View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

For release on delivery

Statement byArthur F. Burns
Chairman, Board of Governors of the Federal Reserve System
before the
Subcommittee on Foreign Economic Policy
and the
Subcommittee on International Exchange and Payments
of the
Joint Economic Committee

June 30, 1971

I am happy to come here today to discuss with you how we
at the Federal Reserve see the problems that are the subject of
these hearings.
My major theme this morning will be the persisting imbalance
in our international economic accounts.

After considering that, I

shall turn to the special problem of short-term capital flows, and
conclude by discussing some of the policy actions that need to be
taken by us and other countries to deal with these two problems.

The Persisting Imbalance
As you well know, our balance of payments is not in a
satisfactory condition.

Indeed, a deficit in our international

accounts has turned up almost every year since 1949.

There are

several ways of judging the balance of payments--through the
balance on official reserve transactions, the balance on the
liquidity basis, or the balance on current account and long-term

V hichever of these concepts we may adopt, the practical

conclusion is the same: a stubborn, persistent deficit has characterized our balance of payments.
V;e should not, however, be misled by the staggering
magnitude of the balance of payments deficit during the past


year and a half*

In 197Q the deficit on the official settlements

basis reached $10.7 billion before allowing for the special
drawing rights (SDRs) allocated to us, and the deficit has continued
at an extremely high rate in the first five months of this year.
These recent deficits exceed anything we have hitherto experienced,
but they also greatly exaggerate our true underlying condition.
Thus, the official settlements deficit over the thirteen years
from 1958 to 1970 averaged only slightly more than $2 billion
per year.

Moreover, the deficit on current account and long-

term capital movements, while larger in 1970 than in immediately
preceding years, has been for several years in the 2 to 3 billion
dollar range.

Of late, this underlying imbalance has been

overshadowed by extraordinary short-term capital movements,
and it is this that has made our balance of payments position
appear much worse than it basically was in 1970—just as it
made it appear much better than it basically was in 1968
or 1969.
It is also worth noting, as some European countries have
recently discovered, that a surplus in the balance of payments is
not always a blessing.

Nor, for that matter, is a deficit always

V e cannot remind ourselves too often that the postwar U.S.


deficits experienced through the late 1950Ts were welcome

The balance of payments problem in those days was

called the world's dollar shortage.
As our deficits persisted through the 1960's, however,
it became increasingly clear that further large deficits could
prove troublesome to us and to other countries.

For the counter-

part of the persistent deficit has been a gradual erosion of the
U.S. international reserve position.
Our reserve assets—which include, besides gold, our
reserve claim on the International Monetary Fund, holdings of
convertible foreign currencies, and more recently SDRs--declined
fairly steadily from a level of about $25 billion in 1957 to less than
$14 billion at the time of the gold crisis in the spring of 1968.
Since then our reserve assets at first rose somewhat; but they
have fallen back more recently to the previous low point of 1968.
In sharp contrast, U.S. liabilities to foreign central banks and
governments have increased rather steadily in the postwar

These claims on U.S. reserve assets grew from an

average level of some $4 billion in 1949-51, to about $12 billion
in I960. By the end of this April, they amounted to $31-1/2 billion,


and there was a further substantial increase during the foreign
exchange crisis in May.
Once welcomed by all concerned, these trends in our
reserve position have gone on much too long.

Continuation of

the decline in U.S. reserve assets and any excessive buildup
of our reserve liabilities are neither desirable nor sustainable.
If we wanted to finance further sizable deficits by reducing
reserve assets, it is obvious that we could not continue doing
so very long.

On the other hand, if we sought to finance per-

sistent deficits by increasing our liabilities to foreign central
banks and governments, we might well find that some countries
no longer wish to add to their dollar reserves.

Certainly, a

continued accumulation of unwanted dollars would make our
friends abroad more and more dissatisfied with the workings
of the present international monetary system.
Now that SDRs are being created, there is also less reason
for large, persistent U.S. deficits.

