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El Paso· Houston· San Antonio

December 1978

The Role of Productivity Gains
in Solving National Economic Problems


A Diminished Role for the Dollar as a Reserve Currency?


Fed Completes National EFT Network


The Community Reinvestment Act and Regulation BB

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (

The Role of Productivity
Gains in Solving National
Economic Problems

Remarks by

G. William Miller, Chairman
Board of Governors of the Federal Reserve System
WashingtoD, D.C.

before the
American Productivity Center
Productivity Conference
New York, New York
Octoher 3, 1978

Inflation is a clear and present danger which affect s aU our lives and all our opportunities. As far
as monetary policy is concerned, the emergence
ea rly this yea r of inflation as a more virulent threat
to our system has placed enormous responsibilities
on the Federal Reserve. Monetary policy must and
w ill be used to restrain inflation, but it needs support from other economic policies in order to
avoid undesirable side effects. The task the central
bank has set out for itself is to use prudent monetary policy to restrain the forces of inflation, by
bringing down the rate of growth of the money
supply, but to do so without triggering a recession
that would work against the overall objective. It
is reassu ring to note that earlier this year, when
December 19781Voice

it became apparent that the effort would not be
left to mone tary policy alone, positive initiatives
were taken by the Administration and by the Can·
gress. There have been substantial changes toward
a more restrictive fiscal policy to help bring down
the rate of inflation.
With this as background, I am particularly
pleased to be here to participate in this conference
on prod uctivity. An initiative to achieve productivity gains is one that we can all endorse and ag·
gressively support. A successful effort to improve
economic efficiency will directly offset the upward
cost pressures on prices. It will tend to make our
output more competitive in international markets,
and thus improve our balance of trade and help
stem the deterioration of the dollar in the currency exchange markets. It will contribute to long·
range increases in our economic capacity and in
our standard of living. Unless the economy's productivity expands at a faster rate, we will be
unable to reduce unemployment without igniting
inflation. Increased productivity is the best prospect for breaking the vicious cycle of wages chasing prices and prices chasing wages.
Because it is imperative that we act now to
achieve such benefits as we can from increased
productivity, it is well worth our time today to
look at some of the historical trends and to discuss some of the public policies that could accelerate such gains.
History shows that productivity gains have been
a key factor in our economic growth and in our
rising standard of living. Output per work hour


Output Per Hour. Private Business Sector


1947-1967 TREND



SOURCE: Board 01 Governor., Flder.' Re •• rwI S,alem.

in the private sector rose more than 125 percent
over the past 30 years. The bulk of the improvement, however, occurred between 1947 and 1967.
During that period, output per hO,ur doubled. Since
1967, output per hour has risen less than one-fifth,
only about half the average pace prior to 1967.
Chart 1 shows that output per hour is now well
below its postwar trend. Even before the oil embargo and the recession of 1974-75, the rate of
productivity growth had slowed down. Prior to
1967 the annual rate of growth was ahout 3 1/s percent; in the years 1967-72. it was only ahout 2 percent. Other things being equal, this added more
than a full percentage point to the rise in unit labor
costs. Such increases in costs are eventually re2

flected in final prices, and that was certainly the
experience in the 1967-72 period. While we
thought in those years that 2 percent was a weak
performance, in the following five years things
have gotten much worse. Coincident with the
quintupling of oil prices and the deep recession
of 1974-75, productivity fell into an unusually long
and deep decline.
Chart 2 shows how output per hour has lagged
during this recovery cycle. Its eventual upturn was
so belated and so mild that by 1977, output per
hour was up only 6 1/ 2 percent from the 1972 level.
That amounts to an average annual gain of only
11/3 percent. Think about that for a moment: an
average efficiency gain of only 11/3 percent a year,
Federal Reserve Bank of Dalla.

little more than one-third the pace in the two
decades ending in 1967. Even if wages and salaries had remained stable-and, of course, they
did not-the productivity slowdown would have
added 2 percentage points to the rise of unit labor
costs. The result is a commensurate impetus to
During the years of strong productivity gains,
workers and their fam ilies became accustomed to
generous increases in their real incomes. America's standard of living rose dramatically; average
work schedules were shortened : leisure time was
increased. Over time, we came to expect an annual improveme nt in our real incomes. In fact, an
allowance of 3 percent or more in productivity
gains was included in the wage-price gUidelin es
set in the Kennedy Administration in the early
1960's. These expectations of regular and sizable
increases in the average standard of living were
subsequently frustrated.
As productivity growth slowed, real income
gains began to fall below individual and collective
expectations. This had serious consequences for
inflationary pressures. In an effort to sustain past
pa tterns of real income growth, wages were
pushed up, setting in motion a cycle of intense
upward pressure on costs and prices. This occurred despite high levels of unemploym ent and
excess industrial capacity. Thus the slowing of
productivity growth helped trigger a spiral of
inflationary wage-price adjustments throughout
the economy.
The lower rate of productivity growth and the
higher rates of inflation at home have contributed
to the imbalance of our trade with other nations.
Growth of productivity in th e United States has
been slower than that of most of our major international trading partners, making us less competitive in the international arena. Slow growth of
our exports has contributed to the decline in the
exchange value of the dollar. which in turn has
fueled domestic infl ation both directly and indirectly. Higher dollar prices for imports raise consumer prices directly, while domestic producers of
competitive goods can raise their prices with less
fear of losing market shares. The resulting inflation further saps confidence in the dollar. It also
contributes to a lower value of the dollar in a
self-reinforcing phenomenon. It is critical that we
break this spiral.
Perhaps it would be worthwhile to review the
trends that sustained the productivity ga in s in
the private sector from 1947 to 1967 and to comDecember 1978/Voice


Cyclical Comparisons of Output
Per Hour, Private Bu siness Sector '



100 f-- , L--/-=----------l



19 78

• Cl>anges l ollowing Il>e cyclical peaks as speci l ied
by NBER.
SOURCE: Board 01 Governors. Federal Reserve Syslem .

pare them with the developments of the last
The first two decades of the postwar era were
marked by significant development and expansion
of new technology and improved methods of operation accompanied by high rates of capital formation. Significant advances in the quality of the
wo rk for ce also occurred. There was a shift of
resources from low- to higher-productivity sectors.
Underlying some of these factors were substantial
investments in research and development and in
workers' educations. After 1967, however, the
economic and demographic trends that supported
su bstantial efficiency gains became much less favorable. and new trends emerged that tended to
retard the growth of productivity.
A crucial factor in the slow rate of efficiency
improvement has been a slackening in the introduction of new technology or, to put it more broadly, in the application of new ideas and improved
ways of doing things. The effect of technology on
productivity is usually associated with equipment
and materials, such as an electronic device that
vastly expands data processing capabilities or a
new chemical that can help multiply crop harvests.



Average Annual Growth
of the Capital Stock








1972 · 1977

• Private non residential nel capital stock mellSured
in cons tant. dollars.
SOURCE: Board 01 Governors. Federal Reserve


But just as important are new management techniques that greatly improve the application and
organization of resources, whether of labor, physical capital, or financial resources. But no matter
what the form of advance in human knowledge,
it frequently requires significant investment in
new plant and equipment in order to exploit full y
the opportunities presented.
Yet we have failed to maintain an adequate rate
of capital accumulation and investment. Indeed
the nation's stock of capita l expanded at an annual rate of only 2.8 percent over the past five
years, barely half the rate over the preceding
decade . Chart 3 shows thi s progressive and disturbing decline.
Capital accumulation per member of the labor
force has slowed even more dramatically. Compared to 1974-75, the amount of capital per person in the labor force ha s actually declined. This
can be seen in Chart 4. At the same time, the

share of capital inveshnent devoted to environmental compliance has increased, and the imposition of environmental standards may have
caused practical obsolescence of some existing
plant and equipment.
In a similar vein, the massive increase in the
price of energy clearly has shortened the economic
life of some of our capital stock. So, in many ways,
the data on the accompanying charts understate
the problem that we face.
Another reason for the slower pace of productivity growth was the huge flood of inexperienced
workers into the lahar force. The figures are stagge ring. Nearly 15 million more young people and
women were in the labor force in 1977 than in
1967. They accounted for nearly four-fifths-a!most 80 percent-of the overall expansion of the
work force over th e decade. Even though these
new workers enjoyed the best health, the highest
educational attainment, and the best working conditions in our history, they stilI had to learn skills
and accumulate experience before they could
achieve the same productivity as employees with
long tenure in a particular trade.
Improving the efficiency of the economy under
these circumstances demands a comprehensi ve,
forward-looking program-a program that will restore a climate fa vorable to productivity growth.
Its principal elements must include, first, a commitment to conquer inflation so that investment
plans can be made in an environment of more
certainty and, second, greater economic incentives
for private investment.
The nation's tax policies have not offered adequate incentives for new capital investment. In
particular, depreciation allowances are nol adequate to provide cash flow s sufficient to encourage
increased fixed investments in today's conditions,
nor to offset the substantial risk of obsolescence.
Higher inflation has made it extremely difficult
for firms to predict forward costs and prices and
thus has shaken confidence in business forecasts
of financial conditions and general economic activity. Facing a less reliable calculation of the real
cost of capital and of expected revenues, prudent
businessmen set high requirements for prospective
returns on investment. Capital spending inevitably
is retarded.
Because we have been neglecting capital accumulation, a larger share of GNP must now be
devoted to capital investments. Raising the amount
of capital per worker will have a favorable impact
on productivity in its own right. Also, since new
Federal Rel.rve Bank of Dallas

