1980 to eliminate the risk-sharing procedure, foreign
monetary authorities in return agreed to changes in the interest rate provisions.
Specifically, in instances where the Federal Reserve initiates the drawings, the foreign
central bank's dollar holdings are still invested at the U.S. Treasury bill rate. However, the
forward exchange rate on the swap is now adjusted to take into account the differential
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between the Treasury bill rate and its foreign counterpart rate. In this way the interest the
United States effectively pays is no greater than that on a comparable instrument in the
other currency.
Establishing the Federal Reserve Swap Network
The first reciprocal currency arrangement established by the Federal Reserve was
with the Bank of France in March 1962. In the following months, additional swap lines
were opened with other central banks and the BIS and, in most cases, utilized
immediately. By the end of 1963, the Federal Reserve had established a $2.1 billion swap
network, consisting of lines with eleven central banks and the BIS. (Table 1 provides
current information on each of the Federal Reserve swap arrangements; Table 2 lists the
swap lines and changes in the limits from 1962 to the present.)
The size of the swap lines was increased periodically in the 1960s and 1970s. The
establishment of or increase in the swap arrangements were often timed so that the
announcement of these operations would create a strong impact in the exchange market,
at times as part of a broader policy package aimed at helping to restore a more orderly
market atmosphere. By 1967 three more central banks and a second swap facility with
the BIS were included in the network. During 1978, the Federal Reserve swap network
was increased to $29.8 billion from $20.2 billion, as swap lines with Germany, Japan and
Switzerland were increased by $4 billion, $3 billion and $2.6 billion, respectively. In 1979,
the Federal Reserve swap line with Mexico was increased to $700 million; in the following
year, the arrangement with Sweden was increased to $500 million.
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arrangement returned to the $300 million maximum in 1981, bringing the total of Federal
Reserve swap network to its current $30.1 billion. Apart from the swap network, the
Federal Reserve has entered into one-time special swap arrangements with Mexico in
1982 and 1989.
Use of the Reciprocal Swap Arrangements
Use of the swap network by the United States has varied since its establishment
in the early 1960s with changes in circumstances and in official policy views. Broadly
speaking, four periods can be identified: 1962-August 1971; August 1971-1973; 19731980; and 1981 to the present.
1962 to August 1971
The swap facilities were used extensively to provide exchange rate cover for other
countries' holdings of dollar reserves as the dollar suffered repeated and increasingly
severe bouts of downward pressure.
[See "Historical Review of Official Holdings of
Foreign Currencies" for further discussion.] The Federal Reserve drew many currencies
in the swap network -- to absorb the mounting dollar liabilities held by a large number of
foreign central banks and thereby limit purchases on U.S. gold reserves. (See Table 3.)
Direct sales in the market of foreign currencies drawn by the United States were extremely
limited.
Ten counterparties also drew on their swap arrangements with the Federal Reserve.
Most importantly, the Bank of England drew a total of $8.7 billion on various occasions
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between 1962 and 1971 as part of efforts to contend with recurring pressures on sterling
during the period. The Bank of France drew $1.2 billion to deal with balance of payments
problems, while the BIS drew $2.3 billion against marks to meet short-term liquidity
requirements.
August 1971 to 1973
During the period immediately following the suspension of gold convertibility, the
swap network was virtually unused. Swap drawings were regarded as inappropriate in
1972 and early 1973, as discussions continued about the future structure of the
international monetary system.
1973 to 1980
In mid-1973, after the move to floating, the United States began once more, in a
modest way, to utilize swaps. (See Table 4.) At first, the United States believed the swap
arrangements should be used only to help finance intervention. Since U.S. intervention
was infrequent and modest in size, the use of swaps by the United States was much
more limited than before 1971. During 1977 - 1980, however, the United States made
substantial use of swaps when it encountered serious exchange rate difficulties. Unlike
in the 1960s, during this period the Federal Reserve drew only those currencies used for
exchange market intervention, principally German marks and Swiss francs. All of these
later drawings were repaid either by buying currencies from the counterpart central bank,
other monetary authorities or the market as the dollar regained its strength after 1978 1979.
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In the mid-1970s, the Federal Reserve also accepted a few requests from other
countries to draw on the swap arrangements under certain circumstances. From 1974
to 1976, the Bank of Mexico drew more than $1 billion on its swap lines to meet a
temporary need to increase its reserves and to help finance its intervention operations.
In January 1976, the Bank of Italy drew $250 million on its Federal Reserve swap line. In
anticipation of medium-term credits to Italy from the International Monetary Fund and
European Economic Community governments, a second drawing for the same amount
was made in March of that year. In June, 1976, the Federal Reserve agreed to include
its swap facility with the Bank of England as part of a $5.3 billion package of standby
credits from Group of Ten countries, the Swiss National Bank and the BIS. The Treasury
also participated with a $1 billion special swap arrangement. The United Kingdom drew
$300 million on each U.S. facility and repaid each in full before year end.
Another
multilateral facility was established for the United Kingdom during January 1977, to deal
with the sterling balances. This facility, however, was not drawn on.
Drawings for these countries were undertaken to combat severe bouts of
downward pressure on their currencies and, at times, to bolster their dollar reserves. In
each case, however, drawings became increasingly tied to implementing changes in
economic policy and assured sources of funds for repayment.
1981 to Present
The United States initiated no swap drawings in the decade of the 1980s. Between
1981 and 1986, most intervention operations which were undertaken involved the sale of
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dollars (purchase of foreign currencies). Subsequent official purchases of dollars (sales
of foreign currencies) in 1987 and 1988 were mainly covered out of balances built up over
the previous seven years. Although reserves of Japanese yen were substantially reduced
by 1988, alternative methods of financing were used (mainly, direct purchases from official
sources in Japan). There were, however, drawings made by Mexico on the swap line in
1982-83, 1986,1988 and 1989 and special one-time swap drawings in 1982 ($325 million)
and 1989 ($125 million) as well as one drawing each by Sweden in 1981 and the BIS in
1982. (See Table-5.)
Federal Reserve Swap Arrangements with the BIS
The System maintains two swap lines with the BIS. The first, a Swiss franc swap
agreement, was established in 1962. The second, a swap arrangement against other
European currencies, was established in 1965. These facilities were negotiated with
recognition of the special status of the BIS as a clearing bank for central banks.
The Swiss franc facility with the BIS, with an initial size of $100 million (subsequently
raised in several steps to its current size of $600 million), was established at the same
time the System established a $100 million swap line with the Swiss National Bank (BNS).
The BIS dollar/franc facility was created at the request of the BNS.
The need to
supplement Switzerland's own swap lines, was due in part to Swiss statutory limits on
"loans"to non-Swiss banks. Along with the BNS swap, the BIS Swiss franc swap was
largely used in the 1960s to purchase dollars from the BNS to avoid BNS purchases of
gold at times when the BNS was gaining dollar reserves.
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The System established its second swap arrangement with the BIS in 1965 with an
initial size of $150 million (subsequently raised in several steps to its current size of $1,250
million), to add to the System's access to European currencies at a time when the swap
network was being expanded with other central banks. Last drawn upon in 1982, the
"other European currency" facility has been used in two types of operations. First, it
replaced an arrangement by which the BIS could borrow against gold it held on the
books of the FRBNY for its temporary cash needs related to its routine transactions. The
facility-was so used on various occasions. During the 1970s the BIS established
arrangements with a commercial bank to meet most of these needs. Second, the facility
was used on some occasions in the 1960s and 1970s as a means by which the Federal
Reserve could supply funds to the Eurodollar market at times of strain in the Euromarket.
ESF Swap Arrangements
Although the Federal Reserve is closely associated with reciprocal currency
arrangements, the Treasury, through the Exchange Stabilization Fund (ESF), maintains
this type of facility with several countries and established the first such arrangement, that
with Mexico, in 1936. It currently has standing arrangements with Germany, Mexico and
the Netherlands. Of the three arrangements, the Mexican facility is the only one that is
reciprocal -- where either party may request a drawing. The arrangement with Germany
allows for the ESF to make drawings while the Netherlands arrangement is set up to allow
the Dutch authorities to request drawdowns. From time to time, the Treasury has also
entered into temporary swap arrangements with LDCs and east European countries.
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In January 1978, the Treasury established a $1 billion reciprocal currency
arrangement with Germany as part of a package to provide supplemental resources to
finance intervention to cushion the dollar's fall in that year. The existence, but not the
size of the facility was announced at that time. The bulk of the Treasury's mark sales
during 1978 were covered through the swap facility with the Bundesbank which became
extensively used during two episodes that year -- January through April and August
through December. The facility was last utilized in September 1979 when the ESF drew
$338 million equivalent; the drawing was fully repaid the same month.
The Treasury had Stabilization Fund Agreements with Mexico as early as 1936 and
has maintained arrangements on a continuous basis since 1941. The 1941 agreement
allowed Mexico to draw up to $40 million to stabilize the peso/dollar rate. On a number
of occasions the terms of the agreement have been revised. The last revised agreement
in January 1990, states that drawings can be requested for "balance of payments
purposes or to forestall or counter disorderly market conditions". The facility has been
used most recently in 1988. Other drawings by Mexico during the past decade have
been made under special swap arrangements.
In August, 1981, the ESF established a swap arrangement with the Netherlands
authorities in connection with arrangements made to settle non-bank claims on Iran after
frozen Iranian assets were released. The Algiers Accords of January 1981 set up a
tribunal for the settlement of such claims. The Netherlands central bank offered to act as
a depository for the fund from which awards by the tribunal are paid.
Because of
concerns that there might be attempts to attach assets in the fund, the Netherlands Bank
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did not want the funds commingled with its own funds and thereby established the N.V.
Settlement Bank of the Netherlands.
As further protection, the Netherlands Bank
requested access to dollar funds that could be drawn in the event of an attachment.
Given that no such attempt at attachment has taken place, the swap has never been
drawn. Since the tribunal is expected to continue to exist, the swap has been renewed
at two-year intervals.
The Treasury has participated in numerous ad hoc swap arrangements with LDCs
and others since 1982.
Most of these special arrangements are part of multilateral
arrangements that provide short-term financing in anticipation of longer-term financing
from the IMF, the World Bank, and at times, from commercial banks. (Table 6 provides
a summary of ESF special swap arrangements from 1982 to the present.) Aside from
Mexico, the largest drawer on these special arrangements has been Argentina. In five
facilities since 1984, Argentina has drawn a total of $1.7 billion from the ESF. Brazil has
made three drawings, in 1983 - 1984 and 1988, totalling $2.1 billion. At the end of 1989,
drawings on ESF facilities were outstanding with Mexico, Bolivia and Poland.
Assessment of the Use of Swaps
The U.S. experience with the use of swaps can be assessed from various
viewpoints. Operationally, the swap network has worked quite well. It is based on a
familiar and widely used market mechanism. It is simple in concept, easy to understand
and easy to work with.
Experience with its use is extensive. With the operational
structure in place, the facilities can be activated quickly once agreement to do so has
been reached.
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It is more difficult to assess the financial impact of the extensive use of swaps
during the 1960s since we do not know what would have happened in the absence of
their use. When the dollar was devalued in 1971, outstanding swaps were $2,855 million
(in addition to foreign currency denominated bonds of $2,145 million) and in a sense the
Treasury and Federal Reserve suffered losses on these amounts because of the change
in exchange rates. But in another sense, assuming that the swaps and other instruments
did succeed in reducing sales of gold at $35 per ounce, the "gains" from reduced gold
sales would have far exceeded the "losses" on the swaps. But the balance would shift
again if it were assumed that such demands to buy gold would have caused the United
States to close the gold window some months or years earlier.
An assessment of the way the swap network was used in the 1960s from a policy
viewpoint is even more complex. It is understandable that the swaps were widely used,
since at that time there were few if any alternatives. But in retrospect the dollar's problem
in the 1960s was not short-term and could not be effectively dealt with by such
mechanisms. In such circumstances, use of the swap network can serve as a stop-gap
measure --to counter market pressure and buy time to agree on and introduce more
fundamental solutions.
Of course, the decision to provide or not to provide swap credit becomes part of
the governmental negotiating process with each party using it for its own ends. The
creditor may strongly favor extending swap credit - it provides an exchange rate
guarantee and may discourage unpalatable corrective action by the debtor. Alternatively,
a swap creditor may withhold the credits to force the debtor to take other actions to
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correct or finance its deficits. One example of this practice is Germany in the late 1970s,
which limited its provision of swap credit in order to "encourage" the United States to use
other sources of finance (notably sales of SDR drawings from IMF, and borrowing in the
market) and to make changes in U.S. economic policies. It was partly in response to this
episode that U.S. authorities decided to build up United States foreign currency balances
in 1980 and 1981. The United States has also used this technique as a creditor -- using
swap credits in 1976 to "encourage" the UK to agree with the IMF on a balance of
payments correction program and similarly with Mexico in 1982.
The swap network is a useful mechanism, and its existence is a valuable and
reassuring manifestation of international cooperation among the major industrial nations
toward management of the system. It cannot replace or obviate the need for owned
foreign exchange holding which can be used without the need for the creditors'
concurrence, but it can be a useful supplement.
The question has been raised to what extent the use of two-way swap
arrangements with foreign central banks might reduce the translation risk associated with
holding foreign currencies now that the United States has built up large currency
balances. As the reciprocal currency arrangements are now structured, the use of swaps
by the Federal Reserve would have no effect on exchange rate risk, although there might
be some reallocation between realized and translation profits and losses. Balances held
are revalued at the end of each reporting month to take account of current exchange
rates.
If, instead, these balances, or a portion of these balances were sold spot to
another central bank under our "swap arrangements" which provide for a simultaneous
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commitment to buy them back three months later, the Federal Reserve would have a
realized profit or loss at the time the swap was entered into. The forward contract to buy
the currency back would be revalued to market rates at the end of each reporting period
during the time the swap was outstanding. The only effect of these transactions, relative
to holding the currency in balances, is that some of the translation profit and loss would
be realized.
The Federal Reserve could permanently sell the currency back to the central bank
of issue or-another central bank and therebyreduce its exposure to translation risk if the
foreign central bank agreed. But the consequence of such an arrangement would be to
reduce the United States foreign currency reserves without recourse in the event of need.
Such an action would bring forward the need to borrow foreign currencies, using
techniques similar to those employed during the 1970s (see "Historical Review of Official
Holdings of Foreign Currencies) -- thereby, subject U.S. economic policy to a greater
degree of influence from other monetary authorities -- whenever the United States might
again find itself intervening to support the dollar.
Central banks from many countries have wrestled with the issues of providing
adequate foreign currency reserves for their own domestic economy, managing to some
degree the exchange value of their currency and avoiding exchange rate risk. Given the
choices, central banks have usually, in the end, accepted the inevitability of exchange
rate exposure.
However, central banks abroad are particularly sensitive to what they regard as the
special role of the dollar: it is the principal currency in their reserves yet difficult for them
Authorized for public release by the FOMC Secretariat on 1/31/2020
STRICTLY CONFIDENTIAL (FR)
CLASS I FOMC
19
to control. Repeatedly since the early 1960s, foreign central banks have asked the United
Sates to devise a means whereby they could be protected from the risk of holding dollars
in their reserves. The U.S. authorities consistently have been unwilling to agree to such
arrangements. The early risk-sharing arrangements related to swap drawings were never
applied when other central banks drew on their swap lines with the Federal Reserve.
Since the suspension of convertibility of the dollar with gold, no such arrangement has
ever applied to dollar balances held by foreign monetary authorities.
Should the United States try to seek the cooperation of these same central banks
in requesting them to accept some of the exchange risk for U.S. holdings of their
currencies, it would be natural for them to expect the United States to be more
sympathetic to similar request from them. In that event, the amount of relief the United
States would get from reducing some of the exchange rate risk on foreign currency
reserves amounting to about $40 billion would pale by comparison to the task the United
States would have of providing relief to others whose dollar holdings are measured in the
hundreds of billions.
Authorized for public release by the FOMC Secretariat on 1/31/2020
TABLE 1
CURRENT PRINCIPAL TERMS AND CONDITIONS
OF FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENT
Applicable Interest Rate
on Swap Drawings by
Agreement
with
Central
Original
Bank of
Date
Amount
(millions)
Term
(months)
Maturity
Date
Federal
Reserve
Foreign
Central Bank
Discount rate
on 3-month
Treasury bills(a)
Side Conditions
(included in text)
of swap agreements)
None
Side Conditions
(not included in text
of swap agreements)
None
Austria
10/25/62
$ 250.0
12/04/90
Unspecified
Austrian
3-month money
market Instrument
Belgium
06/20/62
1,000.0
12/18/90
3-month Belgian
Treasury
Certificates(b)
Canada
06/26/62
2,000.0
12/28/90
3-month Canadian
Treasury bills(c)
None
None
Denmark 05/17/67
250.0
12/28/90
Unspecified Danish
Treasury security
None
None
3,000.0
12/04/90
3-month U.K.
Treasury bills(c)
None
None
England
05/31/62
Fed could, upon mutual
agreement, acquire francs
directly from the BNB
(rather than in the
market) to repay outstanding swap drawings
NOTE: "Unspecified" instrument - Swap cannot be activated without further agreement.
a/ The rate of discount Is applied to the C of I issued to the foreign central bank. Thus, the rate of discount on the bills is equivalent
to the investment yield of the C or I.
b/ Not specified whether rate on a discount basis or on investment yield basis will be used in calculating the amount of interest
c/ Interest rate is on a discount basis.
Authorized for public release by the FOMC Secretariat on 1/31/2020
None
TABLE 1
(Continued)
CURRENT PRINCIPAL TERMS AND CONDITIONS
OF FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENT
Applicable Interest Rate
on Swap Drawings by
Agreement
with
Original
Central
Date
Bank of
France
Term
(months)
Maturity
Date
Federal
Reserve
Foreign
Central Bank
Discount rate
on 3-month
Treasury bills(a)
03/01/62 $2,000.0
12
12/28/90
Interbank rate
on 3-month
collateral loans
less 0.25 percentage points(d)
6,000.0
12
12/28/90
3-month interbank
rate less 0.25
percentage points(d)
Germany 08/02/62
Italy
Amount
(millions)
10/62
3,000.0
12
12/28/90
3-month Italian
Treasury bills
Side Conditions
(included in text)
of swap agreements)
Fed could, upon mutual
agreement, acquire francs
directly from the Bank of
France to repay outstanding
swap drawings
Under certain conditions
agreement, acquire marks
directly from Bundesbank
to repay outstanding swap
drawings
None
a/ The rate of discount is applied to the C of I issued to the foreign central bank. Thus, the rate of discount on the bills is equivalent
to the investment yield of the C or I.
d/ Not specified, but text suggests a rate on an investment yield basis.
Authorized for public release by the FOMC Secretariat on 1/31/2020
Side Conditions
(not included in text
of swap agreements)
None
Letter from former President
Emminger to former Chairman
Miller confirms that the
Bundesbank will give a favorable consideration to sale of
marks to the Fed when it cannot acquire through other means
to repay outstanding swap drawings
None
TABLE 1
(Continued)
CURRENT PRINCIPAL TERMS AND CONDITIONS
OF FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENT
Applicable Interest Rate
on Swap Drawings by
Agreement
with
Original
Central
Bank of
Date
Amount
(millions)
Maturity
Date
Federal
Reserve
Foreign
Central Bank
12
12/04/90
3-month Japanese
Gensaki repurchase
Discount rate
on 3-month
Treasury bills(a)
Term
(months)
Japan
10/29/63 $5,000.0
Mexico
05/17/67
700.0
12
12/04/90
3-month Mexican
Treasury
certificates(b)
Netherlands
06/13/62
500.0
12
12/28/90
3-month
Netherlands
Treasury paper(c)
Norway
05/17/67
250.0
12
12/04/90
Unspecified
Norwegian money
market instrument
Side Conditions
(included in text)
of swap agreements)
Side Conditions
(not Included in text
of swap agreements)
The text contains a
number of provisions
("understandings") which
are of technical nature,
such as which foreign
exchange rate applies
to swap drawings and
renewals of drawings.
Terms provide for a
fairly strong commitment
by Bank of Japan to supply
yen to the Fed to repay outstanding swap commitments
if market conditions do not
permit acquisitions in the
market.
None
Fed could, upon mutual
agreement, acquire
guilders directly from
the Netherlands Bank
to repay outstanding
swap drawings.
None
a/ The rate of discount is applied to the C of I issued to the foreign central bank. Thus, the rate'of discount on the bills is equivalent
to the investment yield of the C or I.
b/ Not specified whether rate on a discount basis or on investment yield basis will be used in calculating the amount of interest.
c/ Interest rate is on a discount basis.
Authorized for public release by the FOMC Secretariat on 1/31/2020
None
None
None
TABLE 1
(Continued)
CURRENT PRINCIPAL TERMS AND CONDITIONS
OF FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENT
Applicable Interest Rate
on Swap Drawings by
Agreement
with
Central
Original
Bank of
Date
Amount
(millions)
Term
(months)
Maturity
Date
Federal
Reserve
Foreign
Central Bank
Discount rate
on 3-month
Treasury bills(a)
Side Conditions
(included in text
of swap agreements)
Side Conditions
(not included in text
of swap agreements)
None
Sweden
01/17/63 $ 300.0
12
12/04/90
Unspecified
Swedish money
market instrument
Switzerland
07/16/62
4,000.0
12
12/04/90
3-month Swiss
govt. money market
certificates(c)
Fed could, upon mutual
agreement, acquire
francs directly from
the BNS to repay outstanding swap drawings
None
B.I.S
07/16/62
600.0
12
12/04/90
3-month Swiss
govt. money market
certificates(d)
Text is silent, but
there is the presumption
that the BNS, upon mutual
agreement, would supply
francs to the Fed to
repay swap drawing.
None
12
12/04/90
Unspecified
(against
SF)
B.I.S.
08/02/65
1,250.0
Unspecified
None
None
(against
European
currencies
other than
SF)(e)
a/ The rate of discount is applied to the C of I issued to the foreign central bank. Thus, the rate of discount on the bills is equivalent
to the Investment yield of the C or I.
c/ Interest rate is on a discount basis.
d/ Not specified, but text suggests a rate on an investment yield basis.
e/ There are three types of drawings under this swap facility:
(1) those made in lieu of loans under the gold loan facility
(2) those made for special cash requirements of the B.I.S., usually for financial assistance to another country; and
(3) those for placement in the Euro-dollar market.
The latter are normally at our suggestion and always with our specific agreement
Authorized for public release by the FOMC Secretariat on 1/31/2020
None
TABLE 2
FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS
CHANGES IN SWAP LIMITS, 1962 - 1989
(INMILLIONS OF DOLLARS)
AUSTR
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981-89
JPN
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981-89
150
150
250
450
750
1000
1000
1000
1000
1000
2000
2000
2000
2000
2000
5000
5000
5000
5000
BELG
CANAD
50
50
100
100
150
225
225
500
500
600
600
1000
1000
1000
1000
1000
1000
1000
1000
1000
250
250
250
250
500
750
1000
1000
1000
1000
1000
2000
2000
2000
2000
2000
2000
2000
2000
2000
MEX
NETH
13
130
130
13
130
10
180
180
360
360
360
360
700
700
700
50
100
100
100
150
225
400
300
300
300
300
500
500
500
500
500
500
500
500
500
FR
GERM
ITL
50
500
750
750
1350
1500
2000
2000
2000
2000
2000
2000
3000
3000
3000
3000
3000
3000
3000
3000
50
100
100
100
100
100
1000
1000
1000
1000
1000
2000
2000
2000
2000
2000
2000
2000
2000
2000
50
250
250
250
400
750
1000
1000
1000
1000
1000
2000
2000
2000
2000
2000
6000
6000
6000
6000
150
250
250
450
600
750
1000
1000
1250
1250
1250
2000
3000
3000
3000
3000
3000
3000
3000
3000
SWE
SWITZ
BIS
$/SF
BIS
S/OTH
DEM
100
100
200
200
200
200
250
250
250
250
250
250
250
250
250
NOR
50
50
50
100
100
200
200
200
200
250
250
250
250
250
250
250
250
250
100
200
250
250
250
250
250
300
300
300
300
300
300
300
500
300
100
150
150
150
200
400
600
600
600
1000
1000
1400
1400
1400
1400
1400
4000
4000
4000
4000
TOTAL
900
150
200
600
1000
1000
1000
1000
1000
1250
1250
1250
1250
1250
1250
1250
1250
1250
Authorized for public release by the FOMC Secretariat on 1/31/2020
2050
2350
2800
4500
7080
10505
10980
11230
11730
11730
17980
19980
20160
20160
20160
29760
30100
30300
30100
TABLE 3
DRAWINGS (+) AND REPAYMENTS (-) UNDER THE
FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS, 1962 - 1973
(IN MILLIONS OF DOLLARS)
A. SWAP DRAWINGS AND REPAYMENTS INITIATED BY THE FEDERAL RESERVE SYSTEM
............................. .....
1962
AUSTRIA
....... ..... ..... ........ ....
: 1965
1964
: 1963
+50.0:
-:
CANADA
+250.0:
-250.0 :
-:
-
:
+20.0 :
-20.0 :
DENMARK
ENGLAND
-:
FRANCE
GERMANY
+95.0 : +65.0 :
-50.0 : -75.0 :
+50 :
-50 :
-
- :
:
- :
- :
- :
- :
- :
- :
:
- :
21.5 :
-12.5 :
- :
-9 :
-:
- :
- :
+105.0 :
-115.0 :
: 1971
:
-
- :
- :
- :
- :
- :
-
- :
- :
-
- :
:
- :
- :
-
+395.0 : +755.0 :
-240.0 :-475.0 :
1972 :
1973
:
-:
10.2 :
-85.2:
- :
- :
:
- :
- :
+750.0 :
-35.0 :
-715.0 :
-
:
+47.0
-47.0
-:
-
- :
+15.0 : +140.0 : +350.0 :+412.1 :
- : -140.0 : -650.0 : -112.1 :
-65.0 :
*6.0
-159.2
- :
:
- :
-:
-:
-:
-:
+30.0 : +110.0 : +107.1 : +55.0 :
-65.0 : -10.0 : -257.1 :
+35.0 :
-35.0 :
+286.0 :
: -226.0 :
1970
:1969
-
-:
-:
- :
50.0 :
-50.0 :
: 1968
:1967
- :
-:
+50.0 :
-50.0 :
BELGIUM
: 1966
.....
