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For release at 1:00 p.m.
Eastern Standard Time
Friday, December 28, 1962

Monetary Policy and International Payments

Remarks of Wm. McC. Martin, Jr.
Chairman, Board of Governors of the Federal Reserve System

at the Joint Luncheon
of the
American Economic Association
and the
American Finance Association

Pittsburgh, Pennsylvania
December 28, 1962

Monetary Policy and International Payments

The task of the Federal Reserve, like that of all parts of our
Government, is (in the words of the Employment Act of 1946) "to foster
and promote free competitive enterprise" as well as "to promote maximum
employment, production, and purchasing power."

These four purposes may

well be summarized under the single heading of orderly and vigorous economic
The Federal Reserve has recently been criticized for neglecting
these goals in favor of another--the achievement of balance in our international payments. Other critics of the Federal Reserve, however, charge
us with neglecting the international payments problem and with concentrating
too much on domestic goals. Both criticisms overlook what seems to me an
obvious fact, namely, that our domestic and international objectives are
inextricably interrelated.

We simply do not have a choice of pursuing one

to the virtual exclusion of the other. Both must be achieved together, or
we risk achieving neither.
Thus, our domestic economic growth will be stimulated when our
external payments problem is resolved. And our payments situation will be
eased when the pace of our domestic growth has been accelerated.


more rapid growth, the United States will become more attractive to foreign
and domestic investors, and this will improve our payments balance by
reducing the large net outflow of investment funds.


In particular, accelerated growth will presumably lead to larger
internal investment and credit demand, and so to some gradual rise in interest
rates, not through the fiat of restrictive monetary policy, but through the
influence of market forces. With rising credit demand pressing on the availability of credit and saving, the flow of funds from the U. S. to foreign money
markets will be more limited. In addition, a closer alignment of interest
rates internationally can be expected to result and this will help to reduce
the risk of disturbing flows of volatile funds between major markets.
Similarly, the maintenance of reasonable stability in average prices,
with progressive gains in productivity, is more than a basis for sustained
domestic growth., It is also a necessary prerequisite for improving the international competitive position of our export industries and our industries
competing with imports, and thus for increasing our trade surplus so that
it can cover a larger part of our international commitments. This is not
to deny that prices and costs of some of our individual industries may be
out of line with those of foreign producers. There are doubtless industries
where grievous competitive problems exist for international reasons, and in
these cases a strong enterprise economy expects the necessary adjustments to
be made through the efforts of such industries themselves.
Even if our country did not suffer from an international payments
deficit, our Government would still have to pursue the twin goals of orderly
and vigorous economic growth and over-all price stability. The payments
deficit provides merely another circumstance that the Federal Reserve must
consider if it is to make an effective contribution to the fulfillment of
the goals set by the Employment Act,


International role of the dollar
In reaching our decisions on domestic monetary policy then, the
Federal Reserve cannot ignore our international financial problems. There
might be countries or times in which there could be enough leeway to do so.
But the United States is not such a country and the present is not such a
The United States at present is the financial leader of the free
world, and the U. S. dollar is the main international currency of the free
world. As long as this leadership exists, we are obliged to keep our policies
compatible with the maintenance of the existing international payments system.
The increase in the volume of world trade and finance since World
War II has led to an unprecedented integration of the world economy. This
economy has become ever more closely bound together by ties of trade, investment, communication, transport, science and literature. Financially, the
world economy has become coordinated by an international payments system in
which the dollar serves both as a major monetary reserve asset and as the
most important international means of payment. And the reliance that the
world has come to place on the dollar requires that the dollar be always
convertible into all major currencies, without restriction and at stable
rates, based on a fixed gold parity.
It is in the light of the special international role of the United
States and its currency, and therefore of the responsibilities of the Federal
Reserve, that a Federal Reserve concern with maintenance of our gold stock,
our balance of payments, and stability of the dollar exchange rate must be

Above all, we must always have in mind that the role of the dollar
in the international payments system is founded upon freedom from exchange

Whatever temporary advantage might be gained for our payments

deficit by controls over capital movement or other international transactions
would be more than offset by the damage such controls would do to the use
of the dollar internationally.
Role of the U. S. gold stock
A persistent decline in our gold stock is harmful to the U. S.
economy for two reasons: First, it endangers our international liquidity
position, i.e., our continuing ability to convert on demand any amount of
dollars held either by foreigners or by U. S. residents into any other currency they may need to settle international transactions. Second, because
of our long-established domestic reserve requirements, a declining gold
stock fosters uneasiness about a curtailed Federal Reserve flexibility to
pursue domestic monetary policies otherwise regarded as appropriate and
Sometimes it is suggested that the decline in our gold stock could
be avoided if we gave up our policy of selling gold freely to foreign monetary authorities for monetary or international settlement purposes. But a
decline in our gold stock stems from the deficit in our international payments
rather than from our gold policy.
A payments deficit initially means an accumulation of dollars in
the hands of foreigners, as virtually all of their commercial or financial
transactions with residents of the United States are settled in dollars•