Ratio of Capital Stock to Labor Force


1947-1967 TREND









SOURCE: Board 01 Governors, Federal Reserve System.

capital also generally embodies new technologies,
there should be an extra increment to efficiency
gains. Newer equipment and structures utilize
energy more efficientIy, and the resulting conservation and cost savings will contribute to achieving our overall goals.
However, it is not enough simply to reach the
past peak levels of 101 /: or 11 percent of GNP,
reflected in Chart 5. The nation should set an
ambitious objective for capital investment of, say.
12 percent of GNP for an extended period of time
in order to enable us to make up for past deficiencies and to narrow the gap between our performance and that of our strong industrial competitors. The Japanese economy spends over 20
December 1978/Volce

percent of GNP on capital investment; West Germany 15 percent. It certainly would be appropriate
for us to seek a 12-percent level.
Another element in a long-term strategy aimed
at a high-growth, low-inflation economy is extensive reform of Federal regulatory activities. We
need to take a critical look at price-regulating
Government programs. Price regulation in the
marketplace tends to discourage or prevent full
competition, which is, after all, a powerful incentive for the development and adoption of the
most efficient techniqu es. In recent years there ha s
been a major increase in well-intentioned laws and
regulations aimed at protecting the environment
and promoting health and safety. These regula5

Ratio of Business Fixed Investment to GNP'



• 8 ••• d on eon,tant·dolla, data.
SOURCE: 80lOrd 01 Governor., Fada"ll Rese • ..,. 51,tam.

tions greatly influence when and where new productive capacity may be built and how firms
may operate. Just hiring the personnel necessary
to keep track of the rules, prepare the reports,
and attend the hearings has swollen overall costs
without any compensating increase in measured
In addition to requiring major expenditures,
these regulations create uncertainties about the
appropriate scale, location , and acceptability of
major new additions to or modernization of our
productive capacity. Protection of the environment
and of public health and safety must be a major
social goal. But the actual benefits of new forms of
protection must be careful1y weighed against the
cost to our economy of achieving them.
Another aspect of a forward- looking growth policy is to assure that our work force continues to
be ready to meet the cha ll enge of developing new
ideas and implementing new technologi es. Government employment and training programs
should be redesigned to provide effective skill

training and work experience to disadvantaged
workers. The emphasis on these programs should
be on training individuals for careers in the private sector. Younger people are affected more
severely than most othe r groups by high unemployment since early employment is essential for
that on-the-job training which lays the foundation
for a successful life career. With loday's very high
levels of unemployment among younger workers.
it is possible that unless we act vigorously. a larger part of that generation will be denied the opportunities to develop the skills. attitudes. and motivation they need to become productive participants in the adult work force and to experience
the self-satisfaction of personal accomplishment.
In addition to investing in human capital in the
forms of direct skill upgrading, we should improve
the links between the classroom and the world
of work and expand apprenticeships and similar
opportunities to assure that younger workers are
prepared to meet the needs of their private-sec tor
employe rs. Methods of raising workers' incentives
Federal Rnerve Baak of Dell••

to become more productive should also get more
attention. Stockownership incentives, profit sharing, labor-management productivity councils arc
possibilities that certainly warrant closer examination and further experimentation.
We need all these government actions and incentives. But even more we need a change in attitude among managers and workers; among all
citizens. America has always been a "can do"
nation characterized by an innovative and competitive spirit. I am convinced that a substantial
cooperative effort in the private sector, coupled
with a reorientation in tax and regulatory policy,
will stimulate productivity growth and will help
ease inflationary pressures without curtailing
growth. Such trends would be self-reinforcing, for
reduced inflationary expectations would enhance
confidence in our economic future. All this in turn
would lessen the burden on monetary policy in
the fight against inflation and improve the prospects for lower interest rates.
In the past few months we have learned a great
deal about the limits of government, the importance of coordinating government economic policies, and the importance of a stronger partnership
between government and th e private sector. Much
has been accomplished. Our fiscal program has



been changed so that the prospective deficit for
the year that began this week has been reduced
by over $22 billion, a significant contribution to
the fight against inflation. There has been cooperation with President Carter's deceleration program, although much more needs to be done and
the President intends to announce other anti-inflation actions. Progress has been made in establishing elements of a national energy policy that
will reduce our dependence on imported energy.
We have taken steps, both through short-term
bridging actions and in addressing the longer-term
fundamentals, to assure a sound and stable dollar, which is essential to our economic well-being.
But much more needs to be done. In the fight
against inflation, and in the campaign to raise productivity gains once again to the level that will assure increases in real incomes and increases in
our standard of living, we need to have the purpose, the determination, the constancy to implement effective long-range programs. We will need
to maintain our efforts for five to seven years in
order to achieve the economic goals of full employment, price stability, and a sound dollar. The
reward will be enhanced prospects for peace and
prosperity in the world.


"CPed Quotes~~
Brief Excerpts from Recent Federal Reserve Speeches, Statements, Publications, Etc.

"Although thrift institutions are not permitted to provide most services to
businesses, certain types of consumer lending, or trust services. it appears that other
factors diminish the importance of these activities in the overall delineation of the
product market. For example, studies have shown that loans to firms beyond a
relatively small size tend to be made in the regional or national market, rather than the
local market. Business can draw also on trade credit as another source of credit. This
suggests that the impact on competition of the proposed acquisition would be less
severe than in the absence of such factors. Other evidence that mortgage lending is
fungible and permits the financing of consumer expenditures through the mortgage of
homes implies that certain consumer credit services are in fact available from
thrifts. This likewise indicates that the competitive impact of the acquisition would be
less severe than in the absence of such factors. For these reasons. I would include
thrift institutions in the competitive analysis to a much greater extent than does the
majority in this case. I would conclude that. because thrifts now offer a diversified
group of banking products and services in direct competition with commercial banks.
the competitive strength of commercial banks is diminished. reducing the anticompetitive character of the acquisition."
Henry C. Wallich. Member. Board of
Governors of the Federal Reserve System
(Dissenting Statement. Federal Reserve Board
Order Denying Acquisition of Bank. October 3.
1978. in the matter of United Bank
Corporation of New York. Albany, New York)

"The quality of bank assets is refl ected by the volume of assets classified by bank
examiners and by the volume of non-earning assets being carried by ban ks. During
1977, the amount of classified assets of insured banks declined by about 10 percent.
after more than tripling between 1973 and 1975. Moreover, the amount of assets
classified by examiners as doubtful and loss-the two most serious classificationsdeclined by about 20 percent. Banks with assets exceeding $5 billion experienced
a slightly greater relative decline in classified assets than did the rest of the banking
system. However, these large banks still have a much higher level of classified
assets relative to their capital than do other banks.
"Other measures of bank asset quality also have shown marked improvement.
Available data indicate that nonperforming assets (which include non-accruing loans.
renegotiated loans, and real estate acquired in foreclosure) fell roughtly 15 percent last
year-despite a 13 percent rise in total bank assets."
G. William Miller, Chairman, and Philip E.
Coldwell , Member. Board of Governors of
the Federal Reserve System
(Statement before the Committee on Ba nki ng,
Housing, and Urban Affairs, U.s. Senate.
May 25 , 1978)

Federal Rewrve B.ak of o.n• •

"At the present time, the consumer often receives lengthy and complex Truth in
Lending disclosures interspersed among contractual provisions and disclosures
required by State laws. We believe that Truth in Lending cannot be truly effective
when the consumer is presented with discouragingly detailed and complicated
disclosures. Overwhelming the consumer cannot result in a better informed, creditconscious consumer; rather, it will result in a consumer who will often ignore all
disclosures and not attempt to digest the information provided."
Philip E. Coldwell, Member, Board of
Governors of the Federal Reserve System
(Statement before the Subcommittee on
Consumer Affairs of the Committee on
Banking, Finance and Urban Affairs, U.S.
House of Representatives, September 6, 1978)

"We must have the national courage to endure small evils or small catastrophes
without putting massive constraints on the freedom of the citizens to solve the
"The resulting evils of using massive constraints are much greater than enduring
the abuses of a few individuals."
Philip C. Jackson, Jr., Member, Board of
Governors of the Federal Reserve System
(American Banker, October 23, 1978)