-:
60.0 :
-10.0 :
- : +561.2
-50.0 : -561.2
-:
-:
-:
-:
- : +350.0 : +325.0 : +500.0 :+175.0
+50.0:
-:
-:
-:
:-50.0 :
- : 250.0 : -410.0 : -15.0: -675.0 :
................................................................................. .. .......... ................. ...............
ITALY
JAPAN
- :
-:
MEXICO
-
-
NETHERLANDS
NORWAY
-:
-:
-:
-:
-:
- :
+60.0 :
-50.0 :
+150.0 :
-80.0 :
+100.0 : +25.0 :
-80.0 : -125.0 :
- :
- :
- :
- :
- :
- :
-:
- :
- :
+65.0 : +170.0 : +15.0 : +340.0 :
-30.0 : -35.0 : -185.0 : -210.0 :
- :
- :
-
:
+300.0 : +250.0 :
-130.0 : -550.0
- :
- :
- :
+2.9
-2.9
-
- :
........................................................................................................
............
SWEDEN
SWITZERLAND
BIS: S/SF
$/OTHER
+50.0 :
+80.0 :
-25.0 :
-
+80.0 :
- : -55.0 :
+25.0 : +150.0 :
-100.0 : -150.0 :
+75.0 : +345.0 : +498.0 : +300.0 :
-60.0 : -110.0 : -428.0 : -475.0 :
+150.0 :
-60.0 :
- :
+100.0 :
-145.0 : -100.0 :
- :
+75.0: +485.0:
- : -160.0 : -400.0
-:
-:
-:
-:
- :
+500.0 : +1750.0:
-345.0 : -450.0 :
-:
- :
- :
Authorized for public release by the FOMC Secretariat on 1/31/2020
-:
-
-430.0 :
-:
-:
-5.0
TABLE 3
(CONTINUED)
B. SWAP DRAWINGS AND REPAYMENTS INITIATED BY FOREIGN CENTRAL BANKS AND THE BIS
1962
1963
1964
1965
1966
:1968
1967
1969
AUSTRIA
-:
+ 210.5 :+513.0
:
-
CANADA
-
-:
:
- :+17.6
-:
-:
-:
-:
:
- :
-:
- : +250.0 :
-250.0 :
DENMARK
-:
-
ITALY
+ 50.0
-:
-:
-
:
-
:
-:
-
125.0 :-25.0 : -125.0 :
:
+80.0:
-80.0:
-:
-100.0
-:
-:
-
335.0 :-720.0 :
- : -300.0 :
-:
-
-1050.0
-:
+400.0
-:
-
1000.0:
-1000.0
-:
-:
-:
-:
-:
+ 54.7 : +191.9 :
-:
-:
- :
-:
BIS: $/SF
- :
- :
-:
-
-:
- :
-:
: +142.0 :
-217.0 :
:
-909.0
:
-85.0 : -691.0
+285.0 :+837.0 :+638.0
-:
-
:
:
-:
-:
-:
-:
-:
-:
-
-:
-:
-:
NORWAY
$/OTHER
-:
+300.0 :
-150.0
NETHERLANDS
SWITZERLAND
-:
1650.0: +2045.0: +795.0 :
-950.0: -1945.0: -1295.0:
-:
MEXICO
SWEDEN
- :
+100.0
-:
-
-:
-: + 1370.0 : +1765.0: +625.0 :
: -1170.0
-1490.0: -750.0 :
-
JAPAN
-
-:
+ 25.0 :
-:
ENGLAND
1973
1972
-:-203.0 :-520.5 :
:
-17.6 :
:
-:
+50.0:
BELGIUM
:1971
1970
-
:
+334.0 : +30.0
-334.0:
Authorized for public release by the FOMC Secretariat on 1/31/2020
-30.0:
-
+19.0
+116.0
-19.0
-116.0
27
TABLE 4
DRAWINGS (+) AND REPAYMENTS (-) UNDER THE
FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS, 1974 - 1980
(IN MILLIONS OF DOLLARS)
A. SWAP DRAWINGS AND REPAYMENTS INITIATED BY THE FEDERAL RESERVE SYSTEM
1974 :
AUSTRIA
BELGIUM *
1975 :
:
1976
:
-:
+29.7 :
-47.9 :
+15.0 :
-15.0 :
:
-297.6
1977:
1978:
- :
- :
-
- :
1979:
1980
- :
CANADA
- :
-:
-
DENMARK
-
-:
- :
-:
-:
-:
-:
- :
- :
- :
- :
- :
- : +166.3
- : -165.2
-
ENGLAND
FRANCE **
GERMANY ***
- :
- :
+45.6 :
-45.6 :
+686.9 :
-468.1 :
+707.5 :
-926.3 :
+148.8 : +835.4 : +5558.6: +4597.5: +1577.8
-133.9 : -50.3 : -1924.7: -5989.4: -4758.0
:
ITALY
-
JAPAN
- :
- :
- :
- :
MEXICO
-:
-:
:
- :
-:
- :
- :
: +156.5 :
- : -50.0 : -106.5 :
-:
:
-
..................................................................................
NETHERLANDS
NORWAY
+96.3 :
-99.6 :
+19.6 :
-19.6 :
- :
- :
- :
- :
- :
- :
- :
- :
+45.7 :
-42.4 :
- :
SWEDEN
-:
- :
-:
- :
- :
-:
- :
-:
- :
- :
- :
-
-
:
..................................................................................
SWITZERLAND
****
BIS: $/SF
S/OTHER
+13.3 :
-199.7 :
- :
+152.0 : +1747.2 :
- : +1086.9: +186.3:
-159.4 : -1863.3 : -544.5 : -649.8: -1130.1:
- :
- :
- :
-
+33.9
-33.9
:
-:
- :
- :
- :
- :
- :
- :
- :
- :
- :
- :
- :
-
* Belgian franc forward commitments assumed prior to 8/15/71
were adjusted upward by $54
million in 1975.
**Revaluation adjustments from
swap renewals totalled $5 5 million.
Repayments include revaluation
adjustments from swap renewals
of $1.1 million.
*** Revaluation adjustments from
swap renewals totalled $145.0
million during 1979-80.
Repayments include revaluation
adjustments from swaps renewed
after 7/31/80 of $6.7 million.
**** Swiss franc forward commitments
assumed prior to 8/15/71 were
adjusted upward by $196 million in
1975.
Authorized for public release by the FOMC Secretariat on 1/31/2020
28
TABLE 4
(CONTINUED)
B. SWAP DRAWINGS AND REPAYMENTS INITIATED BY FOREIGN CENTRAL BANKS AND THE BIS
1974:
1975 :
:
AUSTRIAN
- :
-
BELGIUM
- :
- :
DENMARK
-
:
-:
ENGLAND
-
:
-:
- :
- :
- :
:
- :
-
- :
-:
:
- :
-
-
-300.0
- :
-:
ITALY
- :
- :
-
1979:
-:
- :
- :
- :
-:
- :
-:
-
-:
-:
-:
- :
-:
- :
- :
- :
- :
GERMANY
-:
:
:
+500.0 :
-500.0 :
-
:
+180.0 :
+360.0 :
:
-360.0 :
-180.0
1978:
+300.0 :
:
-
MEXICO
1977:
-:
- :
-360.0 : -150.0 :
+510.0 :
:
- :
-:
-:
- :
-:
-:
NETHERLANDS
- :
-
SWEDEN
SWEDEN
- :
-:
- :
-:
-:
- :
--: :
*-
BIS:
ITALY$/SF
:
-- :
- :
-- :
:
-
---::
:
- :
:
-
+296.0 :
+190.0 :
$/OTHER
-296.0 :
1980
-:
- :
FRANCE
JAPAN
:
1976
:
- :
-:
:
+51.0 : +35.0 : +317.0 :
+70.0 : +242.0
-190.0 :
-51.0 :
-35.0 : -317.0 :
-70.0
Authorized for public release by the FOMC Secretariat on 1/31/2020
:
: -242.0
-
TABLE 5
DRAWINGS (+) AND REPAYMENTS (-) UNDER THE
FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS, 1981 - 1989
(IN MILLIONS OF DOLLARS)
A. SWAP DRAWINGS AND REPAYMENTS INITIATED BY THE FEDERAL RESERVE SYSTEM
(NONE)
B. SWAP DRAWINGS AND REPAYMENTS INITIATED BY FOREIGN CENTRAL BANKS AND THE BIS
1981
: 1985
: 1984
:1983
: 1982
: 1987
:1986
:1989
:1988
AUSTRIA
BELGIUM
CANADA
DENMARK
ENGLAND
FRANCE
GERMANY
ITALY
JAPAN
MEXICO (Regular)
(Special)
-:
-
+2200.0
- 1717.4
+301.0
-43.8
:
:
:
:
-482.6 :
+67.8 :
-325.0 :
-:
-:
-:
+272.0 :
-173.2:
- : +700.0 :
-98.8 : -700.0 :
+84.1
-42.3
NETHERLANDS
-:
+200.0 :
-200.0
-:
-:
NORWAY
SWEDEN
-:
-:
- :
-:
-:
-:
-:
$/OTHER
-:
+124.0
-124.0:
-:
:
-:
-:
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-:
$/SF
-:
SWITZERLAND
BIS:
+700.0
-:
30
TABLE 6
DRAWINGS (+) AND REPAYMENTS (-) BY MEXICO AND LDCS
UNDER U.S. TREASURY SWAP ARRANGEMENTS', 1982 - 1989
(IN MILLIONS OF DOLLARS)
1982 :
MEXICO
1983 :
1984 :
1985 :
1986 :
: +273.0 F/:
: 173.8
: 99.2
:
+825.0
-825.0
+559.0 M/: +122.2 M/:
-81.2
: -600.0
:
:
:
: +500.O M/: +142.9 M/:
ARGENTINA
1987 :
:
1989
: +300.0 M/: +300.0 F/
: -300.0
: -300.0
: * 84.1 M/
-42.3
: +415.0 M/: +550.0
: -415.0
: -642.9
1988 :
: -550.0
: + 79.5 M/:
:
BRAZIL
47.7
: -232.5
604.2 : -1,275.8 :
JAMAICA
: -
31.8
: +232.5 M/:
+1,480.0 : + 400.0 :
-
-
+10.0 :
-10.0 :
PHILIPPINES
:
ECUADOR
:
NIGERIA
:
YUGOSLAVIA
:
: + 45.0 M/:
:
: -45.0
:
:
: +75.0
: + 31.0
:
: -75.0
:
: -31.0
: + 22.2 M/:
22.2
:
:
50.0 M/:-
: -50.0
VENEZUELA
:
:
:
:
+450.0
450.0
: + 250.0
BOLIVIA
: - 175.0
POLAND
:
:
:
:
:
Unless otherwise noted, swap facility is bilateral in nature.
F/ Utilized in conjunction with drawing on Federal Reserve facility.
M/ As part of multilateral arrangement.
1/ All swap drawings were made under special swap arrangements, except
for Mexico's $300 million utilization in 1988.
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: +86.0 M/
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March 9, 1990
STRICTLY CONFIDENTIAL (FR)
CLASS I-FOMC
Profits and Losses in U.S. Foreign Currency Operations*
CONTENTS
List of Appendices, Tables, and Charts ................
ii
I.
Introduction ..........................................
1
II.
Issues in Estimating Profits ...........................
A. Operations ..........................................
1. Sterilized Intervention .........................
2. Asset Exchanges with other Monetary Authorities .
3. Issuance of Foreign Currency Denominated
Securities and Swap Drawings ....................
B. Opportunity Costs ...................................
C. Valuation of Foreign Currency Positions .............
6
6
7
8
III. Foreign Currency and Gold Operations:
1962-1971 .......
A . Operations ..........................................
B. Profitability .......................................
9
10
11
15
15
19
IV.
The Unraveling of the Bretton Woods System .............
23
24
A. Operations ..........................................
B. Profitability ........................................ 26
V.
System and U.S. Foreign Exchange Operations since 1973 .
A. Operations ..........................................
B. Profitability ........................................
1. Methodology .....................................
2. Calculations ....................................
3. Assessment ......................................
Prepared principally by Michael P. Leahy, Division of
International Finance, Board of Governors. This work has had
the benefit of comments from many people, especially Ralph W.
Smith and Edwin M. Truman. Maya Larson provided valuable
research assistance.
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30
34
34
36
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ii
APPENDICES
A.
B.
C.
D.
Derivation of Profits Formula .......................
Comparison with Published Reports ...................
Data ................................................
Memorandum on Shadow Open Market Committee statements
concerning U.S. foreign exchange losses .............
56
62
64
68
TABLES
1.
2.
3.
4.
5.
6.
Net Foreign Exchange and Gold Positions at the end of
August 1971 .........................................
Estimated U.S. Losses on Foreign Currency Operations
Estimates of Profits from Dollar-Mark Operations ....
Estimates of Profits from Dollar-Swiss Franc
Operations ..........................................
Estimates of Profits from Yen Operations ............
Estimates of Profits from Foreign-Currency Operations
23
27
39
47
51
55
CHARTS
1.
2.
3.
4.
5.
6.
Cumulative Estimated Profits from DM Operations and
Positions in the Notional Dollar-DM Portfolio
(Combined System and Treasury) ......................
Cumulative Estimated Profits from DM Operations and
DM Positions in the Notional Portfolio ..............
Cumulative Estimated Profits from SwF Operations and
Positions in the Notional Dollar-SwF Portfolio
(Combined System and Treasury) ......................
Cumulative Estimated Profits from SwF Operations and
SwF Positions in the Notional Portfolio .............
Cumulative Estimated Profits from Yen Operations and
Positions in the Notional Dollar-Yen Portfolio
(Combined System and Treasury) ......................
Cumulative Estimated Profits from Yen Operations and
Yen Positions in the Notional Portfolio .............
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44
48
49
52
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CLASS I-FOMC
I.
Introduction
This paper describes some of the issues involved in estimating
the profitability of foreign currency operations and presents an
assessment of U.S. experience in this regard.
By necessity, U.S. foreign
currency operations expose the accounts of the Federal Reserve System and
the Treasury to foreign exchange risk.
This paper is intended to provide
information helpful in assessing the risk to which the System account has
been exposed or to which it might be exposed, and to describe how U.S.
operations have fared in the face of such risk in the past.
Concerns about the profitability of official foreign currency
operations have taken two forms.
One centers on the question of how
policy-makers should interpret the profitability of their operations.
Some analysts have proposed that profitability be used as a test of the
desirability of official intervention in the foreign exchange markets.
These studies are based on an argument, originally suggested by Milton
Friedman in his essay "The Case for Flexible Exchange Rates,"¹ that
intervention will not be destabilizing if officials sell currencies when
the currency values are above their equilibrium levels and buy currencies
when the values are below.
When the authorities are correct about the
equilibrium levels, buying low and selling high should earn them profits.
When they are wrong, their intervention will be unprofitable.
¹ "To put the same point differently, if speculation were persistently
destabilizing, a government body like the Exchange Equalization Fund in
England in the 1930's could make a good deal of money by speculating in
exchange and in the process almost certainly eliminate the destabilizing
Milton Friedman, Essays in Positive Economics (Chicago:
speculation."
University of Chicago, 1953), p. 175.
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Since Friedman's essay, further analysis of the profitability
criterion has shown that the relationship is not so clear-cut.
Depending
upon the particular assumptions made, it is possible to show that
stabilizing intervention may be unprofitable and that profitable
intervention need not be stabilizing.
One can see some of the
complications by considering two simple examples.
If the authorities
were to purchase foreign exchange when its price was low and sell it when
its price was high, then, abstracting from interest-rate considerations,
the intervention would be profitable even if the purchases and sales had
no significant effect on exchange rates.
If it is possible to earn
profits on intervention that has no effect on exchange rates, then it is
difficult to argue that those profits imply the intervention has had a
stabilizing effect on exchange rates.
Alternatively, if the authorities stabilize the exchange rate
perfectly, then intervention profits (again, abstracting from interestrate considerations) will be zero because all purchases and sales of
foreign exchange will be at the same price.
Taking this argument one
step further, one can see that if the authorities overshoot the exchange
rate target slightly, driving the price just above the target when
purchasing foreign exchange and driving the price slightly below the
target when selling, losses will accrue even though the transactions may
have reduced the exchange rate variability from what it would have been
without any intervention.
Because positive profits do not necessarily imply that
intervention is stabilizing and negative profits do not necessarily imply
that intervention is destabilizing, the usefulness of profitability as a
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criterion for the success of official foreign currency operations is
called into question.²
A second type of concern about profitability focuses on the
fiduciary responsibilities of policy-makers as managers of the public
trust.
As with all public policy actions, it is important to assess the
costs of government operations to taxpayers against the benefits, and to
include in that assessment both the direct effects of the operations and
any indirect effects associated with changes in the overall allocation of
resources.
This paper provides information that bears on this second type
of concern.
Its focus is on estimating the economic profits and losses
generated by U.S. foreign currency operations, which include not only
intervention operations in the foreign exchange market but also nonmarket
transactions between monetary authorities, and on assessing the extent to
which these operations expose the net worth of the System and the
Treasury to foreign exchange risk.
The paper does not purport to present
a complete evaluation of U.S. foreign currency operations, however.
In
particular, no attempt is made here to measure the benefits of these
operations.
To the extent that operations are effective in producing
important but difficult-to-measure benefits, such as might result from
smoothing or stabilizing exchange rates, narrower considerations of
profit and loss need not be dominant.
However, regardless of the
effectiveness of operations in achieving overall goals, any evaluation of
²
One might argue that profitability can be used for a more limited
if the intervention yields profits, then it has not been
inference:
destabilizing. On the other hand, it is incorrect to infer from losses
alone that intervention has been destabilizing.
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those operations should include some measure of the economic cost of that
achievement.
This paper begins with a general discussion of analytical and
methodological issues associated with estimating the economic costs of
official foreign currency operations, including (1) the treatment of the
variety of foreign currency operations conducted by the United States at
different times, (2) the proper measurement of the costs of funds used in
foreign currency operations, and (3) the sensitivity of estimates of
profits to the choice of period examined.
The remainder of the paper looks at U.S. operations since 1962,
with an emphasis on the period since March 1973, and presents assessments
of their profitability.
The discussion is in three parts.
The first
provides a qualitative overview of the profitability of U.S. operations
under the Bretton Woods regime between 1962 and 1971.
The second looks
in somewhat more detail at the steps taken to repay the large foreign
currency debts outstanding at the time of the breakdown of the Bretton
Woods regime in 1971 and attempts to assess the profits and losses those
operations generated.
The third part analyzes U.S. operations since
generalized floating began in 1973.
After a discussion of the evolution
of U.S. operations during the period, this part presents estimates of the
economic profits generated by those operations, along with a discussion
of the methodology used and assumptions made in the calculations, and an
assessment of the sensitivity of the estimates
to fluctuations in
exchange rates.
U.S. foreign currency operations in marks, yen, and Swiss francs
from March 1973 through December 1989 are estimated to have generated
profits of about $6-1/4 billion overall, although, at present, the risk
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of sharp changes in the profitability of those operations is higher than
it has been since generalized floating began in March 1973 because they
have left U.S. authorities with unprecedented levels of foreign currency
exposure.
Four appendices are attached.
The first contains a formal
presentation of the methodology used to calculate profits for the
floating-rate period. 3
The second compares the measure of profits and
losses in this study to those used in reports on Treasury and Federal
Reserve foreign exchange operations by the Manager of the foreign
operations of the System Open Market Account.
data used in the calculations.
The third describes the
The fourth contains a memorandum to the
FOMC written by Edwin M. Truman and Paul R. Wood on a policy statement
recently released by the Shadow Open Market Committee that was critical
of U.S. foreign exchange operations.
3. This approach is presented in more detail in Michael P. Leahy, "The
Profitability of U.S. Intervention," International Finance Discussion
Paper #343, Washington: Board of Governors of the Federal Reserve
System, February 1989. (This paper and other recent papers that discuss
the profitability of intervention are summarized in the Task Force paper
"Foreign Currency Operations: An Annotated Bibliography.")
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II.
Issues in Estimating Profits
Several issues arise in the construction of estimates of the
profitability of foreign currency operations, and different approaches
may produce different results.
issues:
This part focuses on three sets of
what operations to consider, what opportunities should foreign
currency operations be judged against, and how to assess the uncertainty
associated with measuring the value of large foreign currency positions.
A.
Operations
What operations should be considered?
Since the early 1960s,
the System and the Treasury have engaged in a variety of foreign currency
operations, as well as operations involving gold that were related to the
maintenance of the Bretton Woods exchange rate system.
While these
operations were conducted with a variety of aims, some of which are
discussed later in this section and elsewhere in the Task Force papers,
they were not undertaken with a view to their being sources of profit or
revenue for the authorities.
Profits and losses did accrue, however,
when the operations generated exchange-rate or gold-price exposure and
exchange rates or the price of gold subsequently changed.
Generalized
descriptions of the major types of foreign currency operations conducted
by the Federal Reserve and the Treasury are reviewed below, along with an
analysis of the exposures these operations generate.
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1.
Sterilized Intervention
A sterilized intervention transaction is essentially an exchange
between a monetary authority and a private-sector agent in which an asset
denominated in one currency is traded for an asset denominated in
another.
The transaction is considered sterilized if it is not allowed
to affect the monetary liabilities of the monetary authorities.
intervention is routinely sterilized.
U.S.
Sometimes a distinction is made
between active intervention and transactions with customers.
The Foreign
Exchange Trading Desk frequently conducts transactions on behalf of
parties such as the World Bank or monetary authorities of developing
countries.
On occasion, when these transactions are consistent with the
U.S. authorities' objectives in the market, the Desk may act as a
principal, rather than an agent, and consequently conduct an operation
that takes the exposure onto its own books rather than passing that
exposure through to the market.
Such transactions are called customer
transactions.
Regardless of whether the intervention is labeled active or
customer, however, the currency composition of the portfolios held by
both the monetary authorities and the aggregate private sector changes.
For example, a sterilized intervention purchase of dollars against marks
increases the dollar position of the monetary authorities' portfolio and
decreases their mark position.
By necessity, it also decreases the
dollar position of the aggregate private sector and increases its mark
position.
If, after such a transaction, the dollar appreciates relative
to the mark, the net worth of the monetary authorities' portfolio rises
4. In this context, the aggregate private sector may include monetary
authorities from developing countries.
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ENTIAL (FR)
relative to what it would have been without the intervention transaction,
and the net worth of the aggregate private-sector portfolio falls
relative to what it would otherwise have been.
Intervention in the forward market is similarly an exchange
between a monetary authority and a private-sector agent in which an asset
denominated in one currency is traded for an asset denominated in
another.
In the case of a forward purchase of dollars against marks, for
example, the monetary authority would acquire an obligation to pay marks
in the future, just as it would have acquired had it borrowed marks from
the market, and also a right to receive dollars in the future, just as if
it had lent dollars to the market.
Thus, a forward market intervention
is essentially equivalent, in terms of its effects on the currency
composition of portfolios, to a sterilized spot market intervention in
which a mark security was sold and a similar dollar security purchased.
2.
Asset Exchanges with other Monetary Authorities
When monetary authorities conduct foreign currency or gold
transactions among themselves to reconstitute their holdings of reserves
or to reduce their exposures to changes in the values of particular
foreign currencies, they are shifting their foreign exchange exposures
and altering the distribution of any subsequent profits and losses from
what it would otherwise have been.
Included in this category are
transactions such as U.S. official purchases of yen from Japanese
authorities in exchange for dollars.
If, following such a transaction,
the dollar were to appreciate against the yen, the net worth of the U.S.
government would decline relative to what it would have been had there
been no asset exchange, while the net worth of the Japanese authorities
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would rise.
Similarly, a purchase of gold from the United States by
French authorities in exchange for dollars increases the gains to the
French of a possible rise in the dollar price of gold and decreases the
gains to the United States.
3.
Issuance of Foreign Currency Denominated Securities and Swap Drawings
At times U.S. authorities have issued securities denominated in
foreign currencies to foreign monetary authorities
the private sector ("Carter bonds").
("Roosa bonds") or to
As long as the U.S. authorities
hold the proceeds in foreign currency denominated investments, no change
in foreign exchange exposure results; the United States has increased its
foreign currency assets and foreign currency liabilities simultaneously.
Similarly, the foreign monetary authority or private sector has
experienced no change in currency exposure.
Normally, however, foreign
currency bonds are issued so that the foreign currencies can be used to
intervene or to purchase domestic currency from foreign monetary
authorities who have accumulated more than they desire.
These
accompanying transactions, as discussed above, will generate changes in
the authorities' foreign currency exposures.
A swap drawing under the reciprocal currency arrangements
between U.S. and foreign monetary authorities is the same kind of
transaction as a foreign currency bond issuance in terms of the exposure
it generates.
The swap drawing, a purchase of foreign exchange today and
a simultaneous agreement to deliver it back at a predetermined time and
rate in the future, is another method used by monetary authorities to
borrow foreign currencies.
The swap transaction itself generates no
change in the currency exposures of the parties involved, since the
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foreign currency asset acquired today is matched by a foreign currency
liability in the future.
Thus, monetary authorities can hold foreign
currencies but bear no exchange rate risk.
However, if the funds are
used to finance intervention or asset exchanges with other monetary
authorities, as has been the case for Federal Reserve drawings, changes
in exposures will result.
B.
Opportunity Costs
In an ideal calculation of the profitability of foreign currency
operations, one would like to compute the difference between the
government's net worth after the operations and its net worth had no
operations occurred at all.
This kind of computation raises at least two
One concerns the proper measurement of the opportunity costs of
issues.
the funds used in the operations.
A spot purchase of dollars against
marks, for example, requires that the marks be sold from reserves or
borrowed.
Accordingly, interest on DM assets will be foregone or
interest on DM borrowings paid.
Similarly, through the process of
sterilization, the dollars purchased are invested in interest-earning
assets or are used to reduce dollar-denominated debt.
interest on the dollars purchased will be earned.
In either case,
To estimate economic
profits, net of opportunity costs, the interest cost of funds used in the
operations should be deducted from the interest earnings on the funds
acquired.
A second issue concerns the potential complexities in
determining what exchange rates, interest rates, and gold prices would
have been in the absence of the operations.
Lacking a better assumption,
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most academic studies of the profitability of intervention assume, either
implicitly or explicitly, that intervention and other foreign exchange
operations leave market prices unchanged.
This assumption is at least
open to question, and there may be instances in which more likely
alternatives can be proposed.
C.
Valuation of Foreign Currency Positions
Another issue that arises in computing the profitability of
foreign currency operations concerns the problem of valuing large foreign
currency positions.
