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Statement by

Arthur F, Burns

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 27, 1974

No economic event in a long generation, excluding only
wartime upheavals, has so seriously disrupted our economy as
the manipulation of oil prices and supplies over the past year.
The fourfold increase in the international price of oil has compounded the domestic economic problems of other oil-importing
nations as well as our own.
have been upset.

International financial relationships

Plans to reform the international monetary

system have been partially derailed.

And with further interruptions

in the flow of oil still a possibility to be reckoned with, a great
cloud of uncertainty now surrounds the economic future of nations
around the world.
My remarks this morning will concentrate on some of the
implications of high oil prices for international finance - - a s this
Committee has requested.

But I cannot be silent on the bearing

of oil prices on our domestic economy or our international political
position.
The manipulation of oil prices and supplies by the oilexporting countries came at a most inopportune time for the
United States.

In the middle of 1973, wholesale prices of

industrial commodities were already rising at an annual rate
of more than 10 per cent; our industrial plant was operating at

virtually full capacity; and many major industrial materials
were in extremely short supply.

Inflationary expectations

were therefore becoming more deeply ingrained at the very
time when inflation was curtailing the purchasing power of
worker incomes and creating some weakness for big-ticket
items in consumer markets*

Thus, the oil embargo, together

with the huge increase in oil prices that began in the fall of
1973, contributed to the twin economic problems plaguing us
in 1974 - - namely, high rates of inflation and weakness in
production.
Furthermore, the increases in the price of oil have
added to the imbalances that have made the current period of
economic weakness so unusual by historical standards.

Some

sectors that depend heavily on a plentiful supply of inexpensive
fuel -~ such as the automobile industry - - have had to contend
with, sharp declines in sales and considerable idle capacity.
At the same time, the oil crisis bolstered the demand for
energy-saving equipment and stimulated the production of
alternative sources of energy.

Thus, the energy crisis con-

tributed to the tightness in markets for business capital goods
that marked much of this past year.

The adverse effects of rising oil prices have been felt
even more acutely in some foreign countries than in the United
States,

This year, inflation is proceeding at historically high

rates throughout the industrial world, while output is growing
only slowly or actually declining.

In Japan - - which has been

particularly hard hit because of its heavy dependence on
imported oil — consumer prices are 24% higher than a year
ago, while economic activity is below the level of 1973.

This

weak performance of the Japanese economy is particularly
striking when viewed against the background of the preceding
decade, when the output of Japan grew at an average annual
rate of over 10%.
At the other end of the spectrum, several countries - most notably Canada - - have gotten off rather lightly because
of their plentiful domestic supplies of oil.

Even these countries,

however, have been adversely affected by the combination of
inflationary pressures and sluggish economic activity of their
trading partners.
Economic difficulties are by no means confined to the
industrial countries.

In particular, because of the heavy reliance

on oil in the production of fertilizers, the high price of oil has

- 4-

contributed to the danger of widespread starvation in a number
of the less developed countries.
On the other side of the ledger, the increases in the
price of oil have resulted in a spectacular jump in the income
of members of OPEC - - that is, the Organization of Petroleum
Exporting Countries.

The United States alone will spend about

$2.7. 5 billion on fuel imports this year, in contrast to $8. 8
billion for substantially the same volume of imports in 1973.
The higher price of imported oil has in effect been a heavy tax
on American consumers, and it has taken its toll in weaker
domestic markets.
Through the first ten months of 1974, the OPEC nations
have received from other countries about $75 billion in oil
revenues, nearly three times the amount obtained during the
whole of 1973.

The imports of OPEC nations have risen rapidly

in percentage terms, but they have fallen far short of their
increased revenues.

As a result, oil producing countries have

achieved an estimated $45 billion surplus on goods and services
during the first ten months of this year.

Most of this sum has

been invested in highly liquid short-term instruments in the
Euro-currency markets and in the British and U. S. money markets.

5 -

Of the $45 billion, about $10-1/2 billion has been placed
in the United States.

This includes about $5 billion in marketable

securities issued by the Federal Government or its agencies,
chiefly Treasury bills.

Most of the remainder hac been placed

on deposit in our banks, with scattered amounts invested in real
estate, bank acceptances, and other private securities.
Of the total increase in OPEC assets of about $45 billion,
by far the largest share - - about $16-1/2 billion or more than
one-third of the total - - has gone into the Euro-currency market.
Nearly all of this is in the form of Euro-dollar deposits, the
average maturity of which is quite short.

