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Release on Delivery
(Approximately 1:00 p.m.
Tuesday, December 7, 1965)

Remarks by Governor J . Dewey Daane
Member, Board of Governors of the Federal Reserve System
at the meeting of the
Cincinnati Council On World Affairs
Cincinnati, Ohio
on Tuesday, December 7, 1965

As I understand it, anyone from Washington who ever departs from
his prepared remarks on a subject is promptly dubbed a "text deviate".
At the risk of being placed in this category I would like to diverge
from my earlier prepared text on "Our Balance of Payments Situation
and International Liquidity" long enough to make a comment or two on
the actions which the Federal Reserve Board announced yesterday--actions
which are clearly not irrelevant either to the United States balance of
payments position or the continuing strength of the dollar as one of
the major components of world liquidity.

The Federal Reserve actions,

in which I participated as one of the majority of the Board members
favoring, to approve discount rate increases and raise the rate ceilings on bank time deposits parallel and support the Government's actions,
also announced yesterday, to strengthen the balance of payments program
particularly with respect to the dollar drain from overseas investment.
The rationale of the Federal Reserve actions is, I believe, well set
forth in yesterday's press release and I would like to re-emphasize to
you the pertinent passages:
The Federal Reserve announced today two complementary actions to reinforce efforts to maintain
price stability, and thus to foster balance in the
economy's continued growth and strength in the dollar's
international standing.
The actions, intended not to cut back on the present pace of credit flows but to dampen mounting demands
on banks for still further credit extensions that might
add to inflationary pressures, were as follows:

- 2 The increase in the rates that member banks
are permitted to pay their depositors is intended
to enable the banks to attract and retain deposits
of businesses and individuals and thus to make
more effective use of savings funds already available in the economy to finance their loan expansion.
The increase in discount rates is intended to
moderate additional bank reliance on short-term
borrowings from the Federal Reserve to meet intensifying loan demands.
The action contemplates, however, the continued provision of additional reserves to the
banking system, in amounts sufficient to meet
seasonal pressures as well as the credit needs
of an expanding economy without promoting inflationary excesses, primarily through the
Federal Reserve's day-in and day-out purchases
of government securities in the open market.
The changes in discount rates and the
maximum rates that banks may pay depositors
were the first in either respect since November 24,
Since then, total borrowing by consumers,
business, and State and local governments has
risen sharply, and interest rates at all maturities
from the shortest to the longest have been rising
under demand pressures. In these circumstances,
the Federal Reserve would be forced to increase
bank reserves at an accelerated pace if all demands
for borrowing money at present rates were to be
With slack in manpower and productive capacity
now reduced to narrow proportions, with the economy
closer to full potential than at any time in nearly
a decade, and with military demands on output and
manpower increasing, it was felt that excessive
additions to money and credit availabilities in
an effort to hold present levels of interest rates
would spill over into further price increases in
goods and services. Such price rises would endanger
the sustainable nature of the present business expansion. Moreover, increases in costs and prices

- 3 would make it more difficult for American goods
to compete in markets at home and abroad.
In addition, a pattern of interest rates
that is accepted by borrowers and lenders as
fully reflecting market forces should add
assurance of a smooth flow of funds to all
sectors of the economy. Discount rate increases
in 1963 and 1964 did not stop business or credit
growth, but helped to keep the economy within
an expansion that was sustainable.
In sum, the actions taken today should have
the three-pronged impact of:

Backing up the Government's efforts
to prevent inflationary excesses from
damaging an economy now carrying the
added burden of military operations
in Vietnam;


Bolstering the Government's programs
to overcome persistent deficits in
the U.S. balance of payments; and


Demonstrating anew the United States'
determination to maintain the international strength of the dollar.

Five years ago, on the eve of our present relatively long period
of sustained expansion, an expansion which I am firmly convinced our
action this week will help to keep sustainable, I attended an economists
meeting at which one of the leading speakers said profoundly, "We may
be entering into an attenuated state of unstable equilibrium."


puzzling on this I decided that he meant the economy might continue to
go sideways if it did not go up or down.

The second speaker was equally

- 4 profound, saying, "At present, v/e seem to have a delicate balance of
inflationary and deflationary forces, with possibilities of continuing
in this state, of moving temporarily into a moderately deflationary readjustment phase, or of having, after new piecemeal adjustments, a
renewal of inflationary developments."