Suppose, for example, that during a sustained period
of intervention in one direction, U.S. monetary authorities sold dollars
against marks for several months.
Calculating the profitability of the
intervention over that period requires determining the dollar value at
the end of that period of the potentially large U.S. holdings of mark
assets and subtracting from that value the dollar cost of acquiring those
holdings.
When the mark position is large, however, the profitability
measure will be quite sensitive to the exchange rate used to compute its
dollar value.
used.
Normally, the exchange rate at the end of the period is
When that is the case, however, the profitability measure is
sensitive to the choice of period;
operations that are profitable when
measured at one end-of-period exchange rate can become unprofitable
later, even if no additional operations have occurred.
Thus, using an
end-of-period exchange rate makes the profitability measure sensitive to
the choice of the period over which profitability is measured, especially
when the terminal foreign currency positions are large.
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A further complication arises if one takes into consideration
the possibility that selling large foreign currency holdings back into
the market may affect exchange rates.
If one assumes that foreign
currency operations can affect exchange rates, at least in the short run,
then the value of the foreign currency may decline as the reserves are
sold.
Thus, using an end-of-period exchange rate may overstate the
liquidation value, measured in dollars, of a large foreign currency
position.
Similarly, valuing large holdings of foreign currency debt
with an end-of-period exchange rate may understate its dollar value,
since, as foreign currency is purchased in the market to repay the debt,
the value of the foreign currency may increase, making the debt more
expensive in terms of dollars.
In either case, it is not clear how much
these large foreign currency positions are worth in terms of dollars, and
the larger the positions the more likely their calculated values could
not be realized in the market over any given time interval.
Because, in general, profit estimates will be sensitive to endof-period exchange rates, especially when terminal foreign currency
positions are large, it is useful to have some gauge with which to
calibrate the uncertainty of the estimates.
One approach is to decompose
total profits into realized profits and unrealized profits.5
The
precise breakdown into realized and unrealized profits depends on the
accounting convention that profits are "realized" only when purchases or
5. In 1978, the System began reporting unrealized profits and losses on
foreign currency transactions along with the realized profits and losses
it had been reporting up till that time. This shift put the System's
books on a comparable basis with the Treasury's; changes at both
institutions were to incorporate the practice of marking-to-market
described in FASB 8. At that time, the System also began to include the
unrealized profits and losses in its transfers of profits and losses to
the Treasury.
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sales have been reversed and a decision about the accounting method to
use to calculate the "acquisition cost" of foreign currencies resold to
the market--LIFO, FIFO, or an average cost method.
While these practices
are based on standard accounting procedures, their relationship to the
calculation of economic profits from official foreign currency operations
is not transparent.
Still, the practice persists, probably because
splitting total profits into realized and unrealized yields some measure
of the confidence with which one should regard the profit estimate.
An alternative approach to gauging the uncertainty of profit
estimates is to decompose the estimates into the terminal currency
positions.
Because the source of uncertainty in these estimates, from
the U.S. point of view, is the translation of foreign currency positions
into dollar values, separating profits into terminal positions in each
currency makes it easy to evaluate the foreign currency positions at a
variety of exchange rates and, thus, to determine the sensitivity of the
profit estimate to possible future changes in those rates.
For example,
assume $10 million are sold for marks on a Monday at an exchange rate of
2 marks per dollar.
Further, assume that, on Tuesday, $10 million is
repurchased for marks at 1.5 marks per dollar.
In this example, the
terminal dollar position by close-of-business Tuesday is zero, the
terminal mark position is long DM 5 million, and profits are positive.
Using the end-of-period exchange rate, profits are $3-1/3 million.
If,
the next day, the dollar were to depreciate to 1.25 marks, the
profitability of those operations would be $4 million.
If, on the other
hand, the dollar were to appreciate to 1.75 marks, the profitability
would be just under $3 million.
Thus, to calibrate the sensitivity of
the profit estimate to possible future changes in the exchange rate, one
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can evaluate the terminal mark position at a variety of possible exchange
rates.
The conceptual issues presented above are important in the
presentations in the next three parts of this paper.
Each section begins
with a review of the major U.S. foreign currency operations and discusses
how those operations affected the foreign exchange exposure of the U.S.
monetary authorities.
Following those reviews are assessments of the
profitability of the operations.
These assessments include, to varying
degrees of detail, discussions of the net interest costs of the
operations and the alternatives against which to evaluate the overall
economic costs of the operations.
The issue of the valuation of large
foreign currency positions, discussed explicitly only in the final
section of the paper on U.S. operations since March 1973, is most
relevant in that period because of the large foreign currency positions
the operations of that period have generated.
While large positions were
generated in earlier periods, especially at the time of the breakdown of
the Bretton Woods system, the estimates of profit and loss for those
periods are based on exchange rates that occurred as the positions were
being closed out, and thus a discussion of the uncertainty of the
estimates in terms of the valuation of those positions is not necessary
for those periods.
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III.
Foreign Currency and Gold Operations:
1962-1971
In the early 1960s, after nearly thirty years of inactivity, the
U.S. monetary authorities resumed foreign exchange operations.
The mark
and the guilder were revalued in 1961, and there was speculation of
further changes
in par values, including a possible devaluation of the
U.S. dollar with respect to gold.
The United States had been running
persistent balance of payments deficits that generated concerns about a
possible drain of the U.S. gold stock.
With this as background, the FOMC
authorized System open market operations in foreign currencies in
February 1962.
(For details on the legal and procedural developments
regarding Federal Reserve foreign currency operations, see the Task Force
papers "Legal Bases for System Foreign Currency Operations" and
"Evolution of Formal Procedures for FOMC Oversight of System Foreign
Exchange Operations.")
The Treasury had resumed operations less than a
year earlier.
This part of the paper discusses U.S. operations in gold and
foreign currencies between 1962 and 1971 and provides a qualitative
overview of the profitability of these operations.
Because large
movements in exchange rates and the price of gold were infrequent during
these years, periods of large U.S. exposure generated profits and losses
that were quite small relative to those in subsequent years.
A.
Operations
Downward pressure on the dollar during these years was met with
intervention purchases of dollars by foreign monetary authorities,
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generating increases in their holdings of dollar reserves and increases
in their dollar exposures.
Unlike the foreign authorities, however, the
United States was not obliged to intervene in exchange markets to defend
parities under the Bretton Woods system, and U.S. intervention operations
during these years were minimal.
Nonetheless, to relieve foreign
authorities of a portion of the exchange risk their intervention had
generated and to limit temptation to demand gold from the United States
in exchange for their dollar reserves, the United States frequently
purchased dollars directly from foreign authorities during these years
with foreign currencies, thereby taking on the unwanted exchange risk
generated by the defense of dollar parities.
(Further discussion of U.S.
policy at this time is contained in the Task Force papers "Evolution of
U.S. Exchange Rate Policy" and "Historical Review of System Objectives
and Use of Intervention.")
The authorization granted by the FOMC in February 1962 allowed
the System to purchase the foreign currencies necessary to open accounts
with foreign central banks and led to the establishment of a network of
reciprocal currency arrangements--the swap network.
(See also the Task
Force paper "Historical Review of Reciprocal Currency Arrangements.")
These arrangements provided facilities that enabled the System and a
corresponding foreign authority to acquire each other's currencies for
short periods.
When the System initiated a swap drawing under the
Bretton Woods regime, its purpose was normally to transfer dollar
exchange-rate exposure from a foreign central bank to the System.
The
System would use the foreign currency proceeds of a swap to purchase a
foreign central bank's unwanted dollar holdings, thereby substituting
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"covered" for "uncovered" dollars in the foreign bank's reserves and
effectively removing the immediate need for purchases of U.S. gold.
Repayment of System-initiated swap obligations was achieved
through a variety of means.
Often the downward pressures on the dollar
that prompted the swap drawing reversed, and the System could purchase
the foreign currencies from foreign authorities when they found their
dollar holdings decreasing.
repay swap obligations.
In that case, the proceeds could be used to
At other times the pressures did not abate, and
repayment had to be effected through other sources, including purchases
of foreign currencies from the Treasury or, to a lesser extent, from the
market.
These swap operations and asset exchanges with other monetary
authorities accounted for the bulk of the Federal Reserve's foreign
exchange activities between 1962 and 1971.
The System drew on the swap
network frequently throughout the period, with especially heavy activity
in 1967 when pressure on sterling was spilling over onto the dollar, and
again in 1971 as the fixed exchange-rate mechanism began to unravel.
For
the period as a whole, swap drawings initiated by the System totaled
nearly $12 billion, and repayments totaled about $9 billion.
share of System swap activity was in Swiss francs.
The largest
(For further details
on swap network utilization, see the Task Force paper "Historical Review
of Reciprocal Currency Arrangements.")
When a foreign central bank initiated a swap drawing, its
purpose was normally to use the dollar proceeds to intervene in the open
market to defend its currency.
Under these circumstances, the System's
exposure would not change, since the foreign currency assets acquired by
the System were normally held, not sold, and the future dollar value of
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those assets was guaranteed under the terms of the swap.
The Bank of
England drew most heavily on the swap network, especially in the years
immediately before and after the sterling devaluation in 1967.
Swap
drawings initiated by foreign monetary authorities totaled about $15
billion between 1962 and 1971, and by end of 1971 all foreign initiated
drawings had been repaid.
The System also intervened directly in exchange markets during
this period, but, as mentioned before, intervention did not play a big
role in System operations.
It was used on occasion to supplement the
efforts of foreign central banks in the market or to acquire foreign
currencies to repay swap debt.
On rare occasions, the System also
intervened in spot markets when markets were disorderly, such as
following the assassination of President Kennedy in 1963.
Most System
intervention was in the spot market, but there were also a few occasions
on which the System intervened in the forward market.
Financing for Treasury operations, in contrast to that for the
System, came mostly from the issuance of foreign currency denominated
securities.
These securities, which came to be called "Roosa bonds"
after Robert V. Roosa, the Under Secretary of the Treasury who originally
negotiated them, were issued with maturities that were normally longer
than one year and provided the Treasury with a medium-term facility to
borrow foreign currencies.
Between 1962 and 1971, the Treasury issued
about $5 billion equivalent of these securities, the bulk of which were
denominated in Swiss francs and German marks.
The proceeds of these
operations were normally used to purchase unwanted dollars from foreign
monetary authorities, or were sold to the System primarily to repay swap
drawings.
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The Treasury also drew on its holdings of gold to buy unwanted
dollars from foreign monetary authorities, although gold sales were not
considered the first-choice method of transferring foreign exchange
exposure.
Between 1962 and 1971, the Treasury sold on net about $6
billion worth of gold; roughly 1/3 of that amount was sold to France.
U.S. participation in the gold pool, a consortium of monetary authorities
who between 1961 and 1968 operated in the London gold market to contain
the private market price at around the official price of $35 per ounce,
also provided a sizable drain on the Treasury's gold stock.
U.S. net
sales in the gold pool were somewhat less than net sales to France.
The ESF also participated in some non-network foreign currency
swaps and foreign currency/gold swaps.
In addition it conducted some
intervention operations in spot and forward markets, but, as with the
System, these operations were of modest scale.
B.
Profitability
Until 1971, when the Bretton Woods parities came under strong
pressures, profits and losses from foreign exchange operations were
modest.
In general, exposure was not large and, aside from the exchange-
rate realignments mentioned below, exchange rates stayed within narrow
bands for most currencies.
Even when realignments did occur, the swap
6. The upper and lower limits for the European currencies were
established under the European Monetary Agreement at approximately
3/4 percent on either side of the par value, except for Switzerland,
which maintained margins of about 1-3/4 percent on either side of parity.
Canada established a par value in May 1962 with margins set at 1 percent
on either side of parity. This range was in effect until May 1970, when
the Canadian dollar was allowed to float beyond its upper intervention
limit.
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agreements at the time contained clauses providing some protection to
countries that had outstanding swap obligations.
also carried such protection.
Many of the Roosa bonds
While the debtor bore the risks associated
with a devaluation of the debtor country's currency and the risks
associated with exchange-rate changes within the margins around parities,
the debtor was in general protected against a revaluation of the creditor
country's currency.
This provision, along with the generally small
exposures and narrow exchange-rate movements, tended to minimize the
profits and losses associated with the foreign exchange operations by the
System and the Treasury during this period.
(See also the section on
terms and conditions in the Task Force paper "Historical Review of
Reciprocal Currency Arrangements.")
Aside from the contribution of exchange-rate realignments to
profits and losses on foreign exchange operations, one should also
consider interest flows and the cost of financing foreign exchange
operations.
Even without exchange rate changes, U.S. authorities may
have suffered reductions in net worth if the interest cost of currencies
borrowed exceeded the returns on the currencies purchased.
Alternatively, they may have made gains if the reverse were true.
For
most of the period between 1962 and 1971, however, interest-rate
differentials were quite narrow relative to those in the years that
followed, making it unlikely that net interest costs were very large.
The small size of interest-rate differentials was reflected in the terms
of the swap agreements during those years in that foreign currencies were
drawn at identical rates of interest equal to the U.S. Treasury bill
rate.
In an economic sense, this resulted in a transfer or subsidy to
countries whose market interest rates were lower and a tax on countries
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whose interest rates were higher.
However, at least during during period
from 1962 to 1971, this transfer was not likely to have been large.
The
Treasury's borrowing of foreign currencies via Roosa bonds was done at
market rates of interest.
Between February 1962 and August 1971 there were four exchangerate realignments that could have possibly generated significant profits
or losses for the System or the Treasury:
the sterling devaluation in
November 1967, the French franc devaluation in August 1969, the mark
revaluation in September-October 1969, and the Swiss franc revaluation in
May 1971.
The first two events, however, resulted in only negligible
changes in U.S. government net worth.
At the time of the sterling
devaluation, both the System and the Treasury held sterling balances but
the dollar value of these balances was protected through guarantees
offered by the Bank of England and forward sales of sterling.
authorities had no net sterling exposure at that time.
Thus, U.S.
Similarly, at the
time of the devaluation of the French franc, the Treasury's holdings of
francs were almost completely covered by forward sales; the System had no
French franc balances at that time.
In contrast, the mark revaluation generated a small profit for
the System, since the System had a small uncovered long position in marks
when the mark began to float upwards in September 1969.
The Treasury,
however, had mark-denominated securities outstanding when the mark began
to appreciate, and the resultant increase in the dollar value of its debt
was only partly offset by the revaluation of mark balances held by the
ESF and the activation of revaluation protection clauses.
Losses on the
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Treasury's mark position due to the revaluation amounted to $24
million.7
Finally, the 7-percent Swiss franc revaluation generated small
profits for the System because the System had small uncovered holdings of
Swiss francs at the time of the revaluation.
The revaluation generated
no loss for the Treasury, even though the Treasury had a sizable quantity
of outstanding Swiss franc debt, because all of the Treasury's Swiss
franc securities at that time were covered by revaluation protection
clauses and the Swiss National Bank compensated the Treasury for the
increase in the dollar value of its debt.
7. See U.S. Treasury Department, Exchange Stabilization Fund:
Audit, for the fiscal year ended June 30, 1970, footnote c.
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The Unraveling of the Bretton Woods System
IV.
The pressures that culminated in the August 15, 1971 closing of
the gold window left the System and the Treasury with large net
borrowings in foreign currencies.
As shown in the table below, these
debtor positions were concentrated in a few currencies.
System
liabilities were largest in Swiss francs, sterling, Belgian francs, and
marks.
Net liabilities in these currencies were comprised almost
entirely of swap debt;
the swap debt was offset only marginally by small
holdings of foreign currency balances.
in Swiss francs and marks.
The Treasury held net liabilities
Even though the Treasury had sufficient
holdings of gold to extinguish those foreign currency obligations,
Table 1
Net Foreign Exchange and Gold Positions at the end of August 1971
(million of dollars equivalent)
Currency or Commodity
System
Treasury
Total
Sterling
Marks
Swiss francs
Belgian francs
Canadian dollars
Yen
Lire
-749.9
-48.0
-1592.2
-632.9
0.1
0.9
--
0.1
-450.6
-1323.1
0.3
--0.2
-749.8
-498.6
-2915.3
-632.6
0.1
0.9
0.2
Subtotal
-3022.0
-1773.1
-4795.1
Gold
Total
Sources:
--
-3022.0
9665
9665
7891.9
4869.9
Currency positions obtained from "Operations in Foreign
Currencies During 1971," a report prepared for the FOMC by the
Foreign Function of the Federal Reserve Bank of New York, March
1972. Gold holdings obtained from Treasury Bulletin, U.S.
Department of Treasury, Office of the Secretary, January 1972,
Tables IFS-1 and IFS-2. Gold is valued at $35 per ounce.
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President Nixon's decision to close the gold window meant that U.S.
authorities had to look for other ways to meet them.
A.
Operations
The swap debt of the System in sterling and marks was repaid by
the third quarter of 1972.
Most of the relatively small amount of marks
needed to pay down System obligations was acquired directly from German
authorities in July 1972.
The bulk of the sterling was acquired in July
and August of 1972, when sterling came under pressure.
The System
purchased sterling in the market, from the Bank of England, and from the
Treasury, which had drawn sterling from the IMF earlier that year.
Similarly, the mark debt of the Treasury was paid down by October 1973
through regular purchases of marks from German authorities.
The remaining swap debt of the System, in Belgian and Swiss
francs, was not repaid so quickly.
Some of the Belgian debt was repaid
in 1971 and 1972, when, at the request of the National Bank of Belgium,
the System made small purchases of Belgian francs in the market from time
to time, and used the proceeds to work down the debt.
However, these
episodic repayments were halted in 1973, as the Treasury sought to
clarify the terms on which the Belgian debt would be repaid.
The issue
was whether there would be a sharing of the profits and losses associated
with repayment of the debt since generalized floating began.
The switch
to floating exchange rates blurred the interpretation of the revaluation
protection clauses in the swap arrangements, which were designed for an
adjustable peg system; without fixed parities it was difficult to
determine whether one currency appreciated or the other depreciated.
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Treasury wanted equal sharing of the portion of profits and losses
attributable to floating exchange rates, but the Belgians interpreted
this request as a change to the original agreement and felt no obligation
to comply.
The inability of the United States and Belgium to reach
agreement on this issue, however, did not preclude the making of
arrangements under which the System could repay.
In December 1975, the
System and the National Bank of Belgium agreed to adjust the outstanding
swap debt to take into account the revaluation of the Belgian franc in
1971 and the two devaluations of the dollar in 1971 and 1973.
Near the
end of 1975 the dollar had recovered sufficiently to make the losses
associated with the remaining repayment fairly small, and this fact may
have made it easier to ignore the disagreement on loss sharing.
The
System subsequently resumed a program of regular purchases of Belgian
francs from the market and from the National Bank of Belgium and, by
November 1976, had completely liquidated the Belgian franc debt.
Repayment of System Swiss franc debt was made sporadically at
first.
The System acquired Swiss francs in the market from time to time,
as well as from Swiss National Bank, and these were used to make
irregular payments on the swap debt until October 1976, when the System
and the Treasury reached an agreement with the Swiss National Bank on an
orderly procedure for repaying the outstanding indebtedness.
The
System's original swaps were repaid using francs drawn under a newly
established swap facility.
This new drawing was to be liquidated through
regular repayments over the subsequent three years.
Most of the Swiss
francs were purchased directly from the Swiss National Bank against
dollars and other currencies, but some were purchased in the market.
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Prior to this agreement, the Swiss and Federal Reserve had agreed to
adjust the System's Swiss franc swap commitments to reflect the
consequences of the two dollar devaluations.
And, in contrast to the
negotiations with the Belgians, the System and the Swiss agreed on a
loss-sharing procedure in which the two parties would share equally the
losses incurred on System purchases of francs at rates up to 20 percent
above the newly adjusted swap contract rate.
Beyond that, the System
would absorb the full loss.
The Treasury also made regular purchases of Swiss francs from
the Swiss National Bank beginning November 1976, and by April 1979, all
the Swiss franc obligations of the United States incurred before August
15, 1971 had finally been repaid.
B.
Profitability
Different approaches can be used to determine the profitability
of the U.S. operations that generated and subsequently unwound the
positions held on August 15, 1971.
Two are presented here.
The first
measures profits and losses on these foreign currency operations against
a hypothetical alternative in which no operations were conducted.
Implicit is the assumption that these losses could have been avoided had
the United States refrained from the operations that generated the
indebted position in 1971.
The second measures the losses against a
hypothetical alternative in which the Treasury repaid the outstanding
liabilities with gold sales.
The assumptions of the first measure are akin to those behind
the usual presentation of profits and losses for accounting purposes.
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Using a standard accounting approach which defines a profit as the
difference between the original dollar value of the foreign currencies
borrowed and the quantity of dollars ultimately spent to repay the debt,
U.S. losses on these operations were roughly $2-1/2 billion, with System
losses totaling about $1 billion and Treasury losses about $1-1/2
billion.
(See the table below.)
Table 2
Estimated U.S. Losses on Foreign Currency Operaions
to Repay Debt Outstanding on August 15, 1971
(millions of dollars)
System
Sterling
Treasury
13
13
Marks
Total
6
110
116
Swiss francs
841
1,380
2,221
Belgian francs
126
Total
126
1,490
2,476
These estimates are constructed from information contained in a variety
of sources: International Finance Division files at the Federal Reserve
Board; "Operations in Foreign Currencies," reports prepared for the FOMC
by the Foreign Function of the Federal Reserve Bank of New York, various
years; Annual Reports of the Exchange Stabilization Fund, U.S.
Department of Treasury, various years; and testimony by Under Secretary
Edwin H. Yeo, Hearings before the Task Force on Tax Expenditures and
Off-Budget Agencies of the Committee on the Budget, House of
Representatives, February 18, 1976, pp. 39-54. Treasury estimates are
subject to somewhat more error.
While these figures take into account neither the interest costs
of using the foreign currencies while the debt was outstanding nor the
interest earnings on the dollars acquired, an explicit accounting for the
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net interest flows would probably not change the estimates presented
above in significant ways.
Because the interest costs of outstanding
swap debt were tied to the interest rate on U.S. Treasury bills and the
U.S. Treasury bill rate would also have been representative of the rate
of return on the dollars acquired, net interest flows due to swap
borrowings are not likely to have been significant.
Perhaps some
adjustment is required for the Roosa bonds, since the interest payments
were adjusted for realignments of parities in 1971 and 1972.
However,
subsequent interest payments were protected by revaluation protection
clauses.
In addition, although these bonds were issued at foreign market
rates of interest, the interest rates were usually near or below interest
rates on U.S. Treasury securities of comparable maturities at the time of
issue.
Thus, the effects of the devaluations on interest flows was
offset to some extent by the levels of the rates.
If, then, the estimates of loss shown in the table would not be
significantly different after adjusting for interest flows, one may
interpret this measure as being approximately equal to the economic
losses generated by U.S. foreign currency operations in the last stages
of the Bretton Woods system.
However, as mentioned above, implicit in
that interpretation is the assumption that the United States could have
avoided those losses by refraining from the operations, and that the
absence of U.S. operations would have had no effect on exchange rates,
interest rates, or gold prices.
Given the pressures that ultimately
brought the system down and the subsequent movements in exchange rates
and the price of gold, the latter assumption is difficult to accept;
it
seems highly unlikely that exchange rates and interest rates would have
followed the same paths in both scenarios.
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A second approach considers the profitability of the operations
relative to the alternative of selling gold on August 15, 1971 to pay
down the debts.
As before, it is difficult to determine what exchange
rates, interest rates, and gold prices would have been in the
hypothetical scenario.
However, under the assumptions that the Treasury
would have used about $5 billion in gold to liquidate the U.S. foreign
exchange debt outstanding on August 15, 1971 (see table 1 on foreign
currency positions) and that subsequent realized losses in repaying this
debt were roughly $2-1/2 billion (see table 2 on estimated losses), then
a 50 percent rise in the price of gold would have been sufficient to
cover all the losses actually incurred.
Given that after 1971, the price
of gold rose to several multiples of its 1971 value, the losses were more
than covered by the appreciation in the value of gold.8
Thus, viewing
the foreign currency operations as necessary to prevent reductions in the
U.S. gold stock, one could argue that the foreign currency operations
resulted in sizable profits for the United States and losses for the
foreign monetary authorities.
8. For example, from August 1971 to December 1972, the price of gold in
London rose about 50 percent to just under $65 per ounce. By the end of
1973, the price had risen 150 percent to more than $105 per ounce.
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V.
System and U.S. Foreign Exchange Operations since 1973
This part of the paper analyzes the profitability of U.S.
operations since generalized floating began in 1973.
The first section
describes the evolution of U.S. operations during the period.
The second
presents estimates of the economic profits generated by those operations.
The second section has three subsections.
The first contains a
discussion of the methodology used in the calculations, the second
presents the calculations themselves, and the third offers an assessment
of the profitability of U.S. operations.
A.
Operations
Prior to March 1973, U.S. foreign currency operations focused on
covering the dollars foreign monetary authorities had acquired in
intervention operations and taking on the unwanted exposure foreign
operations had generated.
monetary authorities.
Consequently, most operations were with other
After the move to generalized floating in March
1973, however, the mix of U.S. foreign currency operations changed, and
intervention operations began to play a much larger role in the conduct
of U.S. foreign currency operations overall.
of U.S. operations shifted during this period.
Furthermore, the financing
After the United States
made a conscious effort in late 1980 to build foreign currency reserves,
the borrowing of foreign currencies through swap drawings or foreign
currency securities was halted.
Finally, the currencies used to
intervene shifted away from the Swiss franc and towards the mark and,
even later, the yen.
(For further discussion of these changes, see the
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Task Force papers "Evolution of U.S. Exchange Rate Policy" and
"Historical Review of System Objectives and Use of Intervention.")
Since March 1973, there have been two periods of heavy
intervention by U.S. authorities.
early 1981.
The first was between late 1977 and
As the dollar moved down in late 1977 amid concern about
large trade imbalances, the System sold marks, acquired almost entirely
through swap drawings on the Bundesbank.
Pressures on the dollar
continued into 1978, however, and the United States took measures to
increase its access to foreign currency resources that could be used to
defend the dollar.
A new swap line was set up between the Treasury and
the Bundesbank and the swap line between the Federal Reserve and the
Bundesbank was doubled to $4 billion.
In addition to these actions, the
Treasury announced it was prepared to sell special drawing rights to
Germany and, if necessary, to draw on its reserve position at the IMF to
acquire currencies that might be needed.