Before the advent of SDRs,

our deficits played a major role in supplying monetary reserves
to other countries.

There is now general agreement, however,

that growth in the reserve liabilities of the United States should
be much smaller and that the major part of future growth in world
monetary reserves should take the form of SDRs.


The most disappointing feature of the U.S. balance of
payments in recent years has been the weakness of our foreign
trade account.

Since a more viable overall balance of payments

in the future will require a substantial improvement in our trade
balance, I would like to discuss this sector of the balance of
payments with you in some detail.
The U.S. surplus on trade of non-military goods averaged
$5.6 billion in 1956-57, dropped sharply during the late 1950's,
then returned to a robust $5.2 billion average in 1960-6L


the strong recovery of the economy between 1962 and 1964, the
surplus increased somewhat.
surplus has been shrinking.

Since 1965, however, the trade
In 1968 and 1969, it virtually dis-

Though rising cyclically to an annual rate of some 2

to 3 billion dollars in the first three quarters of 1970, the trade
balance has in recent months been in actual deficit.

The data

for April and May of this year are particularly unfavorable.
The most important factor contributing to the post-1964
deterioration in our trade position was the emergence of excess
demand in our economy and the accompanying inflationary conditions*
To be sure, export receipts--while affected adversely by
high demand pressure at home--did increase at a rate of about 10


per cent a year in the period 1965-70*

This growth, however, was

not as rapid as the growth rate of imports by the rest of the world.
Hence the U, S. share in world markets continued its gradual decline.
Data on prices in the United States and foreign countries
support the view that our trade balance during 1965-69 was weakened
by the inflation.

By 1969, export unit values for the United States

had risen by 17 per cent from the 1963-64 average.

Export unit

values for countries such as Germany, Japan, and Italy rose much

A comparison of wholesale price indices again shows a

significantly faster rate of increase for the United States in
1965-69 than for most other industrial countries.
Imports have grown since 1964 at an annual rate of almost
14 per cent, much faster than the growth rate of GNP.

As a con-

sequence, the ratio of imports to the gross national product has
risen by roughly one-third since 1964 to a current level of about
4 per cent.

The impact on imports of the excessive demand

pressure in 1965-69 goes far toward explaining this rise in the
propensity to import.
also played a role.

Shifts in the character of our imports

Finished manufactures have become an

increasingly large proportion of total imports, rising from
37 per cent in I960 to 56 per cent in 1970.

Moreover, imports


of finished goods have also been rising rapidly relative to
domestic production.

These trends were already in evidence in

the 1950's, but only in more recent years have they had a major
effect on the ratio of imports to the gross national product.
No analysis of our trade position would be complete without reference to the fact that some U.S. products are not freely
admitted to foreign markets.

They are subject to quantitative or

administrative quotas (e. g. , consumer goods imports into Japan),
to variable border levies and other special import taxes (e. g. ,
EEC restrictions on the import of agricultural goods), to special
marketing agreements, and so on* Such restrictions limit our
exports of agricultural products, coal, and a wide range of manufactured products including computers, autos, heavy electrical
equipment, drugs, and fabrics.
I shall come back later to the outlook for our balance of
payments and to policy actions that can be taken to deal with the
underlying imbalance.

Before doing so, let us focus on the special

problem of short-term capital flows, particularly our experience
of the last two or three years.


Short-tertti Capital jlows
Troublesome flows of capital often develop when the
business cycle is in a different phase in different countries, and
the monetary policies of the countries are accordingly out of phase.
Thus, the massive flow of short-term funds to the United
States in 1969 was a • byproduct of the tight monetary and fiscal
policies here at that time, while in most European countries the
policy response to the rising boom was Ie6s advanced. Major
American banks experienced increasing difficulty in accommodating
the credit demands of their customers as their time deposits shrank
because of the rise of market interest rates above the Regulation
Q ceiling for CD's. The foreign branches of our banks came to
the aid of their parent institutions by raising funds in the Eurodollar market from foreigners whom they induced to shift out of
assets in their own currencies into dollars. The Eurodollar
market thus served as a channel for large flows of capital to the
United States. In a narrow view, this was not unwelcome as an
offset to our underlying payments imbalance.