"One continues to hear today the plea for gradualism for a slow return to less
inflationary times. Personally I have some reservations about this prescription because
I believe we are dealing heavily in a question of inflationary expectations. A gradual
move toward anti-inflationary actions or moves which will only gradually take effect
will stiIlleave the expectation of inflation almost untouched in the short run and, after
all, the long term is made up of a whole series of short term actions. Moreover,
unless actions are visibly credible, the international value of the dollar will continue to
erode and this too will place greater inflationary pressures on the United States."
"The basic problems [of inflation] are not likely to be addressed by guidelines or
controls. Instead the actions of the Federal Government through monetary and
fiscal policies still seem to provide the best answers for reducing inflation. One of our
basic problems has been that the United States' economy is led by the consumer.
Our consumers have learned to buy and to buy heavily saving only a small portion of
their total income. Part of this habit is caused by the fact that we pay the saver a
negative rate of interest. With the current inflation rate, someone placing funds in a
savings and loan or bank which is paying 5 or 51 /z percent rates of interest is
immediately losing 2 to 3 percent of the value of his money every year and is also
taxed on the nominal interest earned."
Philip E. Coldwell, Member, Board of
Governors of the Federal Reserve System
(Remarks at the Conference on Economic
Development, Troy, Michigan, October 19,
December 1978/Voice


Two New Directors Elected
Lewis H. Bond , Chairman of the Board and Chief
Executive Officer, Texas American Bancshares
Inc., Fort Worth, Texas, and J. Wayland Bennett,
Associate Dean for Industry Relations, College of
Agricultural Sciences, Texas Tech University,
Lubbock, Texas, have been elected to the Board of
Directors of the Federal Reserve Bank of Dallas.
Each director was elected for a term of three years
to begin January 1, 1979.

Bond was elected a Class A director by banks
in Group 1, which consists of member banks
with capital and surplus over $6 million. Bond
succeeds Robert H. Stewart, III, Chairman of the
Board, First International Bancshares, Inc., Dallas,
Bennett was elected a Class B director by banks
in Group 2. This group includes member banks
with capital and surplus between $1 million and
$6 million. Bennett succeeds Thomas W. Herrick,
Cattle and Investments, Amarillo, Texas.
The Board of Directors of the Federal Reserve
Bank of Dallas consists of nine members: three

Simplified Call
Reports Proposed
Simplified reports of condition and income for
small banks have been proposed by the Board of
Governors of the Federal Reserve System. The
reports. which could be used by over 90 percent
of the nation's commercial banks. would require
40 percent fewer items of information than the
standard fonn.

Class A directors, who represent member banks
ond are usually commercial bankers, and three
Class B and three Class C directors, all six of
w'hich are engaged in pursuits other than banking.
The mix on the Board of bankers. businessmen.
and public members brings varied expertise to the
operation and management of the Reserve Bank.
Class A and Class B directors of the Dallas Reserve Bank are elected by the member banks in
the Eleventh Federal Reserve District, and Class
C directors are appointed by the Board of Governors in Washington.
The Board of Directors has responsibilities common to directors of banks: it hires and fires officers, establishes budgets, evaluates performance,
and provides general surveillance, all subject to
th e supervision of the Board of Governors. In addition to its regular duties of overseeing the operations of the Bank, the Board of Directors also
establishes, subject to review and determination
by the Board of Governors, the interest rate
charged on Joans to member banks.

Under the proposal, the simplified version would
become effective for reports as of December 31,
1978, and could be used by banks with less than
$100 million in assets that have domestic offices
only. However, a bank eligible to file the short
form could choose to use the standard version instead in order to comply with state regulations, to
avoid changing accounting procedures. and so on.
The simplified reports reduce the reporting burden by eliminating many specific items now required, reducing the frequency of reporting some
items, and easing the standards for determining
which items are considered "material" for reporting purposes.
Federal Reserve Bank of DaUas

A Diminished Role for the Dollar
as a Reserve Currency?
By Leroy O. Loney

The declin e in the dollar's value in 1977 and 1978
has highlighted again the question of the fu ture
role of the dollar as a reserve currency. This is an
important matter not only for the United States but
for the entire international fi nancial system as we
know it today.
Under the rules of the Bretton Woods system
from 1944 until the early 1970' s, the dollar was
fixed to gold at $35 per ounce and other countries
were obligated to fix their currencies to the doUar
within narrow limits by official exchange market
intervention. The U.S. currency was at the center
of the system and served as an international unit
of account. It was the major vehicle currency in
private transactions. the primary intervention currency for official monetary agencies, and, perhaps
most important, the major sto re of value for both
private and official internationa l liquidity.
The international monetary system that evolved
in succeeding years, and that eventually was offici ally embraced in 1976 with the Jamaica Agreement, requires no unique role for the u.s. dollar.
With no exchange rate guarantees, foreign holders
of dollars are exposed to exchange rate risk in
terms of the home currency or other assets when
December 1978/ Volc::.

the dollar fluctuates. The dollar's 1976 decline
elicited widespread concern about capital loss on
dollar rc:;e rves held by foreign central banks and
by private market participants. There were reports th at at leas t so me central banks as well as
private holders were divers ifying out of dollars,
nnd analysts cited this as one reason for the announcement on November 1, 1978, of the Federal
Rese rve-U.S. T reasury dollar support package. Another development in 1978 that brought attention
to the dollar's future international role was the
plan for a renewed effort to achieve European
mon etary unifica tion .
Will the future for the dollar resemble the historical decline of the British pound as a reserve
currency, or will the dollar remain the world's
primary official reserve asset? Since there is little
desirabilit y or possibility under the current circumstances of returning to fixed exchange rates,
exchange rate risks on U.S. dollar reserves will
continue. But given a flexible or managed floating
exchange rate system, the same kind of risk would
apply to any other reserve asset. With the U.S.
dollar ava ilable to serve as a key currency. it was
feasible for private and official holders of the

pound sterling to shift away from that currency.
Is there a comparable alternative available today
to holders of dolla rs who become disencha nted
with the U.S. currency as a reserve asset?
This article briefly outlines the benefits and
costs of being a reserve currency country and
notes the national charac teristics that seem important in determining the use of a country's currency
as a reserve asset. Availa ble data on changes in
currency composition of offi cial reserves during
the managed floa t are reviewed, and the forces
that determine the mix of currencies held by a
central bank under managed floa ting are identified.
These may throw some light on the probable future role of the dollar as a reserve currency.
Benefits and costs of Ihe reserve center
A reserve cu rrency country has both benefits and
responsibil ities that other countries do not have.
To the extent that other countries desire to increase thei r balances denominated in the center
country's currency as international reserves, balance-of-payment s deficits of the center country
are automa tically financed, and this can enable
the count ry to consume more from abroad than it
exports over the intermediate term. Alternatively
or concurrently, the center country can be a net
long- term investor abroad. Lending longer term
in this fas hion a nd borrowing short term by providing foreigners with liquidity, it can perform a
fi nancial intermediation fu nction conceptuall y the
same as that of a commercial bank. The fi nancial
community of the center country profits from this
intermediation , and corporations can more easily
make long-term direct investment abroad without
putting pressure on the exchange rate.
The a bility of the reserve currency country to
create the world 's liquidity has been labeled
"seigniorage," since the position of a dominant
reserve center roughly corresponds to that of a
sovereign with the priv ilege of issuing fiat money.
The fac t that the center country does pay interest
on the fore ign holdings of dollar assets weakens
the analogy, but it is s till appropriate to the extent tha t borrowing costs to a reserve currency
country are lower than to noncenter countries
seeking the same financing for payments deficits.
If the reserve center country runs large and persistent balance-of- payments deficits, it can be accused of exporting its monetary policy to the res I
of the world. Oth er countries may feel obliged
to buy increasing amoun ts of the rese rve currency
to prevent their currencies from rising against the

center currency. since such a rise tends to place
their export industries at a competitive disadvantage in world markets. Any increase in reserves of the outer countries leads, other things
equal , to monetary expansion if the inflows are
not sterilized in some way. But because the reserve currency country finances its payments deficits with liabilities to foreigners rather than by
drawing down its reserve assets, no contraction
of its own monetary base is forced.
Benefits are, on the other hand, bala nced by certain costs. A foremost responsibility of the reserve
currency count ry is to maintai n confidence in its
currency. Under the gold exchange standard such
confidence usuall y could be maintained by convertibility of the currency at a fixe d price to an
internationally accepted asset such as gold. In
such an arrangement the reserve country forgoes
any active control over its exchange rate. Under a
managed floati ng exchange rate regime the reserve
center gains some control over the exchange value
of its but is not reli eved of its responsibility to maintain price stability. A stable price
level as a national goal is not truly a "cost," of
course, nor a responsibility to foreigners a ny more
than to domestic citizens, since presumably this
would be a goal in any case. But if th e reserve
country's domestic economic policies subordinate
control of infla tion to possible short-run gains in
prod uction and employment, a conflict arises between maintenance of it s role as a reserve cen ter
and national ob jectives.

A foremost responsibility of the reserve
currency country is to maintain confidence in
its currency.

