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The original documents are located in Box B2, folder "Balance of Payments (3)" of the
Arthur F. Burns Papers at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald R. Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date March 25, 1971
To
Chairman Burns and Governor Brimmer
Subject: Paper on the Balance-of-Payments
From Ralph C. Bryant RCB
Impacts of the U.S. Capital Controls
I am attaching with this note a draft of the paper on capital
controls which we have been preparing. Before leaving for Paris, Mr. Solomon
and I agreed we would try to get a draft to you this week. We are planning
to make final revisions in the paper on Monday, March 29th after Mr. Solomon
returns. If you feel it would be appropriate, you might then want to send
the paper on to Mr. Peterson at the White House for circulation to the
members of the Council on International Economic Policy. In Mr. Peterson's
memorandum to the Council, a copy of which you have, comments on the OMB paper
on this subject were requested by March 30th.
FORD & LIBRARY GERALD
CONFIDENTIAL (FR)
DO THE RESTRAINTS ON U.S. CAPITAL
OUTFLOWS IMPROVE THE
BALANCE OF PAYMENTS?
Draft
March 25, 1971
Special Studies Section
Division of International Finance
Board of Governors of the Federal Reserve System
FORD & LIBRARY GFRALD
Table of Contents
Page
Introduction and Summary
1
I. International Economic Interrelationships
5
II. How Much Do We Know About International Capital Flows?
9
III. Judgmental Estimates of the Effects of the U.S. Capital
Control Programs
16
A. Gross Savings on Capital Outflows Covered by the
Programs
16
Interest Equalization Tax
16
Voluntary Foreign Credit Restraint
18
Foreign Direct Investment Program
21
B. Leakages Offsetting the Gross Savings
25
Foreign Purchases of U.S. Securities
25
Errors and Omissions
26
Foreign Holdings of Liquid Assets in the United States
28
Export Performance
30
Other Leakages
31
IV. A Brief Comment on the OMB Paper: "Capital Controls:
Questionable Results and Undoubted Costs"
32
Appendices:
A. Potential Leakages via Reduced Foreign Purchases of U.S.
Corporate Securities
35
B. A Comment on the CPR Report: "Federal Control of Foreign
Direct Investments"
39
C. A Comment on Research by Arthur B. Laffer on Short-term
Bank-Reported Capital Movements
42
D. Annotated List of References
43
-
FORD & LIBRARY GERALD
CONFIDENTIAL (FR)
INTRODUCTION AND SUMMARY
There are good grounds for believing that the restraints
on certain types of capital outflows from the United States -- the
interest equalization tax (IET), the voluntary controls on banks
and other financial institutions (VFCR), and the controls over
direct foreign investment of U.S. companies -- have held such flows
substantially below the levels they would have reached in the absence
of the restraints.
The restraints have been effective in limiting the specific
capital outflows at which they are aimed in good part because they
reinforce one another. Moreover, they undoubtedly have had a greater
impact in limiting these capital outflows during periods of monetary
ease in this country than during periods of tight monetary conditions.
The effect of the capital controls on the overall balance
of payments, however, is not so clear. The gross balance-of-payments
"savings" in outflows of U.S. capital affect monetary conditions
and economic activity here and abroad. Those effects, in turn,
influence the flow of foreign capital into the United States and may
also lead to changes in trade and other elements of the current
account. Specifically, the limitation on outflows of U.S. capital
tends to tighten monetary conditions abroad relative to conditions
that would otherwise prevail, thereby reducing some foreign capital
flows into the United States. Moreover, the restriction on U.S.
FORD is LIBRARY GERALD
- 2 -
capital outflows could limit the availability of trade credit and
thereby result in some loss of U.S. export business. Still more
indirectly, the restraint on capital outflows may cause GNP (nominal
if not real) in other countries to be less than otherwise and thus
reduce the demand for U.S. exports.
Statements about the degree to which gross balance-of-payments
savings resulting from reductions in controlled U.S. capital outflows
are counteracted by "leakages" -- by outflows of uncontrolled U.S.
capital, by the reductions in inflows of foreign capital, and by
the loss of export business -- involve very large elements of judg-
ment. The systematic exploration of structural relationships in the
international economy lags far behind the investigations of behavioral
relationships underlying domestic economic activity, and the effort
suffers from severe data deficiencies. There are therefore firm
grounds for humility in expressing judgments. Our belief is that
offsets to the gross savings in the form of leakages, while signifi-
cant, are not complete. We do believe that the programs yield a
balance-of-payments gain.
The data do not give clear support to an argument that un-
controlled forms of U.S. capital outflow have been larger than they
would have been in the absence of controls; these flows (nonbank
outflows not covered by the programs, and also net errors and omis-
sions) are dominated by shifts in relative monetary conditions between
here and abroad and by other influences unrelated to the controls.
with
FORD i LIBRARY GERALD
- 3 -
The evidence is relatively strong, moreover, that U.S. exports were
not hampered directly by limitations on capital outflows. With
respect to inflows of foreign capital, it is particularly difficult
to make a judgment about the gap between what actually occurred and
what might have occurred in the absence of the capital restraints.
There is no strong evidence suggesting either that the gap was large
or that it was small. Concerning the still more indirect leakages
arising through the general effects of the U.S. controls on economic
developments abroad, there is no empirical basis for a judgment.
Our judgment concerning these most indirect consequences rests on a
theoretical view of the functioning of the international system in
the contemporary environment.
In the next section of the paper, we summarize that view of
international economic relationships and their implications for the
balance-of-payments consequences of the restraints on capital outflows.
Section II is a brief appraisal of the current state of knowledge
concerning the structural relationships between national economies.
We review in Section III some of the empirical evidence that can be
brought to bear on the issue. Several appendices deal in more detail
with various subtopics. Finally, in Section IV, we include a brief
critical comment on a recent paper on this subject prepared in the
Office of Management and Budget.
This paper does not attempt to deal with the broader and
still more difficult question of whether the various costs associated
GERALD FORD LIBRARY
- 4 -
with the U.S. capital controls exceed any benefits. We do not
express judgments about this broader question, and would not wish
readers to infer such judgments. We have deliberately restricted
ourselves here to the narrower question of whether the programs
have a net positive effect in improving the balance of payments.
FORD is LIBRARY GERALD
- 5 -
I. International Economic Interrelationships
The extent to which the gross savings in outflows of U.S.-
owned capital owing to the restraints result in a net gain in the
overall balance of payments depends on the effects that outflows
have on monetary conditions abroad and on the responses of private
decision-makers and government policy-makers. The policy responses
abroad, in turn, depend upon national economic developments and
prospects, especially rates of resource use and degrees of price
pressures. The net effects of capital outflows on the U.S. balance
of payments, in other words, depend a great deal on whether other
industrial countries wish to have policies of expansion or policies
of restraint and the extent to which they are able to implement
their policy goals. Responses in the private sector initially are
influenced by portfolio preferences. The belief that assets denom-
inated in different currencies are not perfect substitutes and that
portfolio preferences abroad differ from those in this country
underlies the analysis below.
One way to view the process is to contemplate what would
have developed had the recent shift toward ease in monetary conditions
in the United States occurred in the absence of any capital controls.
To begin with direct investment, a larger proportion of U.S. business
outlays abroad in recent quarters would have been financed from U.S.
sources. This difference in the source of financing would appear in
the balance of payments as an increase in direct investment. With
GERALD FORD LIBRARY
- 6 -
the passage of time, there also would be a stock adjustment as matur-
ing issues of U.S. corporations held abroad were replaced with issues
in the United States. In the same way, the sale of foreign securi-
ties to U.S. investors would have been greater in the absence of
controls in the environment of easy monetary conditions in the United
States.
Given the large shift in the locus of demands for long-term
capital that would have occurred without controls, the stimulus for
lower interest rates in foreign capital markets would have been
greater than it has been; at the same time, the decline in long-term
rates in the United States would have been somewhat retarded. Never-
theless, interest rates in the United States would have declined
relative to those abroad -- given that foreign monetary authorities
were not also implementing policies of active ease. The re-alignment
in interest rates in the absence of controls would have induced
both American and foreign investors to alter their portfolios of
debt securities in favor of foreign instruments, thereby augmenting
the outflows of capital from the United States.
In the absence of the VFCR, the easing in monetary conditions
in the United States would have induced the same sort of consequences
through an expansion in bank credit to foreigners. In the short-term
area, however, the stock adjustment in response to the changed interest-
rate relationships between here and abroad can be accomplished much
more quickly, producing a substantial outflow promptly.
GERALD R. FORD LIBRARY
- 7 -
The additional capital outflows in the absence of the
capital controls would have tended to increase directly the money
supply in other industrial countries still more than the actual out-
flows have done, and they also would have tended to increase bank
liquidity still more and provided the basis for a larger secondary
expansion in credit and money. If this had been allowed to occur --
if the foreign authorities had made no effort to neutralize the
inflows of funds -- interest rates abroad would have been under still
greater downward pressure. The differential in interest rates be-
tween the United States and foreign countries would have been smaller,
but this would have been the result of larger net outflows of funds
from the United States than actually occurred.
Over time, the process would have produced some balance-of-
payments offsets to the augmented capital outflows. The easier
monetary conditions induced in other industrial countries would have
expanded their demands for U.S. goods and services. Also, working
capital requirements abroad would have been greater, and some portion
of foreign working capital is held in dollars. To the extent that
the additional capital outflows from the United States would have
been accompanied by expansion in private foreign demands for short-
term dollar assets, the rise in the U.S. official-settlements deficit
would have been tempered. The induced expansion in foreign demand
for goods and services occurs with some lag, however, and in the
interim the absence of capital controls during the process of easing
M
FORD is LIBRARY GERALD
- 8 -
monetary conditions in the United States would have augmented the
deficit in the U.S. balance of payments.
How the process would have worked in fact would have been
strongly influenced by the policy responses abroad. To the extent
that the authorities would have been successful in neutralizing the
additional inflows of funds -- in retarding the monetary expansion
and declines in interest rates -- the balance-of-payments offsets to
the additional outflows of U.S. capital would have been prevented
from developing.
The augmented outflows of funds in the absence of the con-
trols would have been in addition to the large repayments of U.S.
bank borrowings from the Euro-dollar market that have occurred and
have been reflected in the extraordinary U.S. official settlements
deficits. Moreover, the augmented outflows from the United States
would have occurred when other industrial countries already were
experiencing boom conditions and inflationary pressures. The ad-
ditional expansive effects on their economies would have been totally
unwanted. Indeed, even the effects of the repayment of the Euro-
dollar borrowings were unwanted and interfered with the policies that
the foreign authorities wished to follow. In the circumstances,
additional outflows of U.S. capital would have generated offsets in
the current account chiefly by raising nominal rather than real GNP
in other industrial countries. It would have done so, in other words,
by accelerating the rates of inflation abroad.
FORD & LIBRARY GERALD
- 9 -
II. How Much Do We Know About International Capital Flows?
We have emphasized that reductions in the outflow of U.S.-
owned capital brought about by the programs will have induced some
offsetting flows in other balance-of-payments accounts. We have
also noted that since financial instruments are not perfect substi-
tutes and international capital and goods markets are not fully
integrated, it seems likely that offsetting flows, while probably
important, would be only partial. What would we need in order
adequately to judge what part of gross balance-of-payments savings
owing to the controls are lost in "leakages?"
In principle, it would be necessary to specify and estimate
a full model of the international economy. We would require demand
and supply equations for each financial instrument which would re-
flect the extent of the international interdependencies between
national money and capital markets. Thus, the model would even re-
quire a complete elaboration of the markets for those financial
instruments issued and held entirely domestically since conditions
in these "domestic" markets would impinge on the decisions of those
individual transactors who hold and those who issue "international
instruments." Moreover, the model would have to embody the relation-
ships between international capital flows, economic activity levels
in the important industrial countries, and merchandise trade flows.
In sum, we would need a set of highly elaborated macroecon-
omic models for the major industrialized countries, with fully
FORD i LIBRARY GERALD
- 11 -
developed linkages between the real and financial sectors, and a
well articulated international sector linking the national models
together. Clearly, such a project is not feasible in the foreseeable
future.
When evaluating such evidence as does exist on the effects
of U.S. capital controls, it is important to realize just how far we
are from having such a model of the world economy. In the first place,
we do not even have the necessary econometric models for the major
industrial countries. Many of the models which do exist do not even
have a link between domestic financial variables and the domestic real
economy. Virtually none attempts to explain international transactions
other than the current account items.
Given this state of affairs, we obviously cannot produce
direct empirical evidence as to whether or not controls on capital
outflows are partially offset through changes in the level of economic
activity abroad that reduce the United States' trade balance. But as
we have noted in Section I, this depends essentially on the ability
and desire of foreign authorities to pursue independent monetary
policies. It might be possible to draw some inferences from investi-
gations of the institutional factors affecting the ability of foreign
authorities to pursue independent policies. While some work along
1/ Producing just such a model is the long-run objective of Project
LINK, a study financed through the Social Science Research Council
and under the direction of Lawrence Klein, Aaron Gordon, Bert Hickman,
and Rudolph Rhomberg. Project LINK is at the present time only in its
initial stage. Not even its most enthusiastic proponents would claim
that its long-run objective could be attained for many years.
FORD i LIBRARY GERALD
- 12 -
these lines has been attempted, it is fair to say that the question
of the degree to which independent policies can be pursued abroad
must be considered open.
The main reason why international capital flow equations do
not appear in any of the existing econometric models is simply that
relatively little work has been done in estimating such equations.
It is a common complaint of all empirical researchers that they are
handicapped by a lack of appropriate data. In this area, the con-
straint is especially severe. Data are often collected by national
agencies on non-comparable bases and much of the data are held con-
fidentially. Moreover, there are important unobservable variables
which play a crucial role in determining capital flows, especially
expectations about interest rates and exchange rates.
There is also a clear need for fundamental improvements in
the theory of international capital flows. It is only recently that
the basic elements of domestic monetary and capital markets theory
have been applied to international flows.
A very serious problem that remains to be solved is the
appropriate treatment of non-price credit rationing, particularly
capital controls imposed by national authorities. Capital controls
introduce a "wedge" between desired flows and actual flows. A
frequently employed technique in studies that have tried to estimate
the quantitative effects of capital flow restraints is the introduc-
tion of an additional ("dummy") variable which differentiates the
pre-control and post-control periods. However, this technique assumes
GERALD FORD LIBRARY
- 13 -
that the effects of the programs are uniform throughout the period
of their imposition, allowing no scope for gradual adjustment by
transactors to the controls or to modifications of the controls by
the authorities. When the effective impact of the programs varies
over the sample period, the "dummy variable" approach can be seriously
misleading.
The "learning by doing" phenomenon is especially important
for estimating the net impact of the capital control programs. Leak-
ages will likely become increasingly important with the passage of
time. In the present context, this points up the necessity for
estimating the lags in behavioral responses. The time path of ad-
justments by transactors in other markets in response to the imposi-
tion of controls in one market is virgin territory for both the
theoretician and the empiricist.
The preceding discussion has pointed out a few of the more
important difficulties in estimating elements of the "ideal model."
We wish to re-emphasize the central point that a thorough understand-
ing of the impact of the capital control programs is contingent upon
the availability of a complete model. The interrelationships between
various capital markets and between capital markets and real economic
activity must be explicitly dealt with.
This point is well illustrated by considering one of the
empirical studies cited in a recent paper of the Office of Management
AM
FORD : LIBRARY GERALD
- 14 -
and Budget. / The cited paper, written by Richard N. Cooper, was
specifically addressed to the time period when only the IET was in
effect. There is general agreement that the leakages were extremely
large at that point. This was clearly recognized and led to a more
comprehensive set of controls. In a more recent unpublished paper
Cooper summarized his judgment on the gross savings and on the
probable magnitude of offsetting leakages. He concluded that the
present elements of the comprehensive set of restrictions are rein-
forcing and they have had a significant net impact on the balance-of-
payments.
Cooper's paper, and all others of which we are aware, have
attempted to estimate the impact (gross or net) of the control pro-
grams on the actually observed, historical data. Needless to say,
this historical analysis by itself is insufficient for our purposes.