Additional resources were
mobilized later in 1978, when on November 1, a program (the "Dollar
Defense Package") was announced that included, among other measures,
increases in the System's swap lines with the Bank of Japan, the Swiss
National Bank and the Bundesbank.
The Treasury announced it would draw
$3 billion in marks and yen from the International Monetary Fund, sell $2
billion equivalent of special drawing rights to obtain additional mark,
yen, and Swiss franc balances, and issue up to $10 billion equivalent of
foreign currency denominated securities ("Carter bonds").
The Treasury
also announced it would substantially increase the amounts of gold to be
offered at its monthly auctions.
With these resources at their disposal, U.S. authorities
intervened heavily during the remainder of this period, mostly in marks.
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Operations in yen were not large, despite the mobilization of resources
in that currency, because the yen began to depreciate.
Much of the mark
and Swiss franc intervention activity was financed through swap
facilities and foreign currency securities.
When downward pressures on
the dollar abated, the swap obligations were quickly repaid in 1980.
(See the Task Force paper "Historical Review of Reciprocal Currency
Arrangements.")
The Treasury took those opportunities to increase its
foreign currency holdings to cover the outstanding foreign currency
securities.
Not all of the foreign currencies used in intervention were
borrowed, however.
Both the System and the Treasury made sizable
purchases of marks directly from the Bundesbank, and the Treasury drew $2
billion equivalent of marks from the IMF and acquired an additional $770
million equivalent from German authorities in exchange for SDRs.
While
these non-market transactions were motivated by the desire to pay down
foreign currency debts without generating additional downward pressure on
the dollar, they also had the consequence of transferring some of the
foreign exchange exposure generated by the intervention to other monetary
authorities.
By the end of 1980, after a number of ups and downs, the dollar
had begun a sustained appreciation as U.S. monetary policy tightened
decisively and the U.S. current account moved into surplus.
U.S.
authorities took advantage of the opportunity to repay swap debt and to
build foreign currency balances.
By the end of March 1981, the System
had accumulated, on a cost-of-acquisition basis, net long positions of
about $2-1/2 billion equivalent in marks, $400 million equivalent in yen,
and $140 million equivalent in Swiss francs.
At the same time, the
Treasury had accumulated net long positions of about $1-1/4 billion
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equivalent in marks and $1-3/4 billion equivalent in yen.
The Treasury
had also covered all but about $50 million equivalent of its outstanding
Swiss franc debt.
(See the Task Force paper "Historical Review of U.S.
Official Holdings of Foreign Currencies.")
In 1981, U.S. policy toward intervention in the foreign exchange
markets changed, and intervention operations were essentially halted,
except in circumstances of extreme disorder.
This inactivity continued
until 1985, when the second period of more active U.S. intervention
began.
By 1985, the dollar had appreciated more or less steadily for 4
years and the U.S. current account had deteriorated.
After a meeting in
January, in which the G-5 reaffirmed their May 1983 Williamsburg
agreement to undertake coordinated intervention as necessary, the United
States entered the market in January, February, and March, selling
9
dollars against marks and yen.
As the dollar moved down from its
February peak, there was no U.S. intervention activity until September,
when, following the Plaza Agreement, the United States intervened
heavily, selling dollars against marks and yen and adding the proceeds to
foreign currency balances.
In 1986, the foreign exchange value of the dollar continued to
decline, and the United States did not intervene.
Intervention resumed
in 1987, and, following the Louvre Accord, the United States and other
nations began to purchase dollars against marks and yen.
Over the course
of the next year, U.S. intervention purchases of dollars substantially
9. The United States also sold dollars against sterling, in what was
one of only a handful of sterling operations since 1973. The amount of
sterling purchased was not large, $16.8 million equivalent.
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reduced System and Treasury holdings of foreign currencies, especially
yen.
This reduction prompted the United States to acquire marks in the
market and yen from foreign authorities in the summer of 1988.
Since
December 1988, U.S. activity consisted exclusively of dollar sales, at
times on a very large scale.
By the end of 1989, U.S. intervention had
generated very sizable long foreign currency positions.
B.
Profitability
1.
Methodology
As mentioned above, calculating the economic profits associated
with any activity requires consideration of alternatives to that
activity.
The profit calculations for this period are based on a
comparison of the returns to U.S. foreign currency operations relative to
the returns that would have been earned had U.S. authorities refrained
completely from foreign currency operations.
As before, it is difficult
to know what exchange rates and interest rates would have been in the
absence of U.S. operations, but, for the purposes of these calculations,
it is assumed that rates would have remained the same.
It is, perhaps,
easier to accept this assumption for the period of managed floating than
for the period of fixed exchange rates, since under managed floating
monetary policies are affected less immediately by exchange-rate concerns
than they would be under a fixed exchange-rate system.
The general approach, presented more formally in Appendix A, is
to construct a notional portfolio of dollar and foreign currency assets.
It is assumed that initially the portfolio contains no assets or
liabilities, of either currency; its initial value is, by construction,
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zero.
This assumption makes it possible to distinguish the returns to
foreign currency operations within a given period from the returns to
operations conducted before the period.
Even though interest flows and
exchange rate changes in one period affect the value of positions
accumulated from operations in previous periods, these returns would have
been earned in the absence of operations this period and, thus, have no
effect on the economic profits or losses associated with this period's
operations.
Consequently, the effects of exchange-rate changes and
cumulative interest flows on stocks of foreign exchange acquired in
previous periods (i.e.,
reserves) are excluded from the calculations.
Within the period, only foreign currency transactions and the effects of
subsequent net interest earnings and exchange-rate changes on the dollar
values of positions generated by those transactions affect the profit
estimates.
To capture economic profits, the calculations incorporate the
interest cost of funds used to intervene and the interest earnings on the
assets acquired, as well as valuation changes arising from exchange-rate
fluctuations.
For example, suppose at the beginning of the period under
consideration, dollars are purchased against marks.
Because the initial
portfolio contains no assets, it is assumed that the U.S. authorities
borrow marks, sell the marks in the foreign exchange market for dollars
at the current exchange rate, and then invest the dollars.
These
transactions would make the dollar-mark portfolio long dollars and short
marks.
At subsequent times, if no further operations take place, the
long-dollar position becomes larger as the interest earned on the dollar
assets accumulates, and the short-mark position becomes larger as more
marks must be borrowed to pay interest on the outstanding mark debt.
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later operations do take place, the dollar and mark positions are
adjusted, and interest flows are calculated based on the adjusted
positions.
Starting from the zero notional portfolio, profits are
calculated by computing the dollar value of the portfolio at the end of
the period.
If, as in the previous example, the notional portfolio is
long dollars and short marks at the end of the period, the dollar value
is computed as if the remaining mark debt had been liquidated by selling
dollars for marks at the end-of-period exchange rate.
Formally, profits
are equal to the accumulated dollar position at the end of the period
plus the dollar value of the foreign currency position at the end of the
period.
2.
Calculations
It should be stressed that the following calculations are
estimates.
They are approximate in that no attempt was made to determine
the exact exchange rates at which each day's operations were done or the
exact rates of return associated with the particular instruments used in
each transaction.
It is assumed that all foreign currency operations for
a particular day were done at exchange rates observed at noon in the New
York market and that the relevant interest rates are those on the U.S.
three-month Treasury bill, the German and Swiss three-month interbank
rates less 25 basis points, and the three-month gensaki rate in Japan. 1 0
These rates are comparable to the actual rates at which U.S. authorities
10. For dates before March 1979, the gensaki rate was not available, so
the interest rates quoted on "over-two-month-end" loans in the Japanese
commercial bill market were used.
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borrow and lend dollars, marks, Swiss francs, and yen, at least in recent
years.
11
(See Task Force paper "Historical Review of U.S. Official
Holdings of Foreign Currencies.")
Furthermore, because, in a few cases,
daily data on U.S. purchases of foreign currencies from other monetary
authorities were not readily available, monthly data for these operations
were used, and a given month's purchases were allocated evenly across the
days of the month. 1 2
In addition, no allowance is made for the sharing
of profits and losses on swap drawings of marks and Swiss francs before
1980, although the relevant amounts do not appear to be large. 1 3
11. These interest rates may misstate to some extent the actual interest
cost of foreign currencies borrowed in earlier years. Between 1973 and
1980, System swap drawings of marks and Swiss francs paid the rate of
interest on U.S. Treasury bills. The same rate of interest applied to
the Treasury's swap drawings of marks between January 1978 and February
1979. Since during most of these years, the U.S. Treasury bill rate was
above the foreign three-month interbank rate, the estimates presented in
this paper may overstate to some extent the actual net interest earnings
during those years. In addition, between December 1978 and January 1980,
the Treasury issued Carter bonds, which had maturities of 2-1/2 to 4
years, and paid market rates of interest. Under the assumption that the
interest rates on longer-term assets are unbiased predictors of the path
of shorter-term interest rates, however, the three-month interest rates
represent reasonable estimates of the rates on the longer-term
securities.
12. This is essentially equivalent to assuming the monthly purchases were
done at the average value of the exchange rate that month, and thus
should not generate any large losses in precision. Two such monthly
figures are used for the mark calculations, which correspond to the
Treasury's mark transactions with the IMF in November 1978 and December
1983. Eight monthly figures on System operations in yen and thirteen
monthly figures on Treasury operations in yen correspond to transactions
with the Bank of Japan, the IMF, and other authorities and are used to
supplement the daily data on yen operations in the market. The bulk of
these correspond to off-market purchases of yen in late 1987 and 1988;
two of the Treasury figures correspond to operations with the IMF in
November 1978 and December 1983.
13. Internal documents compiled for the Manager of Foreign Operations,
System Open Market Account, show realized losses on mark operations for
the System and Treasury for the periods during which mark swap debt was
outstanding. Between July 1973 and September 1980, the System realized
losses of about $43 million on German mark operations. Between January
(Footnote continues on next page)
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Finally, the scope of this calculation is limited to U.S. operations in
marks, Swiss francs, and yen; and it is assumed that these transactions
were made against dollars.
To the extent that the United States bought
or sold these foreign currencies against third currencies or SDRs, as it
did on occasion, the calculations misstate somewhat the exposure and
profits associated with those transactions.
However, nearly all U.S.
foreign currency operations during this period were conducted in these
currencies and against dollars.
Table 3 shows estimates of profits from dollar-mark operations
by the U.S. Treasury and the Federal Reserve System combined for selected
periods.
It also provides information used to compute the dollar value
of the notional dollar-mark portfolio for these periods.
Columns (1) and
(2), which relate to U.S. activity following the Plaza Agreement, are
presented separately to illustrate various features of the calculations
and to show the sensitivity of the estimates to the end-of-period
exchange rate.
As shown at the top of column (1),
cumulative net sales
of dollars against marks between the time of the Plaza Agreement in
September 1985 and the end of that year amounted to almost $1.9 billion.
Since there were no offsetting dollar purchases against marks during that
period, gross dollar purchases and sales, line (2),
are of the same
magnitude as the net.
(Footnote continued from previous page)
1978 and February 1979, the Treasury realized losses of about $41 million
on German mark operations. Assuming these losses are predominantly
associated with swap operations, one can conclude that the profit
estimates in this paper understate actual profits to the extent that
realized losses were shared with the Bundesbank. However, the amounts do
not appear to be large relative to profits overall. Profit sharing on
Swiss franc operations not associated with the repayment of debt
outstanding on August 15, 1971 is likely to have been even smaller.
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Table 3
Estimates of Profits from Dollar-Mark Operations
(rounded to millions of U.S. dollars or equivalent, unless otherwise indicated)
September 1985-
Septe mber 1985-
October 1977-
January 1985-
March 1973-
December 1985
Dece mber 1986
February 1981
December 1989
December 1989
(1)
(2)
(3)
(4)
(5)
(1) Cumulative net
dollars purchased
-1,861
-1,861
-3,685
-14,847
-18,927
(2) Gross dollar purchases and sales
1,861
1,861
50,195
23,818
81,549
(3) Terminal dollar
position
-1,892
-2,012
-2,729
-16,314
-23,176
(4) Terminal mark
position
(millions of DM)
2,052
(5,022)
2,728
(5,247)
3,134
(6,678)
(34,330)
(5) Profits
System
Treasury
161
80
80
20,320
28,424
(48,023)
716
405
4,006
5,248
358
-54
2,082
2,264
358
460
1,924
2,984
723
-16
3,820
5,073
-7
421
1.9235
2.1310
1.6895
1.6895
262
-117
1,398
1,188
9,086
12,354
Memo:
(6) Profits without
net interest
earnings
(7) Net interest
earnings
(8) end-of-period
exchange rate
(DM/$)
2.4470
Profits based on
valuing terminal
mark position at:
(9)
20% stronger
dollar
(10) 20% weaker
dollar
674
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Line (3) shows the short-dollar position that had accumulated in
the notional portfolio by the end of the period.
The magnitude of the
terminal dollar position is slightly larger in absolute value than the
cumulative net dollar purchases because the terminal dollar position
includes an estimate of the accumulated interest cost of the dollars sold
during the period.
Line (4) contains the corresponding mark position in the
notional portfolio at the end of the period and includes an estimate of
the accumulated interest earnings on the marks purchased.
The profit estimate shown on line (5) is the sum of the terminal
dollar position and the terminal mark position, where the latter is
converted into dollars using the end-of-period exchange rate.
If the
dollar-mark intervention immediately following the Plaza Agreement is
evaluated as of the end of 1985, profits are estimated to have been $161
million.
Because all foreign currency operations during this period were
split evenly between the System and the Treasury, the shares of profit
are equal.
System and Treasury profits are calculated from the
operations of each institution by creating a notional portfolio for each.
Lines (6) and (7) show an alternative decomposition of line (5)
into profits from net interest flows and profits from exchange-rate
changes alone. 1 4
The sensitivity of the profit estimates to end-of-period
exchange rates can be seen by comparing columns (1) and (2).
Extending
the calculation period to the end of 1986--in column (2)--when no
additional intervention was done, yields a much larger estimated profit
14. This decomposition is described in equation (9) of Appendix A.
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of $716 million.
Profits increased because the dollar continued to
decline in 1986, by more than the depreciation implicit in the dollarmark interest-rate differential, raising the dollar value of the longmark position that had accumulated by the end of 1985 more than enough to
offset the deterioration of the short dollar position.
To calibrate the
sensitivity of the profit estimates to end-of-period exchange rates,
lines (9) and (10) provide alternative estimates based on hypothetical
values of the dollar that are 20 percent stronger and 20 percent weaker
than the actual end-of-period value.
The remaining columns of table 3 summarize the profitability of
dollar-mark operations over three periods.
Columns (3) and (4) cover the
subperiods from late 1977 to early 1981 and from 1985 to the sample-end
in December 1989--two intervals during which the United States conducted
foreign currency operations frequently and in size.
The last column
covers the entire period of generalized floating since March 1973 with a
cutoff date of December 1989.
As shown in line (5), U.S. operations in
DM in those periods are estimated to have been profitable overall,
although in the earlier subperiod the System portfolio showed a small
loss.
Chart 1 displays cumulative profits and the cumulated dollar and
mark positions, evaluated at month-end exchange rates, for dollar-mark
operations beginning in March 1973 and ending each subsequent month until
December 1989.
The chart shows the correspondence between exposure,
which can be inferred from the bottom panel by the spread between the
dollar and mark positions, and the volatility of estimated profits, shown
in the top panel.
Between 1973 and 1977, exposure was small.
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Chart 1
Cumulative Estimated Profits from DM Operations
Combined System and Treasury
billions of dollars
1977
1974
1989
1986
1983
1980
billions of dollars
billions of marks
Positions in the Notional Dollar-DM Portfolio
/
mark position
(left scale)
dollar position
(right scale)
Plaza Agreement
Louvre Accord
1975
1978
1981
1984
1987
End-of-month data
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Consequently, profits were small, and the values of the portfolios did
not display much volatility.
Beginning in late 1977, however, dollar
support operations generated long-dollar and short-mark positions.
As
shown in the top panel, the level and volatility of profits began to
increase.
Because of a favorable interest-rate differential, especially
after the dollar began appreciating in the second half of 1980, interest
earnings were large.
As shown in column (3) of table 3, profits from
dollar-mark operations during that period alone totaled about $400
million, when measured at the end-of-period exchange rate.
These profits
were more than accounted for by net interest earnings.
Chart 2 shows cumulative profits and the cumulated mark
positions for the System and Treasury separately.15 Corresponding dollar
positions for each portfolio were suppressed to make the bottom panel of
the chart more readable.
In 1980, the profitability of Treasury
operations moved above that for System operations, as the Treasury's
larger short position in marks during that year allowed it to benefit
more from the favorable interest-rate differential and the appreciation
of the dollar.
As the dollar rose against the mark, both the System and
the Treasury took steps to build mark balances, and, by early 1981, both
15. This chart and the comparable chart for the yen operations begin in
1977, rather than 1973, because daily data on the foreign-currency
operations prior to 1977 for each institution are not readily available.
To make the disaggregated computations comparable to those for the
aggregate series, System and Treasury positions at the end of 1976 were
set equal to half the positions calculated using the aggregate data. As
shown in the charts, the estimated positions at the beginning of 1977 are
close to zero and, consequently, do not effect the results in a major
way.
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Chart 2
Cumulative Estimated Profits from DM Operations
billions of dollars
Treasury portfolio
1977
1981
1979
1983
1987
1985
1989
billions of marks
DM Positions in the Notional Portfolio
System Position
1978
1980
1982
1984
1986
1988
End-of-month data
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had generated long positions in marks.
Since that time, neither the
System nor the Treasury has been a net borrower of marks, and the dollarmark portfolios have remained long DM and short dollars.
Mark operations in the four years between March 1981 and
December 1984 were sparse, amounting to net sales of about $200 million
against marks.
Since the dollar appreciated during this period and
interest-rate differentials favored dollar-denominated assets, this small
amount of intervention was undoubtedly unprofitable.
However, the upper
panel of chart 1 shows cumulative profits dropping off substantially
during this period because these small losses were augmented by the
decline in the value of the long mark positions that had been attained by
the beginning of 1981.
As shown in chart 2, the System position in DM
during this period was larger than the Treasury's, and, consequently, the
System took a larger loss than the Treasury on mark balances during the
period.
In early 1985, when the foreign exchange value of the dollar
began to fall, the profitability of the dollar-mark portfolios began to
rise.
As the dollar continued to fall and the operations immediately
following the Plaza Agreement increased still more the long-mark, shortdollar positions, the values of the portfolios increased steadily.
Later, after the Louvre Accord in 1987, the United States began to sell
marks and reduce its long-mark position somewhat.
Mark sales were halted
in early 1988 as the mark began to weaken against the dollar.
By the
summer of 1988, the dollar had strengthened sufficiently to prompt
intervention sales of dollars against marks, increasing the long mark
positions.
These positions grew still larger in 1989 as a result of
heavy intervention sales of dollars.
When measured from January 1985 to
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the end of December 1989, as shown in column (4) of table 3, mark
operations have contributed about $4 billion to U.S. government net
worth.
During that time, the profitability of the dollar-mark portfolios
have become increasingly volatile, reflecting the effects of changes in
exchange rates on the large mark exposure.
Table 4 and charts 3 and 4 provide similar information about
dollar-Swiss franc operations.
Because some Swiss franc operations
between 1973 and 1979 were conducted to repay Swiss franc debt
outstanding on August 15, 1971 and because these operations have been
discussed in a previous section, an attempt was made to adjust the data
used in the calculations for this section to exclude those operations.
The scale of the remaining operations was small relative to that of mark
operations, with the bulk of the Swiss franc operations occurring between
October 1977 and February 1981.
As shown in the bottom panel of chart 4,
the System was a net seller of Swiss francs in the second half of 1978,
but these sales were quickly reversed in 1979 as the dollar strengthened.
Profits attributable to System operations rose relatively sharply at the
end of 1978.
The Treasury had conducted no operations in Swiss francs up
to this time, outside of those undertaken to repay the debt from August
1971.
In the second half of 1980, both the System and the Treasury
purchased Swiss francs to build balances.
have been no operations in Swiss francs.
Since 1981, however, there
As shown in column (1) of table
4, the operations between October 1977 and February 1981 produced profits
of about $50 million for the System and Treasury combined.
After 1981,
this profitability of the Swiss franc positions fell and rose in close
correspondence to movements in the dollar-Swiss franc exchange rate.
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Table 4
Estimates of Profits from Dollar-Swiss Franc Operations
(rounded to millions of U.S. dollars or equivalent, unless otherwise indicated)
October 1977February 1981
(1)
(1)
(2)
(3)
(4)
(5)
March 1973December 1989
(2)
Cumulative net
dollars purchased
-200
-212
Gross dollar purchases and sales
3,367
3,722
Terminal dollar
position
-177
-415
Terminal Swiss franc
position
(millions of SwF)
226
(443)
480
(739)
49
59
-10
65
101
-36
20
96
30
-31
1.9620
1.5410
12
-15
106
185
Profits
System
Treasury
Memo:
(6)
Profits without
net interest
earnings
(7) Net interest
earnings
(8)
end-of-period
exchange rate
(SwF/$)
Profits based on
valuing terminal
SwF position at:
(9)
20% stronger
dollar
(10) 20% weaker
dollar
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Chart 3
Cumulative Estimated Profits from SwF Operations
Combined System and Treasury
billions of dollars
0.2
0.15
0.1
0.05
+
0
0.05
1974
1980
1977
1983
1989
1986
billions of Swiss francs
billions of dollars
Positions inthe Notional Dollar-SwF Portfolio
2.25
0.75
dolla r position
(right
ght scale)
0.5
0.75
0.25
0
0.75
0
0.25
Swiss franc position
(left scale)
1.5
0.5
1975
1978
1987
End-of-month data
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Chart 4
Cumulative Estimated Profits from SwF Operations
billions of dollars
0.2
0.15
0.1
System portfolio
0.05
Treasury portfolio
-
0.05
.1
1974
1977
1980
1983
1986
1989
billions of Swiss francs
SwF Positions in the Notional Portfolio
2
1.5
1
0.5
0.5
0.5
Treasury position
System
1
position
1.5
1975
1978
1981
1984
1987
End-of-month data
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Table 5 and charts 5 and 6 show the results for dollar-yen
operations.
Dollar-yen activity during the first 16 years of the
floating rate period is estimated to have been profitable, on balance,
although, because positions were smaller, profits were smaller than for
dollar-mark.
Between 1978 and 1989, the dollar-yen portfolios were long
yen in the aggregate portfolio, shown in chart 5; as shown in the bottom
panel of chart 6, however, the System was short yen for a brief period in
1978 when the swap line with the Bank of Japan was first activated.
The
Treasury's yen position was boosted sharply in 1978 with yen acquired
through a drawing on the IMF and sales of SDRs.
These long-yen and
short-dollar positions generated losses, on balance, during the early
1980s when the dollar appreciated against the yen.
The Treasury
portfolio shows a larger dip in profitability, as show in the top panel
of chart 6, because of its larger long yen position.
The value of the
dollar-yen portfolio began to increase, however, after the dollar's value
against the yen started falling in February 1985.
Furthermore, following
the Plaza Agreement in September of that year, the profitability of the
dollar-yen portfolio continued to increase, as the United States
increased its long yen position and decreased its short dollar position
while the dollar's exchange value continued to fall.
The large long-yen,
short-dollar positions attained following the Plaza Agreement dropped
quickly in 1987 after the Louvre Accord in April.
Consequently, the
profitability of the dollar-yen portfolios leveled off in the later part
of 1987.
In 1988, these positions were built back up by purchases of $3
billion equivalent of yen from the Japanese Ministry of Finance, split
equally between the System and the Treasury.
The Treasury also acquired
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Table 5
Estimates of Profits from Yen Operations
(rounded to millions of U.S. dollars or equivalent, unless otherwise indicated)
(1)
(2)
(3)
(4)
(5)
January 1985December 1989
March 1973December 1989
(1)
(2)
Cumulative net
dollars purchased
-8,028
-9,843
Gross dollar purchases and sales
25,654
28,362
Terminal dollar
position
-7,951
-13,217
Terminal yen
position
(billions of yen)
9,041
(1,300)
14,159
(2,036)
1,091
399
691
942
672
270
Profits without
net interest
earnings
823
1,517
Net interest
earnings
268
-575
143.80
143.80
-416
-1,418
3,351
4,482
Profits
System
Treasury
Memo:
(6)
(7)
(8)
end-of-period
exchange rate
(¥/$)
Profits based on
valuing terminal
yen position at:
(9) 20% stronger
dollar
(10) 20% weaker
dollar
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Chart 5
Cumulative Estimated Profits from Yen Operations
Combined System and Treasury
billions of dollars
1989
1986
1983
1980
1977
1974
billions of dollars
billions of yen
15
3000
2400
Positions in the Notional Dollar-Yen Portfolio
12
9
1800
1200
6
yen position
(left scale)
600
3
+
0
3
600
dollar position
1200
6
(right scale)
1800
9
2400
12
15
3000
1975
1978
1981
1984
1987
End-of-month data
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Chart 6
Cumulative Estimated Profits from Yen Operations
billions of dollars
1.5
0.5
System portfolio
+
0.5
1
Treasury portfolio
II I
1979
1977
I
I
I
I
I
I
1987
1985
1983
1981
I
I
1989
billions of yen
1200
Yen Positions in the Notional Portfolio
1000
800
600
Treasury position
400
200
System position
0
200
1978
1980
1982
1984
1986
1988
End-of-month data
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smaller amounts of yen through operations with the IMF and sales of SDRs.
Subsequently, System and Treasury balances increased still more through
heavy intervention sales of dollars in 1989.
As shown in table 5, yen
operations since the beginning of 1985 have contributed about $1.1
billion to the net worth of the U.S. monetary authorities.
3.
Assessment
As shown on table 6, U.S. foreign currency operations in marks,
Swiss francs, and yen, when measured from the time of the abandonment of
fixed exchange rates in March 1973 to the end of December 1989, have
produced profits of $6-1/4 billion.
about $3 billion in profits.
System operations have generated
These estimates of economic profits are
subject to all the qualifications laid out earlier in this paper.
Because terminal mark and yen positions are large, however,
these estimates are quite sensitive to subsequent changes in exchange
rates.
For example, a 20 percent increase in the value of the dollar
from the end of December 1989 applied to the same portfolios would alter
the estimate from $6-1/4 billion in profits to almost $1 billion in
losses; the profitability of the System portfolio would change from $3
billion in profits to about $1/2 billion in losses.