Again, after thinking about

this statement, I decided that he meant if we did not go sideways we
would go up or down.
Today, rather than engage in this kind of gobbledygook, which
sometimes seems to be the economists' stock-in-trade, I will simply
say at the outset that I do not know precisely how the balance of payments situation will appear in the future, or precisely how the problem
of shaping our international monetary system for the future will be

What I do know is that we have made substantial progress in

1965 on our balance of payments problem, are taking additional steps to
ensure further progress in 1966, and that we are moving ahead also in
our efforts to determine basic areas of agreement in the field of international monetary reform.
First, taking a look at our own balance of payments situation, last
February the President announced his program to "achieve a substantial
reduction in our international deficit during 1965, and secure still
further improvement in 1966."

The 1965 part of this objective is being

On the former concept, referred to as the "regular transactions"

basis, our deficit this year may prove to be in the $1-1/2 to $2 billion
range, compared with $3.1 billion last year.

On the newer "liquidity"

- 5 or "overall" b a s i s , which simply also takes into account debt prepayments
and prepayments for military g o o d s , the deficit m a y prove to be about
in the $1-1/4 to $1-1/2 billion range this y e a r , compared with more
than $2-1/2 billion in almost every one of the previous seven y e a r s .
Finally, the deficit on the newest "official settlements" basis may
prove to be in the neighborhood of only $1/2 b i l l i o n , compared with
$1-1/4 billion last year and substantially more in earlier y e a r s .


m i g h t m e n t i o n that the 1965 deficit would turn out to be even smaller
if the United Kingdom Treasury had not already converted several
hundred m i l l i o n dollars of its wartime acquired portfolio of U . S .
equity securities into assets w e count as liquid and therefore as a
drain on our b a l a n c e .
Most s i g n i f i c a n t l y , the improvement in our balance of payments
this year has occurred despite a decline in the current account s u r p l u s ,
and specifically in the surplus on trade a c c o u n t .

It has resulted

primarily from a very sharp reduction in the net outflow of United
States private capital from $6-1/2 billion in 1964 to an annual rate
thus far this year of about $3-1/2 b i l l i o n .

This reduction is mainly

attributable to three d e v e l o p m e n t s , (1) the sharp cut in bank credit
outflows achieved under the voluntary restraint program, reinforced by
the interest equalization tax, (2) the substantial reflow from abroad
of corporate liquid funds a n d , (3) the stronger domestic credit demands
generated by our expanding e c o n o m y .

As a major contributing part of the continuing capital outflow
problem, direct investment abroad expanded at a very sharp rate in 1964
and early this y e a r .

It has since diminished but the year's total will

still be very large.

As a result Secretary Connor announced yesterday

more ambitious targets for corporations and called for "special efforts"
to restrain the outflow of funds for direct investment a b r o a d .
Looking ahead at 1966, some encouragement can be found in the m o s t
recent developments in our export and import trade.

Averaging the four

months July-to-October together to iron out some statistical


the surplus of non-military exports over imports was at an annual rate
of $5-1/2 b i l l i o n , compared w i t h a relatively poor $4-1/2 billion average
rate in the first half of this y e a r .

Next year we should be able to

sustain this improvement in our trade position.-

We can also expect

continuing gains in the receipts of income from foreign investments.
On the capital outflow s i d e , w h i c h in 1965 was still a major
drain on our balance of payments, there was a strengthening of the
President's program announced y e s t e r d a y , including a strengthening of
the Commerce program with respect to direct investment, and a renewing
and revising of the Board's program with the issuance of new guidelines
for financial institutions to follow during 1966.

A c c o r d i n g l y , there

should be some further improvement in our payments position next year
as outflows of United States capital are held down by these voluntary

But beyond 1966 it will no doubt become increasingly

to limit capital outflows by voluntary programs.


Since the long run

- 7 objective in any case should be to permit greater freedom of capital
movements, it is obvious that continued improvement in the balance of
payments will require further gains in our receipts from net exports.
In this connection, it remains of crucial importance to avoid inflationary
developments in the United States economy, so as to reap the competitive
advantage of relative price stability here while price increases are
still occurring in most industrial countries abroad.

And, in this

context, the most recent Federal Reserve actions will clearly serve to
reinforce national efforts to maintain price stability.
As to the relationship of the United States balance of payments
and the whole matter of international liquidity and monetary reform
there are both links and what I would term "non-links" between them.
By international liquidity, of course, we mean simply all of the
r e s e r v e s — m a i n l y gold and d o l l a r s — a n d credit facilities available to
monetary authorities to settle imbalances in their balance of payments.
On the "non-link" side it is a misconception to think that somehow
there can be an international liquidity escape route from the hard
road of restoring equilibrium in our balance of payments.

Nor can

or should the creation of international liquidity be looked to as the
means for attempting to ensure appropriate efforts to eliminate
deficits and surpluses in the balance of payments.