Since, as the analysis of the preceding Section suggests, the effective
impact of the restraints will vary with our cyclical position, we
also want to know (a) what the impact of the programs would have been
if we had been more successful in having the economy grow along a
non-inflationary, high-employment growth path, and (b) what the impact
of the programs would be in the future, given a wide variety of alter-
native assumptions about domestic and foreign economic activity.
1/ OMB paper entitled "Capital Controls: Questionable Results and
Undoubted Costs," March 2, 1971 (Mimeo). We discuss the other two
studies cited by the OMB paper in appendices.
2/ Richard N. Cooper, "The Voluntary Credit Restraint Program: An
Assessment," January 1969, theunpublished paper prepared for/meeting of
Academic Consultants at/Federal Reserve Board.
FORD & GERALD LIBRARY
- 15 -
How much do we know about international capital flows?
The profession has barely begun to tackle the job. The evidence
that does exist is sparse. Even tentative conclusions on what the
effects of the United States capital control programs have been
are no more than informed guesses.
FORD i LIBRARY GERALD
- 16 -
III. Judgmental Estimates of the Effects of the
U.S. Capital Control Program
We try in this section to bring together some information
relevant to an analysis of the capital controls and to make some
judgmental estimates of how large the gross balance-of-payments savings
and the offsetting leakages may have been. We put forward these
judgments with genuine hesitation. Although we believe our judgments
are as reasonable as can be made given the present state of knowledge,
we are mainly impressed -- as emphasized in the last section -- with
the inability of anyone to make judgments that are clearly valid.
A. Gross Savings on Capital Flows Covered by the Programs
Interest Equalization Tax. The IET has been imposed on U.S.
purchases of foreign securities since mid-1963 and on long-term bank
lending since February 1965.
The IET induced a sharp reduction in U.S. purchases of
foreign new issues, as suggested by Table 1. The annual average of
these purchases fell by $177 million between 1962-63 and 1964-65, and
an additional $58 million between the latter period and 1966-69. The
severity of the reduction in 1964, shown in Table 1, is probably
attributable to the availability in that year of untaxed bank loans
as substitutes for security issues. With the extension of the IET
to long-term bank loans in 1965, and also the inception of the VFCR,
new security issues rose. The reduction of new issues in 1966 and
FORD i GERALD LIBRARY
- 17 -
subsequent years from the 1964-65 average appears to be attributable
to the relative tightness in the U.S. market for long-term capital.
Thus for new issues alone, the gross savings that can be attributed
to the capital controls seems likely to be well under $200 million
per year on average.
Table 1
U.S. Purchases of Foreign Securities Newly Issued in the United States
by European Countries, Australia, New Zealand and South Africa.
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
24
57
195
289
35
95
15
-
-
14
/ Japan is excluded because Japanese new issues were partially
exempted from the IET. The 1965 exemption of $100 million was con-
tinued for several years, but was not fully utilized because of rising
U.S. interest rates.
In the face of the IET, American net purchases of outstanding
foreign equities reached a cumulative total of only $1/4 billion
during the 1963-70 period. Suppose that in the absence of the IET,
Americans would have wanted to allocate a roughly constant proportion
of their equity portfolios to foreign equities. This assumption
implies that substantial net purchases of foreign equities, possibly
1/ Net purchases of outstanding bonds were negligible. Net U.S.
purchases of Japanese equities in 1969 were very large and more than
offset net U.S. sales of foreign equities during most of the 1963-70
period. At the end of 1969, Japanese long-term assets were brought
under the VFCR program for nonbank financial institutions. This
action has virtually eliminated the flow of funds by U.S. institu-
tional investors into Japanese equities.
GERALD FORD LIBRARY
- 18 -
as much as $3-4 billion, would have occurred. A number such as
$3-4 billion probably represents an upper bound for the cumulative
gross savings for 1963-70. With or without the IET, of course, net
purchases would undoubtedly have fluctuated considerably.
We have not tried to make estimates of the gross savings
attributable specifically to the 1965 extension of the IET to long-
term bank loans. Total foreign lending of banks is considered under
the VFCR program.
Voluntary Foreign Credit Restraint. The introduction of
the VFCR early in 1965, in combination with the imposition of the
long-
IET on banks'/term loans, was associated with a sharp cutback in new
foreign lending by U.S. banks. The balance-of-payments accounts
show that the combined outflow of long-term and short-term bank funds
fell from an annual average of $1.4 billion in 1960-64 to an annual
average of less than $100 million in 1965-69.
That the program played a large role in limiting the out-
flow of bank credit is not contradicted by the continuous existence
of an apparent leeway for additional lending, as shown in Table 2.
The apparent leeway under the ceiling reflects mostly cyclical
factors, differences among banks, and bank uncertainty about draw-
/
downs by foreign borrowers.
1/ Inspection of stock price trends in various countries suggests
that U.S. prices rose at roughly the average of foreign price rises,
but with less fluctuation.
2/ See Bernard Norwood, "Restraining Foreign Credit: Six Year Test,"
Wharton Quarterly, Winter 1970, pp. 32-37.
FORD & LIBRARY 9ERALD
- 19 -
Table 2
Banks' Ceilings and Leeway Under the VFCR
(Millions of dollars, end of year)
1965
1966
1967
1968
1969
1970
General Ceiling
Aggregate ceilinga/
9,973
10,407
11,069
9,729
10,092
9,956
Apparent leeway
321
911
1,204
476
694
606
Total General and Export Term-Loan Ceilings b/
/
Aggregate ceilings
9,973
10,407
11,069
9,729
11,356
11,379
Apparent leeway
321
911
1,204
476
1,939
1,842
/ Ceilings are calculated on the basis of the regulations in effect
during the given year. There was some liberalization of the guidelines,
effective January 1, 1967, and January 1, 1968.
b/ Export Term-Loan Ceiling added in 1968.
Econometric research on bank lending to foreigners has been
fraught with problems, many of which have not been satisfactorily
/
resolved.
With the exception of the studies by Bryant and Hendershott,
this research has allowed for the effects of the VFCR only in a crude,
inadequate fashion. Even Bryant and Hendershott, despite strenuous efforts
to adapt their equations so as explicitly to reflect the varying impacts
1/ Appendix D lists some of the references. The studies most
relevant here are those by Branson, Bryant and Hendershott, Laffer,
Miller and Whitman, and Patrick.
FORD i LIBRARY GERALD
- 20 -
of the VFCR regulations, failed to come up with clear-cut
/
evidence.
If the proportion of foreign loans in the portfolios of
U.S. banks had been the same at the end of 1970 as it was at the
end of 1962, foreign loans would have been $16.6 billion instead of
the observed figure of $13.8 billion. 2/ This calculation may give
a crude indication of the possible magnitude of the effect of the
VFCR on the distribution of U.S. bank portfolios. The precise
impact of the VFCR at any given time, of course, depends critically
on monetary conditions in the United States relative to those abroad.
In recent months, the restraining effect of the VFCR on bank lending
has increased considerably compared with its effect during the most
intense periods of monetary tightness in 1969.
The effect of the VFCR on nonbank financial institutions
is even harder to judge, because of the diversity of such institutions
and because of potential switches between assets not covered (over $13
billion) to covered assets (under $2 billion). One indication of the
1/ See Bryant and Hendershott, Financial Capital Flows in the
Balance of Payments of the United States: An Exploratory Empirical
Study, Princeton Studies in International Finance No. 25, pp. 31-32,
48-50, 60-61; also "Empirical Analysis of Capital Flows: Some
Consequences of Alternative Specifications,' Forthcoming in Universi-
ties-NBER Volume on The International Mobility and Movement of Capital.
2/ Foreign loans here include Canadian, which are exempt from the
VFCR. The year 1962 is taken as a base, because of the surge in
borrowing in 1963-64 after the IET restricted security issues.
FORD i LIBRARY GERALD
- 21 -
effectiveness of the non-bank program is the virtual cessation of
U.S. purchases of Japanese equities after such assets were brought
under the program.
Foreign Direct Investment Program. This program was
designed to limit outflows of U.S.-owned funds (as they are reflected
in the balance of payments) to finance U.S. business investment in
foreign affiliates; it was not the intention to limit the investment
outlays of those affiliates. The program, it was hoped, would shift
the source of financing away from the United States, and it appears
to have been successful in doing that. One possible indication of
the size of gross program savings is given by the amount of funds
obtained abroad by U.S. parent firms; such financing was virtually
zero until the advent of the voluntary program in 1965; in 1968 and
1969 it was more than $2 billion per year. (See Table 3, line 4.2/)
Gross savings are indicated also by the decline in the ratio
of U.S. -controlled funds to plant and equipment expenditures / that
/ For example, Guy Stevens found that "virtually no impact of
the various balance of payments program is evident on plant and
equipment expenditures in manufacturing. " See his "Capital Mobility
and the International Firm," Universities-National Bureau Conference
on International Mobility and Movement of Capital, forthcoming.
2/ These data, from OFDI, are more inclusive than that from OBE,
since they include foreign borrowings which are used abroad without
first being remitted to the United States.
3/ U.S.-controlled funds are defined to include depreciation
allowances since the latter allows direct investors to make some
plant and equipment expenditures without recourse either to foreign
borrowings or U.S. funds. In other words, reinvestment of deprecia-
tion allowances leaves the book value of foreign affiliates unchanged;
thus plant and equipment expenditures should be attributed to depre-
ciation allowances as well as to U.S.-source funds and foreign
borrowing by parent firms.
GERALD FORD LIBRARY
- 22 -
Table 3
Selected Data on Direct Foreign Investment
(millions of current dollars)
Financial
1965
1966
1967
1968
1969
1. Net capital transfers
3926
4386
4178
2671
3720
2. + Reinvested earnings
1492
1692
1390
1950
2325
3. = Direct investment
5418
6078
5568
4621
6045
4. - Long-term foreign borrowing
by parent firms b/ and program
adjustments /
104
638
542
2161
2346
5. = Net use of U.S.-source funds 5314
5440
5026
2460
3699
/
6. + Depreciation
3686
4074
4632
5265
5800
7. + Long-term foreign borrowing
by parent firms and program
adjustments
104
638
542
2161
2346
8. = Gross use of U.S.-controlled
funds
9104
10152
10200
9886
11845
Real
9.
Plant & equipment expenditures 7440
8640
9267
9387
10787
/ Program adjustments are offsets to foreign borrowing, such as
repayments and indirect capital transfers.
b/ Excluding Canada, since no data are available. In contrast, other
data in this table are worldwide, i.e., all three OFDI schedules plus
Canada.
C / Estimated
Source: Depreciation and plant and equipment expenditures from Office
of Business Economics; other data from Office of Foreign Direct
Investments.
FORD & LIBRARY GERALD
- 23 -
has occurred as foreign affiliates have relied to a greater extent
on local borrowing (i.e., borrowing by affiliates, in addition to
foreign borrowing by parent firms). For 1965, this ratio was 1.225;
for the 1966-67 period, when the voluntary program specified firm-
level targets, it fell to 1.135. In contrast, the ratio under the
Mandatory Program in 1968-69 was 1.075. If the 1965 ratio had
prevailed in 1968-69, gross use of U.S.-controlled funds would have
been some $1-1/2 billion greater on average per year.
The trend toward greater reliance on local financing is
consistent with another set of OFDI data, available for 1967-68
(See Table 4) For all direct investment outside Canada these
data show greater use of local funds during 1968, in relation to
current assets, than was the case at the beginning of 1968. However,
comparable data for Canada (Table 4) showed a similar movement,
reminding us that other factors probably accounted for much of the
increased use of local funds on the part of affiliates.
1/ U.S. Department of Commerce, Office of Foreign Direct Invest-
ments, Foreign Affiliate Financial Survey 1967-1968 (Washington,
July 2, 1970). Comparable data for 1966 and 1969 are not yet avail-
able, either from OFDI or OBE.
FORD is LIBRARY GERALD
- 24 -
Table 4
Majority-owned Foreign Affiliates
Current Assets and Foreign-Source Funds, 1967-68
(millions of dollars)
All Schedules
1967
1968
Current assets, end of year
25,805
30,406
Foreign debt
21,909
26,100
Ratio, foreign debt to current
assets
.849
.858
Canada
1967
1968
Current assets, end of year
7,649
8,481
Foreign debt
5,549
6,273
Ratio, foreign debt to current
assets
.726
.740
FORD & LIBRARY 9ERALD
- 25 -
The prima facie evidence is that the Voluntary and
Mandatory Programs had successively larger influences on both
parent-firm and affiliate financing. / But, of course, part of this
increased foreign financing might have occurred even in the absence
of controls as a result of tighter money in the United States toward
the end of the period. 2/
B. "Leakages" Offsetting the Gross Savings
While it is difficult to estimate a possible range of gross
balance-of-payments savings generated by the capital controls, it is
even more difficult to guess at the size of leakages. The difficul-
ties are severe both because of the limited state of our knowledge
(see Section II) and because offsets can conceivably occur in any
balance-of-payments category. In the following subsections we attempt
to review the evidence available for four categories of transactions
where leakages seem particularly likely to have occurred.
Foreign Purchases of U.S. Securities. An obvious source of
potential leakages is in foreign purchases of U.S. corporate securities.
Most directly, the convertible Eurobonds issued by U.S. corporations
1/ The initial Voluntary Program for 1965 did not involve firm-
level targets, and resulted mainly in the repatriation of head-office
balances formerly held in Europe.
/ A further, albeit indirect, effect of the Mandatory Program on
affiliate financing may have resulted from a program-induced change
in the mix of capital expenditures towards LDC's, which in turn
caused firms to make a closer match between local-currency assets and
liabilities.
FORD & LIBRARY GERALD
- 26 -
as a response to the capital controls are undoubtedly a close sub-
stitute for stocks and bonds purchased by foreigners in New York.
There is no convincing evidence that such substitution did or did
not take place. (See Appendix A for a more detailed discussion of
this potential leakage.)
During the period in which the capital controls were in
force, foreign purchases of U.S. securities increased to unprecedented
rates. They might, it is true, have increased still more in the
absence of the controls. The only unambiguously correct statement
that can be made about the magnitude of this leakage is that it could
have been of any size. We find it implausible to imagine that it
could have been in excess of a few hundred million dollars per year
on average.
Errors and Omissions. Another possible offset to the
savings in controlled outflows of capital could have occurred in the
errors-and-omissions account in the balance of payments. When that
account is unusually large and negative, it is often inferred that
flows of unrecorded capital are the cause. There is some evidence,
however, that many of the major movements of the errors-and-omissions
account can be attributed to forces other than the capital controls. /
If unrecorded net outflows of U.S. capital were greater or if
1/ R. Rickover, "Interest Rates, Capital Flows, and Errors and
Omissions in the U.S. Balance of Payments," Research Memorandum of
the Federal Reserve Bank of New York, March 8, 1971.
FORD & LIBRARY 938870
- 27 -
unrecorded net inflows of foreign capital were smaller than they
otherwise would have been in the absence of the capital controls,
this has not been obvious in the actual data for net errors and
omissions.
There appears to be a substantial normal error --
approaching an annual rate of $1 billion -- reflecting systematic
errors in data collection. (See Table 5.) The actual figures vary
from that base because of changes in interest-rate differentials
between here and abroad, quarter-to-quarter changes in imports (the
recording of which appears to lag behind payments), and speculative
movements of funds from time to time.
Table 5
Errors and Omissions
(Billions of dollars)
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
-1.2
-1.1
-1.2
-0.5
-1.1
-0.6
-0.5
-1.1
-0.5
-2.9
The large rise in errors and omissions in 1969, for example,
was associated with the sharp increases in interest rates in the
Eurodollar market, which attracted funds of U.S. residents out of
time deposits in U.S. commercial banks. There was a substantial circu-
lar flow of funds, however, as the U.S. banks borrowed back these funds.
In fact, the banks' borrowings far exceeded these outflows, with the
FORD i LIBRARY GERALD
- 28 -
result that the official-settlements balance of payments was heavily
in surplus. An additional factor contributing to the large figure
for errors and omissions in early 1969 was the dock strike.