Similarly, a 20
percent weaker dollar would substantially raise estimated profits.
Overall, it appears that System and U.S. operations have added to System
and U.S. net worth, although, at present, the risk of sharp changes in
the profitability of these operations is higher than it has been since
generalized floating began in March 1973.
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Table 6
Estimates of Profits from Foreign-Currency Operations
March 1973 - December 1989
(rounded to millions of U.S. dollars or equivalent)
Marks
Swiss francs
Yen
Total
Total profits
5,248
65
942
6,255
System
2,264
101
672
3,037
Treasury
2,984
-36
270
3,218
511
-15
-1,418
-922
System
-86
40
-404
-450
Treasury
597
-55
-1,014
-472
12,354
185
4,482
17,021
System
5,789
193
2,287
8,269
Treasury
6,565
-9
2,195
8,751
Profits based on
valuing terminal
foreign-currency
positions at
20% stronger
dollar:
Total profits
Profits based on
valuing terminal
foreign-currency
positions at
20% weaker
dollar:
Total profits
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Appendix A:
Derivation of Profits Formula
The formula presented below is based on the construction of a
It
notional portfolio of domestic-currency and foreign currency assets.
can be used to estimate the difference between the portfolio's net worth
after a period of intervention and its net worth had no intervention
occurred at all.
In the ideal calculation, to compute the counterfactual
net worth, one would reverse any effects intervention may have had on
exchange rates and interest rates during the period and compute net worth
under the assumption of no intervention with the alternative rates.
This
approach, which would require a model of the effects of the intervention
on exchange rates and interest rates and which would be necessary for a
fuller evaluation of the costs and benefits of intervention, is not taken
here.
Rather, for the limited purpose of calculating the intervention
portfolio's net worth, it is assumed that intervention has no effect on
exchange rates and interest rates and that the same data on rates can be
used to evaluate net worth with intervention and without.
It is necessary to make some assumption about the initial
portfolio of domestic-currency assets and foreign exchange reserves to
compare the change in the value of that initial portfolio to the
difference between the value of the initial portfolio and the value of
the portfolio that results after a sequence of intervention transactions.
For simplicity it is assumed that the initial portfolio is empty (i.e.,
it contains no assets and no liabilities, of either currency of
denomination).
Under these conditions, one can then simply determine the
terminal value of the portfolio that results from the sequence of
intervention transactions to compute the contribution of intervention to
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the final value of the portfolio.
however.
analysis.
This simplification is not necessary,
Any other initial portfolio can be incorporated into the
The contribution of the intervention transactions to the final
value of the portfolio will be the same, however, regardless of the
initial portfolio assumption.
The construction of this formula begins by computing the future
(day t) value of the currency purchased on a given day (day i) less the
future value foregone of the currency sold on that day.
Given the
assumption that the initial portfolio is empty, it will be necessary to
borrow assets to begin intervening.
It is assumed that the interest paid
on an asset borrowed is the same as the interest that would be foregone
if the same asset were sold from the portfolio.
Thus, it makes no
difference for this calculation that the asset sold is not already owned.
Let x i represent government purchases (or sales, if xi< 0) of
dollars against a foreign currency on day i, Si represent the price of
*
dollars in terms of the foreign currency on day i, ri represent the daily
interest rate on dollar assets held as reserves, and ri.represent the
daily interest rate on foreign currency assets.
When the x i dollars are
purchased on day i, it is assumed that these dollars are used to purchase
an asset that earns interest r i , and that principal and interest are
reinvested at the interest rates available on the subsequent days until
day t, the date at which we wish to evaluate the profits associated with
the intervention.
Thus, the dollar value on day t of intervention on day
i is given by:
(1)
VI i1 - xi(l+ri)(l+r
i+l)(l+ri+)...(1+r
1
1
i+1
i+2
t-1 )
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t-l-i
=
x
(1+ri+j)
i j=0
For notational simplicity, define
ri,t
i,
as:
t-l-i
(l+r
(2) ri,t
) - 1.
j=0
The compound interest rate ri,t represents the rate of return associated
with an investment on day i in which principal and interest are
reinvested until day t.
In a world of perfect foresight and no risks, it
might also be interpreted as the rate of return on a single asset that
matures on day t.
(3)
Using ri,t, one can express VI i as:
VI i = xi(l+ it).
To calculate the value on day t of a sequence of intervention
purchases of dollars that began on day k and ended on day t, take the
sum:
t-l
t-1
VI i + x t
(4)
i-k
i=k
t-l-i
xj
(1+r
) + xt
j=0
i+j
t-l
xi(l+ri, t ) + xt
i
it
i-k
= TDP(k,t).
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The expression TDP(k,t) is the terminal dollar position resulting from
intervention beginning on day k and ending on day t.
It is the sum of
the day-t values of dollars purchased (or sold) between days k and t,
including the value of dollars purchased on day t itself.
TDP(k,t) will
be positive when the terminal dollar position is long and negative when
the terminal dollar position is short.
To compute the opportunity cost of these intervention purchases
of dollars (OCI), consider the foreign currency value on day t of the
investment of S x i foreign currency units on day i:
(5)
OCI
i
= Sixi(l+ri)(l+r
i+1
)(l+r
i+2
)...(l+rl)
t-1
t-l-i
II (l+r
ii O
i+j )
j-0
=S x
where r
i,t
is
=
Sixi(1+r
),
t-1
defined as
t-l-i
(6)
r
(1+r
i,t
j=0
) - 1.
The opportunity cost in terms of day-t dollars of the sequence
of intervention purchases between days k and t is:
t-1
(7)
(1/S
t-1
OCI i + S x t
t )
i=k
=
(Sixi/St) II (l+r
jOi=k
t-1
=
(Sxi/St)(l+r,t) + x
i-k
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= -(l/S )TFCP(k,t),
t
where TFCP(k,t) is the terminal foreign currency position from
intervention beginning on day k and ending on day t.
As with TDP(k,t),
TFCP(k,t) is defined to be negative when the terminal foreign currency
position is short and positive when the terminal foreign currency
position is long.
Subtracting from the values of the sequence of interventions
their associated opportunity costs, one can compute the economic profits
(P) arising from intervention between day k and day t:
t-l
(8)
t-1
VIi =(1/St )
P(k,t)
i=k
OCI i
i-k
t-1
(1+r+
II
j-
i=k
)
(Si/S
(1+r
t )
0
j-0
t-l
xi{ (1+it) - (Si/St)(1=r
i=k
=
]}]
i,t
TDP(k,t) + (1/St)TFCP(k,t)
From the derivation shown above,
it
can be seen that this
opportunity-cost measure of economic profits is
equivalent to the sum of
the terminal dollar position plus the dollar value on day t of the
terminal foreign currency position.
Note,
however,
that the sum of
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currency positions will yield the proper measure only if accumulated
interest flows are included in the computation of the position values.
One can also decompose the expression for P(k,t) into profits
from net interest
from foreign exchange transactions alone and profits
flows.
t-1
(9)
t-l
x (l
P(k,t) -
i(ri,t -
- S/St) +
i-k
(Si/St)ri
.
i-k
The first term on the right-hand side of the equation above
represents profits measured at the day-t exchange rate from intervention
if
both dollar and foreign currency interest
term captures the interest
The second
rates were zero.
earnings from purchases
of dollar-denominated
assets and the foregone interest earnings from sales of foreign currencydenominated assets.
Because the interest flows associated with the
foreign currency asset are denominated in foreign currency units,
it is
necessary to include the exchange-rate factors to obtain a dollar value
on day t.
While the interaction,
in
an accounting sense,
exchange-rate changes and foreign currency interest
between
rates is
second-order
for small changes, large swings in exchange rates can produce large
effects on the net interest component of profits.16
16. See Michael P. Leahy, "The Profitability
of U.S. Intervention,"
International Finance Discussion Paper #343, Washington:
Board of
Governors of the Federal Reserve System, February 1989.
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Appendix B:
Comparison with Published Reports
The profit estimates presented above differ in many respects
from the net profits and losses on foreign currency operations in reports
of the Manager of the Foreign Operations of the System Open Market
Account on Treasury and Federal Reserve Foreign Exchange Operations.
The treatment of interest flows is different.
The calculations
of profits and losses on foreign currency transactions in the Manager's
reports add foreign currency interest receipts to foreign currency
balances but treat the interest receipts as if they were "purchased" with
dollars at the exchange rate prevailing at the time interest is received.
Thus, current interest receipts do not contribute to current profits.
However, as future changes in exchange rates generate gains or losses on
the overall foreign currency positions, the accumulated interest receipts
do contribute to calculated profits and losses just as ordinary purchases
of foreign currencies would.
Put another way, the interest payments and receipts associated
with holdings of U.S. dollar-denominated securities that are used in
foreign currency operations are not measured.
Instead, dollar interest
payments are implicitly assumed to be equal to an exchange-rate adjusted
value of foreign interest receipts.17 At the time of the foreign
currency interest transaction, the contribution to profits is zero.
17. In the terminology of Appendix*A, the dollar interest rate ri is
assumed to be equal to (-Qi/Sj+1)r, where Qi is the ratio of the
foreign-currency position at time i to the dollar position at time i,
Si+l is the spot exchange rate at time i+l in terms of foreign currency
per dollar, and r. is the foreign-currency interest rate.
This
assumption essentially adjusts the foreign-currency interest rate for the
rate of appreciation of the foreign currency from an average exchange
rate at which foreign-currency transactions were conducted up to time i.
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Subsequently, however, as the exchange rate used to translate the
foreign currency interest into dollars changes, foreign currency interest
earnings will contribute to profits and losses.
Thus, even if the transactions covered were the same and the
interest rates and exchange rates used were the same, profits and losses
presented in the Manager's reports would differ from the ones presented
in this study, for methodological reasons.
these other factors are not the same.
However, as mentioned above,
The data used in the Manager's
reports are more accurate and the coverage is more extensive.
The
Manager's reports use the exact exchange rates at which transactions were
conducted and take foreign currency interest flows into account more
accurately.
The Manager's reports also cover all foreign currency
transactions over the years, not just transactions in the three
currencies presented in this study.
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Appendix C:
Data
Interest Rates
United States -- daily observations
8
on U.S. three-month Treasury bill
rate, quoted on a discount basis at an annual rate using
a 360-day year, from January 1, 1973 to sample-end.
Source:
Federal Reserve Bank of New York.
-- these discount rates were converted to daily yields
using the following formula:
(discount rate)/100
360 - (91)(discount rate)/100
where 91 days is assumed to be the maturity of the bill
quoted each day.
Germany
-- daily observations on domestic German three-month
interbank interest rates, assumed to be quoted on a
simple-interest basis at an annual rate using a 360-day
year, from January 1, 1973 to sample-end.
The annual
rate was decreased by 25 basis points to obtain a better
approximation to the actual rate of return on U.S.
holdings of DM reserves.
Source:
International Finance Division database,
Federal Reserve Board.
18. Interest rates on Saturdays, Sundays, and holidays are assumed to be
the same as on the previous business day in the country. Exchange rates
on Saturdays, Sundays, and holidays are assumed to be the same as on the
previous business day in the New York market.
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Switzerland
-- daily observations on domestic Swiss three-month
interbank interest rates, assumed to be quoted on a
simple-interest basis at an annual rate using a 360-day
year, from January 7, 1974 to sample-end.
The annual
rate was decreased by 25 basis points to obtain a better
approximation to the actual rate of return on U.S.
holdings of SwF reserves.
Prior to January 7, 1974,
monthly observations on 3-month deposit rates with large
banks in Zurich, decreased by 25 basis points, were
used.
Source:
International Finance Division database,
Federal Reserve Board.
Japan
-- Two interest-rate series were spliced to obtain Japanese
interest rates covering the whole period.
From January
1, 1973 to March 1, 1979, daily observations on interest
rates quoted for "over-two-month-end" loans in Japan
were used.
From March 2, 1979 to sample-end, daily
observations on three-month gensaki rates were used.
Both of these were assumed to be quoted on a simpleinterest basis at an annual rate using a 365-day year.
Source:
International Finance Division database,
Federal Reserve Board.
Intervention Data
Class II FOMC - Strictly Confidential (FR) data on U.S.
official purchases of dollars against yen, Swiss francs,
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and marks, daily observations.
Sources:
from January
1, 1973 to December 31, 1976, Federal Reserve Bank of
New York; from January 3, 1977 to sample-end,
International Finance Division database, Federal Reserve
Board.
System and Treasury operations are disaggregated
in data beginning in 1977 only, and Swiss franc data
were adjusted in an attempt to exclude purchases of
Swiss francs to repay debt outstanding on August 15,
1979.
Purchases of Foreign Currencies from Foreign Monetary Authorities
Class II FOMC - Strictly Confidential (FR) data on
System and Treasury official purchases of dollars
against yen, Swiss francs, and marks for foreign
monetary authorities, monthly observations.
"Operations in Foreign Currencies:
Source:
A Report Prepared
for the Federal Open Market Committee by the Foreign
Function of the Federal Reserve Bank of New York, annual
publication.
Also used were data on U.S. Treasury
Exchange Stabilization Fund purchases of yen against
SDRs from November 1988 to December 14, 1989, daily
observations.
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Exchange Rates
Dollar/mark, dollar/Swiss franc, and dollar/yen exchange
rates are daily observations of noon spot rates in New
York City from January 1, 1973 to sample-end.
Source:
International Finance Division database, Federal Reserve
Board.
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-68September 29, 1989
TO: Federal Open Market Committee
FROM: Ted Truman and Paul Wood
Subject: The Shadow Open Market Committee
on U.S. Foreign Exchange Losses
STRICTLY CONFIDENTIAL (FR)
Class I - FOMC
The Shadow Open Market Committee (SOMC) recently released a
Policy Statement that was critical of U.S. reporting on U.S. foreign
exchange operations. (The relevant excerpt is attached.)
The report
contained a number of inaccuracies that could have been avoided by
relying on material published by the Federal Reserve and the Treasury.
(1) The Policy Statement states:
"In 1988, the Federal
Reserve reported losses of more than $500 million on foreign exchange
market intervention .
losses .
.
.
the Federal Reserve reports only realized
. if no sales occur, no losses are reported."
In fact, the
number that the Policy Statement cites, from Table 6 of the Annual
Report of the Board of Governors of the Federal Reserve System, includes
both realized profits of $610 million and unrealized losses of $1,121
million in 1988.
(2) The Policy Statement states:
". .
. the Federal Reserve
only accounts for losses on foreign exchange on its own books.
It also
intervenes for the account of the Treasury's secret Exchange
Stabilization Fund.
operations publicly."
The fund does not report the results of its
In fact, profits and losses, realized and
unrealized, are reported for both the Federal Reserve and the Treasury
in the Manager's quarterly report on "Treasury and Federal Reserve
Foreign Exchange Operations," which is released to the public, sent to
Congress, and published in the Federal Reserve Bulletin.
In addition,
the Treasury itself publishes a statement of profits and losses in the
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Annual Report of the Exchange Stabilization Fund (ESF) and in the
Treasury Bulletin.
(3) The Policy Statement states:
. the Federal Reserve
". .
made net purchases of $23 billion of foreign exchange in the 13 months
ending July 1989."
In fact, according to figures from the Manager's
published quarterly report, the U.S. authorities made net sales of
$18,372 million (excluding net sales of $225 million in customer
transactions) between June 27, 1988 and July 31, 1989.
(4) The Policy Statement estimates: ". . .the
Fed had
realized and unrealized losses of $5 billion in the year ending July
1989."
The basis of this estimate is not explained.
In fact, between
July 31, 1988 and July 31, 1989, the System's unrealized losses (the
reduction in cumulative valuation profits) were only $56 million, which
were more than cancelled by the System's $155 million in realized
profits during that period.
million, and
For the ESF, unrealized losses were $132
realized profits were $233 million.
Thus, over this 12-
month period, during which the dollar moved little on balance, the U.S.
¹
authorities had a net profit of $200 million .
(These figures do not
¹
The figures for unrealized losses can be derived from Table 3 of
the Manager's quarterly report by subtracting the cumulative valuation
profits for July 31, 1989 from those of July 31, 1988. However, that
would produce unrealized losses of $354 million for the ESF, rather than
the $132 million reported above. The discrepancy arises because the
accounting used in the quarterly report did not mark to market the
expected future receipt by the Treasury of DM 7,952 million that were
warehoused with the System as of July 31, 1989. Instead, those marks
were valued at the exchange rate at which they were warehoused (DM
1.9880 per dollar) so that their dollar value on the books was $4
billion, when in fact they were worth more by July 31, owing to the
dollar's decline since the warehousing was done. Not marking to market
those expected receipts caused the quarterly report's figure for the
Treasury's cumulative profits on July 31, 1989 to be $222 million lower
than it would otherwise be. Having uncovered this inconsistency in
treatment, we are trying to correct it in the future.
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include interest earned on foreign currency holdings nor interest
foregone on U.S. dollar securities.)
For the Committee's confidential information, from the
dollar's low point on December 31, 1987 to September 29, 1989, realized
profits for the System amounted to $435 million while unrealized losses
totaled $1,266 million.
For the ESF, comparable figures were $479
million in realized profits and $1,004 million in unrealized losses.
Thus, the System and the ESF combined have recorded a net loss of $1,356
million (realized profits plus unrealized losses) since the dollar's low
point.
Attachment
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-71Excerpt from Shadow Open Market Committee
Policy Statement
September 18, 1989
EXCHANGE MARKET INTERVENTION
During 1989, the nominal value of the U.S. dollar has risen on the foreign
exchange markets as a consequence of the vigorous monetary restraint the
Federal Reserve initiated in May 1988. The rise of the dollar has
coincided with a decline in gold prices and a one percentage point drop in
long-term bond yields between March and September.
These developments demonstrate that the Fed's anti-inflationary policy
actions are understood in the financial markets and are achieving their
Fears that the strong dollar will hamper growth of U.S.
intended results.
exports are unfounded.
Exports depend on real, inflation-adjusted exchange
rates, not on nominal exchange rates.
If inflation drops, a fall in the
real value of the dollar will coincide with a rise in its nominal value.
By acquiring $34 billion of foreign currency, the monetary authorities have
taken a speculative position that yen, D-marks and other currencies will
appreciate in relation to the dollar. In effect, U.S. authorities are
gambling that their own anti-inflationary policies will fail.
These gambles have been costly.
In 1988, the Federal Reserve reported
losses of more than $500 million on foreign exchange market intervention.
This is only a small part of the cost of intervention to the U.S. public.
There are three major omissions:
One, the Federal Reserve reports only
realized losses. The $500 million loss is the difference between purchases
of foreign currency made at a higher price than was received when the
Currency was sold. But if no sales occur, no losses are reported.
Two, the Federal Reserve only accounts for losses on foreign exchange on
its own books. It also intervenes for the account of the Treasury's secret
Exchange Stabilization Fund. The fund does not report the results of its
operations publicly.
Three, the Federal Reserve made net purchases of $23 billion of foreign
Most of the holdings are in
exchange in the 13 months ending July 1989.
Japanese yen and German marks.
Since the dollar appreciated against both
currencies during the period, the Federal Reserve has large unreported
losses.
We estimate that, on a conservative basis, the Fed had realized
and unrealized losses of $5 billion in the year ending July 1989.
The Federal Reserve, by sterilizing its foreign currency purchases, has not
allowed exchange market operations to alter its restrictive monetary
stance.
Hence, the intervention has not changed the growth rate of the
monetary base.
From June 1988 through May 1989 the monetary base grew by $10 billion.
However, during the same period, domestic interest-bearing securities held
in the System Open Market Account declined by $7 billion.
Net income of
the Federal Reserve Banks, which is normally rebated to the Treasury, has
accordingly been reduced - another loss for taxpayers.
There are
effect on
stopped.
been lost
insist on
Sterilized intervention has no
no benefits to offset the losses.
exchange rates. We urge that these costly operations be
At the same time, the public has a right to know how much has
in foreign exchange market operations. The Congress should
a public accounting of the realized and unrealized losses.
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Foreign Currency Operations:
An Annotated Bibliography
I.
Introduction ...............................................
II.
Definition of Intervention .................................
7
III.
Portfolio Balance Models ...................................
7
IV.
Studies of Expectations or Signalling Channel
and of the Differential Effects of Coordinated and
Noncoordinated Intervention ................................ 28
V.
Descriptive Studies of Particular Episodes of
Intervention ............................................
..
35
VI.
Studies of the Profitability of Intervention ...............
38
VII.
Studies of Factors Promoting Intervention and of
the Extent of Sterilization of Intervention .............
42
Studies That Do Not Make Use of Data on Bond
Supplies or Intervention. ...............................
44
VIII.
A.
B.
IX.
Studies of the Joint Hypothesis ...................... 44
Studies of Maximizing Models with
Imperfect Substitutability ........................... 46
The Effect of Intervention on Interest Rate Volatility .....
Appendix 1: Intervention and the Volatility of Interest Rates .......
Table Al: Months With Zero Intervention ..................
Table A2: Months With Light Intervention ..................
Table A3: Months With Moderate Intervention ...............
Table A4: Months With Heavy Intervention .................
48
50
50
51
52
53
Prepared principally by Hali J. Edison, Division of International
Finance, Board of Governors.
She benefitted from comments from Dale W.
Henderson and other members of the Task Force.
Section IX and Appendix
prepared by Paul Wood, Division of International Finance, Board of
Governors.
STRICTLY CONFIDENTIAL (FR)
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Foreign Currency Operations: An Annotated Bibliography
I. Introduction
This document is an annotated bibliography of recent research on
foreign currency operations or exchange market intervention.
It includes
studies undertaken for the G-7 Working Group on Exchange Market Intervention
(1982-83); subsequent studies on intervention, primarily key empirical
contributions; and some related studies.¹ Of course, the studies reviewed
in this bibliography are not the only information relevant for an assessment
of intervention policy; some of that other information is contained in other
Task Force papers.
There are two types of exchange market intervention: nonsterilized
and sterilized.
Nonsterilized intervention affects the monetary base, but
sterilized intervention does not.
Most of the studies included in this
bibliography address the central question regarding intervention: Does
sterilized intervention have a quantitatively significant effect on the
exchange rate?²
A few studies address other important questions regarding
¹ The G-7 Working Group completed its report in January 1983. It was
released in April 1983. The report is officially entitled the Report of
the Working Group on Exchange Market Intervention and is commonly
referred to as the "Jurgensen Report". The Report itself draws no
explicit conclusions. The official press release of the G-7 Finance
Ministries and Central Bank Governors, who received and reviewed the
report, states that the analysis in the report seems to suggest that (1)
sterilized intervention has a much smaller impact on exchange rates than
does nonsterilized intervention; (2) sterilized intervention can have
some short-run impact on exchange rates and may therefore be effective in
achieving some short-run exchange market objectives; (3) sterilized
intervention does not appear to have much long-run impact, and its
effects are often swamped by those of other macroeconomic policies; and
(4) coordinated intervention is more effective than intervention by a
single country, although the conditions for successful coordination are
exacting.
2. A quantitatively significant effect is one that is predictable,
sizeable, and lasting.
STRICTLY CONFIDENTIAL (FR)
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intervention:
First, does coordinated intervention have a different effect
than noncoordinated intervention?³
profitable?
Second, has intervention been
Third, what factors have prompted intervention?
Fourth, to
what extent has intervention been sterilized?
Researchers have identified two channels through which sterilized
intervention might affect exchange rates: (1) a portfolio balance channel
and (2) an expectations or signalling channel.
Sterilized intervention can
affect spot exchange rates through a portfolio balance channel if domestic
currency bonds and foreign currency bonds are imperfect substitutes, even if
56
Sterilized intervention
the expected future exchange rate is fixed.
changes the relative supplies of domestic and foreign bonds.
A change in
relative bond supplies necessitates a change in relative quantities of bonds
demanded.
wealths.
Relative bond demands depend on expected returns and financial
The expected return on domestic bonds is just the domestic
interest rate and the expected return on foreign bonds is the foreign
interest rate plus the expected rate of depreciation of the domestic
3. Coordinated intervention occurs when two central banks intervene in
the same direction. Noncoordinated intervention occurs either when only
one central bank intervenes or when two central banks intervene in
opposite directions. Noncoordinated intervention has sometimes been
referred to as unilateral intervention.
4. This issue is also discussed in the Task Force paper entitled:
"Profits and Losses in U.S. Foreign Currency Operations".
5. The case in which the expected future exchange rate is fixed is
considered in order to keep the explanation of the portfolio balance
channel as simple as possible. The expected future exchange rate would
be unaffected by a change in the relative supplies of domestic and
foreign bonds if this change were temporary.
6. In addition, it must be assumed that private agents do not regard the
bond holdings of the authorities as their own. If private agents do
regard the bond holdings of the authorities as their own, then a change
in relative bond supplies resulting from a sterilized intervention
operation is matched by an equal change in private relative bond demands,
so there is no need for any change in expected returns and financial
wealths.
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- 3 currency.
Sterilized intervention leaves monetary bases and, thus, interest
rates unchanged. 7
Therefore, the spot exchange rate must change in order
to bring about the required change in relative quantities of bonds demanded
through changes in the expected return on foreign bonds and financial
wealths.
Sterilized intervention can affect the spot exchange rate through
an expectations channel if a change in relative bond supplies conveys any
kind of information that causes agents to change their estimate of the
expected future exchange rate, even if domestic and foreign bonds are
perfect substitutes when their expected returns are equal.
A change in the
expected future exchange rate changes the expected return on foreign bonds.
If domestic and foreign bonds are perfect substitutes, both types of bonds
are held only if the domestic interest rate equals the expected return on
As stated above, sterilized intervention leaves interest
foreign bonds.
rates unchanged.
Therefore, the spot exchange rate must change by as much
as the expected future exchange rate changes in order to reestablish
equality between the domestic interest rate and the expected return on
foreign bonds.
The rest of this bibliography is divided into eight more sections.
Section II contains more detailed definitions of nonsterilized and
sterilized intervention.
listing of papers.
In sections III - VIII a brief overview precedes a
In section VIII, the listing is annotated.
The last
7. This conclusion is based on some implicit assumptions about the
variables that affect the demand for a country's monetary base and the
behavior of those variables in the short run. It is assumed, for
example, that the demand for the domestic country's monetary base depends
only on a domestic price index, a measure of domestic real economic
activity, and the domestic interest rate and that only the domestic
interest rate is free to vary in the short run.
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section and Appendix I present evidence on intervention and the volatility
of interest rates.