A large proportion

consists of 2-day call deposits, and most of the remainder run
6 months or less.

Banks located in Britain have been the

predominant recipients of these deposits.
Several of the oil-exporting countries - - notably Kuwait,
the United Arab Emirates, and Nigeria - - have traditionally kept
part of their reserves in sterling.
being maintained.

Those traditional ties are

During the first ten months of 1974, OPEC

sterling holdings increased by the equivalent of about $6-1/2
billion.

Again, most of this sum has gone into short-term assets,

and only relatively small amounts have been invested in government
bonds, private securities, and real estate.

- 6-

The OPEC holdings thus far specified - - i n the United
States, Britain, and the Euro-currency markets - - account for
roughly three-quarters of the total increase of $45 billion of
OPEC assets.

Of the remainder, an estimated $3-1/2 billion

has been loaned to governmental bodies in continental Western
Europe and Japan,

Bonds issued by international financial

institutions, or loans to the International Monetary Fund for
use under the Oil Facility, account for $2 billion.

Another

$2 billion has been devoted to grants or credits to less-developed
countries, either directly or through contributions to regional
development banks, Egypt has probably been the largest recipient
of such aid.

The remaining increases in OPEC assets - - estimated

at $4 billion - - have been scattered among other items, including
private securities and real estate in continental Europe and Japan,
To date, the huge financial flows to and from OPEC
countries have been handled mainly - - and also reasonably well - by private markets, particularly commercial banks.
is no room for complacency regarding the future.

But there

Because of

the lag in payments to the oil-producing countries, the peak rates
of financial flows to these countries have been experienced only
for a few months.

Greater strains in financial markets may well

develop in the future not only because of new financial flows
to the OPEC countries, but also as a result of the growing
volume of assets that they will already have acquired.
As a matter of arithmetic, the volume of foreign assets
accumulated by the OPEC countries will depend on four factors:
first, the flow of oil revenues to the OPEC countries; second,
the flow of their other earnings, particularly investment
income; third, the expenditures of the OPEC countries on imports
of goods and services; and fourth, the financial resources which
these countries transfer to others in the form of aid.
Roughly speaking, oil revenues of the OPEC nations
will amount to something in excess of $100 billion per year, if
their current oil exports and prices are maintained.

This is

four times as large as the figure for 1973. On the import side,
some of the OPEC countries - - such as Indonesia, Iran, Nigeria,
and Venezuela - - have large absorptive capacities.

But a sub-

stantial proportion of the earnings of other oil exporters - notably Saudi Arabia and the states of the Persian Gulf - - will
not be spent for additional imports in the near future.

The two

other key factors in the picture — the flow of investment earnings
to the OPEC countries and the transfer of resources from the

OPEC nations to the less developed countries - - are as yet
quite small compared to the flow of oil revenues.

While the

future volume of aid by the OPEC countries is uncertain, their
investment earnings promise to grow at a very rapid rate.
All this suggests very large OPEC surpluses - - of
perhaps 55 to 60 billion dollars in 1975, something like $50
billion in 1976, and continuing large surpluses for at least
another five years.

The practical counterpart of these surpluses

would be the accumulation of a huge mountain of debts by the oilimporting countries - - unless the price of oil comes down or
unless the consuming nations take major steps to reduce
dependence on imported oil.
in view of the enormous debts in prospect for oil-importing
countries, it is only natural for governmental leaders and private
financiers to concern themselves with n recycling. n

But pre-

occupation with "recycling1' techniques has had the unfortunate
effect of diverting attention from the fundamental need tc bring
down the price of oil.

Unless that is done, it is extremely

doubtful whether the imarcial problems released by the huge
increase in the price of oil will prove manageable.

As a practical

matter, "recycling1* siemptyrneans that oil-importing countries
will slip more and OMO^B teepfy into debt.

Piling debt on top of

- 9-

debt - - o r speaking more realistically, piling dubious debt on
top of good debt — neither can nor should go on indefinitely.
If the price of oi] remains at anything like its present
level - - and there are repeated stirings in OPEC countries to
move it still higher — there will be a massive redistribution of
economic and political power among the countries of the world.
This of itself ca.rries dangers for our country1 s future.
addition,

In

the huge and growing financial reserves of OPEC

countries may cause very serious problems for some of the
countries - - both in the industrial and less developed parts of
the world - - that will simultaneously be piling up, or even just
handling, enormous debts.
Clearly, as the financial assets in the hands of the OPEC
countries grow, the burden of servicing these assets will grow.
The burden of future repayment will grow.