Foreign Holdings of Liquid Assets in the United States. The
U.S. capital controls no doubt had some effect on foreigners' demand
for liquid dollar assets held in the United States. The growth in
foreigners' awareness of investment opportunities in the Eurodollar
market in the 1964-70 period, together with the relatively higher
yields offered on Eurodollar deposits compared with assets of compar-
able liquidity and maturity in New York, would have constituted
substantial incentives for substituting Eurodollar assets for dollar
assets held in the United States. Imposition of the capital controls,
which in turn led U.S. banks to multiply the number of their foreign
branches and to carry out lending through their branches which might
otherwise have been done at head offices, gave an added fillip to the
bidding for funds in the Eurodollar market. With Eurodollar rates
higher relative to U.S. rates than they otherwise might have been, it
seems likely that a larger proportion of the growth in foreigners'
total holdings of liquid dollar assets took place in the Eurodollar
market rather than in the United States.
In Appendix C, we review some research of Arthur Laffer
which purports to show that this leakage has been so large as to off-
set completely the gross savings due to the VFCR. In that appendix
we give some reasons for believing that the method which Laffer used
FORD is LIBRARY GERALD
- 29 -
to reach his conclusion is not analytically sound. Indeed, using
exactly the same technique that Laffer employed for 1965 and the
first half of 1966, we have updated his analysis to include data for
the last half of 1966 and for 1967-70. When this is done, the results
superficially point to a conclusion that the VFCR has led foreigners
to increase their liquid assets in the United States compared with
what they otherwise would have done. This latter conclusion is of
course nonsense. The fact that Laffer's analytical method leads to
a clearly incorrect conclusion with 1967-70 data, however, should
also make one highly suspicious of the conclusion that Laffer drew
from his analysis using only data for 1965 and the first half of 1966.
Throughout the last fifteen years, U.S. liquid liabilities
to nonofficial foreigners have grown more rapidly than the trade of
the rest of the world. The growth of foreign liquid assets in the
United States relative to foreign trade and GNP has been quite high
even if one excludes the atypical cases of liquid liabilities to
banks in the United Kingdom, Canada, Japan, and Switzerland. If
anything, these trends may have accelerated during the latter half of
/
the 1960'
If leakages from the gross savings have occurred on a
significant scale through this channel, therefore, they have been
much more than offset by other unexplained factors leading to faster
growth of foreign liquid assets in the United States.
1/ These generalizations are based on some recent empirical research
by Ralph Bryant on the international demand for liquid dollar assets.
FORD & LIBRARY 076835
- 30 -
As in the other cases of potential leakages, one cannot
reach clear-cut conclusions. But there is certainly no analytically
acceptable evidence which demonstrates that leakages via this
particular channel have been large. Our best judgment is that the
leakages here might be on the order of a few hundred million dollars
per year, but not so large as to be measured in billions of dollars.
Export Performance. We are reasonably confident that the
VFCR program has had little "direct" adverse impact on U.S. export
performance. None of the export equations of which we are aware
employ the volume of trade credit as an explanatory variable. Yet
the predictive ability of these equations has not been materially
impaired since the imposition of capital controls. Thus, we infer
either that United States exports have not been crucially dependent
on the availability of United States trade credit, or, more likely,
that the programs have succeeded in maintaining the level of these
credits while controlling other flows. Indeed, a recent survey of
banks, conducted by the Federal Reserve Board, "turned up very few
examples of requests for financing the export of U.S. goods that
were denied in 1970 because of [the VFCR] program. 1/1/
1/ Board of Governors of the Federal Reserve System, "Report on
Inquiry into Possible Effects of Voluntary Foreign Credit Restraining
Program in 1970 on Export Financing and on Exports," January 7, 1971.
FORD & LIBRARY GERALD
- 31 -
Of course, there may have been "indirect" effects on United
States exports resulting from a level of economic activity abroad
less than what would have occurred in the absence of U.S. capital
controls. Reduced capital flows to the industrialized countries may
have affected their monetary conditions and thus their levels of
economic activity. Reduced capital flows to the less developed
countries (LDCs) may have reduced LDC demand for U.S. exports direct-
ly, and indirectly reduced U.S. exports as a consequence of reduced
LDC imports from the other industrialized countries. The extent to
which these effects were operative depend in large part upon the
demand management policies pursued abroad and on their effectiveness.
In 1969-1970, economic activity levels in Japan and Western Europe
were quite high; capacity was being strained in these countries and
inflationary pressures were strong. In those circumstances, greater
capital outflows might have enlarged U.S. exports as a result of even
more intense inflation abroad.
Other Leakages. Offsets to the gross balance-of-payments
savings generated by the control programs could in principle have
occurred in every uncontrolled category of transactions in the U.S.
balance of payments. While we believe the four categories discussed
above are likely to have been the most important in quantitative terms,
we recognize that non-negligible offsets could have taken place in
still other parts of the current or capital accounts. We have no way
of making an informed judgment about the magnitude of these other
leakages.
FORD & LIBRARY GERALD
- 32 -
IV. A Brief Comment on the OMB Paper: "Capital Controls:
Questionable Results and Undoubted Costs. II
In light of the discussion in the previous sections, how
should we interpret the recent paper from the Office of Management
/
and Budget?
In our view, the OMB paper fails altogether to do
justice to the analytical complexity of the questions raised by the
capital control programs.
The OMB paper begins, quite correctly, by emphasizing that
any reductions in the outflow of U.S. owned capital brought about by
the programs will have induced some offsetting flows in other balance-
of-payments accounts. Unfortunately, this reasonable a priori
presumption is then used to support the non sequitur (page 2) that
"there is no reason to expect that capital controls would, in any
significant sense, actually reduce the net outflow of reserves."
Financial instruments are not perfect substitutes and international
capital and goods markets are not fully integrated.
Although leakages surely exist, we strongly doubt that they
have completely negated the effects of the controls -- particularly
in periods of monetary tightness in the United States. In any case,
far too little is known about this subject to justify the sweeping
/ "Capital Control Programs: Questionable Results and Undoubted
Costs," transmitted on March 2, 1971, with accompanying memorandum
by the Director of the Office of Management and Budget to the mem-
bers of the Council on International Economic Policy via the
Honorable Peter G. Peterson.
FORD & LIBRARY GERALD
- 33 -
assertions in the OMB paper.
The empirical studies cited in the OMB paper fall very
short of being convincing evidence. We have already noted (page 14)
that the Cooper paper which is cited is not relevant to the present
set of reinforcing controls.
The OMB paper does accurately convey the tenor of a study,
dated May 11, 1970, by the Center for Political Research, the conclu-
sions of which are in opposition to the OFDI program. But in our
view these CPR conclusions are not warranted by the information and
economic analysis in the study (see Appendix B).
The third empirical study cited as evidence in the OMB
paper is by Arthur Laffer and deals with short-term bank-reported
claims and liabilities. We have already noted (pages 28-29) that
Laffer's analytical methods could not adequately justify his conclu-
sion about the effects of the VFCR even in 1967 (when he first wrote
his paper), much less justify the position in the March 1971 OMB
paper (see Appendix C).
The "overall assessment" in the OMB paper states:
Detailed studies of the capital control programs
have uncovered absolutely no evidence of any effect
on the balance of payments.
The common and primary purpose of the capital con-
trol programs is to stem the net outflow of U.S.
official reserve assets by obstructing American
investments and loans to foreigners. All available
evidence suggests that these programs cannot and
have not accomplished or even worked towards this
purpose.
FORD is LIBRARY 07V830
- 34 -
These statements are simply false. It would be equally
misleading, but no more incorrect, to say that "detailed studies of
the capital control programs have uncovered absolutely no evidence
that the gross balance-of-payments savings from reductions in U.S.
capital outflows have been undermined by leakages elsewhere in the
balance-of-payments accounts" and that "there is no available evidence
suggesting that these programs cannot and have not accomplished their
purpose."
There is a trenchant line from the second scene of Act II
of Hamlet, in which Gertrude reprimands Polonius for his rhetoric:
"More matter, with less art." This would be a useful guideline for
improving the OMB paper.
This paper was prepared by
Murray Altmann, Ralph Bryant,
George Henry, and Alan Severn
FORD & LIBRARY GERALD
- 35 -
Appendix A
Potential Leakages via Reduced Foreign Purchases of
U.S. Corporate Securities
A frequently mentioned balance-of-payments account in which
gross reductions in capital outflows might have been offset is that
of foreign purchases of U.S. corporate securities. While foreign
purchases of such securities rose markedly after controls were strength-
ened in 1965, it is of course possible that the rise would have been
greater in the absence of direct investment, or other, controls.
One obvious possibility is that the convertible Eurobonds
issued by American direct investors were a substitute for ordinary
American equities. These Eurobonds were sold only to non-residents of
the United States. They were favorably priced, relative to comparable
securities within the United States. Therefore, the standard argument
goes, investors outside the United States may have been induced to hold
convertible Eurobonds instead of ordinary American equities, since they
received no price concessions on the latter category.
Observed transactions, however, show a close quarter-by-
quarter association between foreign purchases of U.S. equities and of
convertible Eurobonds issued by U.S. corporations (see attached chart).
Thus, if there was substitution in the short run, it was apparently
dominated by causation common to the two types of security. In addi-
tion, there may be a significant lag in foreigners' adjustment to the
surge of Eurobond issues. Therefore, further evidence is needed to
establish the degree of substitution between the two types of security
over a longer period.
FORD & GERALD LIBRARY
- 36 -
Preliminary results from an ongoing study of foreign pur-
chases of U.S. equities being carried out by Alan Severn, however,
fail to indicate any significant degree of substitution. The rela-
tive importance over time of American stocks in foreign equity
portfolios was compared to relative risks and returns and to the
growth of mutual funds abroad / for the period 1962-70. Through
1969 and the first three quarters of 1970, foreign investors con-
tinued to hold as much of U.S. stocks as might be expected in light
of relative risks, returns, and size of portfolios.
Direct investment controls may also have affected foreign
purchases of U.S. equities in ways other than through substitution
of Eurobonds. In particular, any reduction of American cash purchases
of existing foreign firms may have limited the equities purchases of
foreign individuals, i.e., the former owners of the foreign firms.
But since a typical foreign investor is likely to invest only a small
fraction of his equities portfolio in American stocks, this offset is
likely to be small. A similar, and similarly small, offset could be
a restriction of loans available to foreign equity investors as U.S.
corporations pre-empted part of available European capital.
There are also reasons for believing that the U.S. corporate
securities account may contain some offsets to the IET or VFCR programs.
1/ Including closed-end funds, to the extent that data are available.
2/ Holdings during the 1968 Eurobond surge were nearly identical to
those "predicted," while they were higher than "predicted" for 1969
(by $.4 billion), though lower for the first three quarters of 1970
(by $.3 billion).
FORD is LIBRARY GERALD
- 37 -
For example, one could imagine that the virtual cessation of American
purchases of foreign stocks, induced by the IET, caused foreign stock
prices to rise less rapidly, thereby lowering the value of foreigners'
portfolios compared with what they otherwise would have been and,
over time, inducing European investors to reduce their purchases of
/
American equities.
Altogether, it appears that the U.S. capital controls had
relatively little impact on foreign holdings of U.S. equities. Even
if offsets were present, but hidden by other factors relevant to
foreign investment in U.S. equities, the offsets were apparently small
in relation to the gross savings generated by the control programs.
1/ The rise in the nominal value of foreign equity portfolios
exceeded $150 billion during the 1963-70 period. While an infusion
of additional purchases from the U.S. could have raised the value of
foreign equities even further, any reasonable amount of U.S. pur-
chases would have played only a secondary role in foreign stock
markets.
FORD & LIBRARY
14. DI
- 38 - 38
NET FOREIGN PURCHASES OF M.S. SECURITIES, 1965-1970
U.S. Common Stocks
/
CONVERTIBLE EUROBONDS Sold AbRoAd By UIS-INCORPORATED COMPANIES
$
million
800
700
600
500
FORD is LIBRARY GERALD
400
300
/
200
100
0
- 100
1965 4 1966 / 2 3 4 1967 / 2 3 4 1968 / 2 3 4 1969 1 2. 3 4 1970 2 " 3 3 111 4
- 39 -
Appendix B
A Comment on the CPR Report
"Federal Control of Foreign Direct Investments"
This report by the Center for Political Research, dated
May 11, 1970, was apparently done for an unnamed corporate client;
the emphasis is on the locus of decision-making power with respect
to control of foreign direct investment.
Several flaws may be noted in this report:
1. It implies that earnings on direct investment depend on U.S. equity
in such investment, rather than on the aggregate size of the activity
(as measured, for example, by total assets). On page 14 the following
statement appears:
"Just how long OFDI's short-term balance of payments
benefits will last is open to debate
What is not
open to debate is that restrictions on direct U.S.
foreign investment will eventually lead to a decline
(or slower growth) in the dollar amount earned abroad
each year by U.S. firms. In addition, heavy borrowing
abroad by U.S. firms necessarily leads to sharp in-
creases in U.S. interest payments to foreigners. Such
payments have more than doubled since 1966; they are now
running at an annual rate of about 3.3 billion dollars."
2. The above quotation implies that interest payments on corporate
borrowing abroad are an addition to total interest payments by the
United States as a whole. But if the corporations were to borrow in
the United States and send the proceeds abroad, the outflow would be
reflected in combined private and official foreign holdings of dollars.
Since the holders of these additional dollars could be expected to
hold them in interest-bearing form, the interest payments on these
i
FORD
GERALD
717
- 40 -
holdings would partially offset the reduced payments by U.S.
corporations. Thus, only the difference between interest rates is
relevant here.
3. Several New York bankers are quoted as stating that as of 1970,
only half-a-dozen firms (mainly in petroleum and computers) have been
affected by the program; about 200 others have been partially
affected, but can still carry out their investment programs. But
this statement apparently means that plant and equipment expenditures,
rather than the financing of such expenditures, has been largely un-
affected. Yet it is primarily the financing which directly affects
the U.S. balance of payments and which is aimed at by the program.
The debate about the balance-of-payments effects of direct
investment activity (to which the report refers) is not relevant
here, because the scale of such activity has been largely unchanged.
Therefore fees and royalties, parts and components, exports back to
the United States, etc., are not affected.
4. The report states that in the aggregate, firms were below their
"allowables," in both 1968 and 1969. While this is true, it does not
necessarily reflect on the effectiveness of the program. The
regulations are the most restrictive for the continental Western
European countries, and least restrictive for less developed countries.
It appears that most of the leeway below allowables was concentrated
in the LDC's. The CPR report does not mention this possibility as a
FORD in LIBRARY GERALD
- 41 -
partial explanation for the fact that allowables were not fully
utilized.
In summary, the CPR report is analytically weak. Its
worst fault is that it fails clearly to distinguish between financial
and real consequences of the control of direct investment.
FORD & LIBRARY GERALD
- 42 -
Appendix C
(To be inserted in final version)
FORD & LIBRARY GERALD
- 43 -
Appendix D
Annotated List of References
This is not intended as an exhaustive survey of the
literature. It does bring together much of the literature which
bears on the subject matter of this paper.
1. Board of Governors of the Federal Reserve System, "Report on
Inquiry into Possible Effects of Voluntary Foreign Credit
Restraining Program in 1970 on Export Financing and on Exports,
January 7, 1971.
The survey of banks summarized in the report, "turned up very
few examples of requests for financing the export of U.S. goods
that were denied in 1970 because of [the VFCR] program"
2. William H. Branson, Financial Capital Flows in the U.S. Balance
of Payments, (North-Holland Publishing Company, Amsterdam, 1968).
Branson's Ph.D. dissertation applies a stock-adjustment model
to capital flows, with particular emphasis on estimation of lags
via the Almon technique. The capital control programs are taken
into account only by means of on-off dummy variables.
3. William H. Branson and Raymond D. Hill, Jr., "A New Model of
Financial Capital Flows in the U.S. Balance of Payments,"
December 9, 1970 (Mimeo).
This paper updates and revises the empirical results in the
preceding reference.