Sections III - V include empirical studies that address the
central question of whether sterilized intervention has a quantitatively
significant effect on the exchange rate.
Section III is devoted to formal
statistical studies of the portfolio balance channel.
In
the great bulk of
these studies, the researchers did not find a quantitatively significant
effect for sterilized intervention.
In most of the studies,
the researchers
did not find a statistically significant effect for sterilized intervention.
In a few, the researchers found an effect that was statistically but not
quantitatively significant.
In one study, the researchers found a
quantitatively significant effect.
Section IV includes the few available formal statistical
studies
of the expectations or signalling channel and the relative effects of
coordinated and noncoordinated intervention.
preliminary.
studies,
it
Daily data are used in
is
Some of these studies are
all but one study.
In some of the
assumed that sterilized intervention can affect the exchange
rate through both the expectations channel and the portfolio balance
channel, but in others it
is
assumed that sterilized intervention can affect
the exchange rate only through the expectations channel.
In all of the
studies, the researchers found that sterilized intervention has some
statistically significant effect through the expectations channel, but in
one study the researcher found that the effect was very short-lived.
studies,
the researchers
In two
found that the difference between the effects of
coordinated and noncoordinated intervention was statistically
but in one study, the researcher found that it was not.
significant,
In most of the
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- 5 studies, the researchers did not assess the quantitative significance of the
effects that they found.
Just because a quantitatively significant effect for sterilized
intervention has not been found in most of the research studies reviewed in
Sections III and IV does not mean that such an effect definitely does not
exist.
The researchers used particular assumptions, data, and techniques,
and other researchers using different assumptions, data, and techniques
might reach different conclusions.
The studies in Section V are descriptive studies of particular
episodes of intervention.
Most of the descriptive studies included in this
bibliography were undertaken for the G-7 Working Group.
In these studies,
it was concluded that sterilized intervention had a temporary impact on the
exchange rate and that it was useful as a short-run tool to stabilize
trading conditions and provide time to make policy adjustments.
Section VI is devoted to studies that address the question of
whether intervention has been profitable.
(See also the Task Force paper
entitled: "Profits and Losses in U.S. Foreign Currency Operations" for
evaluation of U.S. profitability.)
In most of these studies, the
researchers found that intervention was profitable for a majority of the
time intervals considered.
Section VII includes studies that address the questions of what
factors have prompted intervention and to what extent intervention has been
sterilized.
In these studies, the researchers estimated policy reaction
functions for intervention operations and for conventional open market
operations.
The researchers who analyzed intervention behavior found that
intervention was undertaken to smooth nominal and real exchange rates, to
achieve a target level of the nominal exchange rate, and for some other
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- 6 reasons.
Most of the researchers who analyzed sterilization behavior found
that a large part of intervention has been sterilized.
Section VIII includes two types of empirical studies which do not
make use of data on bond supplies or intervention:
(1) studies of the joint
hypothesis that domestic and foreign bonds are perfect substitutes and that
exchange rate expectations are rational and (2) studies of maximizing models
with imperfect substitutability between domestic and foreign bonds. 8
These
studies are listed because they are closely related to the other studies in
the bibliography.
They are not annotated because they do not directly
address questions regarding intervention.
Section IX investigates whether official intervention in the
foreign exchange market affects the volatility of, or uncertainty about,
U.S. interest rates.
The results show that interest rates are no more
volatile in periods of heavy or moderate intervention than in periods of
little or no intervention.
8. In the theoretical models used in some of these studies to derive the
relations that are used in the empirical work, sterilized intervention
has no effect because it is assumed that private agents treat the bond
holdings of the authorities as their own. See footnote 6.
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II. Definition of Intervention
Intervention has the direct effect of altering the balance sheet
of the monetary authority.
When a central bank intervenes in the foreign
exchange market it, in effect, exchanges bonds denominated in foreign
currency for its own domestic currency reserve liabilities to commercial
banks.
This action has two immediate effects: both the stock of bonds
denominated in foreign currency held by the public (at home and abroad) and
the domestic monetary base change.
This type of intervention is
conventionally referred to as nonsterilized.
When foreign exchange
intervention is nonsterilized it can affect exchange rates by changing the
stock of base money -- a change that leads to adjustments in broader
monetary aggregates, in interest rates, and in market expectations.
If the monetary authority also sells or purchases domesticcurrency bonds in exchange for its own domestic currency reserve liabilities
so that the monetary base remains unchanged, the initial exchange market
intervention is said to be sterilized.
In this sense, sterilized
intervention is a 'pure' change in the relative stocks of national-currency
bonds held by the public that is not accompanied by a change in the monetary
base.
In discussing the macroeconomic effects of intervention the focus in
this paper is on sterilized intervention.
In particular, the review
addresses the important question of whether intervention can have
significant effects on exchange rates independent of the effects of monetary
policy.
III. Portfolio Balance Models
As was stated in the introduction, it is postulated that
sterilized intervention may influence the exchange rate through two possible
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- 8 channels: (1) the portfolio balance channel and (2) the expectations
(signalling) channel.
These two channels would not be operative if
(1) assets denominated in different currencies were perfect substitutes
and/or (2) if current market prices perfectly reflect future prices as the
theory of rational expectations suggests.
Many researchers have used ex
post rates-of-return to test this joint hypothesis --
that assets are
--
perfect substitutes and rational expectations holds
not necessarily with
the intention of testing for the effectiveness of intervention.
9
In these
tests, one cannot differentiate between the two hypotheses, but can only
test jointly for their validity.
There is
considerable evidence,
using many
different types of tests on different data sets, that strongly rejects this
joint hypothesis.
Attempts at explaining the rejection of the joint hypothesis
abound in
the literature.
It
is
possible to divide the explanation of this
rejection into models that have macroeconomic foundations, which tend to
focus on the issue of the effectiveness of intervention,
foundations, which tend to focus on the various
microeconomic (finance)
aspects of risk.
The portfolio balance approach is
the macroeconomic group.
approach is
that it
is
and those that have
an important member of
A salient feature of the portfolio balance
based on a set of postulated (or ad hoc) asset demand
equations where rates-of-return are endogenous and asset supplies are policy
determined.
Typically,
the ex post rate-of-return is
expressed as a
function of outstanding stocks of foreign and domestic securities and
9. The ex post rate-of-return is the difference between the rate-ofreturn on domestic assets and the expected rate-of-return on foreign
assets in domestic terms, where the expected rate of depreciation of the
domestic currency is replaced by the actual rate of depreciation by
assuming rational expectations.
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wealth.
This approach tends to be motivated by policy considerations and
focuses on the effectiveness of sterilized intervention.
The main thrust of the postulated demand literature is that a
necessary and sufficient condition for sterilized intervention to affect the
exchange rate and interest rates is that securities denominated in different
currencies are imperfect substitutes.
qualifications.
This condition requires certain
This proposition may not hold if a government exchange of
foreign for domestic assets with domestic residents has no effect because
private agents fully take account of all future net taxes levied by the
government.
In this extreme case of Ricardian equivalence between debt
issue and taxes, the government cannot systematically affect the relevant
"outside" bond supplies -- the net supply of claims on governments that the
public must hold.
Therefore, in a Ricardian world imperfect
substitutability of assets is not a sufficient condition for sterilized
intervention to affect exchange rates.
Most of the empirical studies summarized in this section use some
form of a postulated portfolio balance model to analyze the effects of
intervention in exchange markets.
In such models, asset holders allocate
their wealth among different assets in shares that are increasing functions
of the expected returns on each asset.
If investors are averse to risk and
if rates-of-return are uncertain, investors will diversify their portfolios
instead of holding only the one asset with the highest expected return.
The portfolio balance model consists of demand equations, for
domestic and foreign assets.
It explains the demand for each asset as a
function of expected returns, wealth, and a variable representing
transactions demand.
Equilibrium occurs when the demand for each asset is
equal to its supply; relative rates-of-return on each asset adjust to
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maintain equilibrium.
In this framework, adjusting the spot exchange rate
can change the value in domestic currency of assets denominated in foreign
currency and alter the expected rate-of-return on foreign assets.10
Three basic approaches have been adopted in the estimation of this
type of model.
The first approach, the direct approach, is simply to
estimate the structural asset demand equations of portfolio balance models.
Asset demands are specified as linear functions of expected returns.
This
approach tends to be straightforward for money demand equations, but is more
complicated for bond-demand equations because data are unavailable for the
typical level of aggregation that is needed.
To circumvent this problem,
the model is frequently estimated by aggregating the asset demands to derive
total demand functions for domestic and foreign-currency bonds -- data that
are readily available.
The coefficients on the rate-of-return variable in
the asset demand function reflect the degree of asset substitutability.
A
small coefficient indicates assets are imperfect substitutes; while a large
coefficient implies assets are close substitutes.
This second approach, the inverted asset demand approach,
estimates inverted postulated asset-demand functions, whether aggregated or
10. The general specification of the postulated asset demand models
assumes that the residents of both countries hold four assets: home
money, foreign money, home (currency) securities, and foreign (currency)
securities. Many of the models summarized in this bibliography have used
models that have made several simplifying assumptions, such as: (1)
Residents do not hold foreign currency (no currency substitution). (2)
Each country's demand for money is independent of the return on the
security denominated in the foreign currency. (3) All changes in
residents' demand for money resulting from changes in nominal income and
prices are matched by changes in demand for securities denominated in
their country's currency. (4) Demand for money is independent of nominal
wealth in each country.
Further details about the specification of the
postulated asset demand functions are described in Branson and Henderson
(1985).
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- 11 The
not, so that the rate-of-return variable appears on the left-hand-side.
rate-of-return variable is typically the ex post rate-of-return, the
difference between the expected returns on domestic and foreign currency
bonds after having invoked the rational expectations hypothesis.
Under the
null hypothesis of perfect substitutes the coefficients on the right-handside are all zero.
Under the alternative hypothesis of imperfect
substitutability, the coefficients are finite but not zero.
To reject the
joint hypothesis of rational expectations and perfect substitutability, all
the coefficients on the right-hand-side should be jointly significant.
In
particular, if the portfolio balance channel holds, then the coefficients on
the asset supplies also will be statistically significantly different from
zero.
The empirical estimates could reject the joint hypothesis and also
reject the perfect substitutes hypothesis.
This would occur if the right-
hand-side coefficients are all zero, but the error follows some process
other than white noise.
Two econometric problems can arise in connection with the
estimation of asset demand functions in either direct or inverted form.
First, several endogenous variables appear on the right-hand-side of the
equation.
Second, assuming that expectations are rational implies that the
overall equation error has unusual properties.
Under the assumption of
rational expectations, the ex post return is used as a proxy for the
expected return.
The difference between the ex post return and the expected
return is a forecast error.
The overall equation error depends both on this
forecast error and on an ordinary equation error.
The presence of the
forecast error gives rise to the unusual properties in the overall equation
error.
Both of these econometric problems can be solved by using some form
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of instrumental variables estimation that allows for errors with unusual
properties.
(See Hodrick (1987) for a description of these techniques.)
A third approach, the individual optimization approach, derives
the asset demand equations from an individual's optimization problem, as in
the micro-finance literature, rather than simply postulating them.
In
particular, it is assumed that investors choose their portfolios so as to
maximize a function of the mean and variance of their real wealth.
In this
way the parameters of the asset demand equations are explicit functions of
the mean and variance of rates of return and investors attitudes toward
risk.
These restrictions can be tested.
In addition, this approach
provides more structure than just testing for non zero coefficients.
What
distinguishes this approach from the general micro-finance literature is
that relative asset supplies are postulated as influencing the rate-ofreturn variable.
In the literature there are examples using each of these three
different approaches.
Some studies examine these issues using a bilateral
exchange rate (and data); some studies, especially those using the
individual optimization approach, use several exchange rates.
The
frequency, the definition, and the quality of the data vary across studies.
When data on actual asset supplies are employed, either weekly, monthly, or
quarterly data have been used.
Those studies using daily data have tended
to use cumulated intervention as a proxy for asset supplies.
A common feature of this entire body of literature is that the
joint hypothesis -- that assets are perfect substitutes and that
expectations are rational -- is consistently rejected statistically.
The
rejection of the joint hypothesis is persistent over data frequency, sample
size, and asset definitions.
In the great bulk of these studies, the
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- 13 researchers did not find a quantitatively significant effect for sterilized
intervention.
In most of the studies, the researchers did not find a
statistically significant effect for sterilized intervention.
In a few, the
researchers found an effect that was statistically but not quantitatively
significant.
In one study, the researchers found a quantitatively
significant effect.
Three studies, Obstfeld (1983), Kearney and MacDonald (1986), and
Blundall-Wignall and Masson (1985), not only estimate portfolio balance
equations but also simulate different forms of intervention using a small
macroeconomic model.
The evaluation of the efficacy of the different types
of intervention is based on how much these policies influence the exchange
rate.
The Obstfeld and the Kearney and MacDonald studies follow very
similar methods.
The latter study examines the United Kingdom and the
former Germany. Both of these studies use the forward exchange rate as a
proxy for the expected future exchange rate.
The study for the United
Kingdom provides some evidence from the simulation exercise that sterilized
intervention could have a quantitatively significant influence on the
exchange rate; this evidence was not forthcoming in the German case.
The
Blundall-Wignall and Masson study which focuses on Germany follows a
slightly different research strategy.
Nevertheless, they find that the
estimates of a portfolio balance equation indicate sterilized intervention
has a statistically significant effect.
In the simulation section of their
study, they show that this effect is not quantitatively significant.
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Blundell-Wignall, A. and P. R. Masson. "Exchange Rate Dynamics and
Intervention Rules," International Monetary Fund Staff Papers, vol. 32
(March 1985), pp. 132 - 59.
This paper extends the well-known Dornbusch overshooting model by
including a role for asset supplies through a risk premium variable and
by including an intervention rule whereby the authorities attempt to
resist movements in the real exchange rate. This model is then
examined empirically for Germany from 1973 Q3 through 1982 Q2.
A small macroeconomic model for Germany is estimated under the
assumption of rational expectations for both the exchange rate and the
price deflator. The risk premium parameter is estimated to be small
but statistically significant. It suggests that a one percent change
in the cumulated current account will lead to a .05 percent change in
the spot exchange rate, other factors given.
In order to examine the full effects of intervention the model was
simulated with and without intervention in the foreign exchange market
assuming that market participants know the structure of the model and
the future values of the the exogenous variables. It is shown that in
response to a 10 percent domestic monetary shock that the effect of
intervention is small, especially over the initial few periods. In
general, if the purpose of intervention is to limit nominal exchange
rate overshooting, then the simulation results suggest that the
evidence provides little justification.
Boothe, Paul, and others. International Asset Substitutability: Theory and
Evidence for Canada. Ottawa: Bank of Canada, 1985.
This work contains a chapter that examines the effectiveness of
sterilized intervention using the Canadian dollar-U.S. dollar exchange
rate. It reports original estimates and surveys other empirical
estimates of the portfolio balance model. This study examines several
of these different models using monthly data from January 1971 to
November 1982. Two definitions for outside assets are used: (1) the
federal debt and (2) the sum of federal, provincial and municipal debt.
The authors show that the empirical work for Canada consistently
rejects the joint hypothesis that assets are perfect substitutes and
expectations are rational. However, movements in the ex post rate-ofreturn are not related to asset stocks, and they conclude that
intervention can only be effective if it can influence expectations.
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Branson, William H., and Dale W. Henderson.
"The Specification and
Influence of Asset Markets," in Ronald Jones and Peter Kenen, eds., Handbook
of International Economics, Volume II. Amsterdam: North Holland, 1985, pp.
749 - 805.
This article provides a complete survey of portfolio based approaches.
It discusses two complementary approaches to the analysis of asset
markets in open economies. The first approach is based on ad hoc
(postulated) asset demand functions. These asset demand functions are
broadly consistent with, but not directly implied by, microeconomic
theory.
The second approach derives asset demands that are based on the
solution to a maximization problem faced by an individual investor.
The consumer arrives at its asset demands by maximizing its utility
given interest rates and the parameters of the distribution of prices
and exchange rates.
Danker, Deborah J., and others. "Small Empirical Models of Exchange Market
Intervention: Applications to Germany, Japan, and Canada," Journal of Policy
Modeling, (Spring 1987), pp. 143 - 73.
This is one of the studies for the G-7 Working Group. The authors use
a standard portfolio balance model with the distinguishing feature that
the private sector in each country is disaggregated into nonbank and
bank sectors. Attention is focused on the demand for bonds denominated
in the home currency.
The home country is represented in succession
by three different countries: Germany, Japan, and Canada. The sample
periods in this study are February 1975 to December 1981 for Germany,
February 1974 to December 1980 for Japan, and quarterly for Canada from
1971:Q2 to 1981:Q4.
The authors first estimate inverted asset demand functions, using the
Hayashi-Sims two-step,two-stage least squares method. The right-handside variables in each equation for each country include part or all of
the available quantity of home bonds. For two of the three countries
studied, Germany and Canada, the authors reject the joint hypothesis
that assets are perfect substitutes and that exchange rate expectations
are rational. They also find some evidence that the ex post rate-ofreturn tended to be correlated with the supply of bonds in the case of
Germany. In the Japanese case they were unable to reject the joint
hypothesis.
The authors do some further testing by examining actual asset demand
equations and by searching over various inverted demand functions, but
are unable to estimate a model that confirms that sterilized
intervention is effective.
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- 16 Engel, Charles M., and Anthony P. Rodriques. "Tests of International CAPM
with Time-Varying Covariances," Journal of Applied Econometrics, vol. 4
(April/June 1989), pp. 119 - 38.
This article attempts to explain by relaxing some assumptions why the
models described and tested in Frankel (1982), Frankel (1986), and
Engel and Frankel (1984) -- all summarized below -- have not been
supported by the data. These studies assume that the regression
coefficients of the inverted demand equations for asset supplies are
proportional to the covariance matrix of the regression errors. In
these above mentioned studies, the conditional variance has been
treated as a constant.
The country coverage is the same as the earlier studies -- the United
States, Germany, the United Kingdom, Japan, France, and Canada. The
data have been updated from the earlier studies and are monthly from
June 1973 to December 1984.
In this study, the authors examine different ways of modeling the
variance. They test a six-country ex post rate-of-return model, first
by relating the variances to macroeconomic data (U.S. money supply and
oil prices) and second by modelling the time varying variances as ARCH
processes. In addition, they allow for a generalization of the
Frankel-type model by introducing the possibility that the asset demand
equation does not hold exactly.
The empirical section first estimates the standard Frankel equation and
imposes and tests the restriction that coefficients on asset supplies
are proportional to the variance term, which is assumed constant. This
restriction is rejected.
The basic formulation of this model does not require the assumption
that the variance is constant, therefore the authors relax this
assumption by allowing the variance to move with other macroeconomic
data. The estimates of this model, using either economic variable,
show that the assumption of a time-varying constant is a significant
improvement, however the coefficient restrictions placed on the model
are still rejected. The ARCH model does not require knowledge of the
economy, but allows the variances to vary. The estimates of this
formulation of the model also show that the explanatory power of the
model is increased by letting the conditional variances follow an ARCH
process. Yet, the suggested restrictions of the derived demand
functions are once again rejected.
One explanation for the rejection of these restrictions may be that the
initial formulation of the model assumes that the asset demands hold
exactly. Consequently, the authors relax this assumption and create a
composite error term, which is often pursued in the more standard
empirical literature on postulated portfolio demand models. In
general, the estimates of the measurement error models do not
significantly improve the explanatory power of the models.
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This paper extends the frontiers of estimation of these models to
consider some of the most important possibilities that have been
suggested for the empirical failure of that model; yet the model is not
supported by the data.
Frankel, Jeffrey A. "In Search of the Exchange Rate Premium: A Six Currency
Test Assuming Mean-Variance Optimization," Journal of International Money
and Finance, vol. 1 (December 1982), pp. 255 - 274.
This study tests a portfolio balance model where asset demand functions
are based on mean-variance optimization using monthly data from June
1973 to August 1980 for six countries: the United States, Germany, the
Rates of return are based
United Kingdom, Japan, Canada, and France.
on the difference of the log of the forward rate and the log of next
month's spot rate. Asset supplies are calculated as the outstanding
government debt corrected for three factors: (1) debt issued in foreign
currency, (2) cumulated central bank intervention and (3) foreign
exchange intervention in the domestic currency by other countries'
central banks. Net wealth is calculated as the cumulation of the
government deficit and the current account surplus.
One of the major contributions of the paper is the estimation of the
system of equations subject to the restrictions imposed by the meanvariance optimization. Frankel estimates his equations under the
assumption of rational expectations. The estimates are imprecise.
Nevertheless, the estimates appear to be consistent with risk neutral
investors in which case investors would only hold the asset with the
highest rate of return, so that domestic and foreign assets are perfect
substitutes.
Frankel suggests that the failure to reject the null hypothesis does
not imply that the null is true, but that the test may not be very
powerful.
He also notes that several auxiliary assumptions are made
when testing this hypothesis.
Therefore the test is more than just a
joint test. In this vein the assumption that consumption shares are
identical across countries is relaxed. As before the estimates are
very imprecise and the hypothesis that the risk aversion term is zero
could not be rejected.
This study is able to reject the joint hypothesis, but is unable to
establish a link between asset supplies and relative rates-of-return.
. "The Implications of Mean-Variance Optimization for
Four Questions in International Macroeconomics,"
Journal of International
Money and Finance, vol. 5 (March 1986), pp. S53 - S75.
This paper shows that the hypothesis of mean-variance optimization has
important implications for some standard questions of interest in
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macroeconomics. It presents a limited number of new estimates and
draws upon the database of Frankel (1982).
One of the main points of the paper, relevant for the current
discussion, shows that changes in relative asset supplies tend to imply
very small changes in the ex post rate-of-return. The author argues
that this result does not, however, imply that intervention will have
negligible effects on the level of the spot rate, because intervention
may affect expectations which, in turn will affect the exchange rate.
The argument is that the hypothesis of mean-variance optimization
implies that the current exchange rate is very sensitive to
expectations of future changes. The paper gives an estimate that if
the expected permanent rate of growth of domestic asset supply is
raised by .1 percent per annum, the mean-variance model would predict a
20 percent increase in the current exchange rate.
and Charles M. Engel. "Do Asset Demand Functions
Optimize Over the Mean and Variance of Real Returns? A Six-Currency Test",
Journal of International Economics, vol 17 (November 1984), pp. 309 - 323.
This study is similar to the Frankel (1982) study discussed above.
Instead of studying the relationship between nominal ex post rate-ofreturns and outside asset supplies they study the relationship between
real ex post rate-of-returns and outside real asset supplies, thereby
relaxing the assumption that inflation is predetermined. The same data
set (June 1973 to August 1980) and same country coverage is used.
The first part of the paper estimates a standard real ex post rate-ofreturn equation. Each equation is estimated unconstrained by OLS using
all six outside real asset supplies as right-hand-side variables.
Although each equation contains only one or two coefficient estimates
that are statistically significantly different from zero, they report
that the test of the constraint that all coefficients are zero is
rejected. From this part of the paper, they conclude that the low
degree of precision plagues the estimation of general portfolio-balance
equations. This provides motivation for considering the constraints
placed on the parameters by the mean-variance optimization.
The second part of the paper estimates the constrained model with and
without the estimation of the relative risk aversion parameter. When
the relative risk aversion parameter is constrained to be equal to 2,
the model fits considerably worse than the unconstrained model. The
authors choose to interpret this as a rejection of the optimization
hypothesis. When the relative risk aversion is allowed to be a free
parameter, its maximum likelihood estimate is -67. Since their model
of a risk-averse investor only makes sense with the relative risk
parameter constrained to be greater than zero, this finding is a clear
rejection of the model.
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- 19 This study, like most of these studies, is able to reject the joint
hypothesis, but is unable to establish a link between asset supplies
and relative rates-of-return.
Ghosh, Atish, R. "Is it Signalling?
Exchange Intervention and the Dollar-
Deutschemark Rate," Unpublished paper, Princeton University, September 1989.
This paper tests the portfolio balance channel, while controlling for
the signalling channel using a sticky price-monetary model to
characterize the movements in the exchange rate. The null hypothesis
of the paper is that the monetary model is the true model, so that
sterilized intervention can, at best, influence the current exchange
rate by signalling future changes in monetary policy. The alternative
model, is the monetary model augmented to include the portfolio balance
channel. The two models are examined empirically from December 1979 to
December 1988 using monthly data.
The monetary model is statistically rejected, but is shown to perform
well both in its in-sample forecasting and out-of-sample prediction.
The portfolio balance model when using the supply of assets denominated
in dollars and marks account for significant deviation of the exchange
rate from its value implied by the monetary model. However, changes in
reserve assets, an alternative measure of outside assets, appear to
have little effect on the exchange rate.
The results are interpreted as being generally supportive of sterilized
intervention being effective through the portfolio channel.
Henderson, Dale W. and Stephanie Sampson. "Intervention in Foreign Exchange
Markets: A Summary of Ten Staff Studies," Federal Reserve Bulletin, vol. 69
(November 1983), pp. 830 - 36.
This paper summarizes the ten staff studies of the Federal Reserve
System and the U.S. Department of Treasury written for the G-7 Working
Group. These studies covered a wide range of topics including: (1) the
definition of intervention, (2) the studies of historical episodes of
intervention, (3) the calculation of the profitability of intervention,
(4) the review of the research literature, and (5) the presentation of
formal econometric analysis. Most of these studies are summarized
within this paper.
Kearney, Colm, and Ronald MacDonald. "Intervention and Sterilisation under
Floating Exchange Rates: the UK 1973 - 1983," European Economic Review, vol.
30 (April 1986), pp. 345 - 64.
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- 20 This article is divided into two parts. The first part addresses the
question: Does the Bank of England intervene in the foreign exchange
market, and, if so, how? The second part considers whether sterilized
intervention is effective at influencing the exchange rate. It
estimates a central bank reaction function and a small portfolio
balance model for the British pound-dollar exchange rate using
quarterly data over the period 1973 Q2 to 1983 Q4. The resulting
estimates of the reaction function show that the Bank of England has
tended to intervene in the foreign exchange market in a 'leaning
The authors also test and confirm that the
against the wind' fashion.
Bank of England usually sterilizes its intervention.