Yet both of these

misconceptions frequently emerge.
I have been struck by the fact that much of the continental
European yearning for international monetary reform and new forms of

- 8


liquidity basically teflects a desire to constrict the present degree
of liquidity, and in a way that w o u l d , as they see it, enforce monetary
discipline upon the reserve currency countries.

To be blunt, it is

no secret that some European observers feel that our monetary policies
in recent years have not been sufficiently restrictive--and contend
that our ability to finance external deficits with the dollar in its
role as a reserve currency has exempted us from monetary discipline.
Here at h o m e , on the other h a n d , m u c h of the academic and other clamor
for greater international liquidity and for altering the international
monetary system reflects the idea that this would enable much more
expansionary domestic policies, monetary and other.

In fact, both

notions a r e , in my judgment, erroneous.
The answer to the first charge lies in the continuous and increasingly comprehensive efforts made to contain the United States
balance of payments deficit, beginning in 1960, broadened greatly in
February, 1961, accelerated in m i d - 1 9 6 3 , widened further in February
of 1965, and strengthened again this w e e k — e f f o r t s which have all along
not neglected actions in the monetary area.

Thus I would categorically

deny the assertion of some continental European bankers and economists
that the reserve currency status of the dollar enables the United States
to live consistently beyond its means and to flout the discipline of
the balance of payments.
The United States


current willingness to explore new methods

of reserve asset creation does n o t , and cannot, reflect any lessened

- 9 determination to achieve equilibrium in our balance of payments.
President Johnson has made this crystal c l e a r , not only in his remarks
last fall at the meetings of the international Monetary Fund and World
Bank but in his letter of yesterday approving the strengthened balance
of payments program and directing that it be put into e f f e c t .


cannot replace dollar viability and dollar viability rests squarely on
the continuance of appropriate domestic


I have dwelt thus far on the "nonlinks" but there are valid links
as well between the United States balance of payments deficit and the
need for contingency planning w i t h respect to international monetary

If one looks at the increase in world monetary reserves over

the past seven y e a r s , around one-third of the total increase in such
reserves was accounted for by increased holdings of United States dollars,
reflecting the continuance of United States deficits.

Most strikingly,

in the earlier part of this period, 1958-1962, the United States deficit
contributed substantially to international liquidity as the dollars
flowing out were largely retained in foreign reserves.

In fact, in

this 1958-62 period almost two-thirds of the increase in world monetary
reserves represented increased official foreign holding of U . S. d o l l a r s .
More r e c e n t l y , h o w e v e r , the United States deficit has been neutral or
even contractive of world liquidity as foreign central banks have
converted dollar reserve accumulations into g o l d , or even in a few
i n s t a n c y so converted previously accumulated dollar b a l a n c e s .


the United States' ability to eliminate its deficit is directly relevant
to the amount of world liquidity in the form of monetary


- 10 The real point of contact then between U.S. balance of payments
equilibrium and international liquidity is not that more liquidity
would enable the United States to avoid taking necessary adjustment
measures, but is twofold.

Unless the United States succeeds once and

for all in dispelling skepticism regarding its ability to put its
house in order, the conversion of dollars into gold can and will continue and can only be contractive of world reserves and world liquidity
As the United States succeeds, the outflow of dollars will no longer
serve to meet in the same way the needs for world reserves and world

Hence, both until and after equilibrium is achieved, our

dollars will not provide as much international liquidity as they have
in the past.
As to the other reserve asset forming the bulk of world monetary
reserves, namely gold, it is generally conceded that the production
of gold will prove to be insufficient, and Soviet sales unreliable
as a supplement, to meet growing needs for reserves.

Cn this score,

for example, it is interesting to note that world monetary gold reserves have not increased at all this past year.

And total world

monetary reserves, including gold, have declined from 58% of imports
in 1953 to 39% in 1965.
If we are to ward off the contractive threat of insufficient
reserves leading to restrictive measures by various countries--each
country seeking to improve its own reserve position at the expense of
others, which will inevitably make world economic growth less than it

- il might be and should b e — t h e r e is a clear need to provide for other
means to increase liquidity when and if needed, both through owned
reserves and credit facilities,

Cn the latter score much has already

been done in the way of additional credit facilities in the network
of Federal Reserve swap and standby swap arrangements, now totaling
close to $3 billion, in Roosa-type bonds, and in substantial additions
to resources of the IMF both by increases in quotas of member countries
and by the agreement to provide supplemental resources in the General
Arrangements to Borrow.

But there has also been a wide variety of pro-

posals for other new arrangements put forth over the past two years,
some looking toward new methods of reserve asset creation within the
International Monetary Fund itself and others outside of the Fund.


do not intend today to make a detailed examination of these various
proposals and of their possible merits and demerits.