4. Ralph C. Bryant and Patric H. Hendershott, "Financial Capital
Flows in the Balance of Payments of the United States: an Ex-
ploratory Empirical Study," Princeton Studies in International
Finance No. 25 (June 1970).
Bryant and Hendershott attempt to elaborate an appropriate
theoretical framework for investigating international capital
flows. The model is applied to data for U.S. short-term outflows
to Japan with particular attention placed on trying to capture
the influence of the VFCR program.
BERALD FORD LIBRARY
- 44 -
5. Ralph C. Bryant and Patric H. Hendershott, "Empirical Analysis
of Capital Flows: Some Consequences of Alternative Specifica-
tions," a paper presented at a Universities - NBER Conference
on International Mobility and Movement of Capital, January 30-
February 1, 1970, Washington, D. C.
This paper, which expands the analysis in the previous reference,
discusses the substantial difficulties in determining an appro-
priate specification for capital flow equations. Alternative
specifications are shown to imply very different conclusions
about the effect of capital control programs.
6. Center for Political Research, "Federal Control of Foreign Direct
Investments, May 11, 1970.
The report discussed the program and concludes that "the avail-
able statistics regarding the OFDI program
cast doubt on the
extent to which the program actually restricts direct foreign
investment today."
7. Richard N. Cooper, "The Interest Equalization Tax: An Experiment
in the Separation of Capital Markets," Finanz Archiv, 24 (Decem-
ber 1965), 447-471.
Cooper investigates the period when only the IET was in effect
and concludes that, for all intents and purposes, offsetting
flows in other accounts entirely negated the impact of the IET.
8. Richard N. Cooper, "The Voluntary Credit Restraint Program:
An Assessment," January 1969 (Mimeo). Unpublished paper prepared
for FRB Academic Consultants.
Cooper summarizes his judgment on the gross savings and on the
probable magnitude of offsetting leakages. He concludes that the
present elements of the comprehensive set of restrictions are
reinforcing and that they have had a significant net impact on
the balance-of-payments.
9. Arthur B. Laffer, "Short-term Capital Movements and the Voluntary
Foreign Credit Restraining Program" 1969 (Mimeo).
Laffer presents regression equations for the changes in "U.S.
private short-term claims on foreigners" and for the changes in
"U.S. short-term liabilities to private foreigners." The relation-
ship between actual flows and what his equations predict lead him
to conclude that there has been no net balance-of-payments saving
from the VFCR program.
FORD & LIGRARY GERALD
- 45 -
10. Walther Lederer, "Notes on the Structure of the U.S. Balance of
Payments," not dated, (Mimeo).
Lederer argues that "major fluctuations in the balance on goods
and services are to a large extent offset by fluctuations in
unilateral and nonliquid capital transactions." However, some
regressions of the capital flow balance on the goods and services
balance and various dummy variables lead him to conclude that the
capital constraint programs have had a net effect on the balance
of payments.
11. C. H. Lee, "A Stock-Adjustment Analysis of Capital Movements:
The United States-Canadian Case," Journal of Political Economy,
Vol. 77 (July/August, 1969), 512-523.
This is another econometric application of the stock-adjustment
model, in this case to U.S.-Canadian capital flows. On-off
dummy variables are used to allow for the effects of the capital
control programs.
12. Fritz Machlup, "The Transfer Gap of the United States," Banca
Nazionale del Lavoro Quarterly Review, No. 86 (September 1968),
195-238.
Machlup rearranges the standard balance-of-payments accounts to
arrive at what he calls the "net real transfers" and the "net
financial transfers" of the United States. His work leads him
to conclude that in most circumstances changes in net financial
transfers will be offset by changes in net real transfers. He
concludes that "the balance-of-payments program pursued by the
United States Government
...
is useless for the purpose for
which it was designed."
13. N. C. Miller and M. V. N. Whitman, "A Mean-Variance Analysis of
United States Long-Term Portfolio Foreign Investment," The
Quarterly Journal of Economics, LXXXIV (May 1970), 175-196.
In this and several subsequent papers, Miller and Whitman apply
the portfolio selection approach to various categories of capital
flows in the U.S. balance-of-payments. On-off dummy variables
are used to allow for the effects of the capital control programs.
14. John Patrick, "Bank Lending to Foreigners under the FCRP and the
IET," NYFRB Research Memorandum, June 20, 1969.
QERALD FORD LIBRARY
- 46 -
Patrick reviews recent data on capital flows and then presents
regression results for equations explaining (quarterly changes
in) short-term bank-reported claims on foreigners and in total
bank-reported claims on foreigners. His results lead him to
conclude that the two programs do reduce (and quite substantial)
the flows at which they are directed.
15. Samuel Pizer, Statement to the Commission on International Trade
and Investment Policy on the "Capital Restraint Programs,"
October 15, 1970.
Pizer argues that there has been a large impact of the programs
in reducing gross outflows in the categories controlled. He con-
cludes moreover that despite the possibility of some leakages,
there has been a substantial net effect.
16. Martin F. J. Prachowny, A Structural Model of the U.S. Balance
of Payments (North-Holland Publishing Company, Amsterdam, 1969).
This is another econometric study that uses on-off dummy vari-
ables in some capital flow equations to allow for the effects of
the U.S. capital control programs.
17. R. Rickover, "Export Finance Before and After the Voluntary
Foreign Credit Restraint Program," NYFRB Research Memorandum,
October 14, 1969.
Rickover attempts to estimate the effect of the VFCR program on
export financing with a simple regression relating changes in
trade credit to (current and lagged) changes in the value of U.S.
exports. He believes that the volume of export trade financing
has been affected by the VFCR program.
18. R. Rickover, "Interest Rates, Capital Flows, and Errors and
Omissions in the U.S. Balance of Payments," NYFRB Memorandum,
March 8, 1971.
Rickover concludes that the "normal" unrecorded outflow (errors
and omissions) attributable to systematic errors in data collec-
tion is sizable. Interest rates (in the United States, Canada,
and the Euro-dollar market) and U.S. banks' liabilities to their
foreign branches exert a strong influence on unrecorded outflows.
Delays between payments for U.S. imports and their recorded
arrival in the United States also influence errors and omissions
when significant changes occur in the volume of imports.
&
FORD
GERALD
LIBRARY
- 47 -
19. Guy Stevens, "Capital Mobility and the International Firms,"
a paper presented at a Universities-NBER Conference on Interna-
tional Mobility and Movement of Capital, January 30-February 1,
1970, Washington, D. C.
Stevens estimates an econometric model of firm behavior. He con-
cludes that "virtually no impact of the various balance-of-
payments programs is evident on plant and equipment expenditures
in manufacturing."
not
FORD & LIBRARY GERALD
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date April 12, 1971
To
Board of Governors
Subject: Effects of Balance of Payments
From
Robert Solomon
Restraint Programs.
CONFIDENTIAL (FR)
The attached paper, prepared in the International Division's
Special Studies Section, under the guidance of Ralph Bryant, examines
the impact of the capital outflow restraint programs and tries to
evaluate the various leakages that could offset their direct impact.
After studying the evidence, the authors of the paper state
their belief that "the programs yield a significant balance of pay-
ments gain."
RS
9)
Attachment.
lifend and
FN. blance
FORD & GERALD LIBRARY
CONFIDENTIAL (FR)
DO THE RESTRAINTS ON U.S. CAPITAL
OUTFLOWS IMPROVE THE
BALANCE OF PAYMENTS?
April 7, 1971
Special Studies Section
Division of International Finance
Board of Governors of the Federal Reserve System
FORD & LIBRARY GERALD
Table of Contents
Page
Introduction and Summary
1
I. Analytical Frame of Reference
5
II. How Much Do We Know About International Economic
Relationships?
12
III. Judgmental Estimates of the Effects of the U.S. Capital
Control Programs
14
A. Gross Savings on Capital Outflows Covered by the
Programs
14
Interest Equalization Tax
14
Voluntary Foreign Credit Restraint
16
Foreign Direct Investment Program
19
B. Leakages Offsetting the Gross Savings
22
Foreign Purchases of U.S. Securities
24
Errors and Omissions
24
Foreign Holdings of Liquid Assets in the United States
26
Export Performance
28
Other Leakages
29
IV. A Brief Comment on the OMB Paper: "Capital Controls:
Questionable Results and Undoubted Costs"
31
Appendices:
A. An Appraisal of the State of Current Knowledge
34
B. Potential Leakages via Reduced Foreign Purchases of U.S.
Corporate Securities
40
C. A Comment on the CPR Report: "Federal Control of Foreign
Direct Investments"
43
D. A Comment on Research by Arthur B. Laffer on Short-term
Bank-Reported Capital Movements
46
E. Annotated List of References
57
FORD & LIBRARY GERALD
Confidential (FR)
INTRODUCTION AND SUMMARY
There are good grounds for believing that the restraints
on certain types of capital outflows from the United States -- the
interest equalization tax (IET), the voluntary controls on banks
and other financial institutions (VFCR), and the controls over
direct foreign investment of U.S. companies -- have held such flows
substantially below the levels they would have reached in the absence
of the restraints.
The restraints have been effective in limiting the specific
capital outflows at which they are aimed in good part because they
reinforce one another. Moreover, they undoubtedly have had a greater
impact in limiting these capital outflows during periods of monetary
ease in this country than during periods of tight monetary conditions.
The effect of the capital controls on the overall balance
of payments, however, is less clear. The gross balance-of-payments
"savings" in outflows of U.S. capital affect monetary conditions
and economic activity here and abroad. Those effects, in turn,
influence the flow of foreign capital into the United States and may
also lead to changes in trade and other elements of the current
account. Specifically, the limitation on outflows of U.S. capital
tends to tighten monetary conditions abroad relative to conditions
that would otherwise prevail, thereby reducing some foreign capital
flows into the United States. Moreover, the restriction on U.S.
FORD is LIBRARY GERALD
- 2 -
capital outflows could limit the availability of trade credit and
thereby result in some loss of U.S. export business. Still more
indirectly, the restraint on capital outflows may cause GNP (nominal
if not real) in other countries to be less than otherwise and thus
reduce the demand for U.S. exports.
Statements about the degree to which gross balance-of-payments
savings resulting from reductions in controlled U.S. capital outflows
are counteracted by "leakages" -- by outflows of uncontrolled U.S.
capital, by reductions in inflows of foreign capital, and by loss of
export business -- involve very large elements of judgment. The
systematic exploration of structural relationships in the international
economy lags far behind the investigations of behavioral relationships
underlying domestic economic activity, and the effort suffers from
severe data deficiencies. There are therefore firm grounds for humility
in expressing judgments. Our belief is that offsets to the gross
savings in the form of leakages, while far from negligible, are also
far from complete. We do believe that the programs yield a significant
balance-of-payments gain.
The data do not seem to give much support to an argument
that uncontrolled forms of U.S. capital outflow have been substantially
larger than they would have been in the absence of controls; these
flows (nonbank and bank outflows not covered by the programs, and also
net errors and omissions) are dominated by shifts in monetary policies
FORD is LIBRARY GERALD
- 3 -
here and abroad and by other influences unrelated to the controls.
The evidence is relatively strong, moreover, that U.S. exports were
not hampered directly by limitations on capital outflows. With
respect to inflows of foreign capital, it is particularly difficult
to make a judgment about the gap between what actually occurred and
what might have occurred in the absence of the capital restraints.
There is no reliable evidence showing either that the gap was large
or that it was small. Concerning the still more indirect leakages
arising through the general effects of the U.S. controls on economic
developments abroad, there is no empirical basis for a judgment.
Judgments concerning these most indirect consequences necessarily
rest on a theoretical view of the functioning of the international
system in the contemporary environment.
In the next section of the paper, we briefly summarize the
analytical perspective appropriate for studying the balance-of-
payments consequences of the restraints on capital outflows. Section
II and Appendix A give our appraisal of the current state of knowledge
concerning the structural relationships between national economies.
We review in Section III some of the empirical evidence that can be
brought to bear on the issue. Several appendices deal in more detail
with various subtopics. Finally, in Section IV, we include a brief
critical comment on a recent paper on this subject prepared in the
Office of Management and Budget.
FORD i LIBRARY GERALD
- 4 -
Our paper does not attempt to deal with the broader and
still more difficult question of whether the various costs associated
with the U.S. capital controls exceed any benefits. We do not ex-
press judgments about this broader question, and would not wish readers
to infer such judgments. We have deliberately restricted ourselves
here to the narrower question of whether the programs have a net
positive effect in improving the balance of payments.
FORD & LIBRARY 0ERALD
- 5 -
I. ANALYTICAL FRAME OF REFERENCE
An analysis of the balance-of-payments effects of imposing
controls on U.S. capital outflows should in principle take into
account all the behavioral relationships which link national economies
together into an interdependent world economy. It is clearly insuffi-
cient to look just at the reductions in outflows of the specific types
of capital at which the controls are directed, large though these gross
savings may be.
One way to establish the appropriate analytical perspective
is to pose the following three questions: 1) Do U.S. residents
directly substitute other types of capital outflow for the flows of
controlled capital that otherwise would have occurred? 2) How are
monetary conditions and economic activity in the United States affected,
and how do such effects feed back onto the balance of payments? 3) How
are monetary conditions and economic activity in foreign countries
affected, with consequent feedback effects on the U.S. balance of
payments?
The various control programs -- the IET, the VFCR, and the
OFDI regulations -- cover the principal types of U.S. capital outflows
that may substitute for one another and therefore are mutually re-
inforcing. The remaining flows of U.S. capital not subject to controls
are the claims of nonbanks on foreigners - both those claims reported
and those that are not reported but reflected in errors and omissions
GERALD FORD LIBRARY
- 6 -
-- and also some exempted claims of banks. The extent to which these
other outflows can and do substitute for the controlled outflows has
to be ascertained before one can answer the question posed in this
paper.
The way that a reduction in capital outflows from the United
States affects monetary conditions and economic activity in the United
States is conditioned by the reserve-currency role of the dollar. If
the reduction in the outflow of capital and the initial improvement in
the U.S. balance of payments has no effect on U.S. holdings of gold and
other reserve assets, there is no automatic effect on the money supply
and on the reserves of U.S. commercial banks. Since U.S. official
settlements deficits or surpluses are often financed solely by changes
in reserve liabilities, the U.S. monetary authorities are frequently
not confronted, as other countries in such circumstances always are,
by the issue of whether to offset the effects of the balance of pay-
ments on money supply and bank liquidity. Demand management policies
in the United States, therefore, have probably been little if any
different from what they would have been without the controls -- unless
prior to introduction of the controls, the concern for external balance
was leading U.S. policy-makers to pursue more restrictive policies than
/
they wanted to pursue for domestic reasons alone.
On the other hand, the controls and their immediate balance-of-
payments effects did induce shifts in both the demand for and supply
of funds in particular sectors of the U.S. money and capital markets,
which had some consequences for the size and composition of. banks'
assets and liabilities and also for the term structure of interest rates.
Through causal sequences of this type, the imposition of the controls
could have produced second-order feedback effects on a number of cate-
gories of balance-of-payments transactions.
FORD & LIBRARY GERALD
- 7 -
What type of feedback effects can result from the impacts
of the controls on monetary conditions and economic activity in
foreign countries? The way an analyst answers this third question is
likely to be a critical factor in determining his estimates of the
importance of leakages, and hence his judgment about the ultimate net
effects of the controls on the U.S. balance of payments.
Reduced outflows of capital from the United States tend to
hold down the growth in money supply, bank liquidity, and credit flows
in the rest of the world, compared with what would occur in the absence
of the U.S. controls. The extent to which these effects are important
in individual countries depends critically on government policy-makers.
At one extreme, a country's policy-makers may have such a variety of
policy instruments and be so skillful at offsetting external influences
that they succeed in creating virtually the same domestic monetary
conditions and economic activity that would have prevailed in the
absence of the U.S. controls. If all foreign policy-makers were so
fortunate and skillful, the initial gross savings in the U.S. balance
of payments attributable to the capital controls would not be badly
eroded by unfavorable feedback effects. At the other extreme, a country's
policy-makers may be unable to prevent the reduced outflows of capital
from the United States from having a full impact on domestic monetary
conditions and economic activity. If all foreign policy-makers were
limited in that way, a very large proportion of the initial gross savings
FORD & GERALD LIBRARY
- 8 -
in the U.S. balance of payments might ultimately be eroded and there
might be little net effect of the controls on the overall balance of
payments. Most countries, of course, fall somewhere in between these
two extremes.