To assess the efficacy of sterilized intervention the authors estimate
and simulate a small macro model of the U.K. economy. The authors
estimate equations for money demand, money supply, domestic demand for
bonds, and foreign demand for such bonds. Foreign wealth, proxied by
U.S. wealth, is measured as portfolio wealth for the United.States and
domestic wealth as financial wealth for the United Kingdom. They use
the three-month forward premium as a proxy for the expected change in
the exchange rate following an earlier Obstfeld paper -- summarized
below. As noted in our review of that study this proxy assumes assets
are perfect substitutes and clouds the interpretation of the results.
The coefficient estimates of the demand for U.K. bonds by both U.K. and
U.S. residents are correctly signed, but few are statistically
significant.
To evaluate the effectiveness of sterilized intervention the authors
conduct two policy simulations. A nonsterilized intervention is
considered first, in which the authorities sell foreign exchange
reserves and allow the monetary base to contract by 10 percent. A
sterilized intervention is subsequently considered in which the
monetary consequences of an equal sale of foreign exchange are offset
by a reduction in the stock of privately held domestic assets. Both
policies are considered transitory. The effect of the nonsterilized
intervention causes an immediate appreciation of the exchange rate of
almost eight percent. The sterilized intervention causes the value of
sterling to appreciate by just over three percent on impact.
The conclusion of this study is that sterilized intervention does
appear to have an effect on the exchange rate though not as great as
nonsterilized intervention, but nevertheless substantial.
Lewis, Karen K. "Testing the Portfolio Balance Model: A Multi-lateral
Approach,"
Journal of International Economics, vol 24 (February 1988), pp.
109 - 27.
This paper estimates directly, as opposed to the inverse form, outside
multilateral as opposed to bilateral asset demand equations for the
portfolio balance model for the currencies of five countries: the
United States, the United Kingdom, Germany, Japan, and Canada. The
data cover the period from January 1975 through December 1981. Data
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- 21 for Canadian, German, and Japanese assets and wealth are from the
Danker et al study with some modification in timing.
As in most studies, this author assumes rational expectations,
therefore the error becomes a composite error. The author uses the
two-step, two stage least squares estimator. This enables her to
estimate the equations consistently. She also exploits some of the
cross equation restrictions on the covariance matrix.
The coefficients on the relative rates of return are insignificant for
the most part. The only exception is the positive relationship between
yen returns and Canadian bonds. The effect of wealth upon asset
In general the
demands provides some evidence for the portfolio model.
empirical results indicate little relationship between asset supplies
The domestic variables--income and interest rates
and rates of return.
were generally insignificant.
Despite attempts to use improved and more efficient empirical
techniques, the results of this study indicate that estimates of the
portfolio balance model are imprecise.
. "Inflation Risk and Asset Market Disturbances: The MeanVariance Model Revisited," Journal of International Money and Finance, vol.
7 (September 1988), pp. 273 - 88.
This paper studies the ex post rate-of-return using a mean-variance
optimizing model. It is an extension of the earlier work by Frankel
(1982) and Frankel and Engel (1984). It explicitly introduces
inflation risk without requiring purchasing power parity. In addition,
it allows for the possibility of there being asset market disturbances.
The estimation uses data for six different countries -- Canada, France,
Germany, Japan, the United Kingdom, and the United States. The model
is estimated using monthly data from January 1975 through December
1981.
Interest rates on one-month Eurocurrency deposits are used as
measures of the rate of return on the asset.
The results in this paper are similar to the earlier studies despite
differences in estimation methods.
The covariance parameter estimates
are like those in Frankel and Engel.
In fact, the point estimates of
the risk aversion parameter in this paper are closer to zero.
These
estimates may be imprecise, but the results are consistent with risk
neutral investors.
This result in turn implies that intervention which
would alter asset supplies will have no effect on the expected ratesof-return.
In other words, this study does not report findings that
suggest intervention may be effective.
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Loopesko, Bonnie E. "Relationships Among Exchange Rates, Intervention, and
Interest Rates: An Empirical Investigation," Journal of International Money
and Finance, vol. 3 (December 1984), pp. 257 - 77.
This is one of the studies for the G-7 Working Group. It analyzes the
effect of sterilized intervention using daily data on the exchange rate
of the U.S. dollar vis-a-vis the currencies of the other G-7 countries.
The data are carefully compiled and constructed taking into
consideration the institutional structure of the various markets.
It uses an ex post rate-of-return equation to test the joint hypothesis
that assets are perfect substitutes and expectations are rational. To
test this joint hypothesis, Loopesko estimates an equation for the ex
post returns that uses lags of itself, lagged exchange rates, and
cumulated intervention as a proxy for the stock of domestic outside
assets.
The joint hypothesis is rejected for all currencies and subsamples
examined. For at least one subsample period for five out of the six
exchange rates examined sterilized intervention may have affected the
exchange rate through the portfolio channel. In about half of the
total cases considered the data do not support the existence of a
portfolio balance channel. Thus, sterilized intervention could have a
short-term impact on exchange rates for all the countries in the study,
but through a variety of channels.
Loopesko also tests the proposition that coordinated intervention is
more effective than noncoordinated intervention for the case of the
United States and Germany. The test that is actually implemented
compares whether these two types of intervention have different
effects. The results of this test are dependent on the definition of
intervention used. When using a broad definition of intervention
(including a component categorized as "other") it appears that
coordinated and noncoordinated intervention have the same effect. But
when a narrower definition (one that excludes "other" intervention
transactions by the Bundesbank) is used, coordinated intervention has
in general an effect on the exchange rate that differs significantly
from that of noncoordinated.
Micossi, S. and S. Rebecchini. "A Case Study on the Effectiveness of Foreign
Exchange Market Intervention: The Italian Lira (September 1975 - March
1977)," Journal of Banking and Finance, vol. 8 (December 1984), pp. 535 55.
This paper discusses the effects of Italian intervention during an
episode of major depreciation of the Italian lire, September 1975 to
March 1977. Daily time series of official intervention, the exchange
rate, and interest rates are estimated in a general framework that does
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not depend on any particular structural model. Interest rates and
intervention do not explain changes in the exchange rate, but the
interest differential seems to influence intervention significantly.
The study also estimates the effects of intervention on the ex post
rate of return following the work of Loopesko. However, unlike
Loopesko, the estimation shows that intervention itself was not
significant. Nevertheless, they report rejecting the perfect
substitutability hypothesis because lagged values of the ex post
returns were significant.
Obstfeld, Maurice. "Exchange Rates, Inflation and The Sterilization Problem:
Germany 1975 - 1981," European Economic Review, vol. 21 (March 1983) pp. 161
- 89.
This paper examines the Bundesbank's foreign exchange intervention
policy during the years 1975 - 1981. It asks whether the Bundesbank
pursued a sterilized intervention policy or not. Since it finds that
German intervention was predominately sterilized, it then asks whether
sterilized foreign exchange intervention is effective in the German
case.
The first question is addressed by estimating a domestic credit
reaction function. This reaction function tested whether the
Bundesbank responded positively to cyclical shortfalls in output, but
negatively to increases in foreign exchange reserves. The econometric
evidence supports the hypothesis that the Bundesbank used domestic
credit policy to attain domestic policy objectives while engaging in
sterilized intervention.
To assess the efficacy of sterilized intervention the author estimates
and simulates a small macro model of the German economy, which contains
structural asset demand equations. Obstfeld estimates equations for
money demand, money supply, domestic demand for bonds denominated in
deutsche marks, and foreign demand for such bonds. In the two domestic
demand equations, he includes income as a transaction variable, and a
lagged dependent variable to allow for stock adjustments. In the
estimation Obstfeld uses the forward premium for the expected exchange
rate depreciation. This procedure implies the absence of an exchange
risk premium and clouds interpretation of his results.
The coefficient on interest rates in the equation for foreign demand
for bonds is significant, but this is the only equation in which the
rate-of-return variable has a significant effect. The explanatory
power of the bond-demand equations is almost entirely due to the wealth
and lagged dependent variable terms. These results offer only slight
support for the portfolio-balance model.
Obstfeld adds a price equation to the model which allows changes in the
exchange rate to affect prices and feed back into the model via money
demand. To evaluate the effectiveness of sterilized intervention three
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simulations are considered. First, the benchmark simulation, the model
is simulated assuming perfect foresight for the exchange rate, so that
the forward rate in one period is equal to the solution for the spot
rate in the next period. The next simulation considers the effect of a
10 percent temporary (three-quarter) decline in the monetary base.
This monetary perturbations causes an immediate 3.0 percent
appreciation of the currency relative to its benchmark value. The last
simulation considers the effect of a sterilized sale of DM 13.25
billion. This policy change causes on impact a .04 percent
appreciation of the exchange rate relative to the benchmark.
The conclusion reached in the simulation experiments suggest that the
Bundesbank's ability to influence the exchange rate using sterilized
intervention is very limited.
. "The Effectiveness of Foreign-Exchange Intervention:
Recent Experience," NBER Working Paper 2796, (December 1988).
The paper relies on a casual observation rather than any formal
statistical analysis. It reviews the recent evolution of key
macroeconomic fundamentals, other than intervention, that are likely to
have influenced exchange rates. It sets out the mechanics of both
sterilized and nonsterilized intervention, and emphasizes the effects
on asset supplies of alternative intervention strategies. It also
considers an alternative to the portfolio balance rationale for
sterilized intervention, the signalling theory. According to this
view, official portfolio shifts between nonmoney assets can influence
exchange rates, independent of any necessity for private portfolio
rebalancing, by credibly signalling future policy intentions or
information not widely appreciated by the market. It also raises
several fundamental questions about the effectiveness of this channel.
The paper concludes that the international currency experience since
1985 lends little support to the idea that sterilized intervention has
been an important determinant of exchange rates. Anecdotal evidence
suggests that intervention has been useful as a device for signalling
official views on currency prices to the exchange market.
Rogoff, Kenneth. Time-Series Studies of the Relationship between Exchange
Rates and Intervention: A Review of the Techniques and Literature. Staff
Studies 132. Washington: Board of Governors of the Federal Reserve System,
September 1983.
This is one of the studies for the G-7 Working Group. This review
article explores whether the nonstructural time-series techniques,
especially vector autoregressions, can be used to examine the impact of
intervention in the short run. It concludes that the gains in using
this approach are more apparent than real, especially when modelling
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effects of intervention on exchange rates with daily data. This
technique is not a way of escaping the severe problem of omitted
variables presented by daily data. The money supply is not available
daily, and one can reasonably assume that changes in the money supply
are correlated with sterilized intervention and changes in the exchange
rate.
It also surveys three time-series investigations of the effectiveness
of exchange rate intervention. Two use daily data on exchange rates
and intervention to analyze the Canadian experience with floating
exchange rates. Neither of these studies distinguish between
sterilized and nonsterilized intervention. The first study concludes
that official intervention did play an important role in stabilizing
the Canadian dollar from 1952 to 1960. The second study, using the
same data but somewhat less sophisticated econometric techniques, finds
that if one adds lagged exchange rates to the equation that the
intervention variable becomes insignificant. The third study
differentiates between sterilized and nonsterilized intervention and
estimates a six variable vector autoregressions for the United States,
the United Kingdom, Germany and Japan. There are a number of
econometric problems making the interpretation of the results rather
cloudy.
. "On the Effects of Sterilized Intervention: An Analysis of
Weekly Data," Journal of Monetary Economics, vol. 14 (September 1984), pp.
133 - 50.
This study tests for the existence of the "portfolio balance effect" by
using high frequency data and by implementing an instrumental variable
technique. Weekly data, the shortest interval for which money supply
and net new government bond sales data are available, for the Canadian
dollar-U.S. dollar are used for the period March 1973 - December 1980.
An ex post rate-of-return equation that depends on the ratio of
Canadian dollar government bonds to the Canadian dollar value of U.S.
government bonds is estimated. Expectations are assumed to be rational
so that the actual exchange rate and a forecast error are substituted
for the expected exchange rate. The equation contains both the
serially correlated portfolio balance error as well as the rational
expectations error. Therefore the equation is estimated using OLS and
two-step, two-stage least squares. The advantage of such an
instrumental variable technique is that it gives consistent estimates
under both hypotheses. Relative asset supplies are constructed
alternatively using interest bearing assets only, and interest-bearing
assets plus the monetary base. The coefficients on these two different
measures of relative asset supplies are insignificant and of the wrong
sign. These results are invariant to a number of alternative
specification and estimation procedures. In addition, different
interest rate data are considered but similar results emerge.
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- 26 The study concludes that it is difficult to demonstrate that the ex
post return responds as predicted by theory to changes in the relative
supplies of outside assets denominated in different currencies.
Taya, Teizo. "Effectiveness of Exchange Market Intervention in Moderating
the Speed of Exchange Rate Movements: An Empirical Study of the Case Of
Japan," in David Bigman and Teizo Taya, eds., Exchange Rate and Trade
Instability: Causes, Consequences and Remedies. Cambridge, Mass.: Harper and
Row, Ballinger, 1983, pp. 217 - 55.
This paper examines the effectiveness of intervention on moderating
exchange rate movements utilizing Japanese data. It uses daily and
weekly data by observing the yen-dollar exchange rate from both the
London and Tokyo market from October 1977 to December 1979. These two
markets are sampled to examine possible intra-day effects of
intervention. Two separate subperiods are analyzed: a period of dollar
support (October 1977 - December 1978) and a period of yen support
(January - December 1979). The intervention figures are those
estimated by market sources for the Bank of Japan in Tokyo and quoted
by the Reuters wire service.
Simple linear regressions of the change of the exchange rate on
interest rate differentials and intervention are used. Over the two
subsamples intervention and lagged intervention are not significant.
The conclusion reached in this study is that intervention does not
appear to have a significant effect on the market. (The reviewer notes
that the results are somewhat difficult to interpret because there are
a number of econometric problems.)
Tryon, Ralph W. Small Empirical Models of Exchange Market Intervention: A
Review of the Literature. Staff Studies 134. Washington: Board of Governors
of the Federal Reserve System, September 1983.
This is one of the studies for the G-7 Working Group. It reviews the
literature on the empirical estimation of small structural models,
which shows the effects of intervention in foreign exchange markets.
It begins with a theoretical framework for examining these effects
using a standard portfolio balance model and goes on to discuss ways to
estimate the model econometrically. It notes that two problems are
encountered in the estimation of these models: (1) data on bond
holdings of residents of each country are not generally available and
need to be estimated, and (2) expected future exchange rates are
unobservable therefore one must make an assumption about how
expectations are formed. It then reviews existing empirical studies in
this area.
None of the studies reviewed provide a definitive answer to
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the question of whether sterilized intervention is an effective means
of altering exchange rates.
Weber, Warren E. "Do Sterilized Interventions Affect Exchange Rates?"
Federal Reserve Bank of Minneapolis Quarterly Review. vol. 10 (Summer 1986),
pp. 14 - 23.
This article reviews the mechanics of a sterilized foreign exchange
market intervention and presents a theoretical model that shows how
intervention may affect the exchange rates. It also reviews the
empirical literature. The empirical evidence cited, most of which is
surveyed here, does not show that sterilized intervention has an effect
on exchange rates, at least over time intervals of a month or more.
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IV. Studies of the Expectations or Signalling Channel and of the
Differential Effects of Coordinated and Noncoordinated Intervention
Sterilized intervention might affect exchange rates through an
expectations or signalling channel, whether or not domestic and foreign
bonds are imperfect substitutes.
Sterilized intervention operates through
this channel if it causes private agents to change their exchange rate
Private agents might change their exchange rate expectations
expectations.
for one of two reasons.
First, they might change their views about the
likely future actions of the monetary or fiscal authorities or of other
private agents.
Second, although they do not change their views about
likely future actions, they might change their views about the likely
implications of these actions for the future exchange rate.
Analysts who are skeptical of the argument that sterilized
intervention has affected exchange rates through an expectations channel
raise two obvious questions.
The first question is, Why do the authorities
not always announce their intervention when they are doing it, and why do
they not disclose more data on intervention?
If intervention is to affect
the exchange rate expectations of private agents, they must know about it.
In the studies of the expectations channel, the researchers have not to date
answered the skeptics' first question directly.
However, some of them have
recognized that the question must be taken seriously.
Dominguez
(forthcoming) used actual intervention data for Germany which are not
available to the public and newspaper reports of intervention for the United
States.
She argued that her comparisons of the newspaper reports of
intervention with actual intervention data covering longer periods that were
released in connection with published reports on Treasury and Federal
Reserve foreign exchange operations suggest that the newspaper reports were
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accurate.
Dominguez and Frankel (1989) used one variable based on newspaper
reports of both intervention and related developments and another based only
on newspaper reports of intervention and actual intervention data.
The skeptics have a second question:
What do the authorities have
to gain by using intervention instead of, or in addition to, simple
announcements when attempting to affect the exchange rate expectations of
private agents?
In the studies of the expectations channel, the researchers
do answer the skeptics' second question directly.
They argue that the
authorities care about the domestic currency value of their balance sheet.
If the authorities sell foreign bonds for domestic bonds and the domestic
currency ultimately depreciates, the domestic currency value of their
balance sheet is lower than it otherwise would be.
That is, if the
authorities intervene in order to affect exchange rate expectations,
attempts to mislead the public result in a loss of more than just face.
Therefore, if the authorities use intervention instead of, or in addition
to, simple announcements to affect exchange rate expectations, they are more
likely to be taken seriously.
There are only a few studies of the expectations channel.
except one use daily data.
All
The two most promising studies, Dominguez and
Frankel (1989) and Humpage (1989), are preliminary.
Dominguez and Frankel
assume that sterilized intervention can have effects through both the
portfolio balance channel and the expectations channel while Humpage assumes
that sterilized intervention can have effects only through the expectations
channel.
Dominguez and Frankel use data on exchange rate expectations
obtained from surveys instead of imposing the assumption of rational
expectations.
All the studies of the expectations channel found that
sterilized intervention had some statistically significant effect through
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the expectations channel.
Dominguez and Frankel found that sterilized
intervention had a statistically significant effect through the portfolio
balance channel when estimating the equation using instrumental variable
estimators.
This result was not forthcoming for the OLS regression except
for the 1-day intervention during the latter part of their sample period.
Dominguez and Frankel report that their results appear to be quantitatively
significant under many parameter values.
Humpage found that the
statistically significant effect of sterilized intervention was very shortlived.
In most of the studies, the researchers did not assess the
quantitative significance of the effects that they found.
There are also only a few studies of the differential effects of
coordinated and noncoordinated intervention.
Loopesko (1984) and Dominguez
(forthcoming) found that the difference between the effects of coordinated
and noncoordinated intervention was statistically significant, but Humpage
Loopesko and Dominguez did not assess the
found that it was not.
quantitative significance of the difference in effects.
Dominguez, Kathryn Mary.
"Does Sterilized Intervention Influence Exchange
Rates? A Test of the Signalling Hypothesis." Unpublished paper, Harvard
University, 1986.
This paper presents a set of empirical tests of the signalling
hypothesis using the mark-dollar exchange rate from February 1977 to
September 1981. These tests utilize daily data on intervention from
the Bundesbank and the Federal Reserve.
A distinction is made between subperiods where the Federal Reserve
appeared credible (November 1978 - May 1979, October 1979 - March 1980)
and periods in which it appeared non-credible (September 1977 - October
1978, May 1979 - October 1979, April 1980 - February 1981). This
credibility criterion is based on whether the Federal Reserve announces
major shifts in monetary policy designed to accomplish antiinflationary goals and simultaneously backed this change with major
policy changes.
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- 31 The first test examines whether a relationship exists between
intervention and weekly money surprises, using publicly available preannouncement money supply forecasts. This test provides some evidence
that during high-reputation periods money supply surprises are
positively correlated with intervention. A second test examines the
effects of intervention during high-reputation periods. On days that
the Federal Reserve intervenes heavily in the market, and has high
credibility, the exchange rate change is in the direction implied by
intervention. This relationship is not forthcoming in either the lowreputation period or for a given random sample. A third test considers
whether intervention helps to explain changes in the spot rate. The
results show that without isolating subperiods based on credibility, it
is impossible to determine the effects of intervention.
. "Market Responses to Coordinated Central Bank
Intervention." Forthcoming in Carnegie-Rochester Series on Public Policy,
Volume 32.
This paper tests whether sterilized intervention influences exchange
rates through the expectations or signalling channel by providing
information about future monetary policy. It also attempts to
determine whether the effects of coordinated and noncoordinated
intervention differ.
It examines the dollar-mark and the dollar-yen exchange rate. An
inverted asset demand function is used. Ex post returns are calculated
daily for dollar-mark and dollar-yen over the same period using
overnight, one-month, and three-month eurocurrency interest rates.
These returns are regressed on a constant and the previous day's
intervention. Intervention is broken into coordinated intervention,
defined as the sum of Federal Reserve and Bundesbank intervention on
days when at least two of the G-3 central banks were in the market, and
noncoordinated intervention by the Bundesbank and by the Federal
Reserve, which only pertains to days in which each of these respective
authorities was the only G-3 central bank in the market. (Bank of
Japan intervention is not included explicitly in the regression.)
The regressions were run over the entire three-year period 1985 through
1987, and over five subperiods: January - March 1985, September December 1985, September 1986 - January 1987, February - June 1987, and
October - December 1987. The results are mixed. In the first two
episodes -- periods of dollar sales -- the coefficients on both
coordinated and noncoordinated intervention are generally statistically
significant and of the correct sign, though the two periods differ in
terms of whether noncoordinated or coordinated intervention has a
larger effect. Noncoordinated Bundesbank intervention is statistically
insignificant in the post-Plaza period when it played a relatively
minor role.
During the three later periods of dollar purchases, the
coefficient on intervention -- when statistically significant -- is
generally of the wrong sign, except for coordinated intervention in the
post-Louvre period over the one and three-month horizons. For the
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three year period as a whole, coordinated intervention is generally
statistically significant and of the correct sign, but the magnitude
seems implausibly large. In general, coordinated intervention is
reported to have a different effect than noncoordinated intervention.
The results reported in this paper should be interpreted cautiously.
First, it is not theoretically obvious whether the choice of the level
of intervention rather than cumulated intervention as used in the
Loopesko study is the most appropriate. Second, to make this test more
rigorous additional right-hand-side variables should have been
included. Third, the parameters in the equation appear to exhibit
instability. Fourth, the significance of some of the coefficients,
especially for the longer investment horizons, is likely to be
overstated.
, and Jeffrey Frankel.
"Does Foreign Exchange
Intervention Matter? Disentangling the Portfolio and Expectations Effect for
the Mark." Unpublished paper, Harvard University, December 1989.
This study tests both the signalling channel and the portfolio balance
channel without invoking rational expectations. They use survey data
on market forecasts of exchange rates for the expected future exchange
rate. One of the innovations of this study is that they estimate both
a portfolio balance equation and an equation for the formation of
exchange rate expectations.
The study covers two subperiods: November 17, 1982 - October 10, 1984
and October 24, 1984 - December 18, 1987. The equations are estimated
by ordinary least squares (OLS) and instrumental variables. The focus
is on the mark-dollar exchange rate.
The first equation of their two equation system, the portfolio balance
equation, is an inverted asset demand equation and imposes the meanvariance optimization constraint. Asset supplies are modelled as
intervention or intervention as a percentage of total wealth, which is
defined to be the outstanding stock of government debt. In each case.
intervention is measured in three different ways: (1) intervention
which occurred the end of the day before the survey; (2) intervention
which is accumulated between survey forecasts; and (3) intervention
which is accumulated from the beginning of the sample period.
The other equation models the formation of expectations. The dependent
variable is the investor's forecast of the change in the expected
future spot rate, as measured by survey data. The regressors include
the difference between the lagged and contemporaneous spot rate, and
three different intervention variables: a dummy to reflect information
on intervention appearing in the newspaper, and actual intervention by
the Bundesbank and the Federal Reserve, respectively, when reported in
the newspapers.
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The authors find intervention has a significant effect both through the
expectations channel and through the portfolio channel. In addition,
they show that these effects can also be quantitatively significant.
This result, however, varies depending both on the particular estimates
chosen for the key parameters and on the precise experiment that one
considers.
Humpage, Owen F. "On the Effectiveness of Exchange-Market Intervention."
Unpublished paper, Federal Reserve Bank of Cleveland, June 1989.
This study examines the relationship between day-to-day official
intervention and day-to-day exchange rate movements. It examines
intervention for the yen-dollar and the mark-dollar rate between August
3, 1984 and October 30, 1987. It uses exchange rates quoted in French
francs and therefore calculates the dollar rates using the French
franc-dollar rate. Intervention is classified in three ways: actual
total daily intervention, coordinated/noncoordinated intervention, and
initial/subsequent intervention.
The analysis assumes that intervention works only through the
expectational channel. To test this the author regresses the spot
exchange rate on lagged intervention, lagged interest rate
differentials and the two-day lag of the spot rate.
This equation is estimated over five subperiods: August 3, 1984 - May
31, 1985; June 3, 1985 - December 30, 1985; October 1, 1986 - February
10, 1987; February 11, 1987 - October 30, 1987. The author draws three
conclusions from his results: (1) that systematic intervention has no
apparent impact on exchange rates, (2) intervention can have a shortterm effect if it provides new information to the market, and (3) that
the distinction between coordinated and noncoordinated intervention is
not important. This latter conclusion is the opposite reached by
Loopesko (1984) and Dominguez (1988).
Loopesko, Bonnie E. "Relationships Among Exchange Rates, Intervention, and
Interest Rates: An Empirical Investigation," Journal of International Money
and Finance, vol. 3 (December 1984), pp. 257 - 77.
This paper is summarized in Section III.
Mussa, Michael. "The Role of Official Intervention," Group of Thirty
Occasional Papers 6. New York: Group of Thirty, 1981.
This article surveys the role of intervention. It
earlier arguments that sterilized intervention may
signalling future monetary policy. It argues that
for intervention on the grounds that central banks
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- 34
and knowledge not available to private market participants. In
particular, a central bank has the ultimate control over the supply of
domestic money and knows about future monetary policy that is not
available to market participants. Thus a central bank can use its
knowledge of its own future policy to guide its speculations in foreign
exchange and if the need arises can use its control over monetary
policy to guarantee the success of its speculations.
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V. Descriptive Studies of Particular Episodes of Intervention
This section includes descriptive studies of particular episodes of
intervention.
Group.
Three of these studies were written for the G-7 Working
These studies discuss the objectives and effects of U.S.
intervention operations for several important episodes during the period of
floating dollar rates before 1982 both from the perspective of the U.S.
monetary authorities at the time the operations were undertaken and from the
perspective of the U.S. authorities at the time of the G-7 Working Group.
The other two studies have a different focus.
The Funabashi study
gives a behind-the-scenes account of Plaza Agreement of September 1985
through the Louvre Accord of February 1987.