But it was trouble-

some to some European countries* Moreover, the flow was bound
to turn around sooner or later--as in fact it did in 1970.


In the latter part of 1969 and in 1970, many European
countries found it necessary to tighten their monetary policies.
In the United States, on the other hand, excess demand for goods
and services vanished during 1970, and monetary policy shifted
away from severe restraint toward moderate ease. It therefore
became cheaper for American banks to attract funds at home than
to maintain large Eurodollar borrowings.

The branches, getting

repayments from their head offices, had additional funds to lend

In turn, business firms in Germany and other countries

where credit conditions were tight found Eurodollar loans readily
available at lower cost; so the Eurodollar market now served as
a channel for a flow of short-term capital from the United States
to other countries.

As a result, the official settlements deficit

of the United States increased very sharply, other countries
experienced large reserve gains, and the efforts of European
countries to fight inflation with restrictive monetary policies were
to some degree undermined.
This year, the flow of short-term capital to European
countries, particularly to Germany, was at first simply a continuation of the earlier flows arising from national differences
in credit conditions.

In April and May, however, the inter-

national flow of funds --whether through the Eurodollar market


or directly from country to country--expanded enormously.
Interest differentials could not be the main factor in these new
and massive capital movements; for interest rate spreads were
then actually in process of narrowing.

What happened was that

a speculative movement developed in the expectation, which was
stimulated by widespread reports concerning intentions of the
German government, that the D-mark and some other currencies
would soon be revalued.

As everyone knows, a monetary up-

heaval of some dimensions did occur in Europe in early May.
This recent experience with speculation on foreign exchanges underlines the fact that short-term capital flows are not
independent of persistent payments imbalances.

Had there not

been a long experience with U.S. deficits and German surpluses,
it is doubtful if the flow of short-term funds to Germany and
other countries would have reached such huge proportions.
Incidentally, it is important to recognize that some part
of the large reserve gains of European central banks during the
past year is directly attributable to the practice of major European
central banks in depositing funds, usually through the Bank for
International Settlements, in the Eurodollar market.


the banks in which these central bank funds were placed lent them

out to European borrowers, who in turn often converted the
funds into their own domestic currencies.

These conversions

into domestic currencies expanded the money supply of the
affected countries and eased the liquidity positions of their
commercial banks, thereby frustrating to some degree the
restrictive policy of central banks.

In the end, central banks,

serving as residual buyers of dollars in their exchange markets,
reacquired—in whole or in part—the funds that they themselves
had initially lent to the Eurodollar market.

By this process,

increases in official dollar holdings were magnified far beyond
what they would otherwise have been.

Yet the whole blame for

the rapid increase in foreign dollar reserves was widely, but
incorrectly, attributed to the U. S. deficit.

Outlook for the Balance of Payments
For the near-term future, a repetition of capital flows
such as we have recently observed is highly unlikely.


liabilities of U. S banks to their foreign branches fell from a
peak of over $14 billion in 1969 to about $2 billion in recent

Clearly, they are now at or close to rock bottom.

Moreover, the Voluntary Foreign Credit Restraint program
inhibits the banks in increasing their foreign assets.

Thus the


large outflow of short-term funds which began in 1970 is now
behind us.

For this reason alone, we can expect the official

settlements deficit to fall back sharply from the unprecedented
rates of 1970 and early 1971.
What about the prospects for other categories of transactions?

As 1 try to look ahead, I see some significant areas

of strength.

First, growth in our receipts of investment in-

come from abroad has been rapid and fairly steady.