The feedback effects on the U.S. balance of payments can in
principle occur in virtually all categories of balance-of-payments
transactions. Tighter monetary conditions and higher interest rates
abroad (compared with what they would be in the absence of the U.S.
controls) could reduce all types of foreign capital flows in the United
States. Slower real growth and/or a less rapid rate of inflation
than would otherwise occur may reduce foreign imports from the United
States.
The qualitative effects of the controls on capital outflows
and on the balance of payments can be illustrated more specifically
by describing the hypothetical situation that might have developed had
the recent shift toward ease in monetary conditions in the United
States occurred in the absence of any capital controls. Our purpose
in including this hypothetical description here is still the limited
one of outlining an appropriate analytical frame of reference. We are
not attempting to predict what might happen if the existing control
programs were to be dismantled.
To begin with direct investment, a larger proportion of U.S.
business outlays abroad in recent quarters would have been financed
from U.S. sources. This difference in the source of financing would
GERALD FORD LIBRARY
- 9 -
appear in the balance of payments as an increase in direct investment.
There also would be a stock adjustment as maturing debt of U.S. cor-
porations held abroad -- much of which is short-term -- was replaced
with issues in the United States. The sale of foreign securities to
U.S. investors would have been greater in the absence of controls in
the environment of easy monetary conditions in the United States.
Given the large shift in the locus of demands for long-term
capital that would have occurred without controls, the stimulus for
lower interest rates in foreign capital markets would have been greater
than it has been; at the same time, the decline in long-term rates in
the United States would have been somewhat retarded. Nevertheless,
interest rates in the United States would have declined relative to
those abroad -- given that foreign monetary authorities were not also
implementing policies of active ease. The re-alignment in interest
rates in the absence of controls would have induced both American and
foreign investors to alter their portfolios of debt securities in favor
of foreign instruments, thereby augmenting the outflows of capital from
the United States.
In the absence of the VFCR, the easing in monetary conditions
in the United States would have induced the same sort of consequences
through an expansion in bank credit to foreigners. In the short-term
area, the stock adjustment in response to the changed interest-rate
relationships between here and abroad can be accomplished quickly,
producing a substantial outflow promptly.
FORD & LIBRARY GERALD
- 10 -
The additional capital outflows in the absence of the capital
controls would have tended to increase directly the money supply in
other industrial countries still more than the actual outflows have
done, and they also would have tended to increase bank liquidity still
more and provided the basis for a larger secondary expansion in credit
and money. If this had been allowed to occur -- if the foreign author-
ities had made no effort to neutralize the inflows of funds -- interest
rates abroad would have been under still greater downward pressure.
The differential in interest rates between the United States and
foreign countries would have been smaller, but this would have been the
result of larger net outflows of funds from the United States than
actually occurred.
Over time, the process would have produced some balance-of-
payments offsets to the augmented capital outflows. The easier mone-
tary conditions induced in other industrial countries would have ex-
panded their demands for U.S. goods and services. Also, working capital
requirements abroad would have been greater, and some portion of foreign
working capital is held in dollars. To the extent that the additional
capital outflows from the United States would have been accompanied by
expansion in private foreign demands for short-term dollar assets, the
rise in the U.S. official settlements deficit would have been tempered.
The induced expansion in foreign demand for goods and services occurs
with some lag, however, and in the interim the absence of capital
GERALD R. FORD LIBRARY
- 11 -
controls during the process of easing monetary conditions in the
United States would have augmented the deficit in the U.S. balance
of payments.
How the process would have worked in fact would have been
strongly influenced by the policy responses abroad. To the extent that
the authorities would have been successful in neutralizing the addi-
tional inflows of funds -- in retarding the monetary expansion and
declines in interest rates -- the balance-of-payments offsets to the
additional outflows of U.S. capital would have been prevented from
developing.
The augmented outflows of funds in the absence of the controls
would have been in addition to the large repayments of U.S. bank borrow-
ings from the Eurodollar market that have occurred and have been re-
flected in the extraordinary U.S. official settlements deficits. More-
over, the augmented outflows from the United States would have occurred
when other industrial countries already were experiencing boom conditions
and inflationary pressures. The additional expansive effects on their
economies would have been totally unwanted. Indeed, even the effects
of the repayment of the Eurodollar borrowings were unwanted and inter-
fered with the policies that foreign monetary authorities wished to
follow. In the circumstances, additional outflows of U.S. capital would
have generated offsets in the current account chiefly by raising nominal
rather than real GNP in other industrial countries. It would have done
so, in other words, by accelerating the rates of inflation abroad.
FORD & LIBRARY GERALD
- 12 -
II. HOW MUCH DO WE KNOW ABOUT INTERNATIONAL ECONOMIC RELATIONSHIPS?
How would it be possible adequately to appraise the magnitude
of gross balance-of-payments savings due to the U.S. capital controls
and the proportion of these gross savings that are lost through leakages?
As the preceding section suggests, it would be necessary to
specify and estimate a highly elaborated model of the international
economy. Such a model would need to include demand and supply equations
for each important financial instrument (international and domestic).
These equations would in turn have to be specified so as adequately to
reflect the complex interrelationships between all financial markets.
Moreover, the model would have to embody the behavioral relationships
linking international capital flows, merchandise trade flows, and
economic activity levels for all major countries or regions. Finally,
the analysis would have to take explicit account of the likely reactions
of foreign policy makers to various types of U.S. policy actions.
The economics profession is very far from having such a
model of the international economy. The partial evidence about behav-
ioral relationships that does exist is grossly inadequate. In these
circumstances, even tentative conclusions about the effects of the
United States capital control programs can be no more than informed
guesses. A fuller treatment of this important point has been deferred
to Appendix A.
We try in the next section to bring together some empirical
information relevant to an analysis of the capital controls and to
FORD & LIBRARY GERALD
- 13 -
make some judgmental estimates of how large the gross balance-of-
payments savings and the offsetting leakages may have been. We put
forward these judgments with genuine hesitation. Although we believe
our judgments are as reasonable as can be made given the present state
of knowledge, we are mainly impressed -- as emphasized in Appendix A --
with the inability of anyone to make judgments that are clearly valid.
FORD & LIBRARY GERALD
- 14 -
III. JUDGMENTAL ESTIMATES OF THE EFFECTS OF THE
U.S. CAPITAL CONTROL PROGRAM
A. Gross Savings on Capital Flows Covered by the Programs
Interest Equalization Tax. The IET has been imposed on U.S.
purchases of foreign securities since mid-1963 and on long-term bank
lending since February 1965.
The IET induced a sharp reduction in U.S. purchases of
foreign new issues, as suggested by Table 1. The annual average of
these purchases, which had been building up sharply in 1962 and early
1963, fell by $177 million between 1962-63 and 1964-65, and an addi-
tional $58 million between the latter period and 1966-69. The severity
of the reduction in 1964, shown in Table 1, is probably attributable
to the substitution of untaxed bank loans for security issues in that
year. With the extension of the IET to long-term bank loans in 1965,
and also the inception of the VFCR, new security issues rose moderately.
The reduction of new issues in the 1966-69 period from the 1964-65
average appears to be attributable in large part to the relative tight-
ness in the U.S. market for long-term capital. With the advent of
easier money in the United States after 1969, the IET undoubtedly had
more of a restraining effect on foreign new issues.
FORD i LIBRARY GERALD
FORD & GERALD LIBRARY
- 15 -
Table 1
U.S. Purchases of Foreign Securities Newly Issued in the United States a/
by European Countries, Australia, New Zealand and South Africa.
(millions of dollars)
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
b/
24
57
195
289
35
95
15
-
-
14
/ Japan is excluded because Japanese new issues were partially exempted
from the IET. The 1965 exemption of $100 million was continued for several
years, but was not fully utilized because of rising U.S. interest rates.
b/ Excluding an exchange of stock issued to finance a foreign direct
investment in the United States. This transaction had a neutral effect on
the balance of payments.
The IET has at least two types of effects on new issues. Most immediately,
potential foreign borrowers are deterred by the existence of the tax itself.
Less directly, the cumulative effects of the tax over time probably have
given an added fillip to the development of European capital markets,
inducing Europeans to raise more capital in their own markets as opposed
to the U.S. market. In the face of growing foreign demand for long-term
capital, the full impact of the IET on new issues in 1970 could well have
been substantially in excess of the average volume of new issues observed
in 1962-63.
In the face of the IET, American net purchases of outstanding
foreign equities reached a cumulative total of only $1/4 billion during the
/
1963-70 period.
Suppose that in the absence of the IET, Americans would
1/ Net purchases of outstanding bonds were negligible. Net U.S. purchases
of Japanese equities in 1969 were very large (approximately $300 million) and
more than offset net U.S. sales of foreign equities during most of the 1963-
70 period. At the end of 1969, Japanese long-term assets were brought under
the VFCR program for nonbank financial institutions. This action has virtu-
ally eliminated the flow of funds by U.S. institutional investors into
Japanese equities.
- 16 -
have wanted to allocate a roughly constant proportion of their equity
portfolios to foreign equities. This assumption implies that sub-
stantial net purchases of foreign equities, possibly as much as $3-4
billion, would have occurred. A number such as $3-4 billion probably
represents an upper bound for the cumulative gross savings for 1963-70.
Without the IET, of course, net purchases would undoubtedly have
fluctuated considerably.
We have not tried to make estimates of the gross savings
attributable specifically to the 1965 extension of the IET to long-term
bank loans. Total foreign lending of banks is considered under the
VFCR program.
Voluntary Foreign Credit Restraint. The introduction of the
VFCR early in 1965, in combination with the imposition of the IET on
banks' long-term loans, was associated with a sharp cutback in new
foreign lending by U.S. banks. The balance-of-payments accounts show
that the combined outflow of long-term and short-term bank funds fell
from an annual average of $1.4 billion in 1960-64 to an annual average
of less than $100 million in 1965-69.
That the program played a large role in limiting the outflow
of bank credit is not contradicted by the continuous existence of an
apparent leeway for additional lending, as shown in Table 2. The
1/ Inspection of stock price trends in various countries suggests
that U.S. prices rose at roughly the average of foreign price rises,
but with less fluctuation.
FORD & LIBRARY GERALD
- 17 -
apparent leeway under the ceiling reflects mostly cyclical factors,
differences among banks, and bank uncertainty about draw-downs by
/
foreign borrowers.
Table 2
Banks' Ceilings and Leeway Under the VFCR
(Millions of dollars, end of year)
1965
1966
1967
1968
1969
1970
General Ceiling
/
Aggregate ceiling
9,973
10,407
11,069
9,729
10,092
9,956
Apparent leeway
321
911
1,204
476
694
606
b/
Total General and Export Term-Loan Ceilings
/
Aggregate ceilings
9,973
10,407
11,069
9,729
11,356
11,379
Apparent leeway
321
911
1,204
476
1,939
1,842
a / Ceilings are calculated on the basis of the guidelines in effect
during the given year. There were both liberalizations and intensifica-
tions of the guidelines from 1965 to mid-1968 and several relaxations
since late 1968.
b/ Export Term-Loan Ceiling added at the end of 1969.
Econometric research on bank lending to foreigners has been
fraught with problems, few if any of which have been satisfactorily
2/
resolved.
With the exception of the studies by Bryant and Hendershott,
1/ See Bernard Norwood, "Restraining Foreign Credit: Six Year Test,"
Wharton Quarterly, Winter 1970, pp. 32-37.
2/ Appendix E lists some of the references. The studies most
relevant here are those by Branson, Bryant and Hendershott, Laffer,
Miller and Whitman, and Patrick.
-
FORD & LIBRARY GERALD
- 18 -
this research has allowed for the effects of the VFCR only in a crude,
inadequate fashion. Even Bryant and Hendershott, despite strenuous
efforts to adapt their equations so as explicitly to reflect the
varying impacts of the VFCR guidelines, failed to come up with clear-
cut evidence. /
If the proportion of foreign loans in the portfolios of U.S.
banks had been the same at the end of 1970 as it was at the end of
1962, foreign loans would have been $16.6 billion instead of the
observed figure of $13.8 billion. This calculation may give a crude
indication of the possible magnitude of the effect of the VFCR on the
distribution of U.S. bank portfolios. The precise impact of the VFCR
at any given time, of course, depends critically on monetary conditions
in the United States relative to those abroad. In the past year, the
restraining effect of the VFCR on bank lending has increased considerably,
compared with its effect during the most intense periods of monetary
tightness in 1969. It is estimated that German companies borrowed
nearly $1.8 billion in Eurodollars during 1970. In the absence of the
VFCR, a significant portion of this loan demand might have been met by
U.S. banks.
See Bryant and Hendershott, Financial Capital Flows in the Balance
of Payments of the United States: An Exploratory Empirical Study,
Princeton Studies in International Finance No. 25, pp. 31-32, 48-50,
60-61; also "Empirical Analysis of Capital Flows: Some Consequences of
Alternative Specifications," Forthcoming in Universities-NBER Volume on
The International Mobility and Movement of Capital.
2/ Foreign loans here include Canadian, which are exempt from the
VFCR. The year 1962 is taken as a base because of the surge in borrowing
in 1963-64 after the IET restricted security issues.
BERALD FORD LIBRARY
- 19 -
The effect of the VFCR on nonbank financial institutions is
even harder to judge, because of the diversity of such institutions
and because of potential switches between assets not covered (over $13
billion) and covered assets (under $2 billion). One indication of the
effectiveness of the non-bank program is the virtual cessation of U.S.
purchases of Japanese equities after such assets were brought under
the program, in contrast to net U.S. purchases of $300 million in 1969.
Foreign Direct Investment Program. This program was designed
to limit outflows of U.S.-owned funds (as they are reflected in the
balance of payments) to finance U.S. business investment in foreign
affiliates; it was not the intention to limit the investment outlays
of those affiliates. The program, it was hoped, would shift the source
of financing away from the United States, and it appears to have been
successful in doing that. One possible indication of the size of
gross program savings is given by the amount of funds obtained abroad
by U.S. parent firms; such financing was virtually zero until the
advent of the voluntary program in 1965; in 1968, 1969, and 1970 it
was more than $2 billion per year. (See Table 3, line 4.2/)
1/ For example, Guy Stevens found that "virtually no impact of the
various balance of payments program is evident on plant and equipment
expenditures in manufacturing." See his "Capital Mobility and the
International Firm," Universities-National Bureau Conference on
International Mobility and Movement of Capital, forthcoming.
2/ These data, from OFDI, are more inclusive than those from OBE,
since they include foreign borrowings which are used abroad without
first being remitted to the United States.
GERALD FORD VIBRARY
R.
FORD
- 20 -
GERALD
Table 3
LIBRARY
Selected Data on Direct Foreign Investment
(millions of current dollars)
Financial
1965
1966
1967
/
1968
1969
1970
1. Net capital transfers
3926
4386
4178
2671
3720
4250
2. + Reinvested earnings
1492
1692
1390
1950
2325
3150
3. = Direct investment
5418
6078
5568
4621
6045
7400
4. - Long-term foreign borrowing
by parent firms and program
adjustments
b/
104
638
542
2161
2346
2500
5. If Net use of U.S.-source funds
and Reinvested Earnings
5314
5440
5026
2460
3699
4900
/
6. + Depreciation
3686
4074
4632
5265
5800
6400
7. + Long-term foreign borrowing
by parent firms and program
adjustments
104
638
542
2161
2346
2500
8. = Gross use of U.S.-controlled
funds
9104
10152
10200
9886
11845
13800
Real
9.
Plant & equipment expenditures
7440
8640
9267
9387
10787
13200
/ Excluding Canada, since no data are available. In contrast, other
data in this table are worldwide, i.e., all three OFDI schedules plus
Canada.
/ Program adjustments are offsets to foreign borrowing, such as repay-
ments and indirect capital transfers.