Furthermore, as

the potentia.1 for shifts in deposits from one bank to another
increases, financial institutions here and there may become
vulnerable,

So too may foreign exchange markets, if funds

should be moved abruptly and on a large scale from one currency
into another.

These dangers can be easily exaggerated, but they

cannot be dismissed.

Nor can we ignore the possibility that this

or that foreign industrial country, already finding itself in a

-10-

weakened position, may be unable to adjust sufficiently to the
burdensome price of oil and as a result suffer economic and
political collapse.
As I have already noted, commercial banks - - particularly banks in the Euro-currency markets - - have been playing
a major role as intermediaries in the oil-related financial flows,
taking the deposits of the OPEC nations and relending them.
Thus far, they have been able to cope with the strains brought
on by the oil financing.

But OPEC money cannot continue to be

directed to the banks on anything like the recent scale.
Financial prudence sets limits to the willingness of banks
to rely on large, interest-bea.ring, potentially volatile deposits
from relatively few sources.

Banks must be concerned that the

maturity structure of their assets and liabilities does not endanger
their liquidity.

They must be concerned that their exposure in

any one country does not become excessive.

They must be con-

cerned about the decline in the ratio of their capital to their
liabilities.

The well-publicized difficulties of several banks

heavily engaged in international finance have served as a warning
that bankers have not overlooked.
entirely silent.

Nor have their regulators been

-li-

lt is clear, therefore, that banks cannot prudently
continue to play the role of intermediary for flows of oil money
to the extent that they have in the recent past.

Indeed, as banks

have moved toward the limits of sound intermediation, they have
begun to shave the interest rates at which they will accept large
new deposits on a short-term basis.

In recent months, OPEC

countries have not put so large a share of their assets in the
Euro-currency markets as they did in the first half of 1974,
And there have been some indications of larger diversification
of OPEC holdings among countries.
As yet, however, there has been no large shift by OPEC
nations into longer-term assets; as noted earlier, most of their
holdings continue to be short-term assets.

This may simply

reflect a lag in the adjustment of the OPEC countries to their
newly won affluence.

As large and growing creditors, they have

an increasing stak2 in international financial stability, and they
should contribute to it by moving more rapidly to acquire longerterm assets.

Further reductions in the interest rates paid on

large short-term deposits would hasten such movement.
Even so, the plight of countries whose weak financial
position makes them unable to borrow in international financial

-12-

markets will remain very worrisome.

To be sure, it is desirable

that they, along with other oil-consuming nations, look sternly to
measures of oil conservation and the development of alternative
sources of power as a means of controlling their deficits.

But

as long as oil prices remain at their present level, a huge overall deficit will remain for the oil importers as a group; and some
countries will have disproportionately large deficits.

If help is

not provided to those in a weak financial situation, they may be
driven towards beggar-thy-neighbor trade policies, thus disrupting international trading relationships.

They may be driven

towards excessively tight domestic policies, threatening a prolonged recession and political disorder.

And in their desolate

need, they may be tempted to bend to the political will of oilexporting countries in order to obtain loans.
It is therefore to the interest of the United States and
the entire community of industrial nations that we develop
institutions to ease the financial strains to which any one of
them may be subjected, . If the weaker countries are left iinprotected to face their oil bills, they may be forced into special
arrangements with oil-producing countriese

Such arrangements

would undercut the bargaining power of the oil-consuming nations,

-13-

and delay the day when the present exorbitant oil prices are
reduced.
It is towards the goal of unity and mutual aid among the
industrial countries that a new initiative has recently been
announced by Secretary Kissinger and elaborated by Secretary
Simon*

The American proposal for a new financial mechanism,

to be developed in association with the Organization for Economic
Cooperation and Development, would provide stand-by financial
assistance to participating countries that find themselves in
difficulty after reasonable efforts on their part to deal with
their oil import and balance of payments problems.

The proposal

is intended to promote cooperation among oil-importing countries
and to facilitate rational dialogue with the oil-exporting countries.
It is not intended to replace the private market and other official
channels such as the International Monetary Fund, but rather
to supplement them.
The details of the American proposal remain to be worked
out, and the proposal itself must still be negotiated with other
countriese

It is nevertheless clear that any new financing

facility must have sufficient resources at its disposal to meet
the needs of countries in difficulty.

Unless that is assured, the

-14-

new facility will not serve the purpose of providing mutual
security to its participants.