This trend

can be expected to continue.
Second, foreigners have in recent years stepped up their
purchase of equities in the U.S. stock market.

This trend, too,

may well continue in the future— especially if corporate profits
pick up and we make reasonable progress in restoring full
Third, the reduction of troop levels in Southeast Asia
is mitigating the drain on our balance of payments from overseas
military expenditures, and further reductions in the foreign exchange cost of our overseas operations are expected.
To be sure, these favorable trends could be offset by
weakness in other categories of international transactions.


have already noted that our trade position is not nearly as strong


as it needs to be.

The fact that our price performance since

1969 has been better than that of many other industrial countries
suggests that we may be on the road to regaining at least part of
the competitive strength that we lost in the second half of the

Any such conclusion;

however, would be premature.

On balance, it appears that while we can look forward to
a very substantial reduction in the official settlements deficit
over the coming months, we need to recognize that economic
policies since 1958 or thereabouts have been entirely insufficient
to achieve equilibrium in our international accounts.


decisive steps v/ill need to be taken to correct the situation*

Policy Guidelines for the Future
The obvious place to begin is at home.

Let us therefore

consider the question: What policy actions can and should the
United States take?
The first and foremost requirement for improving our
trade position and the overall balance of payments is to restore
and maintain general price stability while we continue to strive
for a healthy rate of economic expansion.

That reliance on

monetary and fiscal policy may prove insufficient to realize
this objective is attested by our own recent experience as well


as that of Canada and Great Britain.

In all three countries a

substantial increase of unemployment has failed to check the
rapidity of wage advances or to moderate appreciably the rise
of the general price level.
With increasing conviction, I have therefore come to
believe that our nation must supplement monetary and fiscal
policy with specific policies to moderate wage and price increases.

As I have noted on previous occasions, I am not

unaware of the pitfalls that could accompany governmental
involvement in the determination of wages and prices.

I also

recognize that previous experiments with incomes policy have
hardly been a huge success.

At the same time, I attach great

weight to the moral force that strong government leadership
could at the present time bring to bear on private decisions in
key industries.

If we are to restore price stability with high

employment in our economy, I see no immediate alternative to
a cogent incomes policy.

Over the longer run, we may well need

legislation to deal with abuses of private power in our labor and
product markets.


V/hile the restoration of general price stability is basic
to the correction of our trade position, other measures that can
improve our exports deserve consideration.

The recent decision

of the Administration to remove some of the restrictions on trade
with mainland China might be followed up by some liberalization
of trade with the Soviet Union.

A proposal for establishing

domestic international sales corporations, whereby taxes on
earnings from exports may be deferred, has been put before the

And so too have some proposals for strengthening

the Export-Import Bank, such as providing it with increased
program authority to extend loans, guarantees, and insurance.
All these measures may prove helpful.
But far more important than these specific measures
for stimulating exports, as I have already tried to suggest, is
the restoration of general price stability and improvement of
the economic climate in our country.

Restoration of general

price stability is vital to the return of a healthy trade balance,
while larger profits than American corporations have achieved
in the past few years from their domestic enterprises are vital
to improvement in the long-term capital account of our international transactions.

-16Sincie the United States has experienced a persisting imbalance in its international payments, it follows that the rest of
the world has been in persistent surplus.

Thus the rest of the

world must be prepared to see its surplus decrease if the U.S.
deficit is to decrease.

This simple thought leads me to ask:

What actions should our trading partners take?
There are at least two areas in which they can be very

First, as I have already intimated, other nations need

to review their trade policies and relax restrictions on their

A timely initiative by Japan and some European

countries to open up their markets more freely to the products
of others is overdue*

Trade liberalization should be accompanied

by relaxing the heavy restrictions that nations often impose on
investments abroad by their citizens.
Second, foreign countries can and should undertake a
significantly larger contribution to the defense of the Free

The United States is not going to cast off its respon-

sibilities for leadership in this area*

But the nations of western

Europe and Japan, where overseas military expenditures by the
United States are ^ery large, now have strong economies and
a capacity to contribute significantly more to the financing of


the military shield from which they as well as we benefit.


more equitable sharing of the defense burden would require
them to do so.
Clearly, neither the problem of persisting payments
imbalances nor the problem of destabilizing short-term capital
flows can be dealt with effectively by the United States on a
purely unilateral basis.