/ Estimated
Source: Depreciation and plant and equipment expenditures from Office of
Business Economics; other data from Office of Foreign Direct Investments.
- 21 -
The decline in the ratio of U.S.-controlled funds to plant
and equipment expenditures that has occurred as foreign affiliates
have relied to a greater extent on local borrowing (i.e., by affiliates,
in addition to foreign borrowing by parent firms) is a possible indica-
tion of additional gross savings. For 1965, this ratio was 1.225; for
the 1966-67 period, when the voluntary program specified firm-level
targets, it fell to 1.135. In contrast, the ratio under the Mandatory
Program in 1968-70 was 1.065. If the 1965 ratio had prevailed in
1968-70, gross use of U.S.-controlled funds would have been some $1-3/4
billion greater on average per year.
The trend toward greater reliance on local financing is con-
sistent with another set of OFDI data, available for 1967-68 (See
2/
Table 4).
For all direct investment outside Canada, these data show
that each dollar of new current assets was matched in 1968 by 91 cents
in affiliate borrowing, as opposed to 85 cents in outstanding affiliate
U.S.-controlled funds are defined to include depreciation allow-
ances since the latter allow direct investors to make some plant
and equipment expenditures without recourse either to foreign borrowings
or U.S. funds. In other words, reinvestment of depreciation allowances
leaves the book value of foreign affiliates unchanged; thus plant and
equipment expenditures should be attributed to depreciation allowances
as well as to U.S.-source funds and foreign borrowing by parent firms.
2/ U.S. Department of Commerce, Office of Foreign Direct Investments,
Foreign Affiliate Financial Survey 1967-1968 (Washington, July 2, 1970).
Comparable data for 1966 and 1969 are not yet available, either from
OFDI or OBE.
MA
FORD & LIBRARY GERALD
- 22 -
borrowing per dollar of current assets at the beginning of 1968. /
However, comparable data for Canada (Table 4) showed a similar move-
ment, reminding us that other factors probably accounted for much of
the increased use of local funds on the part of affiliates.
The prima facie evidence is that the Voluntary and Mandatory
Programs had successively larger influences on both parent-firm and
affiliate financing. But, of course, part of this increased foreign
financing might have occurred in 1968 and 1969 even in the absence of
controls as a result of tighter money in the United States. In 1970,
however, the Mandatory Program was undoubtedly effective in preventing
corporations from shifting new financing back to U.S. sources, as well
as refinancing outstanding foreign debt in the United States.
B. "Leakages" Offsetting the Gross Savings
While it is difficult to estimate a possible range of gross
balance-of-payments savings generated by the capital controls, it is
even more difficult to guess at the size of leakages. The difficul-
ties are severe both because of the limited state of our knowledge
(see Appendix A) and because offsets can conceivably occur in any
1/ Affiliate financing is functionally related to current assets
because of seller financing of locally obtained inputs and because firms
attempt to match local-currency assets and liabilities. See S. Robbins
and R. Stobaugh, Comment on Stevens' "Capital Mobility and the Interna-
tional Firm," Universities-National Bureau Conference on International
Mobility and Movement of Capital, forthcoming.
2/ The initial Voluntary Program for 1965 did not involve firm-
level targets, and resulted mainly in the repatriation of head-office
balances formerly held in Europe.
FORD & LIBRARY GERALD
- 23 -
Table 4
Majority-owned Foreign Affiliates
Current Assets and Foreign-Source Funds, 1967-68
(millions of dollars)
Outstanding
Outstanding
Change during
end-1967
end- 1968
1968
All Schedules
Current assets
25,805
30,406
4,601
Foreign debt
21,909
26,100
4,191
Ratio, foreign debt to
current assets
.849
.858
.911
Canada
Current assets
7,649
8,481
831
Foreign debt
5,549
6,273
724
Ratio, foreign debt to
current assets
.726
.740
.871
FORD & LIBRARY GERALD
- 24 -
balance-of-payments category. In the following subsections we attempt
to review the evidence available for four categories of transactions
where leakages seem particularly likely to have occurred.
Foreign Purchases of U.S. Securities. An obvious source of
potential leakages is in foreign purchases of U.S. corporate securities.
Most directly, the convertible Eurobonds issued by U.S. corporations
as a response to the capital controls are undoubtedly a close sub-
stitute for securities which foreigners would otherwise purchase in
New York.
During the period in which the capital controls were in force,
foreign purchases of U.S. securities increased to unprecedented rates.
They might, it is true, have increased still more in the absence of the
controls. Indeed, there is no convincing evidence on what the magnitude
of this leakage may have been. We find it implausible, however, to
imagine that it could have been in excess of a few hundred million
dollars per year on average. (See Appendix B for a more detailed
discussion of this potential leakage.)
Errors and Omissions. Another possible offset to the savings
in controlled outflows of capital could have occurred in the errors-
and-omissions account in the balance of payments. When that account is
unusually large and negative, it is often inferred that flows of un-
recorded capital are the cause. There is some evidence, however, that
GERALD FORD LIBRARY
- 25 -
many of the major movements of the errors-and-omissions account
can be attributed to forces other than the capital controls.
There appears to be a substantial normal error -- approaching
an annual rate of $1 billion -- reflecting systematic errors in data
collection. (See Table 5.) The actual figures vary from that base
because of changes in interest-rate differentials between here and
abroad, quarter-to-quarter changes in imports (the recording of which
appears to lag behind payments), and speculative movements of funds
from time to time.
Table 5
Errors and Omissions
(Billions of dollars)
1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970
-1.2 -1.1 -1.2 -0.5 -1.1 -0.6 -0.5 -1.1 -0.5 -2.9 -1.3
The large rise in errors and omissions in 1969, for example,
was associated with the sharp increases in interest rates in the Euro-
dollar market, which attracted funds of U.S. residents out of time
deposits in U.S. commercial banks. There was a substantial circular
1/ See, for example, R. Rickover, "Interest Rates, Capital Flows,
and Errors and Omissions in the U.S. Balance of Payments," Research
Memorandum of the Federal Reserve Bank of New York, March 8, 1971.
FORD & GERALD LIBRARY
- 26 -
flow of funds, however, as the U.S. banks borrowed back these funds.
In fact, the banks' borrowings far exceeded these outflows, with the
result that the official-settlements balance of payments was heavily
in surplus. An additional factor contributing to the large figure
for errors and omissions in early 1969 was the dock strike.
If unrecorded net outflows of U.S. capital have been greater
or if unrecorded net inflows of foreign capital have been smaller than
they otherwise would have been in the absence of the U.S. capital con-
trols, this has been far from obvious in the actual data for net errors
and omission.
Foreign Holdings of Liquid Assets in the United States. The
U.S. capital controls no doubt had some effect on foreigners' demand
for liquid dollar assets held in the United States. The growth in
foreigners' awareness of investment opportunities in the Eurodollar
market in the 1964-70 period, together with the relatively higher
yields offered on Eurodollar deposits compared with assets of compar-
able liquidity and maturity in New York, would have constituted
substantial incentives for substituting Eurodollar assets for dollar
assets held in the United States. Imposition of the capital controls,
which in turn led U.S. banks to multiply the number of their foreign
branches and to carry out lending through their branches which might
otherwise have been done at head offices, gave an added fillip to the
bidding for funds in the Eurodollar market. With Eurodollar rates
higher relative to U.S. rates than they otherwise might have been, it
GERALD FORD CIBRARY
- 27 -
seems likely that a larger proportion of the growth in foreigners'
total holdings of liquid dollar assets took place in the Eurodollar
market rather than in the United States.
In Appendix D, we review some research of Arthur Laffer
which purports to show that this leakage has been so large as to off-
set completely the gross savings due to the VFCR. In that appendix
we give some reasons for believing that the method which Laffer used
to reach his conclusion is not analytically sound. Indeed, using
exactly the same technique that Laffer employed for 1965 and the
first half of 1966, we have updated his analysis to include data for
the last half of 1966 and for 1967-70. When this is done, the results
superficially point to a conclusion that the VFCR has led foreigners
to increase their liquid assets in the United States compared with
what they otherwise would have done. This latter conclusion is of
course nonsense. The fact that Laffer's analytical method leads to
a clearly incorrect conclusion with 1967-70 data, however, should
also make one highly suspicious of the conclusion that Laffer drew
from his analysis using only data for 1965 and the first half of 1966.
Over the last fifteen years, U.S. liquid liabilities
to nonofficial foreigners have grown more rapidly than the trade of
the rest of the world. The growth of foreign liquid assets in the
United States relative to foreign trade and GNP has been quite high
even if one excludes the atypical cases of liquid liabilities to banks
in the United Kingdom, Canada, Japan, and Switzerland. If anything,
FORD & LIBRARY GERALD
- 28 -
these secular trends may have accelerated during the latter half of
the 1960'
If leakages from the gross savings have occurred on a
significant scale through this channel, therefore, they have been much
more than offset by other unexplained factors leading to faster growth
of foreign liquid assets in the United States.
As in the other cases of potential leakages, one cannot
reach clear-cut conclusions. But there is certainly no analytically
acceptable evidence which demonstrates that leakages via this
particular channel have been large. Our best seat-of-the-pants judg-
ment is that the leakages here might be on the order of a few hundred
million dollars per year, but not so large as to be measured in
billions of dollars.
Export Performance. We are reasonably confident that the
VFCR program has had little "direct" adverse impact on U.S. export
performance. 2/ None of the export equations of which we are aware
employ the volume of trade credit as an explanatory variable. And
the predictive ability of these equations has not been materially
/ These generalizations are based on some recent empirical research
by Ralph Bryant on the international demand for liquid dollar assets.
2/ A recent survey of banks, conducted by the Federal Reserve Board,
"turned up very few examples of requests for financing the export of
U.S. goods that were denied in 1970 because of [the VFCR] program."
Board of Governors of the Federal Reserve System, "Report on Inquiry
into Possible Effects of Voluntary Foreign Credit Restraining Program
in 1970 on Export Financing and on Exports," January 7, 1971.
FORD & GERALD LIBRARVA
- 29 -
impaired since the imposition of capital controls. Thus, we infer
either that United States exports have not been crucially dependent
on the availability of trade credit, that the programs have succeeded
in maintaining the level of U.S. trade credits while controlling
other U.S. flows, or, most likely, that other sources of credit
(including lending by the foreign branches of U.S. banks) have been
substituted for U.S. credit.
Of course, there may have been "indirect" effects on United
States exports resulting from a level of economic activity abroad less
than what would have occurred in the absence of U.S. capital controls.
Reduced capital flows to the industrialized countries may have affected
their monetary conditions and thus their levels of economic activity.
Reduced capital flows to the less developed countries (LDCs) may have
reduced LDC demand for U.S. exports directly, and indirectly reduced
U.S. exports as a consequence of reduced LDC imports from the other
industrialized countries. The extent to which these effects were
operative depends in large part upon the demand management policies
pursued abroad and on their effectiveness. In 1969-1970, economic
activity levels in Japan and Western Europe were quite high; capacity
was being strained in these countries and inflationary pressures were
strong. In those circumstances, greater capital outflows might have
enlarged U.S. exports as a result of even more intense inflation abroad.
Other Leakages. Offsets to the gross balance-of-payments
savings generated by the control programs could in principle have
FORD is LIBRARY GERALD
- 30 -
occurred in every uncontrolled category of transactions in the U.S.
balance of payments. While we believe the four categories discussed
above are likely to have been the most important in quantitative
terms, we recognize that non-negligible offsets could have taken
place in still other parts of the current or capital accounts. We
have no way of making an informed judgment about the magnitude of
these other leakages.
FORD & LIBRARY GERALD
- 31 -
IV. A BRIEF COMMENT ON THE OMB PAPER: "CAPITAL CONTROLS:
QUESTIONABLE RESULTS AND UNDOUBTED COSTS."
In light of the discussion in the previous sections, how
should we interpret the recent paper from the Office of Management
and Budget? / In our view, the OMB paper fails altogether to do
justice to the analytical complexity of the questions raised by the
capital control programs.
The OMB paper begins, quite correctly, by emphasizing that
any reductions in the outflow of U.S.-owned capital brought about by
the programs will have induced some offsetting flows in other balance-
of-payments accounts. Unfortunately, this reasonable a priori pre-
sumption is then used to support the non sequitur (page 2) that
"there is no reason to expect that capital controls would, in any
significant sense, actually reduce the net outflow of reserves." It
is a big step from the plausible statement that leakages exist to the
statement that they completely offset the effects of the controls.
Financial instruments are not perfect substitutes and international
capital and goods markets are not fully integrated.
1/ "Capital Controls: Questionable Results and Undoubted Costs,"
transmitted on March 2, 1971, with accompanying memorandum by the
Director of the Office of Management and Budget to the members of the
Council on International Economic Policy via the Honorable Peter G.
Peterson.
FORD is LIBRARY QERALD
- 32 -
Although leakages surely exist, we strongly doubt that they
have completely negated the effects of the controls -- particularly
in periods of monetary tightness in the United States. In any case,
far too little is known about this subject to justify the sweeping
assertions in the OMB paper.
The empirical studies cited in the OMB paper fall very short
of being convincing evidence. We note in Appendix A (page 34) that the
Cooper paper which is cited is not relevant to the present set of
reinforcing controls.
The OMB paper does accurately convey the tenor of a study,
dated May 11, 1970, by the Center for Political Research, the conclu-
sions of which are in opposition to the OFDI program. But in our
view these CPR conclusions are not warranted by the information and
economic analysis in the study (see Appendix C).
The third empirical study cited as evidence in the OMB paper
is by Arthur Laffer and deals with short-term bank-reported claims
and liabilities. We have already noted (pages 27-28) that Laffer's
analytical methods could not adequately justify his conclusion about
the effects of the VFCR even in 1967 (when he first wrote his paper),
much less justify the position in the March 1971 OMB paper (see
Appendix D).
The "overall assessment" in the OMB paper states:
Detailed studies of the capital control programs
have uncovered absolutely no evidence of any effect
on the balance of payments.
FORD & LIBRARY GERALD
- 33 -
The common and primary purpose of the capital con-
trol programs is to stem the net outflow of U.S.
official reserve assets by obstructing American
investments and loans to foreigners. All available
evidence suggests that these programs cannot and
have not accomplished or even worked towards this
purpose.
These statements are simply false. It would be equally mis-
leading, but no more incorrect, to say that "detailed studies of the
capital control programs have uncovered absolutely no evidence that
the gross balance-of-payments savings from reductions in U.S. capital
outflows have been undermined by leakages elsewhere in the balance-of-
payments accounts" and that "there is no available evidence suggesting
that these programs cannot and have not accomplished their purpose."
There is a trenchant line from the second scene of Act II
of Hamlet, in which Gertrude reprimands Polonius for his rhetoric:
"More matter, with less art." This would be a useful guideline for
improving the OMB paper.
This paper was prepared by
Murray Altmann, Ralph Bryant,
George Henry, and Alan Severn
FORD & LIBRARY GERALD
- 34 -
Appendix A
AN APPRAISAL OF THE STATE OF CURRENT KNOWLEDGE
Reductions in the outflow of U.S. owned capital brought
about by the programs will have induced some offsetting flows in other
balance-of-payments accounts. However, since financial instruments
are not perfect substitutes and international capital and goods markets
are not fully integrated, it seems likely that offsetting flows, while
probably important, would be only partial.
In order adequately to measure the size of gross balance-of-
payments savings owing to the controls and to determine what part of
the gross savings are lost in "leakages," it would be necessary to
specify and estimate a full model of the international economy. We
would require demand and supply equations for each financial instrument
which would reflect the extent of the international interdependencies
between national money and capital markets. Thus, the model would even
require a complete elaboration of the markets for those financial in-
struments issued and held entirely domestically since conditions in
these "domestic" markets would impinge on the decisions of those
individual transactors who hold and those who issue "international
instruments." Moreover, the model would have to embody the relation-
ships between international capital flows, economic activity levels
in the important industrial countries, and merchandise trade flows.