In addition to the direct costs and benefits to
the reserve currency country itself, there a re indirect costs and benefit s to noncenter countries. A
well-functioning intern ational mone tary system,
made possible by the provision of ap propriate levels of international liquidity from the center country, benefi ts everyon e. If non center countries a re
forced to acquire more liquidity than they desire,
however, in order to peg their currencies to the
center currency or perhaps simply because of a
reluctance to see their currencies rise against it,
this benefi t tu rns into a cost. Th is aspect was a
net benefit with respect to th e dollar in earl y postFedera l Relerve Be nk of O.Uel

war years but turned into a net cost in the later
years of the Bretton Woods system and periodically under managed floating. Such a cost can be
seen to depend importantly on the international
monetary system and is less under managed floating than under the Bretton Woods adjustable peg
system, since now the latitude exists for allowing
the exchange rate to adjust. While the cost for
outer countries of acquiring more of the reserve
currency than is desired is less under a managed
float, the cost of exchange rate risk on accumulated reserves is more evident now.
It is important to recognize the benefits and
costs of being a reserve center country, as well
as those that apply to the outer countries, because
they frequen tly are forgotten in day-to-day affairs.l It is not generally possible, however, for a
reserve currency country, or a potential or declining one, to weigh benefits against the costs
and actively change some of the factors that determine its reserve currency status. Governments
have limits on their longer-run ability to change
some underlying market characteristics.
Fundamental attributes
of a reserve currency country
A history of economic growth can be important
since most outer countries would not desire to
accumulate balances in a currency backed by a
secularly weak economy. Price stability, however,
can be even more important to the international
financial community because domestic inflation
undermines the currency as a store of value.
A reserve currency role is enhanced 'by economic ind ependence from foreign influences, since a
relatively independent economy is more inclined
to postpone adjustment to the rest of the world
by borrowing to finance payments deficits. Both
economic size and the relative openness of the
economy to world economic activity are important indicators of independence. ("Openness"
should be distinguished here from "integration"
with the world economy. The former term, as

1. For a morc detailed discussion of the costs and
benefits of being a reserve center countr y, as well as
the basic characteristics of such a country. as discussed
later. see C. Fred Bergsten. The Dilemmas of the
Dol/or: The Economics ond Politics of United Slates
fn ternationaI Monetary Policy {New York: New York
University Pres!! for the Council on Foreign
Relations. 1975).
December 1978/Voice

used here, relates to the importance of international trade and financial flows to the economy,
while the latter relates to the extent to which such
flows are allowed to affect the economy.)
Breadth and depth of domestic capital markets,
and access to them by other countries, are crucial.
Capital markets must have a scope such that foreigners who hold balances in them can liquidate
sizable holdings without incurring Significant capital loss. A high level of domestic savings and investment and a widely held and actively traded
public debt provide volume for capital market development. Public debt issues, moreover-particularly short-term instruments with little price riskhave characteristics of security and liquidity
that can appeal to both private investors and official foreign entities, especially the latter. (At the
end of 1977, for example, approximately 70 percent of the outstanding stock of U.S. liabilities
to official foreigners was held as obligations on
the U.S. Treasury; of this amount approximately
48 percent was Treasury bills and certificates.)
National markets are not the only source of international liquidity in today's world since external financial markets or "Eurocurrencies" (a
misnomer, as deposits in such markets are not
currency and may not be in Europe) can playa
Significant role in both official and private international liquidity. A Eurocurrency deposit may
be defined as a deposit denominated in a currency
other than that of the country in which the issuing
bank is domiciled. Significant levels of official
reserves are held in the Euromarket today, rather
than in national capital markets, partly because
of higher yields there.
Conceivably Eurocurrency deposits can change
the currency composition of world liquidity even
if nations that correspond to the relevant currency do not meet the general conditions outlined
above. Historically, the currency composition of
international liquidity held in national markets and
that in Euromarkets have not diverged significantly. But if monetary authorities of potential new
reserve centers are reluctant to have their currencies assume a reserve currency role and capital controls are invoked to prevent it, then Euromarkets can service excess demand [or a national
currency. The United States' own experience with
capital controls in the sixties demonstrated how
artificial constraints could be circumvented by
the Euromarket.
Historically, several of the ahove reserve center
attributes have been quite important. National

Growth rates have declined overall,
but the U,S, decline has been less
than for other countries


Growth in















currencies were used as stores of official international liquidity even under the classical gold
standard that existed prior to World War I, when
Great Britain was the primary reserve center. Although the pound sterling dominated the world's
official foreign exchange, the German reichsmark
and the French franc were also important toward
the end of the period at least, especially in continental Europe. {The existence of multiple reserve
currencies under a gold standard is obviously quite
different from a multiple reserve asset system
under the present managed float, but liquid claims
on these major reserve centers exceeded their
total reserves and corresponding liquidity ratios
of countries holding the claims were much smaller.) Price stability was not questioned because of
similar movements in national price levels, and
all three countries were net long-term investors
abroad at the same time they were accumulating
liquid liabilities to official foreigners. All three
had relatively well developed capital markets,
were relatively important in world commerce, and
showed no particular desire to escape their special
role. 2
Although the British pound continued to have
an international reserve role in the interwar years
while the other two currencies did not, it was the
U.S. dollar that became increasingly important.
The size and rise of the United States as a world
economic power, the relatively closed nature of
its economy, and the rise to international prominence of the New York financial market were all
important. FollOwing the fragmentation of the
world monetary system in the thirties, the U.S.
dollar's reserve role was increased in the postwar
period, under the Bretton Woods adjustable peg
system, relative to both monetary gold and other
foreign currencies. (See Table 1.)
How have basic reserve currency country characteristics changed during the seventies, during
which the international monetary system has un-








10 12

SOURCES: Inlorn.tlonal Monotn, Fund.
Economic Co-oparallon
and O.. "olopmenl.



2. For an In-depth treatment of th i! period. see Robert
Trimn. The Evo/ulion of the International Monetary
System: Historical Reappraisal and Future Perspectives.
Princeton Studies in International Finance. no. 12
(Princeton: Princeton University. Department of
Economics, International Finance Sectlon. 1964), on the
workings of the classical gold standard, and see Peter
H. Lindert, Key Currencies and Gold, 1900-1913,
Princeton Studies in International Finance, no. 24
(1969). for an a!sessment of the role of the three
rese rve centers retative to each olher.
Federal ROlorve aauk of Dalla.

Table 1















U.S. dollars ....... .
U.K. pounds ...




' .9


Difference relalive 10 lolal
reporled foreign exchange' ..

- .9


' .7







3. t





(Billions of U.S. dollars. End-of-year flgures)

.......... .

.. ...........
Foreign exchange ............. ...
Uabilities to official foreigners
as reported by Unlled Slales
and United Kingdom

.. ..........

Reserve positions In
International Monetary Fund
Special Drawing Rlghls . . .....
Total reseNe assels ..........




I. DI"erlnee d . rI .... prlmllll~ Irom hold ings In e~lemll flnlne ll l markll •.
ml , nOI ICI d 10 101111 bK..... 01 round ing.
SOURCE: Inllmi llonil Monell .., Fund.
NOTE : 0.11111

dergone the change to managed floating? With respect to the economic growth criterion, the United
States has performed relatively well recently compared with other countries in the Group of Ten
plus Switzerland (Chart 1). All growth rates have
fallen in the midseventies, but growth in the
United States in the 1974-77 period has fallen less
relative to the sixties and the early seven ties than
for other countries in the group. U.S. consume r
price inflation, on the other hand, has not declined in recent years to the same ex tent as in
most of the other countries (Chart 2). Inflation
rates generally rose in the seventies, and some of
the countries still show poorer price performance
than the United States. But the downward trend
is more noticeable for most foreign countries, and
many show lower inflation absolutely in recent
Table 2 presents comparisons of economic size,
openness, and breadth of capital markets for the
group as of the beginning of the decade and in
the most recent year for which data are available.
Not much has changed on the basis of economic
size. The United States is still by far the largest
coun try, and others in the group have maintained
smaller and relatively constant sizes. Only Japan
shows much of an increase relative to others in
the group. All counldes have become more open ,
according to the measure presented in the table,
December 1975/Voice

but some more so than others. The United States
remains the most closed economy but also shows
the greatest percentage increase in openness during the seventies. The percentage composition of
security issues on domestic markets-a rough
gauge or their breadth and abili ty to accommodate
liquid holdings also-indicates a slight decline for
the still-d ominant United States but slight gai ns
for Germany, Japan, Switzerland, and the United
Kingdom. International exposure of relevant capital markets, measured here by a percentage breakdown of foreign bond issues in local markets,
shows a dominant and increasing share for the
United States at the expense of all others except

It is clear from the figures that the United
States remains dominant with respect to most
reserve currency country attributes.

Cbanges in the role of th e public debt in providing volume, relative security, and liquidity to domestic capital markets are indicated in Table 3, in
which the outstanding central government debt
in marketable securities is given as a percentage
of nominal gross national product for countries

Inflation rates in most major foreign countries

have recently fallen more than in the United States
CHART 2. Changes in Consumer Prices




1978 (9 MONTHS,






















SOURCES: Internatlonel Monetary Fund.
OrIl,nlMtion tor Economle CO-operation and Dev,lopment.