foreign corporations or individuals choose not to hold dollars, they convert


them into their own or into other foreign currencies; in either case,
the dollars fall eventually into the hands of one foreign central bank
or another.
If in turn the foreign central bank acquiring dollars chose not
to enlarge its dollar holdings, and if it could not convert its dollar
receipts into gold, it would present dollars to us for redemption into
its own currency. Once U. S. holdings of that currency, including credit
availabilities, were exhausted, we could acquire the currency only by
selling gold. If the U. S. declined to sell gold in such circumstances,
foreign private recipients of dollars could no longer count on converting
dollars at par into their own or other foreign currencies.
Thus, a gold embargo would terminate the convertibility of the
dollar at fixed values, not just into gold, but into any foreign currency.
This would obviously be the end of the dollar as a currency that bankers,
merchants, or investors could freely use to settle their international
Since there is a statutory linkage between gold and our domestic
money supply, through the minimum gold certificate reserve requirements of
the Federal Reserve Act, consideration must also be given to the effect of
changes in the U. S. gold stock on the gold certificate reserve ratio of the
Federal Reserve Banks. At present, this ratio still exceeds the required
minimum of 25 per cent both against Federal Reserve Bank deposits and against
Federal Reserve notes. Should it fall below that minimum, the Board of
Governors would have full authority to suspend the Reserve Bank gold
certificate reserve requirements.


Some interest has been expressed in the mechanics of suspending
these requirements. Let me summarize them at this point in briefest form.
Upon action to suspend requirements, the Board of Governors would have to
establish a tax on the Reserve Banks graduated upward with the size of their
reserve deficiencies. The tax could be very small for as long as the reserve
deficiencies were confined to the reserves against deposits and the first
five percentage points of any deficiencies against Federal Reserve notes.
If the reserve deficiencies should penetrate below 20 per cent of Federal
Reserve notes outstanding, the tax would undergo a fairly steep graduation
in accordance with statutory specifications.
The Federal Reserve Act further specifies that, should the reserve
deficiencies fall below the 25 per cent requirement against notes, the amount
of the tax must be added to Reserve Bank discount rates. But if the reserve
deficiencies were confined to reserves against Reserve Bank deposits, the
required penalty tax could be nominal and no addition to Reserve Bank discount rates would be necessary.
It is perhaps easier to talk about this subject just now when the
gold stock has shown no change for two months. But our progress this year
in rectifying our international payments disequilibrium has fallen short of
our target, in part because of a rise in our imports of $1-1/2 billion.
Hence, we must now intensify our efforts to re-establish payments balance.
And until we have regained equilibrium, we shall have to be prepared to
settle some part of any deficits experienced through sales of gold.


Nevertheless, any decline In our gold stock large enough to bring
its level significantly below the gold certificate reserve requirement of
the Federal Reserve could raise further questions about maintenance of dollar
convertibility. And It could also lead to heavy pressures on the U. S. monetary authorities to take strong deflationary action that might be adverse to
the domestic economy, or, alternatively, to pressures on Congress to devalue
the dollar, a subject to which I return later.

It Is of utmost importance,

therefore, to shorten as much as possible the period in which further large
decline in our gold stock will occur and to hasten the arrival of a period
in which our gold stock may from time to time increase.
The point I should like most to emphasize here is the following:
No question exists or can arise as to whether we shall pay for the debts or
liabilities we have incurred in the form of foreign dollar holdings, for
that we most certainly must do--down through the last bar of gold, if that
be necessary. What is in question Is how we best manage our affairs so
that we shall not incur debts or liabilities that we could not pay.
Balance of payments
To maintain the credit-worthiesss of the United States, to support
confidence in the dollar, to check the decline in our gold stock, to bring
our international payments and receipts into balance without interfering
with the convertibility of the dollar—these objectives are all synonymous
one with another. We in the Federal Reserve are concerned about the balance
of payments because it is vital that the full faith and credit of the
United States not be questioned .