In consideration of this security,

participating countries should undertake cooperative efforts to
reduce dependence on oil imports*

They should also undertake

to follow responsible adjustment policies, avoiding the use of
trade restrictions*

The facility might be financed through

direct contributions by the participating governments or through
loan guarantees, with the credit risks being shared.

In either

case* Congressional authority will be needed for U.S. participation.
The program proposed by the Administration thus has
the objective of bringing the major oil-consuming countries
together in a common effort.

It has two major aspects:

cooperation to reduce dependence on imported oil and financial
cooperation.

Financial cooperation is important; it can contribute

to international economic and political stability in the face of
large oil deficits.

But financial cooperation alone is not enough.

Even with an orderly financing of deficits, the immense burden
of carrying and ultimately repaying the debts will still remain.
Financial cooperation may ease the transition, but it does not
answer the most troublesome question:

I!

A transition to what? u

- 15-

Th e fundamental problem is the huge oil bill of the
importing countries, and a fundamental solution requires that
the price of oil be reduced.

The OPEC cartel will not last for-

ever, and the most promising way of breaking or weakening it
is to bring about changes in the demand and supply relationship
of the oil market.
taking place.

Already some change in this relationship is

Excess capacity of oil producers is now much

larger than it was last year.

New oil discoveries have occurred

in Bolivia* China, Malaysia, and Mexico, to name a few.

The

proven oil resources of the North Sea have doubled in the past
year.

In the United States, the potential of off-shore oil fields

is enormous.

The high price of oil is thus stimulating the search

for new oil fields, and also the development of coal, nuclear
power, and other alternative sources of energy.
While the effects of these adjustments on the supply side
will not become quickly visible, immediate adjustments are
already taking place on the demand side.

Oil consumption of

the importing countries will be about 3% less this year than
last.

A number of countries have recently stepped up their

efforts to save oil.
oil imports.

France has set a limit on expenditures for

The recent British budget again hiked the gasoline

-16-

tax, and as a consequence the British motorist will now payabout $1*20 per gallon.
The United States consumes
oil production.

about 30 per cent of world

Partly for that reason, partly also because of

our strategic role in the world, other nations look to us for
leadership.

The Administration has invited other industrial

countries to join us in a vigorous cooperative effort to deal with
the grave oil problem.

We should now do our part by moving

more decisively to conserve energy, by moving more resolutely
to develop domestic alternatives to imported oil, and by reducing
our vulnerability to the threat of embargo by increasing our
storage capacity.
This October, the President outlined a number of proposals to conserve energy and develop alternative domestic
sources.

The President's program included legislation to

require the use of coal or nuclear power in new electric
generating plants, and the conversion of existing plants to
coal.

It included proposals for gasoline savings on new auto-

mobiles, for fuel savings by industry, and for further conservation
within the government. The immediate objective of the program
was to achieve a reduction of 1 million barrels a day in oil

-17-

consumption by the end of 1975. These proposals by the President
deserve strong support from the Congress and the general public.
While the President's program emphasizes voluntary
actions, it is well to keep in mind that he has indicated that
more stringent measures to reduce dependence on imported
oil may become necessary in the future.

In view of the gravity

of the international energy situation, I believe that some preliminary planning on stronger measures to reduce domestic
consumption should be undertaken at once.

These might include

a sizable tax on gasoline, or on imported oil, or on automobiles
according to their weight or horsepower.
The recent report of the Federal Energy Administration
on Project Independence also deserves prompt attention by the
Congress.

While this report does not offer specific recommen-

dations for the reduction of oil imports, it does provide a wealth
of information and analysis regarding the steps that might be
taken to increase domestic sources of energy, to conserve fuel,
and to establish standby emergency programs, including stockpiling.

It is high time that we moved from the rhetoric to the

reality of Project Independence, and the FEA study can help to
speed and guide our path to this objective.

-18-

In conclusion, I can only say to this Committee that the
problems caused by the recent manipulation of oil prices and
supplies are among the gravest with which this nation has had
to contend under peacetime conditions.

Unless we take stronger

measures than we have yet done to conserve oil, to develop
alternative sources of energy, and to lead other industrial
nations in a common policy to lighten the burdens that OPEC
oil actions have imposed on the world, we may endanger our
nation's future.

The policy that I have advocated this morning

is a policy of austerity.

I recognize that it must be carried out

prudently - - if possible, without intensifying the recessionary
tendencies that are already developing in our economy.

The

alternative of drift, I fear, may lead to a permanent decline of
our nation's economic and political power in a very troubled
world.