Federal Reserve Bank of Dallaa

Table 2






., ........ ,
France ....
Germany .............
Japan ..... ......
Netherlands ..........
Sweden ..... .... .....
Switzerl and ....
United Kingdom
United Stales
Total, 11 countries ...


of group',

01 grouP'1
I...... on













I......., by



















61 .2

ComplItld frem rOClI-c:~r ....c, "llIonll prodllcta conwrted 10 u.s. doltar, at ave"9' 1970 ncllang. ,at., to abatract lrom
.11...1. 01 Uchl/lg' .. t. ehllD" on prQ90rtlo"l.
2. ComPUted '1 the "tlo 01 the 111m of •• portt l lId ImPOfU 10 IIren national product. R..IIUI are not alleeted ,Ignlncanlty wh.n
II' OS' c.P1l11 nOWI .,.. edd.cllo Ifad. 1Iow• •
3. Security m.,_.t , en'll" lI,elud., bondt, l1l\I111... IIIId eertllle.tas 01 ind.btedn .... To Ibtt Irom IxchallD' .. te .n... t. on
p'OI)Ortl_ , loc.l-c:u,rellCy lOlli, eonwrted \0 U.S. doll.rl II constant 1973 .xchang ... tet .

•. Foreign bond .ctl'lllY COlFlPtlnd 01 "llIdlllonll" III"", Ih"., placed on t~e ma,kel ot a slngla country and denomlnaled In
the eu .. I"er 01 1"1' country. "'lilted 01 compulltlon ...... lit . .. me 8S In nole (3).
EUh" 1010 Or I... I",,, on... h." 01 I pIIC.nt.
SOURCES: Inte rn.llon.l Monelary Fund.
Organisation lor Economic Co-operallon Ind Oevelopm. nt.
Fedaral R,serve Bank 01 Dallas.

in the group for which comparable data are readily
available. This ratio has remained relatively can ·
stant in the United States through the seventies
at a level somewhat below the sixties. A declining
trend into the seventies is indicated for France and
the United Kingdom, but for Japan and Germany
the ratio has increased. (The lower absolute proportions of government debt initially for the last
two countries can be traced not only to generally
lower government borrowing but also to a lower
base upon entering the postwar period; the United
States and the United Kingdom carried into this
period significant war debt.)'
It is clear from the figures that the United States
remains dominant with respect to the reserve currency country attributes discussed. Some of these
factors change only slowly, but when and if those
3. Among other countries in the Group of Ten plus
Switzerland analyzed earlier, an inspection of public
debt-GNP ratios computed from available data of the
International Monetary Fund Indicates slight declines
over the period for Belgium, Canada, and the
Netherlands, relative constancy for Sweden and
Switzerland, but a steady increase fo r Italy. Ratios are
lowes t l or Switzerland and h ighest for Italy, but the
data may not bB d irectly comparable across countries.
December lan/Voice

factors beyond the control of the authorities do
change over the longer term, it is questionable
whether the trend can be reversed. 4
In addition to center country characteristics, it
is also possible to look at the other side of the
coin. This is the matter of what determines the
currency mixture of foreign exchange for a given
central bank under the managed floating system.
4. For the altitude of the Germany monetary authorities
on Ihis, for example, see Otmar Emminger, president
of the German Federal Bank, "Internationel Currency
and Foreign Exchange Problems," an address in
Munich, June 3, 1978, in which he states that "there is, in
the foreseeable future, no substitute for the dollar as a
vehicle currency for transactions, nor as a reserve
currency." He also states, "Although we cannot
entirely prevent the use of the DMark as a reserve
currency, we shall continue to do everything in our
power at least to slow down any further tendency for It
to assume such a role." At the same time, however, he
observes more ge nerall y tha t "II may be true that the
dollar is somewhat over-extended in its international
use," and he seems to point to at least one condition
that would foster Germany's taking on a gre a ter
reserve center role when he predicts that his country
will more regularly be an external deficit country by
basic balance definition when capital inflow s are
not distorted by confidence factors.

The surge in international reserves in the 1970's
has been due to the foreign exchange component,

with developed countries as well as oil exporters posting large gains
CHART 3 . Offlci.1 International Reserves of IMF Member Countries
340 - - - --




1 7 0 - - - - - - - - - - - -"L --

300 _


150 -




130 -

240 -

120 -


110 "


200 180 -


160 -



~. ......



60 -














.. " I

' 70 '71 '72 '73 '74 '75 '76'77 '78







.... _------------


100 -



80 -





120 -




160 -

320 -







.,.,.,I ..........'·./'·OTHER
,•••••• I



,,, ,,,'

l --T--r--r--r--r--rI--r
l --rl'~'T'rl'70 ' 71 ' 72 '73 ' 74 ' 7 5 '78 '77 '78

SOURCE: Internellone l Monet8ry Fund.


Federal Reserve Bank of Dallal

Official reserve asset choice
under managed floating
Centra l banks have an incentive under flexible exchange rates to diversify foreign exchange reserves similar to the incentive for private holders.
The portfolio choice for central banks is rather
different from that for private entities, however.
Most important, a large set of variables that influence currency portfolio risk and return-such
as monetary growth rates, interest rates, and exchange market intervention-cannot be taken as
exogenous to the central banks' own actions.
In addition , central banks may also have motives for currency choice that are irrelevant in the
private sector. Official interven tion, with the presumed goal of stabilizing exchange rates, dictates
the sale of strong currencies for weaker ones. But
if a reserve currency happens to be one of the
weaker ones, this implies the accumulation of
more reserve assets subjec t to probable capital
loss. An alterna tive for ce ntral banks whose own

Central banks have an incentive under
flexible exchange rates to diversify foreign
exchange reserves similar to the incentive
for private holden, bullhey may al&o have
motives for currency t:hoice that are
irrelevant in the private sector.

currencies are strong would be to buy another
currency instead. Then, even though they would
not be reducing the quantity of their holdings of
the reserve currency, they would at least not add
to it. In the long run , diversification out of the
primary reserve cu rrency can occur in a more or
less orderly fashion. When the cu rrency becomes
relatively strong again, it can be sold , but its levels
do not have to be replenished when it is again
weak. Even though this is more orderly diversification, the net effect is still downward pressure
on the reserve center currency over the longer
haul since net demand for it is less than otherwise.
Another factor that can influence the composition of official foreign exchange reserves for a
given central bank, regardless of exchange rate
risk, is the pattern of the country's trade with the
rest of the world. This relates to the vehicle role
of some currencies in private transactions and
tends to correspond to the role of the reserve currency country in world trade. If residents of the
December 1978/Volce

Tabla 3
(As percent of nominal GNP)

A .... r~ ••

France ......
Germany ......


Japan' ...........


United Kingdom'

United States . . . . . .









1. FI,eal·yeer b •• I• .

SOURCE: Orglnllllion lor Eeonomle Co-operallon and

domestic economy trade with another country, it
is likely that the central bank will de sire to hold
precautionary balances in the currency of that
other country also.
Still another determinant of a central bank's
currency portfolio is the exchange rate arrangement of the country. Other things equal, an official monetary institution would be more likely
to hold higher reserve balances in a given foreign
currency if it fixes its own currency's value to tbat
foreign unit. There is less foreign exchange risk in
terms of the domestic currency jf tbe home unit
moves with the foreign unit and is expected to
continu e to do so because of pegging arrangements. The fact tbat most countries no longer peg
to the dollar, as they did under the Bretton Woods
system, could be a reason for holding few er dollars. a
In spite of some considerations that make central bank portfolio decisions different from private
ones, it is still true that central banks have a general and strong aversion to losses on reserves,
even though such losses may be incurred as a resu lt of efforts to insulate the domestic economy
from developments the monetary authority believes to be economically disadvantageous or polit ically distasteful.
Central bank diversification of additions to reserves can occur only gradually over time, however. Trade patterns also do not change very quick-

5. H. Rohert Heller and Malcolm Kni ght. in "Reserve
Currency Prefe rences of Centra l Banks," an International
Monetary Fund Research Department memorandum
daled January 5. 1978, present evidence that both Irade
patterns and exchange rate arrangements are important
determinants of o Ulcial fo reilln exchange holdings.


Iy, and even though exchange rate arrangements

are a subject of national decree and can change
abruptly, they are not undertaken without extensive deliberation. Increased foreign exchange
assets have accounted for the surge in official
liquidity that began in the seventies, at the same
time the world moved to more flexible exchange
rates (Chart 3).s Did greater currency diversification accompany this increase?