Our international payments deficit this year was less than one-half
of one per cent of our gross national product. That deficit did not represent
a decline in our international wealth because the rise in our foreign assets
exceeded the drop in our net monetary reserves. Yet the deficit was of vital
concern in that it extended by one more a series of large deficits, a series
that has now persisted for five years.
A payments deficit means either a decline in U. S. gold or foreign
exchange reserves, or an increase in U. S. short-term liabilities to foreigners.
In either case, it worsens the ratio of reserves to liabilities; in other words,
it weakens the nation's international liquidity position.
The United States, as the free world's leading international banker,
can fulfill its role only if it keeps the confidence of its depositors. No
banker can suffer a continuous decline in his cash-deposit ratio without
courting danger of a run.
The best method to combat a payments deficit is to improve the
competitive position of our export industries and our industries competing
with imports. This method can be effective only in the long run, but in the
long run it is bound to be effective. And its accomplishment will have an
expansive rather than contractive influence on our domestic economy as a whole.
Dollar exchange rate
Some economists have argued forcefully that as a general principle
a country, suffering at the same time from external deficit and from domestic
unemployment, should devalue its currency, either by a shift to a floating
rate or by a change in its gold parity. But if there ever is any merit to
that argument, say in the case of countries whose currencies are not


extensively used in international transactions, it is not applicable to the
United States. This is so because the United States, as the world's leading
banker, is responsible for a large part of the monetary reserves of foreign
countries, and for the great bulk of the international working balances of
foreign bankers, traders, and investors. We have accepted these balances
in good faith and as I said earlier, we must stand behind them.
Whatever other consequences would follow from a devaluation of the
dollar, I am convinced that it would immediately spell the end of the dollar
as an international currency and the beginning of a retreat from the present
world role of the United States that would produce far-reaching political
as well as economic effects.

It would, in my judgment, invite the disinte-

gration of existing relationships among the free nations that are essential
for the maintenance and extension of world prosperity and even world peace.
It has sometimes been suggested that we could maintain the dollar
as an international currency simply by giving a gold value guarantee to some
or all foreign holders of liquid dollar assets. At first glance, it might
seem a good idea for a foreign central bank or a foreign investor to own an
asset that would be not only as good as, but actually better than gold:
a kind of interest-bear ing gold.

But I do not think that the suggestion

for a gold value guarantee is realistic.
First, if foreign holders of dollars did not trust our repeated
assurance that we would not devalue the dollar, they would hardly trust our
assurance that, if we devalued the dollar contrary to our previous assurance,
we would do it in such a way that some or all foreign holders would be
treated better than domestic holders.


Second, I do not think it would be possible to limit effectively
a gold value guarantee to the dollars held by some or all foreign holders;
and if it were possible to make an effective distinction between foreign
and domestic holders, this would amount to unjustified discrimination against
domestic holders. In my judgment, neither Congress nor public opinion would
tolerate any such discrimination.
In spite of our international payments deficit, the United States
has refrained from drastically cutting Government expenditures abroad for
defense or for economic aid, and from curtailing the freedom of capital

To have done otherwise would have undermined our position of

economic and political leadership of the free world.

So would any failure

on our part to maintain the established par value of the dollar.
Role of the Federal Reserve
Within the limitations set by the international role of the dollar,
what can the Federal Reserve do to achieve its domestic policy goals together
with contributing to the achievement of international balance?
My friends sometimes accuse me of being a chronic optimist. But
I believe that we can find ways of furthering our domestic economic aims
while, at the same time, we are making progress in overcoming our payments
problem internationally. And I believe that these ways will contribute
better to sustainable economic growth than would flooding the economy with
Indeed, my present feeling is that the domestic liquidity of our
banks and our economy in general is now so high that still further monetary
stimulus would do little if any good—and might do actual harm—even if we


did not have to consider our payments situation at all. This means that if
any additional governmental action is needed in the financial field in order
to give fresh expansive impulse to the economy, it would probably have to
come from the fiscal side. The part played by monetary policy, from both an
internal and an external point of view, would then be mainly supplementary
and defensive.
In this context, monetary policy would have to be on guard against
two dangers: first, the danger that too rapid domestic monetary expansion
would eventually produce rising domestic costs and prices as well as unwise
speculation and in this way curtail exports and over-stimulate imports; and,
second, the danger that too easy domestic credit availability and too low
borrowing costs would encourage capital outflows.
For the past few years, monetary policy has already contributed to
the needed stability of the domestic price level, while prices in some other
important industrial nations have been under steady upward pressure. In
specific terms, Federal Reserve policy has been seeking to maintain a condition of credit availability that would be adequate for domestic needs while
avoiding any serious deterioration of credit standards or any widespread
speculative reliance on credit financing and at the same time limiting the
spillover of credit funds—short-term and long-term—into foreign markets.
Nevertheless, our monetary policy has remained easier through this
economic cycle than during previous cycles because that has seemed to be
needed in a domestic situation of lagging longer-term growth and a less-thanrobust cyclical expansion.