For that I re-

fer you to the excellent report published last August of the Study
Group on the Creation of Reserve Assets, under the chairmanship of
one of the Italian Deputies of the Ten, Signor Rinaldo Ossola.
Most of the proposals under discussion are aimed at the deliberate
and controlled creation of international reserves.

Furthermore, most

of them create reserve assets "out of thin air" in the sense that
countries participating in the proposed arrangements would benefit
from an increase in the reserves without giving up goods and services
or accepting a capital inflow.

Most schemes would also require some

limitation on the freedom of countries to determine the composition

- 12 of their reserves.

For the schemes to be w o r k a b l e , participating

countries would have to commit themselves to accepting the newlycreated assets in payment for surpluses within agreed limits.


their other characteristics the various schemes for creating reserve
assets differ considerably.

Although I do not intend to elaborate

on the technical aspects of the various proposals, the Ossola Report
highlights four issues in reserve asset c r e a t i o n , apart from the
fundamental issue of whether a new reserve asset should supplement
or supplant reserve currency balances (i.e. dollars or p o u n d s ) .


issues, also in part technical, are:

the q u e s t i o n of a link between gold and
a new reserve a s s e t , the closeness of
that link, and its effects on the existing


the width of m e m b e r s h i p for purposes of
m a n a g e m e n t and distribution of the assets;


the role of the I.M.F. as regards deliberate
reserve creation;


the rules for decision-making concerning
the creation of reserve a s s e t s .

The Deputies of the Ten (the Deputies of the Ministers of Finance
and central bank Governors of the ten leading industrial countries) are
now engaged in seeking o u t the basis for agreement on these and related
issues with a view to m a k i n g a progress report by late Spring of 1966.
On these issues, the substantive views of the United States are
in process of development and c r y s t a l i z a t i o n .

B u t , on the first question

of whether or not a new reserve asset can be used for settlements only

- 13 along with a specified quantity of gold or of other reserves, or may
circulate on its own Under Secretary Deming has recently stated:


our part, we believe that the creation or use of a new unit should
not influence nations directly or indirectly to seek to add unnecessarily to their holdings of gold.

As the country to whom others

turn for gold when new supplies are not available, we have a vital
interest in this respect,"
On the second question of the width of membership it may be noted
that this raises economic, financial, and political questions involving
the status of nations outside the Group of Ten and their relationship
to the process of creating and distributing new reserve assets.
With respect to the third question of the role of the International
Monetary Fund, Pierre-Paul Schweitzer, the Managing Director, says
simply and directly that "International liquidity is the business of
the Fund."

Support for this view which emerged at the last meeting

of the International Monetary Fund and World Bank suggests adaptation
of the existing IMF procedures to deliberate reserve creation.
general idea is simple in substance:


the creation of claims on the

Fund and a limited commitment by countries to accept such claims when
they are in surplus.

On the other hand, others have expressed the

view that the International Monetary Fund should properly be provided
with sufficient resources to fulfill its function of providing credits
to individual countries, but that the Fund should not have a leading or
important policy role in the deliberate creation of reserves.

- 14 Similarly, as to the fourth question of the rules for decision
making, again this involves both economic and political questions as
to how to design the decision making process to protect the minority
without providing a veto power that could prove stultifying.
Finally, I would like to close with a few comments as to the
guidelines or objectives on which the United States has consistently
stood firm.

The first is that any scheme should not be contractive

of world liquidity.

A new reserve asset should not be detrimental

to existing liquidity.

An important part of existing liquidity re-

presents reserve currency holdings, and the attitudes of their holders
are of vital concern in constructing an acceptable reserve asset that
x^ould add to, and not subtract from, present liquidity.

Secondly, the

first phase of preparation for new and improved monetary arrangements
now underway in the Group of Ten must be followed by a second phase
of preparation involving more countries in a wider forum.


Fowler emphasized this point in his address at the Bank-Fund meetings
stating that "there lies a second phase of preparation of the utmost
importance, on which the United States has been both insistent and
persistent in its pursuit of appropriate preparation for an international monetary conference.

This second phase should be designed

primarily to assure that the basic interests of all members of the
Fund in new arrangements for the future of the world monetary system
will be adequately and appropriately considered and represented before
significant intergovernmental agreements for formal structural

- 15 improvements of the monetary system are concluded.

Within the Fund

membership there are variations in the extent to which individual
countries are able to, or choose to, accumulate and hold large reserve

A l l , however, have a vital interest in the evolution of

the world's monetary arrangements. *'