Variation in the currency composition
of official foreign exchange in 1970's
The International Monetary Fund (IMP) recently
has published an aggregate currency breakdown
of the foreign exchange reserves of 76 countries
that report to it, accompanied by data for a constant sample of 53 of the countries (some countries did not report in certain years), as well as a
breakdown for countries grouped according to exchange rate regimes. All data are for the interval
from 1970 through 1977.
Table 4 presents the breakdown for the constant sample of 53 countries. It is apparent that
although the total has exploded, the proportion
held in U.S. dollars has hovered around 80 percent. 1 The most notable changes are the decline
for the pound sterling and the rise for the German
mark. Apparently, price stability aspects of the
two currencies have contributed importantly to
their changing roles. The pound fell from 9.0 percent of total foreign exchange reserves at the end
of 1970 to 1.5 percent at the end of 1977, while the
mark rose from 2.1 percent to 6.9 percent. Other
currencies. primarily the Swiss franc and the
Dutch guilder, rose from 5.4 percent to 9.8 percent. Although the reversing roles in the aggregate
6. The dramatic increase in official foreign exchange
during this period is attributable not only to the
overvaluation of the dollar in the early seventies. prior
to floating. and the dollar weakness more recently but
also to rising oil producer holdings, which increased
with their investable surplus after 1973. The rise for
oil-producing countries came mainly from investment of
their export earoings rather than from intervention to
prevent the fan of the dollar against the respective
domestic currencies.
7. The contribution of countries excluded from this
constant sample does not appreciably change either the
aggregate total of reserves or the percentage held in
dollars. At the end of 1977. the 76 countries recorded
total reserves of $173.1 billion. compared with $160.1
billion for the constant sample. Of the former 81.1
percent was dollars. and of the latter 61.2 percent
was dollars.

of the mark and the pound are evidence of a
longer-run trend toward a rising key-currency role
for the former and a declining one for the latter,
data through 1977 at least show no diminution of
the dollar's role following revocation of Bretton
Woods obligations to peg to the U.S. currency.
Since exchange rate arrangements were highlighted earlier as an important determinant of reserve asset composition. the status of the dollar
might surprise some, but the aggregate data here
include some countries that continue to peg to
the dollar as well as those that adhere to various
other arrangemen ts. A breakdown by exchange
rate regimes shows that countries whose currencies used to be pegged to the dollar but are
now floating independently have indeed reduced
the proportion of their reserves held in dollars.s
This is seen in Table 5. which summarizes the 1970
and 1977 currency composition of official foreign
exchange portfolios for five categories of countries among the total group reporting to the IMP.
classified by the exchange rate arrangements that
existed at the end of 1976.
Those countries classified here as independent
floaters continue to hold most of their foreign exchange in dollars, but there has been a decline in
the dollar proportion during the seventies. There
was a relatively steady decline in the dollar share
from about the end of 1972 through the end of
1976, when it stood at 74.2 percent, but the proportion rose to 84.6 percent by the end of 1977.
It is clear from this that currency components
sometimes can be erratic. There was an increase
in the German mark share from 3.2 percent for
1970 to 4.9 percent for 1977, but at the end of
1976, the mark's proportion had been higher at
8.2 percent. The sterling component was quite
small and declining over the 1970-77 interval;
about 1974-75 there was a surge in official holdings of the pound, but this was reversed subsequently and. in any case, can be attributed to a
single country.
The official foreign exchange reserves of countries that participate in the European joint float
are dominated by U.S. dollars and the dollar
share has even risen somewhat.' This may be at8. Major foreign countries with currencies that float

independently are Canada, France. Italy. Tapan.
Switzerland. and the United Kingdom.
Q. Participants in the European jOint float at the end of
1976 were Belgium-Luxembourg. Denmark. Germany. the
Netherlands, Norway, and Sweden.
Federal Renrve Bank of Dalla,

Table 4
(Dollar amounts In millions of U.S. dollars)






count.les '

do ll".

Sle.ll rtg

$ 33,356

$ 27,113
(81 .3)
(77.6 )
(81 .0 )


(100. 0)
(100 .0)


( 1.6)
(1.5 )



(2.1 )
(3.1 )
(6. 2)
11 ,122



( .0)

(A )

(A )




cu rren cies

$ 1,800
( 6.4)
11 .803
( 10.2 )


$ 737

(4.8 )

(.6 )



(.3 )


1. Con. lanl se mple.
2 Co nslSI S main ly 01 US. T.u su ry se curilies issued 10 cert . ;n c e nlral bank, In the '''I' 1960·, end denomina ted
In !he currency <ll!h e holder (Roos, bonds). Howeve •. It a 'so include. small am",,"ls 01 esset. held by regions'
Clea ring unionl . whaleve r tha i. cu,,,,ocy of denomination, and a small .esldual er..,r due 10 report,o" IffeguleriUes.
NOTE: Fi gures in parenlhes.. indlcale percenlages 01 101111.
Delalis may nol add 10 10181s beClun 01 r<lundl"".
SOURCE: Inlernation al Mone l"'y Fund .

tributable not so much to the economic determinants mentioned earlier as to an institutional constraint imposed as part of the Basle Agreement of
April 10, 1972, which formalized the European
Community "snake." Participating central banks
were restricted at that time from holding an ything
other than working balan ces in the currencies of
other members, and intervention in U.S. dollars
within the snake has increased in importance
over time. The use of the snake currencies themselves as a medium of intervention has been disco uraged in practice except at the mandatory in tervention limits; inside the limits, intervention in
other Eu ropean currencies is subject to prior authorizati on by the other central bank who se currency is being bought or sold, and intervention
mu st be discontinued if it is believed to have any
adverse effect on that participant's currency. When
currencies reach the limits , the central bank whose
currency is strongest is mandated to buy the
weakest currency, while the central ba nk whose
currency is weakest simultaneously sells the
strongest currency.tO
The prior-approval provisions for intervention
inside the band and restrictions aga in st significant
holdings of other participants' currencies can be
December IIm1/Voice

seen to relate to the previous reluctance of snake
members to become reserve centers. This is especially the case with respect to Germany, whose
currency is most important within the snake in

10. See "The Eu ropean System of Narrower Exchange

Rate Margins." Monthly Report of the Deutsche
Bundesbonk 28 (January 1976):22-29. In contrast to the
restrictio ns on use of European currencies. snake
participants can intervene in U.S. dollars at will and
can borrow freely in dollars. Settlement is often in
dollars even when intervention does ta ke place in
snake currencies. The use of the U.S. dollar as an
intervention medium wi thin the snake can also have a n
effect o n the value of the dollar itself. II dollar purchases
equal dollar sales, there is no net effect; but if sales
exceed purchases, then the net effect is downward
pressure on the dollar (and vice ve rsa If purchases
exceed sales). This has been the case in the past
when dollar purchases by Germany have not been
large enough, because of its relative indiffe rence to the
DM/S rate, to negate the dollar sales of other snake
participants that were forced to keep up with the
mark. For an analysis of the effects of different snake
in tervention responses on the European valuation of
the do llar. see Joanne Salop, "Dollar Interven tion
Within the Snake," Internalionol Monetory Fund Staff
Paper5 24 (March 1977) :64-76.

Table 5
(Dollar amounts in millions 01 U.S. dollars)





Snake countries


U.S. dollar peggers ..
Sterling peggers .....
Basket peggers ......

dolla ...


(91 .7)




December 31, 1977

D.c.mbe , 31, 1970






(9.1 )



( .2)

S 264

(72.4 )











(10.1 )










(1 .3)



(8.1 )







1. As of Oflcemba. 31. 1976.
NOTE : Figures In pa.antMues Indicate pelcflntagas 01 10tell.
SOURCE: Inlf1.nstlonal Monetary Fund.

the sense that other participants often must match
its movements, rather than vice versa.
The removal of these constraints, should the
doUar become less desired as a reserve currency
and should Germany become more willing to have
the mark used as a store of international liquidity,
could have consequences for the reserve role of
the U.S. dollar. This did not go unnoticed in the
1978 discussions of European monetary unification. As an alternative to the use of the German
mark itself as a reserve asset, the use of some
artificial reserve unit similar to the SDR (Special
Drawing Right) has been discussed as a solution
more acceptable to Germany. At this writing there
is some indication that with the December 1978
agreement on the European Monetary System,
more snake intervention is intended in currencies
of participating countries rather than dollars.
The countries that continued to fix their currencies to the dollar continued to hold a dollar
proportion of official foreign exchange that was
quite close to the aggregate for all countries. a This
proportion was just above 80 percent at both the
end of 1970 and the end of 1977. Although the
dollar component fell to 71.4 percent in September
1973, it rebounded subsequently. The declining
role of sterling and the rise of the German mark
are also quite apparent for this group. The pound's
share fell from 9.1 percent at the end of 1970 to
11. The countries that continue to peg to the dollar are
primarily less developed countries (LOC's) in Latin
America, Africa. and the Far East.