In balancing the scope and the limitations of

our monetary policy, however, I am convinced that, within limits imposed by


human imperfection, the Federal Reserve has paid neither too much nor too
little attention to our international payments problem.
As I mentioned at the outset, criticism of our policy through this
economic cycle has been about equally divided between two groups. The first
complains that we have violated the classical principle of an international
payments standard based on fixed exchange rates by failing to contract our
money supply in the wake of a decline in our gold reserves. The second
complains that we have neglected our duties to the domestic economy by permitting the decline in our monetary reserves to have some impact on our
money markets, especially on short-term interest rates.
If all criticism had come from one side only, I would still believe
it unjustified. But the very fact that criticism comes from both sides inclines
me even more strongly to the comforting thought that we have been keeping to
the golden mean.
Foreign currency operations
The Federal Reserve has not been content to limit its participation
in solving the country's payments problem to its traditional tools of monetary policy.

It has felt a particular need to set up defenses against

speculative attacks on the dollar pending an orderly correction of our
payments disequilibrium.

And it has felt a more general need to cooperate

directly with foreign central banks in efforts to reinforce the international
payments structure. Recognition of these needs underlies the decision that
we took just a year ago to participate on Federal Reserve account in foreign
currency operations.


Since the Treasury also engages In similar operations, Federal
Reserve activities have had to be, and will continue to be, conducted in
cooperation with those of the Treasury. Smooth coordination has been
facilitated by the fact that the instructions of both agencies are carried
out through the same staff members of the Federal Reserve Bank of New York,
headed by Mr. Charles A. Coombs, Vice President in charge of the Foreign
Department of that Bank and Special Manager for Foreign Currency Operations
of the Federal Open Market Committee. At the same time, both the Board of
Governors and the Federal Reserve Bank of New York have endeavored to maintain close contact with the central banks of foreign countries, bilaterally
as well as through regular meetings of the Organization for Economic Cooperation and Development in Paris and the Bank for International Settlements in
The most important foreign currency activity of the System thus
far has been the conclusion of reciprocal currency arrangements with leading
foreign central banks and the Bank for International Settlements. Under
these arrangements, the System acquires, or reaches agreement that it can
acquire on call, specified amounts of foreign currencies against a resale
contract, usually for three months. Concurrently, the foreign central bank
acquires, or can acquire on call, an equivalent amount of dollars under
resale contract for the same period.
In these contracts, both parties are protected during the active
period of a swap arrangement against loss in terms of its own currency from
any devaluation or revaluation of the other party's currency.

These arrange-

ments, of course, are subject to extension or renewal by agreement. Interest


rates paid on the deposit or investment of funds acquired through swaps
are set at equal levels for both parties, in the neighborhood of the current
rate for U. S. Treasury bills, so that, as long as neither party utilizes
any of its currency holdings, there is no gain or loss of income for either.
So far, agreements have involved a total approximating $1 billion.
For the most part, they are stand-by arrangements.

Only a small fraction of

actual currency drawings has been utilized for market operations. And a
large part of amounts so utilized has been reacquired, and used for repayment of the swap drawings.
In entering into swap arrangements, the Federal Reserve has had
three needs in view. First, in the short run, swap arrangements can provide
the System with foreign exchange that can be sold in the market to counter
speculative attacks on the dollar or to cushion market disturbances that
threaten to become disorderly.
Second, swap arrangements can provide the Federal Reserve with
resources for avoiding undesired changes in our gold stock that may result
when foreign central banks accumulate dollars in excess of the amounts they
wish to hold, especially if these accumulations seem likely to reverse themselves in a foreseeable period.
Third, when the U. S. balance of payments has returned to equilibrium, swap arrangements with other central banks may be mutually advantageous
as a supplement to outright foreign currency holdings in furthering a longerrun increase in world liquidity, should this be needed to accommodate future
expansion of the volume of world trade and finance.


Concluding remarks
As long as the U. S. balance of payments is in over-all deficit,
and we are therefore losing rather than gaining monetary reserves, on balance,
the Federal Reserve cannot expect to accumulate outright large amounts of
foreign exchange. Meanwhile, System holdings of foreign currencies will
necessarily be limited to relatively small amounts, swollen on occasion by
But over the longer run, the System may find it useful to increase
gradually its foreign currency holdings and operations. This development
could be modified, of course, by further changes in the institutional framework of our international payments system. For this reason, the Board's
staff, in cooperation with the staffs of the Treasury and other interested
agencies of the Government, is carefully scrutinizing the various recent
proposals designed to adapt, strengthen or reform this framework.
Whatever the fate of these reform proposals, it seems likely that
Federal Reserve operations in the international field will need to be continued for the foreseeable future. The Federal Reserve's involvement in
foreign exchange problems is the inevitable consequence of its role as the
central bank responsible for the stability of the world's leading currency.
Such a responsibility necessarily carries with it the responsibility for
helping to preserve and improve the existing international monetary system,
thus to contribute to the stability and prosperity of the free world.

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102