FORD & LIBRARY GERALD
- 35 -
In sum, we would need a set of highly elaborated macroecon-
omic models for the major industrialized countries, with fully
developed linkages between the real and financial sectors, and a well
articulated international sector linking the national models together.
/
Clearly, such a project is not feasible in the foreseeable future.
When evaluating such evidence as does exist on the effects
of U.S. capital controls, it is important to realize just how far we
are from having such a model of the world economy. In the first place,
we do not even have the necessary econometric models for the major
industrial countries. Many of the models which do exist do not even
have a link between domestic financial variables and the domestic real
economy. Virtually none attempts to explain international transactions
other than the current account items.
Given this state of affairs, we obviously cannot produce
direct empirical evidence as to whether or not controls on capital
outflows are partially offset through changes in the level of economic
activity abroad that reduce the United States' trade balance. This
depends essentially on the ability and desire of foreign authorities
to pursue independent monetary policies. It might be possible to draw
/ Producing just such a model is the long-run objective of Project
LINK, a study financed through the Social Science Research Council
and under the direction of Lawrence Klein, Aaron Gordon, Bert Hickman,
and Rudolph Rhomberg. Project LINK is at the present time only in its
initial stage. Not even its most enthusiastic proponents would claim
that its long-run objective could be attained for many years.
GERALD FORD LIBRARY
- 36 -
some inferences from investigations of the institutional factors
affecting the ability of foreign authorities to pursue independent
policies. While some work along these lines has been attempted, it
is fair to say that the question of the degree to which independent
policies can be pursued abroad must be considered open.
The main reason why international capital flow equations
do not appear in any of the existing econometric models is simply
that relatively little work has been done in estimating such equations.
It is a common complaint of all empirical researchers that they are
handicapped by a lack of appropriate data. In this area, the con-
straint is especially severe. Data are often collected by national
agencies on non-comparable bases and much of the data are held con-
fidentially. Moreover, there are important unobservable variables
which play a crucial role in determining capital flows, especially
expectations about interest rates and exchange rates.
There is also a clear need for fundamental improvements in
the theory of international capital flows. It is only recently that
the basic elements of domestic monetary and capital markets theory
have been applied to international flows.
A very serious problem that remains to be solved is the
appropriate treatment of non-price credit rationing, particularly
capital controls imposed by national authorities. Capital controls
introduce a "wedge" between desired flows and actual flows. A
FORD LIBRARY
- 37 -
frequently employed technique in studies that have tried to estimate
the quantitative effects of capital flow restraints is the introduc-
tion of an additional ("dummy") variable which differentiates the
pre-control and post-control periods. However, this technique assumes
that the effects of the programs are uniform throughout the period
of their imposition, allowing no scope for gradual adjustment by
transactors to the controls or to modifications of the controls by
the authorities. When the effective impact of the programs varies
over the sample period, the "dummy variable" approach can be seriously
misleading.
The "learning by doing" phenomenon is especially important
for estimating the net impact of the capital control programs. Leak-
ages will likely become increasingly important with the passage of
time. In the present context, this points up the necessity for
estimating the lags in behavioral responses. The time path of ad-
justments by transactors in other markets in response to the imposi-
tion of controls in one market is virgin territory for both the
theoretician and the empiricist.
The preceding discussion has pointed out a few of the more
important difficulties in estimating elements of the "ideal model."
The central point is that a thorough understanding of the impact of
the capital control programs is contingent upon the availability of a
complete model. The interrelationships between various capital markets
GERALD FORD LIBRARY
- 38 -
and between capital markets and real economic activity must be
explicitly dealt with.
This point is well illustrated by considering one of the
empirical studies cited in a recent paper of the Office of Manage-
ment and Budget. The cited paper, written by Richard N. Cooper,
was specifically addressed to the time period when only the IET was
in effect. There is general agreement that the leakages were es-
tremely large at that point. This was clearly recognized and led to
a more comprehensive set of controls. In a more recent unpublished
paper, 2/ Cooper summarized his judgment on the gross savings and on the
probable magnitude of offsetting leakages. He concluded that the
present elements of the comprehensive set of restrictions are rein-
forcing and they have had a significant net impact on the balance-of-
payments.
Cooper's paper, and all others of which we are aware, have
attempted to estimate the impact (gross or net) of the control pro-
grams on the actually observed, historical data. Needless to say,
this historical analysis by itself is insufficient for our purposes.
Since the effective impact of the restraints will vary with our cycli-
cal position, we also want to know (a) what the impact of the programs
1/ OMB paper entitled "Capital Controls: Questionable Results and
Undoubted Costs," March 2, 1971 (Mimeo). The other two studies cited
by the OMB paper are discussed in Appendices C and D.
2/ Richard N. Cooper, "The Voluntary Credit Restraint Program: An
Assessment," January 1969, unpublished paper prepared for a meeting of
Academic Consultants at the Federal Reserve Board.
GERALD FORD VIBRARY
- 39 -
would have been if we had been more successful in having the economy
grow along a non-inflationary, high-employment growth path, and (b)
what the impact of the programs would be in the future, given a wide
variety of alternative assumptions about domestic and foreign economic
activity.
How much do we know about international capital flows?
The profession has barely begun to tackle the job. The evidence that
does exist is sparse. Even tentative conclusions on what the effects
of the United States capital control programs have been are no more
than informed guesses.
FORD i LIBRARY GERALD
- 40 -
Appendix B
POTENTIAL LEAKAGES VIA REDUCED FOREIGN PURCHASES OF
U.S. CORPORATE SECURITIES
A frequently mentioned balance-of-payments account in which
gross reductions in capital outflows might have been offset is that
of foreign purchases of U.S. corporate securities. While foreign
purchases of such securities rose markedly after controls were strength-
ened in 1965, it is of course possible that the rise would have been
greater in the absence of direct investment, or other, controls.
One obvious possibility is that the convertible Eurobonds
issued by American direct investors were a substitute for ordinary
American equities. These Eurobonds were sold only to non-residents of
the United States. They were favorably priced, relative to comparable
securities within the United States. Therefore, the standard argument
goes, investors outside the United States may have been induced to hold
convertible Eurobonds instead of 'ordinary American equities, since they
received no price concessions on the latter category.
Observed transactions, however, show a close quarter-by-
quarter association between foreign purchases of U.S. equities and of
convertible Eurobonds issued by U.S. corporations (see attached chart).
Thus, if there was substitution in the short run, it was apparently
dominated by causation common to the two types of security. In addi-
tion, there may be a significant lag in foreigners' adjustment to the
GERALD FORD LIBRARY
- 41 -
surge of Eurobond issues. Therefore, further evidence is needed to
establish the degree of substitution between the two types of security
over a longer period.
Preliminary results from an ongoing study of foreign pur-
chases of U.S. equities being carried out by Alan Severn, however,
fail to indicate any significant degree of substitution. The relative
importance over time of American stocks in foreign equity protfolios
was compared to relative risks and returns and to the growth of mutual
funds abroad / for the period 1962-70. Through 1969 and the first
three quarters of 1970, foreign investors continued to hold as much
of U.S. stocks as might be expected in light of relative risks, returns,
2/
and size of portfolios.
Direct investment controls may also have affected foreign
purchases of U.S. equities in ways other than through substitution
of Eurobonds. In particular, any reduction of American cash purchases
of existing foreign firms may have limited the equities purchases of
foreign individuals, i.e., the former owners of the foreign firms.
But since a typical foreign investor is likely to invest only a small
fraction of his equities portfolio in American stocks, this offset is
Including closed-end funds, to the extent that data are available.
2/ Holdings during the 1968 Eurobond surge were nearly identical to
those "predicted," while they were higher than "predicted" for 1969
(by $.4 billion), though lower for the first three quarters of 1970
(by $.3 billion).
VERALD FORD LIBRARY
- 42 -
likely to be small. A similar, and similarly small, offset could be
a restriction of loans available to foreign equity investors as U.S.
corporations pre-empted part of available European capital.
There are also reasons for believing that the U.S. corporate
securities account may contain some offsets to the IET or VFCR programs.
For example, one could imagine that the virtual cessation of American
purchases of foreign stocks, induced by the IET, caused foreign stock
prices to rise less rapidly, thereby lowering the value of foreigners'
portfolios compared with what they otherwise would have been and, over
time, inducing European investors to reduce their purchases of American
/
equities.
Altogether, it appears that the U.S. capital controls had
relatively little impact on foreign holdings of U.S. equities. Even
if offsets were present, but hidden by other factors relevant to foreign
investment in U.S. equities, the offsets were probably small in relation
to the gross savings generated by the control programs.
1/ The rise in the nominal value of foreign equity portfolios
exceeded $150 billion during the 1963-70 period. While an infusion
of additional purchases from the U.S. could have raised the value of
foreign equities even further, any reasonable amount of U.S. pur-
chases would have played only a secondary role in foreign stock
markets.
FORD & LIBRARY GERALD
FORD & LIBRARY
- 42a -
NET FOREIGN PURCHASES OF U.S. SECURITIES, 1965-1970
U. S. Stocks
Convertible Eurobonds Sold Abroad by U.S. - Incorporated Companies
$
million
800
700
600
500
400
300
200
100
0
- 100
1965
1966
1967
1968
1969
1970
IV I II III IV I II III IV I II III IV I II III IV I II III IV
- 43 -
Appendix C
A COMMENT ON THE CPR REPORT
"FEDERAL CONTROL OF FOREIGN DIRECT INVESTMENTS"
This report by the Center for Political Research, dated
May 11, 1970, was apparently done for an unnamed corporate client;
the emphasis is on the locus of decision-making power with respect
to control of foreign direct investment.
Several flaws may be noted in this report:
1. It implies that earnings on direct investment depend on U.S. equity
in such investment, rather than on the aggregate size of the activity
(as measured, for example, by total assets). On page 14 the following
statement appears:
"Just how long OFDI's short-term balance of payments
benefits will last is open to debate
What is not
open to debate is that restrictions on direct U.S.
foreign investment will eventually lead to a decline
(or slower growth) in the dollar amount earned abroad
each year by U.S. firms. In addition, heavy borrowing
abroad by U.S. firms necessarily leads to sharp in-
creases in U.S. interest payments to foreigners. Such
payments have more than doubled since 1966; they are now
running at an annual rate of about 3.3 billion dollars."
2. The above quotation implies that interest payments on corporate
borrowing abroad are an addition to total interest payments by the
United States as a whole. But if the corporations were to borrow in
the United States and send the proceeds abroad, the outflow would be
reflected in combined private and official foreign holdings of dollars.
Since the holders of these additional dollars could be expected to
GERALD R. FORD LIBRARY
- 44 -
hold them in interest-bearing form, the interest payments on these
holdings would partially offset the reduced payments by U.S.
corporations. Thus, only the difference between interest rates is
relevant here.
3. Several New York bankers are quoted as stating that as of 1970,
only half-a-dozen firms (mainly in petroleum and computers) have been
affected by the program; about 200 others have been partially affected,
but can still carry out their investment programs. What this state-
ment apparently means is that plant and equipment expenditures, rather
than the financing of such expenditures, has been largely unaffected.
But the stated purpose of the control programs was and is to affect
the financing, which in turn is what directly affects the U.S. balance
of payments.
The debate about the balance-of-payments effects of direct
investment activity (to which the report refers) is not relevant here,
because the scale of such activity has been largely unchanged. There-
fore fees and royalties, parts and components, exports back to the
United States, etc., are not affected.
4. The report states that, in the aggregate, firms were below their
"allowables," in both 1968 and 1969. While this is true, it does not
necessarily reflect on the effectiveness of the program. The regula-
tions are the most restrictive for the continental Western European
countries, and least restrictive for less developed countries. It
appears that most of the leeway below allowables was concentrated in
FORD is LIBRARY GERALD
- 45 -
the LDC's. The CPR report does not mention this possibility as a
partial explanation for the fact that allowables were not fully
utilized.
In summary, the CPR report is analytically weak. Its
worse fault is that it fails clearly to distinguish between finan-
cial and real consequences of the control of direct investment.
FORD : LIBRARY GERALD
- 46 -
Appendix D
A COMMENT ON RESEARCH BY ARTHUR B. LAFFER ON
SHORT-TERM BANK-REPORTED CAPITAL MOVEMENTS
Arthur Laffer carried out some econometric research during
1966-67 from which he drew strong conclusions about the balance-of-
payments impacts of the VFCR program. Laffer's conclusions have
been recently cited in the March 1971 OMB paper entitled "Capital
Controls: Questionable Results and Undoubted Costs," as follows:
the net effects of the VFCRP on the U.S.
balance of payments seem to be quite negligible.
In fact, for a long time, the VFCRP appears to
have cost the United States in terms of foreign
exchange, and only after a year or more in
operation were the net effects on the U.S.
official settlements balance of payments non-
negative. Therefore, the ostensible success of
this program with respect to U.S. capital flows ap-
pears to have been negated by foreign capital flows.
We believe Laffer's research to be so inconclusive and the
method by which he reached his judgment about the VFCR to be so
/ The basic research done by Laffer is described in detail in his
Stanford Ph.D. dissertation entitled International Hot Money and the
U.S. Balance of Payments. Part of this research, particularly that
part concerned with the VFCR, is summarized in an unpublished paper
"Short-term Capital Movements and the U.S. Balance of Payments"
(December 1967). We believe that a slightly revised version of the
December 1967 paper was circulated in 1969 at the University of Chicago
under the title "Short-term Capital Movements and the Voluntary Foreign
Credit Restraint Program." We were unable to obtain a copy of the 1969
version of the paper; as far as we are aware the equations and empirical
results are identical in the 1967 and 1969 versions.
2/ OMB paper, p. 6. The same passage appears on page 20 of the
December 1967 paper.
FORD is GERALD LIBRARY
- 47 -
unreliable that little if any weight should be attached to his sup-
posed evidence. The purpose of this appendix is to review Laffer's
research briefly and to update it with data for 1967-70.
As we note in the text (p. 27 above), our replication and
updating of Laffer's results yield an opposite conclusion from the
one originally reached by Laffer. In our opinion, however, neither
conclusion -- that the VFCR does or does not improve the balance of
payments -- is warranted by Laffer's research and our updating of it.
Synopsis of Laffer's Methods and Conclusion
Laffer's study deals with only two types of capital flows:
(a) changes in the short-term claims on foreigners reported by U.S.
banks, and (b) changes in the liabilities to private foreigners
reported by U.S. banks. For each of these two flows, Laffer estimates
a regression equation, using monthly data for the period January 1959
through December 1964. (The influence of the VFCR program is held to
have begun during January 1965; although the program was not announced
until mid-February, Laffer argues that the market anticipated its
imposition.) Using these estimated equations, Laffer then projects
the values of the two capital flows for the eighteen-month period
January 1965 through June 1966. He interprets the differences
between the actual values and the predicted values of the capital
flows (the "residuals") as measures of the impact of the VFCR program.
In other words, data for the explanatory variables for the
January 1965 to June 1966 period are plugged into the estimated equa-
tion in order to obtain a "predicted" series for the two capital flows.
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For the eighteen-month period examined by Laffer, the
predicted net outflows for bank lending substantially exceed the net
outflows actually observed. This result leads Laffer to conclude
that the VFCR was successful in holding down the category of capital
outflow at which it is directed. But for his other category of
capital flow, Laffer finds a result that seems consistent with large
"leakages" having occurred. Actual inflows of foreign liquid funds
into U.S. banks are substantially less than the inflows predicted
by the equation. Laffer attributes the entire amount of these
residuals to the effects of the VFCR as well. When the supposed
effects of the VFCR on the two types of capital flows are netted
together, it turns out -- for this eighteen-month period -- that the
net effect is quite close to zero.
Chart 1 (reproduced from the OMB paper) shows these alleged
impacts of the VFCR program. In that chart, the residuals calculated
by Laffer (the difference between predicted and actual flows) are
accumulated through time, so that the plotted curves give the supposed
cumulative effects of the program.
Actual bank claims on foreigners changed little from the
beginning to the end of the period. Laffer's equation predicts a
significant net increase.