1.2 percent at the end of 1977, while the mark
rose from an almost negligible 0.9 percent to 8.2
The tenet that when a country pegs to a currency, its holdings of that currency tend to dominate its total foreign exchange is also borne out
for the group of sterling peggers at the beginning
of the period, when the pound's share in their reserves was 72.4 percent. 1Z But it is not consistent
with the sharp and steady decline in sterling holdings over the period to 15.7 percent at the end of
1977, symptomatic of the decline of sterling as a
reserve asset for all reporting countries. The diminished share of sterling was accounted for by
an increase in the doIIar component from 17.2
percent to 44.6 percent, a large shift in the German
mark's share from almost nothing at the end
of 1970 to 21.9 percent at the end of 1977,
and an increase in other currencies from 10.1 percent to 17.8 percent.
These same trends are apparent for the group
composed of countries that peg to some form of
currency basket. I3 Under this relatively new practice, a country fixes its currency to a group of
others weighted in some fashion. This could include SDR weights, trade weights, or some other
basis. The increase in the dollar proportion for

12. Ireland continues to peg to the pound, as well as
some small, Jess developed nations in Asia and Africa.
13. This group is also composed mostly of LDC's but
includes some European countries and oil-exporting
nations as well as nono il LDC's.
Federal Relerve Bank of Dan••

this group, which rose from 45.5 percent to 55.6
percent , was somewhat smaller. Sterling fell from
37.7 percent to 3.5 percent, and the mark rose from
3.2 percent to 17.1 percent while the "other" component rose from 13.6 percent to 23,8 percent.
These shifts were also relatively steady over the

Through the end of 1977 at least, the dollar
proportion of aggregate reserves essentially
remained constant even though there
were changes for other currencies, such as the
rising role of the German mark and the
demise of the British pound.

In summary, the move to generalized floating
earlier in this decade did not diminish the dollar's
role as an international reserve asset, as might
have been expected. Through the end of 19 77 at
least, the dollar proportion of aggregate reserves
essentially remained constant even though there
were changes for other currencies, such as the rising role of the German mark and the demise of
the British pound.
Most of the underlying factors that determine a
reserve currency can only change slowly, so that,
barring SDR consolidation of existing dollar balances by the IMF, which in itself can only be an
evolutionary process at best, one can expect the
dollar to remain at center stage for some time. This
should be true at least as long as the United States
mee ts the price stability respon sibilities of a reserve center coun try. At no pOint in recent history
has a single reserve asset completely dominated ,
and the trend now may be toward more diversification rather than less. But sudden shifts are
neither likely nor in the interest of anyone concerned.

December lU"U/Voice

There were indications during the 1978 decline
of the dollar that at least some central banks do
not consider it unthinkable, under certain circumstances, to diversify their foreign exchange reserves away from dollars.H This factor may weigh
increasingly on U.S. policy in the future. The official announcement in November 1978 for augmentation of U.S. foreign currency reserves provides some evidence of U.S. willingness to foster
greater symmetry in the financing of payments
deficits. By drawing foreign currencies on its reserve position in the International Monetary Fund.
by selling Special Drawing Rights for foreign currency. and. especially important, by issuing bonds
to foreigners denominated in foreign currency to
finance payments deficits, the United States has
indicated, at leas t in a minor way, a propensity
to borrow and accumulate its own foreign currency reserves. It has signaled a willingness not
to rely solely on traditional, if augmented, shortterm swap arrangements and balance-of-payments
financing via the accumulation of dollar-denominated liabilities to official foreigners.
As long as the dollar does remain at the center
of the international mon etary system. however,
the continued cost must be borne by the United
States. Its responsibility for maintenance of confidence in the currency is foremost in a world in
which the market can immediately signal expectations by exchange rate adjustments.

14. In IIddition to severlll IIrlicles in the financ ial press
in the Ilitter ha.1f of 1978 a.lludlng to diversification out
of dollllr5, see "How Centrlll Banks Are Ditching the
Dollar," Euromoney, October 1978, In which a number
of central bankers were quoted 89 saying that they had
already reduced or were seriously considering reducing
the dollar proportion of thei r portfolios. Most sources
quoted were representlltivel of the smaller central banks
in Latin America, the Fir EIISt, lind the Middle East.


Fed Completes National EFT Network

A nationwide electronic funds transfer (EFT) network linking 32 automated clearinghouses (ACH's)
has been completed by the Federal Reserve System, in cooperation with the National Automated
Clearing House Association. With the completion
of the system, ACH's can now transfer funds
electronically across the nation.
The network, now serving some 9,400 banks
and 1,500 thrift institutions that are members of
ACH associations and some 6,000 corporations,
is linked together by the Federal Reserve's computerized communications system. Any bank or
thrift institution that belongs to an ACH can now
present payment instructions recorded on magnetic tape to the nearest Federal Reserve facility
for transmission nationwide. Most payments currently are payroll deposits, mortgage payments,
and U.S. Treasury deposits for social security

A pilot program for the national EIT network
was approved by the Federal Reserve in 1975 and
started the following year. The first live entries
were sent in February 1977. By November 30,
1977, the monthly interregional volume was 45,000
items, valued at $4 million. When the pilot was
evaluated in December 1977, it was considered a
success, and expansion was recommended. The
Board of Governors of the Federal Reserve System published for comment a proposal to expand
the network nationwide and received favorable response. The Board and the National Automated
Clearing House Association agreed to establish
the interregional ACH system, and expansion began in May for the Reserve districts and ACH's
not involved in the pilot. The network's last links
were completed in September 1978.

Bank Holding
Company Study

holding companies and covers the principal areas
of competition , public benefits and community
convenience and needs, operating performance
and efficiency, safety and soundness, and concentration of resources.
Copies of the report may be obtained from Publications Services, Division of Administrative Services, Board of Governors of the Federal Reserve
System, Washington, D.C. 20551. The price is $2.50
per single copy (in quantities of ten or more sent
to one address, $2.25 per copy), and remittances
should be made payable to the Board of Governors
of the Federal Reserve System.

The Bonk Holding Company Movement to 1978:
A Compendium, a study by the staff of the Board
of Governors, is available. The report is a comprehensive review of the available research on bank

Federal Reserve Bank of Dalia.

The Community Reinvestment Act
and Regulation BB
By Richard B. West

An additional regulation affecting banks became
effective November 6, 1978. Its rationale, content,
implementation. and enforcement procedures are
described briefly here. Those desiring "official"
information ore referred to the relevant act and
The Community Reinvestment Act (eRA) was
passed on October 12, 1977, as part of the Com·
mllnity Development Act of 1977. Briefly, the act
requires Federal financial regulatory agencies to
use their authority to encourage financial institu·
tions to help meet the credit needs of their local
communities. The act further requires that in can·
Dection with the examination of a financial institu·
tion, the Federal regulator is to regularly assess the
institution's record of meeting credit needs of its
entire community, including low- and moderateincome neighborhoods, consistent with the sound
operation of the institution. This record is then to
be taken into account by the regulator in evaluation
of an y application for charter, deposit insurance.
branch. other deposit facility, acquisition, or merger or any bank holding company application.
It is interesting to examine the records of the
committee hearings held while the act was under
consideration. Generally, supporters of the act
gave four reasons why the act should be passed.
First, it was assumed that financial institutions
rather than the Government should play the leading role in providing capital required by local communities in meeting housing and economic development needs. Second, as recipient of a public
charter, a bank, savings and loan, or other finan cial institution was considered to have a responsibility to its community to provide adequate capital
to meet the economic needs of that community.
December 1918/Voice

Third, studies have shown that financial institutions to a significant degree have shunned tbe
credit needs of their local neighborhoods, especially if these neighborhoods are of low- or moderate-income character and are located near the
central city. Often deposit funds are taken from
these neighborhoods and reinvested in mortgages
in suburban areas. Fourth, and perhaps most important. there was a feeling on the part of many
in Congress that the Federal regulatory agencies,
in evaluating applications, have not given sufficient weight to the convenience and needs of the
community. In particular, they have not given adequate weigbt to the need for credit services in a
community as well as the need for deposit services.
In summary, it was the feeling on the part of
many that the Community Reinvestment Act
merely reasserts long-standing policy that had been
ignored by the regulators. This policy is, simply,
that the convenience and needs criteria used in
evaluating an application also include credit ne eds.
Those opposing the act did so primarily on the
basis that authority already existed that could be
used by the regulatory agencies in encouraging
financial institutions to meet the credit needs of
their local communities. It was pointed out that
the bill might impose a significant additional burden in administrative processes and paperwork on
banks and other institutions, Opponents feared
that the act would limit the ability of financia l
institutions to generate needed funds for loans in
their primary service areas since often these funds
are obtained through loan participations in lines
of credit with correspondents in other areas. Opponents also expressed the concern that the act
would be a major step toward allocation of credit
since it would substitute the judgment of a Federal