The Obstfeld study, on the
other hand, examines the intervention policies and macroeconomic policies of
the United States in order to explain the movement of the dollar during the
1980s.
Funabashi, Yoichi. Managing the Dollar: From the Plaza to the Louvre,
Washington D.C.: Institute for International Economics, 1988.
This book is a case study of the policy coordination involved in the
G-5 Plaza strategy, focusing primarily on the United States, Germany,
and Japan. The time frame is roughly the period from the Plaza
agreement in September 1985 to the Louvre Accord, in February 1987.
The book has three objectives. The first objective is to account for
the Plaza strategy as it evolved, using interviews and reports with the
leading people involved. The second objective is to explain the events
in the context of both domestic and international politics. The third
objective is to analyze the Plaza agreement in terms of its
implications for international economic policy coordination.
Greene, Margaret L. U.S. Experience with Exchange Market Intervention:
January - March 1975. Staff Studies 127. Washington: Board of Governors of
the Federal Reserve System, September 1983.
This is one of the studies for the G-7 Working Group. This study
covers the first major episode of the U.S. exchange market intervention
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36 in the period of floating rates. The United States, Germany and
Switzerland intervened in late 1974 and early 1975 to moderate the
dollar's depreciation against European currencies and to counter
disorderly market conditions. In February 1975, the first large-scale
These operations appear to have
concerted intervention began.
achieved the objective of the U.S. authorities because the pattern of
daily declines ended. However, the trend of dollar movements appears
not to have been reversed until the market became convinced that the
U.S. economic performance was improving relative to those of other
countries.
. U.S. Experience with Exchange Market Intervention:
September 1977 - December 1979. Staff Studies 128. Washington: Board of
Governors of the Federal Reserve System, September 1983.
This is one of the studies for the G-7 Working Group. This case study
examines several episodes of U.S. intervention during the roughly two
years between September 1977 and December 1979. At various times
between September 1977 and December 1979 U.S. authorities shifted their
intervention tactics and other polices to meet their changing exchange
market objectives. In addition, the Federal Reserve's operating
procedures were changed in October 1979 and there was a the subsequent
tightening of money market conditions. In general, the evidence from
this period suggests that, while intervention was successfully used as
a short-run tool to stabilize trading conditions and provide time to
make policy adjustments, it did not have a lasting positive impact in
the face of persistent, adverse fundamentals.
U.S. Experience with Exchange Market Intervention:
October 1980 - September 1981. Staff Studies 129. Washington: Board of
Governors of the Federal Reserve System, September 1983.
This is one of the studies for the G-7 Working Group. This case study
covers the year between October 1980 and September 1981. The period
includes two subperiods: October 1980-February 1981 and April 1981 to
mid-August 1981. During both of these subperiods the dollar
appreciated by about 20 percent against the German mark. During the
first rise in the dollar the U.S. authorities sought to take advantage
by acquiring currencies to repay outstanding foreign-currency
commitments. The second run-up of the dollar occurred after the U.S.
Treasury decided not to intervene in the market. Evidence of the role
of intervention in this period on volatility of exchange rates was
ambiguous.
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Obstfeld, Maurice. "The Effectiveness of Foreign-Exchange Intervention:
Recent Experience," NBER Working Paper 2796, (December 1988).
This paper is summarized in Section III.
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VI.
Studies of the Profitability of Intervention 1 1
This section discusses the literature that analyzes profitability as a
measure of the effectiveness of intervention in stabilizing exchange rates.
This argument can be traced back to Milton Friedman.
Friedman argues that
the criterion with which to evaluate a central bank that is trying to
stabilize foreign exchange markets should be the same as that of a private
speculator: profitability.
In this context, stabilizing speculation is
defined to reduce price volatility while destabilizing speculation is
generally interpreted to mean greater price volatility than would otherwise
have been the case.
Friedman's proposition raises several theoretical
issues: whether destabilizing speculation is synonymous with losses by
speculators and stabilizing speculation always associated with
profitability, and whether welfare increases as a result of reduced price
volatility.
Much of the early debate on the relationship of profitability of
speculation and stability of prices was inconclusive.
Depending on their
assumptions some studies showed that profits could be associated with
increased price variability and some showed losses could be possible with
reduced price variability.
Discussion about the profit criterion generally
shifted from the ambiguous relationship between profitability and price
stability to the general welfare effects of the profits (or losses) that
arise from speculation.
In addition to some unsolved theoretical questions, there are
substantial practical problems in trying to calculate profits made from
11. For a more detailed discussion on Profitability of Intervention see
the Task Force paper entitled: "Profits and Losses in U.S. Foreign
Currency Operations".
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central banks intervening in the foreign exchange market.
The emphasis of
the reviews contained here will be on these practical issues rather than on
the interpretation of the results in regard to the effectiveness of
intervention.
Most of these studies use different methods with which to
choose the time period for their calculations and to deal with the related
problem of valuing changes in the stock of foreign assets.
Dramatically
different results arise from altering various assumptions.
Jacobson, Laurence R. Calculations of Profitability for U.S. Dollar-Deutsche
Mark Intervention. Staff Studies 131. Washington: Board of Governors of the
Federal Reserve System, September 1983.
This is one of the studies for the G-7 Working Group. The paper
reviews the literature that analyzes profitability and calculates the
profits on dollar-mark intervention from 1973 to 1981.
The author calculates profits using different formulas. For some
comparisons to the earlier literature, profits are calculated as the
dollar value of foreign currency purchased since the initial period,
evaluated at end-of-period exchange rates, less its initial dollar
cost. For the entire period 1973-81, using this formula, net profits
are $289 million. However, the evaluation from 1973-79 shows a loss of
$500 million. This loss is a consequence of the revaluation of large
net dollar purchases at the dollar's historic low. These differences
in results indicate how profit calculations are sensitive to the choice
of time period. This result also sheds some light on the results of
earlier work by Taylor -- summarized below.
The author also calculates profits for eight subperiods in which net
intervention is nearly zero. These calculations also include net
interest earnings. Profits are positive for all but one subperiod when
the differential between the U.S. Treasury bill rate and the German
interbank rate is used to calculate net interest earnings. They are
positive for all subperiods when the forward discounts are used.
Including net interest earnings increases measured profits
significantly. Almost 90 percent of gross daily intervention occurred
during one subperiod, October 1977 to January 1981. Profits calculated
for this episode are close to the total calculated for the entire
period. Moreover, net interest earnings in this subperiod constitute
more than half the total profit figure: the United States gained by
issuing mark debt at interest rates substantially lower than dollar
interest rates.
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Leahy, Michael P. "The Profitability of U.S. Intervention"
International
Discussion Papers 343. Washington: Board of Governors of the Federal Reserve
System, February 1989.
This study evaluates the profitability of U.S. intervention. It offers
a method of calculating profits that differs from earlier studies in
that it computes net interest earnings using a general formula; other
formulas are shown to be variants of a first order approximation.
In general, the results of these calculations show that since 1973 the
monetary authorities in the United States have earned profits. It is
estimated that the combined net worth of the Federal Reserve and the
U.S. Treasury increased due to intervention by $5.5 billion from 1973
to January 1988.
The results of these profit calculations indicate that the calculations
are extremely sensitive to changes in sample periods and end-of-period
exchange rates. For example, U.S. dollar-mark intervention from
September 1985 to December 1985 yielded profits of $161 million.
Extending the calculation period to the end of the next year -- when no
intervention was done -- yields a much larger estimates for profits,
$716 million. Profits increased because the dollar continued to
decline in 1986, by more than the depreciation implicit in the dollarmark interest rate differential, raising the dollar value of the longmark position that had accumulated by the end of 1985 more than enough
to offset the deterioration of the short dollar position.
The study also reports that dollar-yen intervention during the first 15
years of the floating rate period was profitable -- $1,172 million.
Studying the various subperiods are limited for the yen because the
U.S. intervention in the yen was minimal until 1978. It is important
to note that this study does report some periods where the central bank
incurs losses. During the period January 1981 to January 1985, U.S.
intervention in the yen showed losses of $1,426 million.
Murray, John, and others. "Measuring the Profitability and Effectiveness of
Foreign Exchange Market Intervention: Some Canadian Evidence," Unpublished
paper, Ottawa: Bank of Canada, May 1989.
This paper presents empirical evidence on the profitability of Canadian
intervention over the period 1975 to 1988. This study incorporates
many of the refinements to the calculation of profits that are
suggested in the Leahy study.
The authors calculate profits over nine different sample periods. The
first included the full sample, July 1, 1975 to June 30, 1988. The
remaining eight were run over various subperiods. The results suggest
the Canadian foreign exchange market intervention has been very
profitable over the post Bretton Woods period. They show that total
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profits on trading and investment income generated C$1,625 million in
net profits. More than 78 per cent of these returns came from net
interest earnings. Although large net profits were reported for the
period as a whole, substantial trading losses were realized through
most of the 1980s.
Taylor, Dean. "Official Intervention in the Foreign Exchange Market, or, Bet
Against the Central Bank," Journal of Political Economy, vol. 90 (April
1982), pp. 256 - 68.
This is one of the earlier studies on profitability of central bank
intervention. The paper examines nine major industrial countries -Canada, France Germany, Italy, Japan, Spain, Switzerland, the United
Kingdom, and the United States -- using monthly data to investigate the
profitability of central bank intervention from the early 1970s, at the
start of the floating exchange rate period, through the end of 1979.
The author defines profits of the foreign central banks as the sum of
dollars purchased less the sum of the dollar value of domestic currency
sold. It excluded valuation changes in the assets initially held, the
losses incurred due to the inflow or outflow of reserves just prior to
the unpegging of the exchange rate, and net interest income.
According to the estimates in the paper, central banks lost between $11
billion and $12 billion over the entire period. The paper also reports
profits and losses for various subperiods. Generally, the central
banks studied show a loss for subperiods of 4 to 5 years. The profits
and losses for an individual country varied substantially depending on
the dates that are used to begin and end the calculations.
These results lead the author to claim that intervention was
necessarily costly to central banks and probably deceitful to foreign
exchange markets, though there appears to be little empirical basis for
the latter conclusion.
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- 42 VII. Studies of Factors Prompting Intervention and of the Extent of
Sterilization of Intervention
This section includes studies of the factors that have prompted
intervention and of the extent to which intervention has been sterilized.
In these studies, the researchers estimated policy reaction functions for
intervention operations and for conventional open market operations.
The
researchers who analyzed intervention behavior found that intervention was
undertaken to smooth nominal and real exchange rates, to achieve a target
Most of the
level of the nominal exchange rate, and for some other reasons.
researchers who analyzed sterilization behavior found that a large part of
intervention had been sterilized.
Blundell-Wignall, A and P. R. Masson. "Exchange Rate Dynamics and
Intervention Rules," International Monetary Fund Staff Papers, vol. 32
(March 1985), pp. 132 - 59.
This paper is summarized in Section III.
Gartner, Manfred. "Intervention Policy Under Floating Exchange Rates: An
Analysis of the Swiss Case," Economica, vol. 54 (November 1987), pp. 439 53.
This study evaluates the Swiss National Bank's intervention. It
considers two motivations: smoothing of short-run fluctuations of the
exchange rate ('leaning against the wind') and exchange rate targeting.
In this study no attempt is made to distinguish between sterilized and
nonsterilized intervention. It instead attempts to explain Swiss
National Bank foreign exchange market intervention by modelling a
reaction function using the Swiss franc-dollar exchange rate from
January 1974 to June 1986. The empirical estimates of the reaction
function, using instrumental variables to take account of simultaneity,
reveal that the Swiss National Bank leans not only against today's
wind, but also uses intervention to target the exchange rate.
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Kearney, Colm, and Ronald MacDonald. "Intervention and Sterilisation under
Floating Exchange Rates: the UK 1973 - 1983," European Economic Review, vol.
30 (April 1986), pp. 345 - 64.
This paper is summarized in Section III.
Neumann, Manfred J. M. "Intervention in the Mark/Dollar Market: the
Authorities' Reaction Function," Journal of International Money and Finance,
vol. 3 (August 1984), pp. 223 - 39.
This paper investigates the intervention behavior of the Bundesbank
using a central bank reaction function for the dollar-mark exchange
rate over the period March 1974 to December 1981. The intervention
data are those provided by the Bundesbank. The reaction function
depends on: (i) the difference in the actual dollar-mark exchange rate
from its target rate (various alternative formulations of exchange rate
targets are considered), (ii) the expected risk premium, (iii) current
account surplus, and (iv) the difference in base money from its target.
Two findings reported in this study are striking.
In contrast to the
Obstfeld (1983) study, this paper reports evidence that the Bundesbank
does not fully sterilize its exchange rate intervention. Secondly, it
finds that the Bundesbank shifts in favor of achieving its monetary
targets with perceived increases in exchange rate uncertainty.
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VIII.
Studies That Do Not Make Use of Data on Bond Supplies or Intervention
This section includes two types of empirical studies that do not make
use of data on bond supplies or intervention:
(1) studies of the joint
hypothesis that domestic and foreign bonds are perfect substitutes and that
exchange rate expectations are rational and (2) studies of maximizing models
with imperfect substitutability between domestic and foreign bonds.
The maximizing models with imperfect substitutability in the studies
included in this Section are asset pricing models.
One example is the
consumption-based asset pricing model in which the consumption-saving and
portfolio allocation decisions are interdependent.
In this model a key
determinant of ex post asset returns is the conditional covariance between
asset returns and the rate of change in consumption.
Although domestic and
foreign bonds are imperfect substitutes in this model, sterilized
intervention has no effect.
Changes in the bond holdings of the authorities
do not alter the covariance of asset returns denominated in different
currencies with consumption.
Empirically, tests for imperfect substitutability of domestic and
foreign bonds conducted without using data on bond supplies have yielded as
little evidence in favor of imperfect substitutability as tests conducted
using such data.
A. Studies of the Joint Hypothesis
Baillie, Richard T. and others. "Testing Rational Expectations and
Efficiency in the Foreign Exchange Market," Econometrica, vol. 51 (May
1983), pp. 553 - 63.
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- 45 Cumby, Robert E. and Maurice Obstfeld. "A Note on Exchange-Rate Expectations
and Nominal Interest Differentials: A Test of the Fisher Hypothesis,"
Journal of Finance, vol. 36 (June 1981), pp. 697 - 703.
Giovannini, Alberto and Phillipe Jorion. "Interest Rates and Risk Premia in
the Stock Market in the Foreign Exchange Markets," Journal of International
Money and Finance, vol. 6 (March 1987), pp. 107 - 23.
Hansen, Lars P. and Robert J. Hodrick. Forward Exchange Rates an Optimal
Predictor of Future Spot Rates: An Econometric Analysis," Journal of
Political Economy, vol. 88 (October 1980) pp. 829 - 53.
Hsieh, David. "Tests of Rational Expectations and No Risk Premium in Forward
Exchange Markets," Journal of International Economics, vol. 19 (August
1984), pp. 173 - 84.
Korajczyk, Robert A. "The Pricing of Forward Contracts for Foreign
Exchange," Journal of Political Economy, vol. 93 (April 1985), pp. 346 - 68.
Levich, Richard. "On the Efficiency of Markets for Foreign Exchange," in
Rudiger Dornbusch and Jacob Frenkel, eds., International Economic Policy:
Theory and Evidence, Baltimore: The Johns Hopkins University Press, 1979.
Tryon, Ralph W. "Testing Rational Expectations in Foreign Exchange Market,"
International Finance Discussion Paper 139, Washington: Federal Reserve
Board, 1979.
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B. Studies of Maximizing Models with Imperfect Substitutability
Campbell, John Y. and Richard H. Clarida. "The Term Structure of Euromarket
Interest Rates: An Empirical Investigation," Journal of Monetary Economics,
vol. 19, (January 1987), pp. 25 - 44.
Domowitz, Ian and Craig Hakkio. "Conditional Variance and the Risk Premium
in the Foreign Exchange Market," Journal of International Economics, vol. 19
(August 1985), pp. 47 - 66.
Giovannini, Alberto and Phillipe Jorion. "The Time-Variation of Risk and
Return in the Foreign Exchange and Stock Markets," Journal of Finance, vol.
64 (June 1989), pp. 307 - 325.
Hansen, Lars P. and Robert J. Hodrick. "Risk Averse Speculation in the
Forward Foreign Exchange Market: An Econometric Analysis of Linear Models,"
in Jacob A. Frenkel, ed., Exchange Rate and International Macroeconomics.
Chicago: University of Chicago Press for National Bureau of Economic
Research, 1983.
Hodrick, Robert J. The Empirical Evidence on the Efficiency of Forward and
Futures Foreign Exchange Markets. Fundamentals of Pure and Applied Economics
24. Chur, Switzerland: Harwood Academic Publishers, 1987.
Hodrick, Robert J. and Sanjay Srivastava. "The Covariation of Risk Premiums
and Expected Future Spot Exchange Rate," Journal of International Money and
Finance, vol. 3 (April 1984), pp. 1 - 29.
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Mark, Nelson C. "Time Varying Betas and Risk Premia in the Pricing of
Forward Exchange Contracts," Journal of Financial Economics, vol 22
(December 1988), pp. 335 - 354.
Robichek Alexander A. and Mark R. Eaker. "Foreign Exchange Hedging and the
Capital Asset Pricing Model," Journal of Finance, vol. 33 (June 1978) pp.
1011 - 18.
Roll, Richard and Bruno Solnik. "A Pure Foreign Exchange Asset Pricing
Model," Journal of International Economics, vol 7 (May 1977), pp. 161 - 80.
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IX. The Effect of Intervention on Interest Rate Volatilityl2
This note investigates whether official intervention in the foreignexchange market affects the volatility of, or uncertainty about, U.S.
interest rates.
present.
The period studied extends from October 1982 to the
First, we look at monthly standard deviations of daily changes in
U.S. short-term interest rates, long-term interest rates, and the weightedaverage value of the dollar.
Since volatility is not a scale-free measure
and can vary with the overall level of interest rates, we also calculate the
corresponding coefficient of variation.
We divide the months into those
with no U.S. foreign-exchange intervention (39 months), those with light
intervention (greater than zero but less than $100 million; 10 months),
those with moderate intervention ($100-$500 million; 19 months), and those
with heavy intervention (above $500 million; 20 months).
We find that, by
either measure, interest rates are no more volatile in periods of heavy or
moderate intervention than in periods of little or no intervention.
Standard Deviation
Weighted-average
dollar
3-month CD
10-year Treasury
Zero
intervention
0.15
0.16
1.31
Light
intervention
0.20
0.16
1.35
Moderate
intervention
0.16
0.15
1.28
Heavy
intervention
0.13
0.14
1.17
12. Section IX and Appendix I have been prepared by Paul Wood, Division
of International Finance, Board of Governors.
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- 49 Coefficient of Variation
Weighted-average
dollar
3-month CD
10-year Treasury
Zero
intervention
0.019
0.017
0.011
Light
intervention
0.022
0.014
0.010
Moderate
intervention
0.018
0.015
0.011
Heavy
intervention
0.016
0.016
0.012
Next, if intervention contributes to uncertainty about interest
rates, or increases the variance of interest rates, then its inclusion
should reduce the forecast error in an equation forecasting interest
rates.
A first-order auto-regressive process is used to forecast
interest rates.
To alleviate potential simultaneity bias, we use lagged
daily intervention.
We also use cumulated intervention for the previous
5 business days to allow for any effects of sustained intervention.
Neither of those two measures of intervention proves to be a significant
factor in explaining the behavior of U.S. interest rates.
There may be
omitted variables which might help explain interest rates but, to the
extent that those variables are significant, their inclusion would only
make it more difficult for intervention to show a significant effect.
CDrate = 0.0126 + 0.9984 CDrate(-l) - 0.0025 Intervention(-l)
(-0.72)
(1.11)
(738.6)
CDrate = 0.0136 + 0.9983 CDrate(-l) - 0.0010 CumulatedIntervention(-l)
(-0.93)
(729.0)
(1.19)
TenYear = 0.0081 + 0.9990 TenYear(-l) + 0.0022 Intervention(-l)
(0.73)
(891.4)
(0.63)
TenYear - 0.0088 + 0.9990 TenYear(-l) + 0.0014 CumulatedIntervention(-l)
(0.79)
(882.4)
(1.27)
The t-statistic is in parenthesis.
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Appendix 1: Intervention and the Volatility of Interest Rates
Table Al:
Months with Zero Intervention
Coefficient of Variationa
Dates
Dates
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Sep
Feb
Mar
Apr
Jun
Jul
Aug
Nov
Dec
Apr
May
Jun
Jul
Aug
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Feb
Jul
Feb
May
Average:
Monthly U.S.
Intervention
(in millions
of dollars)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
3-month
CD
rate
0.023
0.014
0.022
0.019
0.032
0.024
0.025
0.016
0.019
0.014
0.025
0.007
0.023
0.012
0.005
0.030
0.037
0.029
0.035
0.018
0.019
0.006
0.014
0.010
10-year
Treasury
yield
yield
TradeWeighted b
U.
S Dollar
U.S
Dollar
b
0.010
0.010
0.017
0.023
0.013
0.009
0.019
0.011
0.011
0.010
0.016
0.009
0.010
0.003
0.007
0.005
0.006
0.015
0.014
0.013
0.013
0.009
0.014
0.022
0.006
0.016
0.011
0.018
0.030
0.020
0.021
0.018
0.028
0.008
0.020
0.016
0.035
0.022
0.033
0.022
0.015
0.015
0.012
0.028
0.008
0.009
0.013
0.008
0.005
0.015
0.008
0.017
0.014
0.007
0.021
0.009
0.006
0.009
0.024
0.011
0.017
0.008
0.008
0.015
0.007
0.013
0.029
0.017
0.012
0.009
0.005
0.008
0.012
0.009
0.011
0.005
0.006
0.005
0.006
0.019
0.017
0.011
0.044
0.021
0.014
0.010
0.033
0.016
0.010
0.008
0.044
0.014
0.023
0.023
0.014
0.012
a. Monthly standard deviation of daily data divided by the monthly mean.
b. Against the other G-10 currencies plus the Swiss franc.
STRICTLY CONFIDENTIAL (FR)
Class I-FOMC
Authorized for public release by the FOMC Secretariat on 1/31/2020
51 Table A2:
Months with Light Intervention
Coefficient of Variationa
Dates
Dates
Oct
Jul
Oct
Nov
Dec
Oct
Jan
Mar
Jan
Nov
Average:
Monthly U.S.
Intervention
(in millions
3-month
CD
of dollars)
rate
of dollars)
-91.0
-24.7
-9.6
-20.0
-50.0
-95.0
-94.0
-97.5
50.0
-50.0
rate
10-year
Treasury
yield
yield
TradeWeighted b
U.S.
Dollarb
U.S. Dollar
0.070
0.011
0.006
0.007
0.019
0.051
0.010
0.019
0.009
0.014
0.036
0.015
0.012
0.008
0.007
0.024
0.008
0.008
0.006
0.007
0.006
0.005
0.006
0.007
0.010
0.004
0.028
0.021
0.008
0.022
0.014
0.010
0.019
a. Monthly standard deviation of daily data divided by the monthly mean.
b. Against the other G-10 currencies plus the Swiss franc.
STRICTLY CONFIDENTIAL (FR)
Class I-FOMC
Authorized for public release by the FOMC Secretariat on 1/31/2020
- 52 -
Months with Moderate Intervention
Table A3:
Coefficient of Variation a
Monthly U.S.
Intervention
(in millions
Dates
Aug
Jan
May
Sep
Feb
Sep
Nov
May
Sep
Oct
Mar
Apr
Sep
Oct
Dec
Feb
Apr
Jul
Dec
Average:
of
dol1ars)
-229.3
-143.4
135.0
-185.0
-451.3
-408.0
-102.2
293.0
335.0
460.3
318.0
500.0
-392.3
200.0
300.0
-350.0
-270.0
-230.0
-100.0
3-month
CD
rate
10-year
Treasury
yield
TradeWeighted b
U.S. Dollar
0.019
0.010
0.026
0.021
0.019
0.011
0.008
0.024
0.031
0.069
0.005
0.012
0.009
0.006
0.008
0.026
0.010
0.017
0.009
0.018
0.007
0.025
0.015
0.018
0.010
0.013
0.019
0.014
0.052
0.017
0.013
0.009
0.007
0.008
0.016
0.009
0.010
0.007
0.009
0.005
0.006
0.014
0.020
0.032
0.010
0.009
0.006
0.016
0.008
0.006
0.005
0.017
0.011
0.008
0.005
0.008
0.013
0.018
0.015
0.011
a. Monthly standard deviation of daily data divided by the monthly mean.
b. Against the other G-10 currencies plus the Swiss franc.
STRICTLY CONFIDENTIAL (FR)
Class I-FOMC
Authorized for public release by the FOMC Secretariat on 1/31/2020
-53 -
Table A4:
Months with Heavy Intervention
Coefficient of Variation
Dates
Oct
Mar
Apr
Jun
Aug
Nov
Dec
Jan
Jun
Jul
Aug
Nov
Jan
Mar
May
Jun
Aug
Sep
Oct
Jan
Average:
Monthly U.S.
Intervention
(in millions
of dollars)
-2790.7
2405.2
1628.4
513.0
-601.3
1217.0
2208.0
715.0
-535.0
-2429.7
-1815.2
2100.0
-1880.0
-1618.1
-6735.0
-4952.0
-1020.0
-3081.0
-1770.0
-600.0
3-month
CD
10-year
Treasury
yield
TradeWeighted b
U.S.
U.S. Dollar
yield
0.007
0.010
0.033
0.008
0.010
0.024
0.028
0.017
0.010
0.019
0.020
0.033
0.004
0.013
0.019
0.011
0.021
0.009
0.023
0.005
0.012
0.013
0.040
0.018
0.013
0.011
0.016
0.026
0.011
0.012
0.015
0.016
0.013
0.009
0.024
0.015
0.020
0.009
0.015
0.017
0.005
0.009
0.007
0.007
0.017
0.011
0.016
0.012
0.019
0.008
0.007
0.014
0.012
0.008
0.022
0.013
0.016
0.017
0.010
0.008
0.016
0.016
0.012
rate
Dollar
a. Monthly standard deviation of daily data divided by the monthly mean.
b. Against the other G-10 currencies plus the Swiss franc.
STRICTLY CONFIDENTIAL (FR)
Class I-FOMC
Authorized for public release by the FOMC Secretariat on 1/31/2020
@FedFRASER