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- 49- 49
Chart 1
CUMULATIVE BALANCE-OF-PAYMENTS IMPACTS
OF VFCR PROGRAM FOR SIXTEEN-MONTH PERIOD
JANUARY 1965 TO APRIL 1966 AS CALCULATED
BY ARTHUR LAFFER
(chart reproduced from OMB Paper)
1965
1966
XII
=
III
IV
Y
vi
we
viii
IX
X
XI
xii
il III ir
2.0
(a)
1.5
accumulated U.S. private short-term
capital flows
1.0
.5
0
net of (a) and (b)
-5
-1.0
-1.5
(b)
-2.0
assumulated foreign private shert-term
capital flas
FORD & GERALD LIBRARY
- 50 -
Updating Laffer's Conclusion
Even if Laffer's method were analytically reliable, it
would seem undesirable from the vantage point of March 1971 to accept
a conclusion based only on an analysis of the eighteen-month period
ending in June 1966. We therefore thought it only prudent to bring
Laffer's results up to date by considering the whole period January
1965 to September 1970 (the last month for which we could easily ob-
tain data for all the required variables). The results of updating
his analysis are displayed in Chart 2. As the reader can easily
verify, the first eighteen months of Chart 2 are essentially a re-
/
production of Chart 1.
If we follow Laffer in attributing residuals from his equa-
tions entirely to the VFCR program, Chart 2 tells us that the VFCR
held bank lending to foreigners some $1-2 billion below what it other-
wise would have been throughout the five years ending in September
1970. It also says that the VFCR had the effect, up until mid-1968,
of reducing foreigners' holdings of liquid assets in U.S. banks com-
pared with what they otherwise would have been. After the summer of
1968, however, the VFCR began to give an immense stimulus to
foreigners to hold more liquid assets in U.S. banks than they otherwise
would have held. Still taking the results at face value, Chart 2 tells
1/ The very minor differences between the paths plotted in Chart 1
and those in Chart 2 (for the period January 1965 to April 1966) are
due to very minor differences between Laffer's equations and our replica-
tions of Laffer's equations. These differences are explained further
below.
FORD & LIBRARY GERALD
- 51 -
GERALD FORD LIBRARY
Chart 2
1965-70 CUMULATIVE BALANCE- OF PAYMENTS IMPACTS
OF THE VFCR PROGRAM CALCULATED VIA METHOD
ADVOCATED BY ARTHUR LAFFER
(billions of dollars)
11.0
11.0
10.0
10.0
9.0
9.0
8.0
8.0
7.0
7.0
Favorable-Effect on Balance of Payments
6.0
6.0
Alleged Cumulative Impacts
of VFCR on U.S. Balance of
5.0
5.0
Payments: Sum of (a) and (b)
4.0
4.0
(a) Accumulated residuals for
short-term bank-reported
3.0
U.S. capital flows
3.0
2.0
2.0
1.0
1.0
0
0
Unfavorable Effect
1.0
1.0
(b) Accumulated residuals for
short-term bank-reported
2.0
foreign private capital flows
2.0
3.0
3.0
1965
1966
1967
1968
1969
1970
M
J
S
D
M
3
S
D
M
J
S
D
M
J
S
D
M
J
S
D
M
J
S
D
- 52 -
us that the impact of the VFCR on the two capital flows combined
was either perverse or zero until mid-1966, became sharply favor-
able in the last half of 1966, became perverse again in mid-1967,
and thereafter became immensely favorable.
These inferences are of course completely unfounded. The
equations which underpin the analysis are weak and the residuals
calculated from them, therefore, cannot be validly used to make such
strong inferences about the impacts of the VFCR. We have taken the
trouble to present the updated calculations only to emphasize that
Laffer's evidence will not begin to support the conclusions that have
been based on it.
Some Weaknesses in Laffer's Econometric Analysis
This is not the place to present a detailed, technical
review of Laffer's research. Of necessity, therefore, we merely
enumerate here what we believe to be some of its most serious weak-
nesses.
The Achilles' heel in Laffer's methodology is his interpre-
tation of the post-1964 residuals calculated from his equations as
entirely due to the impacts of the VFCR program. This procedure would
only be acceptable if his estimated equations were highly successful
in all other respects at explaining the two types of capital flow.
But in fact the explanatory power of his equations is quite poor (the
adjusted R²¹s in his two equations are .49 and .35). What is worse,
FORD is LIBRARY GERALD
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the economic rationale for the estimated equations is doubtful in
several ways. In these circumstances, it can be extremely mis-
leading to project the equations outside the sample period and to
assign the calculated residuals to only one of many omitted influences.
Just how misleading this procedure can be is amply illustrated by
Chart 2. The tremendous bulge in foreign holdings of liquid assets in
U.S. banks in 1969 had little if anything to do with the VFCR. But
there is nothing in Laffer's methodology -- even for the 1965-66 period
-- that guards against such a serious misinterpretation.
The basic weaknesses in Laffer's research stem from the in-
adequate and incomplete specification of his equations. Although
Laffer argues that interest rates ought to appear in the equations, he
drops them out of his analysis after a superficial effort suggests
they are statistically insignificant. The least unsatisfactory econo-
metric studies of capital flows to date have produced evidence that
capital flows are quite sensitive to interest rates. / The failure
appropriately to take interest-rate effects into account is almost
certainly a major explanation for the poor performance of Laffer's
equations.
The equation for changes in bank claims on foreigners in-
cludes a variable representing the previous month's capital flow.
1/ See, for example, the studies by Branson, Bryant and Hendershott,
and Miller and Whitman cited in Appendix E.
DERALD FORD VIBRARY
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Laffer includes this variable on the grounds that "we might easily
expect a repayment effect on capital flows of this month due to
capital flows of the previous month. 1/1/ We believe that this variable
in fact introduces a complicated lag pattern into the equation that
cannot be explained as a "repayment effect" and that is difficult to
rationalize on theoretical grounds.
The equation for changes in bank liabilities to private
foreigners makes no distinction between liabilities to overseas
branches of U.S. banks, liabilities of U.S. - located agencies of Cana-
dian and Japanese banks to their head offices abroad, and liabilities
to other private foreigners. An analysis that does not make these
distinctions may well fail from the outset. The greatly increased
borrowing of U.S. banks from their own branches in the Eurodollar
market, for example, is the primary reason why Laffer's equation pro-
duces huge residuals in 1969 and 1970, which in turn underly the big
hump in Chart 2.2/
A major part of the statistical explanatory power of the
liabilities equation, which in any case only captures 35 per cent of
the variation, is due to several "institutional" variables having
/ Laffer paper of December 1967, p. 12.
2/ In fairness to Laffer, it should be noted that no one has yet
been very successful in econometrically analyzing the liabilities of
U.S. banks to their overseas branches. But even in 1967 Laffer
should have been aware of the importance of making this distinction.
FORD :- LIBRARY GERALD
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purely transitory effects (e.g., year-end window-dressing, month-
end so-called "Thursday-Friday" transactions). Well over half of
the variables that Laffer's theory suggests to him should have non-
transitory effects on the stock of foreign private liquid assets in
the United States (e.g., interest rates, U.S. imports, growth rates
in the United States and foreign countries) turn out to be statis-
tically insignificant.
Of the two equations, the one for changes in bank claims
on foreigners is less unsatisfactory. As can be seen in Chart 2,
it does much less badly in tracking the actual 1965-70 changes in bank
claims than the other equation does in tracking changes in bank
liabilities.
All in all, Laffer's two econometric equations cannot be
accepted as reliable. We were led to further skepticism, moreover,
in the process of trying to duplicate the equations. We were able to
come close to Laffer's equations only by using the exact data which he
had used. When we collected revised data for the two capital flow
variables and for several of the explanatory variables, which are
presumably more correct than the data used by Laffer, we found that
there were non-trivial changes in some of the coefficients in Laffer's
equations and that the explanatory power of one of the equations
1/ In replicating Laffer's equations, we drew on the data tables
contained in appendices to his Ph.D. dissertation. In a few very
minor respects, we were unable to duplicate Laffer's data exactly.
These data discrepancies account for the very small differences be-
tween Laffer's coefficients and the coefficients we obtained using
his data.
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declined appreciably. We also re-estimated Laffer's equations for
some other sample periods. In these cases, too, the equations
were altered to such a degree that we found ourselves becoming more and
more doubtful of the basic specifications.
Concluding Comment
We have been quite critical of Laffer's research in this
note. We would like to end by trying to dispel a possible misinter-
pretation of our views. We are certainly not maintaining that we
ourselves have an unambiguously superior method of estimating the
impacts of the VFCR on short-term bank-reported capital flows. All
researchers in this difficult area have every reason to present
research results with a large dose of humility. The only unpardonable
sin is to pretend that blood can be squeezed out of a turnip.
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Appendix E
Annotated List of References
This is not intended as an exhaustive survey of the
literature. It does bring together much of the literature which
bears on the subject matter of this paper.
1. Board of Governors of the Federal Reserve System, "Report on
Inquiry into Possible Effects of Voluntary Foreign Credit
Restraining Program in 1970 on Export Financing and on Exports,
January 7, 1971.
The survey of banks summarized in the report, "turned up very
few examples of requests for financing the export of U.S. goods
that were denied in 1970 because of [the VFCR] program"
2. William H. Branson, Financial Capital Flows in the U.S. Balance
of Payments, (North-Holland Publishing Company, Amsterdam, 1968).
Branson's Ph.D. dissertation applies a stock-adjustment model
to capital flows, with particular emphasis on estimation of lags
via the Almon technique. The capital control programs are taken
into account only by means of on-off dummy variables.
3. William H. Branson and Raymond D. Hill, Jr., "A New Model of
Financial Capital Flows in the U.S. Balance of Payments,"
December 9, 1970 (Mimeo).
This paper updates and revises the empirical results in the
preceding reference.
4. Ralph C. Bryant and Patric H. Hendershott, Financial Capital
Flows in the Balance of Payments of the United States: an Ex-
ploratory Empirical Study, Princeton Studies in International
Finance No. 25 (June 1970).
Bryant and Hendershott attempt to elaborate an appropriate
theoretical framework for investigating international capital
flows. The model is applied to data for U.S. short-term outflows
to Japan with particular attention placed on trying to capture
the influence of the VFCR program.
GERALD FORO LIBRARY
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5. Ralph C. Bryant and Patric H. Hendershott, "Empirical Analysis
of Capital Flows: Some Consequences of Alternative Specifica-
tions," a paper presented at a Universities - NBER Conference
on International Mobility and Movement of Capital, January 30-
February 1, 1970, Washington, D. C.
This paper, which expands the analysis in the previous reference,
discusses the substantial difficulties in determining an appro-
priate specification for capital flow equations. Alternative
specifications are shown to imply very different conclusions
about the effect of capital control programs.
6. Center for Political Research, "Federal Control of Foreign Direct
Investments, May 11, 1970.
The report discussed the program and concludes that "the avail-
able statistics regarding the OFDI program
...
cast doubt on the
extent to which the program actually restricts direct foreign
investment today."
7. Richard N. Cooper, "The Interest Equalization Tax: An Experiment
in the Separation of Capital Markets," Finanz Archiv, 24 (Decem-
ber 1965), 447-471.
Cooper investigates the period when only the IET was in effect
and concludes that, for all intents and purposes, offsetting
flows in other accounts entirely negated the impact of the IET.
8. Richard N. Cooper, "The Voluntary Credit Restraint Program:
An Assessment," January 1969 (Mimeo). Unpublished paper prepared
for FRB Academic Consultants.
Cooper summarizes his judgment on the gross savings and on the
probable magnitude of offsetting leakages. He concludes that the
present elements of the comprehensive set of restrictions are
reinforcing and that they have had a significant net impact on
the balance-of-payments.
9. Arthur B. Laffer, "Short-term Capital Movements and the Voluntary
Foreign Credit Restraining Program" 1969 (Mimeo).
Laffer presents regression equations for the changes in "U.S.
private short-term claims on foreigners" and for the changes in
"U.S. short-term liabilities to private foreigners." The relation-
ship between actual flows and what his equations predict lead him
to conclude that there has been no net balance-of-payments saving
from the VFCR program.
GERALOR FORD FIBRARY
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10. Walther Lederer, "Notes on the Structure of the U.S. Balance of
Payments," not dated, (Mimeo).
Lederer argues that "major fluctuations in the balance on goods
and services are to a large extent offset by fluctuations in
unilateral and nonliquid capital transactions." However, some
regressions of the capital flow balance on the goods and services
balance and various dummy variables lead him to conclude that the
capital restraint programs have had a net effect on the balance
of payments.
11. C. H. Lee, "A Stock-Adjustment Analysis of Capital Movements:
The United States-Canadian Case," Journal of Political Economy,
Vol. 77 (July/August, 1969), 512-523.
This is another econometric application of the stock-adjustment
model, in this case to U.S.-Canadian capital flows. On-off
dummy variables are used to allow for the effects of the capital
control programs.
12. Fritz Machlup, "The Transfer Gap of the United States," Banca
Nazionale del Lavoro Quarterly Review, No. 86 (September 1968),
195-238.
Machlup rearranges the standard balance-of-payments accounts to
arrive at what he calls the "net real transfers" and the "net
financial transfers" of the United States. His work leads him
to conclude that in most circumstances changes in net financial
transfers will be offset by changes in net real transfers. He
concludes that "the balance-of-payments program pursued by the
United States Government
is useless for the purpose for
which it was designed."
13. N. C. Miller and M. V. N. Whitman, "A Mean-Variance Analysis of
United States Long-Term Portfolio Foreign Investment," The
Quarterly Journal of Economics, LXXXIV (May 1970), 175-196.
In this and several subsequent papers, Miller and Whitman apply
the portfolio selection approach to various categories of capital
flows in the U.S. balance of payments. On-off dummy variables
are used to allow for the effects of the capital control programs.
14. John Patrick, "Bank Lending to Foreigners under the FCRP and the
IET," NYFRB Research Memorandum, June 20, 1969.
GERALD FORD VIBRARY
- 60 -
Patrick reviews recent data on capital flows and then presents
regression results for equations explaining (quarterly changes
in) short-term bank-reported claims on foreigners and in total
bank-reported claims on foreigners. His results lead him to
conclude that the two programs do reduce (and quite substantial)
the flows at which they are directed.
15. Samuel Pizer, Statement to the Commission on International Trade
and Investment Policy on the "Capital Restraint Programs,"
October 15, 1970.
Pizer argues that there has been a large impact of the programs
in reducing gross outflows in the categories controlled. He con-
cludes moreover that despite the possibility of some leakages,
there has been a substantial net effect.
16. Martin F. J. Prachowny, A Structural Model of the U.S. Balance
of Payments (North-Holland Publishing Company, Amsterdam, 1969).
This is another econometric study that uses on-off dummy vari-
ables in some capital flow equations to allow for the effects of
the U.S. capital control programs.
17. R. Rickover, "Export Finance Before and After the Voluntary
Foreign Credit Restraint Program," NYFRB Research Memorandum,
October 14, 1969.
Rickover attempts to estimate the effect of the VFCR program on
export financing with a simple regression relating changes in
trade credit to (current and lagged) changes in the value of U.S.
exports. He believes that the volume of export trade financing
has been affected by the VFCR program.
18. R. Rickover, "Interest Rates, Capital Flows, and Errors and
Omissions in the U.S. Balance of Payments,' NYFRB Memorandum,
March 8, 1971.
Rickover concludes that the "normal" unrecorded outflow (errors
and omissions) attributable to systematic errors in data collec-
tion is sizable. Interest rates (in the United States, Canada,
and the Euro-dollar market) and U.S. banks' liabilities to their
foreign branches exert a strong influence on unrecorded outflows.
Delays between payments for U.S. imports and their recorded
arrival in the United States also influence errors and omissions
when significant changes occur in the volume of imports.
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19. Guy Stevens, "Capital Mobility and the International Firms,"
a paper presented at a Universities-NBER Conference on Interna-
tional Mobility and Movement of Capital, January 30-February 1,
1970, Washington, D. C.
Stevens estimates an econometric model of firm behavior. He con-
cludes that "virtually no impact of the various balance-of-
payments programs is evident on plant and equipment expenditures
in manufacturing."
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