agency for that of a financial institution determining what constitutes a legitimate credit need.
The act is not very specific; fo r example, it
does not define "community" or " l ow~ and moderate-i ncome neighborhoods." It required the Federal
regulatory agencies to d raft a regulatio n by
November 6, 1978, that would make explicit the responsibili ties of fin ancial institutions in complying
with the Community Reinvestment Act.
The Federal Reserve Board regulation implementing the Community Reinvestment Acl has
been deSignated Regulation BB. It applies only to
sta te-chartered banks that are members of the Federal Reserve System, However, it is virtually identica l to the regulations issued by the other Federal
regulatory agencies that apply to other fi nancial
ins titutions.
Th e new Regu lati on BB we nt into effec t
November 6, 1978, It can be divided into three main
parts: firs t, a bank's duty under the act ; second, the
duties of the Federal Reserve banks in evaluating
state member banks' performance under the act;
and third, the duties of the Federal Reserve System in considering appli cations.
A bank's duties under eRA
Under Regulation BB the fi rst step a bank must
take is to determine its own community or communities. The bank may have more than one com~
munity, depending on the number of offices or
branches. Three bases may be used by a bank in
defining its own community. First, it may use the
boundaries of a standard metropoli tan statistical
area (SMSA) or county, ad justed for adjacent areas
it wishes to serve; and if the bank is small, its commu nity can be part of a coun ty or SMSA. Usually,
the community will not be larger than a county
or SMSA for a bank having only one office. Second , a bank's community may be its effec tive
lending territory and oth er areas equidistant from
each of the bank's offices, circular in shape. A
bank located in a downtown area would be prohibited from excluding low- and moderate-income
neighborhoods near its main office while including wealthier areas located greater distances
fro m the central city. Thi rd, a bank can use any
basis that meets the purpose of the CRA, does not
exclude low- and mode rate-income ne ighborhoods.
and is not based on arbitrary criteria.
The regu lation requires that the bank defin e its
community by u sing a map, that it be approved
by the board of directors of the ban k and reviewed
at least annually, and that the map be made

part of the bank's Community Reinvestment Act
The second requirement placed on banks by
Regulation BB is that by February 4, 1979, they
prepare a Community Reinvestment Act Statement, which must be adopted and reviewed and
updated annually by a ban k's board of directors,
The CRA Statement must include a map showing
the bank's community or communities, a list of
the principal types of credit the bank is prepared
to extend to its community, and a copy of the
Community Reinvestment Act Notice tha t is outlin ed in the regulation.
A bank should includ e on its list only those
types of loans it definit ely plans to make available
within its community, including low- and moderateincome neighborhoods. Its performance under the
act will be judged according to its effectiveness in
actuall y providing these services. Examples of the
types of services that may be provided and the
specificity with which they should be listed are
residential loans for one to four dwelling units,
housing rehabilitation loans, home improvement
loans, small business loans, agricultu ral loans, consumer loans, and so on.
Banks are encouraged also to include in their
CRA Statement materials on how the bank is helping to meet it s community's credit needs, periodic
report s on how it has actually helped to meet those
needs during the past year, and details about how
community credit needs were ascertained .
The CRA Statement must be kept at the head
office of the bank, and if the bank has one or more
branches, the statemen t dealing with th e local community of each bran ch must be kept at the branch
office, Copies of a CRA Statemen t must be fur~
nished, should they be requested, to any individual
or gro up without charge other than for ordinary
copy ing.
A bank must post in its lobby the Community
Reinvestment Act Notice contained in the regulation. Th e notice describes the act , tells where a
customer can obtain the bank's CRA Statement
and where written comments concerning the
bank's performance under the act may be sent,
indica tes that a customer can examine all letters
received by the bank in th e past two years concerning its performance and that comments received by the local Federal Reserve Bank concerning the bank's CRA performance can be examined,
and indicates how announcements of applications
dealing with firms covered by the Community Reinvestment Act may be requested fro m the loca l
Federal Reserve Bank of Dallas

Reserve Bank. If the bank is a subsidiary of a bank
holding company, the notice must also provide that
fact and that the bank's CRA performance will
be taken into account in all holding company
Files relating to the Community Reinvestment
Act available for public inspection must contain
all signed written comments received from the
public in the past two years relating to the bank's
Community Reinvestment Act Statement or its performance under the act. Responses to such letters
may be included in the files; however, material
harmful to any person's good name or reputation
and letters that relate only to a particular credit
application should not be included.
Evaluation of a bank'. performance
The second part of Regulation BB deals with the
responsibility o{ the Federal Reserve Bank in assessing the record of performance under the Community Reinvestment Act of a state member bank.
The responsibility of other Federal regulators in
assessing the record of performance of their banks
is iden tical.
A bank's performance under the Community
Reinvestment Act will be evaluated as part of
the regular examina tion process. In the Eleventh
Federal Reserve District, this assessment will
take place during the bank's consumer affairs
Examiners are instructed to determine whether
the Community Reinvestment Act Notice has been
placed in the lobby, to review the bank's CRA
Statement and any signed written comments received by the bank or by the Reserve Bank, and
to determine that appropriate files are being kept
by the bank.
Examiners will make an assessment of the
bank's performance und er the CRA, giving consideration to the following {actors:
1. Activities undertaken by the bank to determine the credit needs of its local community, including the extent of the bank's efforts to communicate with members of th e community regarding
credit services offered by the bank.
2. Marketing and credit-related programs to
make the community aware of the credit services
3. The extent of participation of the bank's
board of directors in formulating policies and reviewing performance.
4. Evidence that the bank actually encourages
applications for the types of credit it has listed
December 1918/Volce

in its CRA Statement. Any efforts by the bank to
discourage applicants from applying for any of
the types of credit it is claiming to provide to the
community will be considered a negative factor.
5. Geographic distribution of a bank's credit extensions, credit applications, and denials.
6. Evidence of discrimination or other illegal
credit practices, including any violations of either
the Equal Credit Opportunity Act or the Fair
Housing Act.
7. The bank's record of opening and closing
offices and providing services at these offices, in
order to determine whether each office is providing appropriate credit services to its local
8. Participation in local community development
and redevelopment programs.
9. Origination or purchase of residential mortgage loans, home improvement loans , and small
business or small farm loans within the community.
10. Participation in Government-insured, -guaranteed, or -subsidized loan programs for housing,
small businesses, or small farms.
11. The ability of the bank to meet the commu·
nity credit needs, given the bank's size, financial
condition, various legal restrictions, local economic factors, and other variables.
12. Any other factors that bear on whether the
bank is meeting the credit needs of the entire
community, including low- and moderate-income
Obviously, a bank will not have to score well
on all these factors in order to receive a favorable
If the examiners conclude that a bank is not
adequately meeting the credit needs of its entire
community, they will point out to the bank where
they feel any shortcomings lie and encourage it to
increase services in these areas. However, the act
is not intended to force any bank into allocating
credit or into making loans that are unsafe or unsound. It does not provide any specific penalties
for noncompliance. It does provide, however, that
a bank's record under the CRA be taken into account when a bank is involved in any application
process that requires Federal approval.
Effect on application.
In the case of a bank holding company appJication,
the Board of Governors of the Federal Reserve
System is required to consider the record under
the Community Reinvestment Act of each subsidiary of the applicant bank holding company. In


addition, the Board is required to consider each
proposed subsidiary bank that has an officer, employee, or significant stockholder associated with
the applicant. State banking departments may
comment on the applications, and the Board must
consider their views. Further, at the request of the
applicant holding company, the Board can consider
the record of non banking subsidiaries in meeting
local community credit needs.

The Community Reinvestment Act and Regulation BB call for a careful and ongoing assessment
on the part of both regulators and bankers of a
bank's role in meeting the credit needs of its entire
community. Regular consultation with community
groups is encouraged, to determine both the community's credit needs and the effectiveness of the
bank's programs in meeting those needs.

New member banks
Southwest Lubbock National Bank, Lubbock, Texas, a newly organized
institution located in the territory served by the Head Office of the Federal
Reserve Bank of Dallas, opened for business November 20, 1978, as a
member of the Federal Reserve System. The new member bank opened with
capital of $1,000,000 and surplus of $1 ,000,000. The officers are: Wayne
Finnell, Chairman of the Board; Sill D. Horton, President and Chief Executive Officer; and Bill Kirkland, Cashier.
Citizens National Bank, Houston, Texas, a newly organized institution
located in the the territory served by the Houston Branch of the Federal
Reserve Bank of DaUas, opened for business December 1, 1978, as a member of the Federal Reserve System. The new member bank opened with
capita l of $500,000 and surplus of $700,000. The officers are: W. Phillip
Johnson, Chairman of the Board and Pres ident; Carroll C. Simmons, Executive Vice President; and Nelda L. Eaves, Vice President and Cash ier.
Ingram Park Bank of Commerce, N.A., San Antonio, Texas, a newly organized institution located in the territo ry served by the San Antonio
Branch of the Federal Reserve Bank of Dall as, opened for business December 4, 1978, as a member of the Federal Rese rve System. The new member
bank opened with capital of $625,000 and surplus of $625,000. The officers
are: Louis F. Lagledler, President; Frank W. Patlon, Jr., Senior Vice President; and Miguel S. Reyes, Cashier.

New nonmember bank
Metro Bank, Midland, Texas, a newly organized insured nonmember bank
located in the territory served by the EI Paso Branch of the Federal Reserve
Bank of Dallas, opened for business December 1, 1978.


Fede ra l Re.erve Bank of Dalla.