Neither can other major countries

effectively deal with these problems by unilateral action..
Since we are all parts of a community of nations, perhaps the
most important question we have to ask ourselves is: What
policy actions can the major countries take cooperatively?
There are four areas of joint policy action I would like to
First, we should try to work with other nations to bring
about smaller divergences of interest rates.

More effective

use of fiscal policy by each major country in the interest of
its own economy could reduce international differences in
credit conditions, thus limiting short-term movements of
funds and payments imbalances.
Second, there is a need to work closely with other
countries on devising methods to mitigate the undesirable


impact of capital flows on international reserves and domestic
monetary conditions.

Both the United States and other countries

have already taken some significant steps in this direction*
For example, we recently sold $3 billion of special ExportImport Bank and U.S. Treasury securities to foreign branches
of U.S. banks, thereby absorbing funds that probably would
otherwise have moved through the Eurodollar market to foreign
central banks. We have also indicated our readiness to consult
with other governments on the question of providing suitable
dollar investments for their reserves held in the United States,
and two days ago the Treasury formally announced a $5 billion
funding of U. S. liabilities to the Bundesbank in Germany.
I am also pleased to report that the placement of central
bank reserves in the Eurodollar market has now been halted by
the central banks of the major industrial countries.


more, discussion is proceeding among leading central banks on
the question of when and how a gradual withdrawal of central
bank reserves from that market might be accomplished.


problem of short-term capital flows is also being studied intensively now by the International Monetary Fund and the Organization for Economic Cooperation and Development.


Cooperative management of world reserves is the third
area in which all the major countries need to take joint policy

Looking to the long future, it is essential to maintain

an adequate rate of growth in world monetary reserves and to
ensure that there are no destabilizing shifts among countries1
holdings of gold, SDRs, and reserve currencies.

The nations

of the world took a significant step forward with the amendment
to the IMF Articles of Agreement providing for the creation of

The recent rapid buildup of dollars in central bank re-

serves should not divert us from prudent steps to increase the
future role of SDRs in world monetary reserves.
Finally, we should continue to participate actively with
other nations in discussions of ways in which the balance of
payments adjustment process can be improved.

The question

of greater flexibility in exchange rates has been extensively
discussed in the IMF and elsewhere in the past two years*
Thinking has centered on the possible advantages of some
widening of the margins for exchange rate fluctuations around
their parities, of a "transitional float11 from an old to a new
parity, and of smaller but more prompt changes in parities.
A widening of margins, for example, holds considerable promise

-20as a device for permitting greater divergences in monetary
conditions to exist among countries without those divergences
giving rise to excessive flows of short-term capital.


turbulent events in exchange markets this May have underlined
the need for informed discussion and reconsideration of the
international rules governing exchange rate policies.

Concluding Observations
In closing, let me say that I hope I have made it clear
that the Federal Reserve Board rejects an attitude of complacency
about the U S. balance of payments.

We also reject any radical

courses of action that would imperil the institutional arrangements and good will among countries that have been carefully
built up in the quarter century since the Second World War.
What we need is measured, deliberate steps to resolve the
problems that confront us.
We can go about this task in a mood of confidence.
For our economy is larger and more productive than that of
any country in the world.

Not only that, the foreign assets of

the United States far exceed our foreign liabilities, and this


excess has grown steadily since World War II. It is the liquidityaspect of the U.S. debtor-creditor position, not the overall
international balance sheet, that causes us concern. In considering the balance of payments problem, we should not lose
sight of our fundamental strength.