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Balance of Payments (5)
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The original documents are located in Box B2, folder "Balance of Payments (5)" 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States of America his copyrights in all of his unpublished writings in National Archives collections.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.
STRICTLY CONFIDENTIAL (FR)
CAN CONTROLS BE SUCCESSFULLY USED TO PREVENT
SPECULATIVE CAPITAL MOVEMENTS IN THE U.S. BALANCE OF PAYMENTS?
Prepared by
Division of International Finance
Federal Reserve Board
FORD & LIBRARY GERALD
July 31, 1972
STRICTLY CONFIDENTIAL (FR)
Table of Contents
CAN CONTROLS BE SUCCESSFULLY USED TO PREVENT
SPECULATIVE CAPITAL MOVEMENTS IN THE U.S. BALANCE OF PAYMENTS?
Page
Summary
I.
Types of Capital Flows to be Controlled
1
II. Which Types are most Important?
5
III. Effectiveness of Existing Control Programs
10
IV.
Alternative Regulatory or Restraint Programs
14
V.
Consideration of Exchange Controls
19
VI.
Notes on Foreign Experience with Control Programs
27
Tables
Appendix A. Activities of Multinational Corporations.
Appendix B. Activities and Role of Commercial Banks.
Appendix C. Selected Material on Foreign Experience with Controls.
Summary Table on Main forms of controls.
Control of Capital Transactions in France.
Note on French Dual Exchange Market.
Exchange Controls in the United Kingdom.
Appendix D. Regulations on Short-Term Capital Movements: Recent
Technique in Selected Industrial Countries.
FORD i LIBRARY 9ERALD
STRICTLY CONFIDENTIAL (FR)
SUMMARY
Very large amounts of funds have flowed through the
foreign exchanges during recent international monetary crises.
Such capital movements tend seriously to disrupt the domestic and
international economic policies of many nations, and complicate the
problems of establishing and maintaining appropriate exchange rates
between currencies. What are the possibilities of the United States
Government's using controls to prevent or substantially to moderate
these disruptive flows in a time of exchange market crisis, without
at the same time interfering to an unacceptable degree with normal
trade and investment transactions?
The discussion here does not deal with questions of whether
controls or other measures could be so used as to prevent the emer-
gence of speculative crises, nor with the still broader questions
of achieving and maintaining basic equilibrium in the balance of
payments. Large flows of short-term capital in response to interest-
rate differentials sometimes have disruptive effects in domestic
financial markets, and sometimes are among the background causes of
a speculative crisis in foreign exchange markets. The discussion
here deals only with flows at times when market participants are
already expecting or fearing an early change in currency values.
The observations and conclusions contained in the body
of the paper can be summarized as follows:
FORD & LIBRARY GERALD
- -ii-
STRICTLY CONFIDENTIAL (FR)
1. Certain types of transactions in the U.S. balance of
payments have been especially important at times when participants
in exchange markets have expected a change in official policies
(either abroad or in the United States) that would lead to a depre-
ciation of the dollar against one or more major foreign currencies.
Broadly defined, these are:
a. changes in the timing of international pay-
ments and receipts for current account trans-
actions (e.g., acceleration of payments for
imports and delaying of export receipts)
commonly referred to as "changes in leads
and lags";
b. direct placements of funds abroad by persons
and businesses not covered by any of the
existing control programs;
c. outflows of funds that in principle are
covered by existing control programs but
that in practice may nevertheless occur
(the OFDI program covers major corpora-
tions and the VFCR program applies to
banks and nonbank financial institutions);
d. other borrowings by foreigners from U.S.
sources of credit (e.g., borrowings by
foreign companies from their direct invest-
ment affiliates located in the United
States, which in turn borrow from U.S.
banks); and
e. actions by foreigners to reduce normal inflows
to the United States -- equities as well as
interest-bearing assets -- or to withdraw
funds from the United States by selling assets.
The first type of flows -- changes in leads and lags -- has probably
been the most important quantitatively.
FORD & LIBRARY GERALD
-iii-
STRICTLY CONFIDENTIAL (FR)
2. The existing control programs (OFDI, VFCR, IET)
might be tightened up so as to reduce the possibilities for out-
flows of type (c) and further extended to deal with outflows of
type (d), but not without introducing further complications into
normal business and banking operations. Changes in legislation
might be required.
3. A tightening up and extension of existing control
programs that was not combined with an effort to control flows of
type (a) (leads and lags) and flows of type (b) would fail to meet
the objective of stemming a major fraction of the disruptive flows.
In fact the result might be a larger outflow through the uncon-
trolled channels.
4. The only possibilities for controlling leads and lags
and flows of type (b) would involve surveillance of all payments
from U.S. residents to nonresidents, and probably also receipts
by U.S. residents from abroad.
5. It would be technically feasible to design such a
system of exchange controls. Banks would of necessity play a major
role in its administration. But the system would have to reach into
the entire network of normal trade and investment transactions.
6. If capital outflows of type (e) above were to be
controlled, exchange controls would have to be extended to nonresi-
dents (e.g., preventing foreigners from reducing their deposits
in U.S. banks or repatriating the proceeds from the sale of
equities without prior authorization). Such controls would
GERALD R.
-iv-
STRICTLY CONFIDENTIAL (FR)
discourage normal inflows, with serious long-run effects on the
U.S. balance of payments. Furthermore, there would be no way to
prevent the cessation of normal inflows at times of speculation
against the dollar.
7. The experience of foreign countries has been that
without willingness to inflict very severe penalties on violators
it has been impossible to organize and administer water-tight
exchange control regimes. Even in countries that had quite compre-
hensive exchange controls in the earlier post-war years, there were
sharp spurts in outflows at times when market participants believed
exchange rates were seriously out of line. Growth of the operations
of multinational corporations has been a significant factor making
reliance on banks as administrators of controls an inadequate strategy.
8. Because of the number and complexity of U.S. businesses
and financial institutions, and a past history of relative freedom
for foreign payments and receipts, the chances of instituting a
U.S. program of exchange controls that could effectively prevent
disruptive flows in an exchange crisis are even less than the chances
of doing so in other countries.
9. Thus, on technical and administrative grounds alone,
there is substantial doubt that the U.S. Government can effectively
control disruptive capital flows in a time of exchange crisis --
whatever the nature of the control program. Even the attempt would
require extending the control system to include all transactions,
including normal trade and investment flows.
GERALD FORD VIBRARY
STRICTLY CONFIDENTIAL (FR)
-1-
I. Types of Capital Flows to be Controlled
A first step in an analysis of measures to limit disruptive
capital flows is to try to identify the types of flows to which
attention should be directed. For the U.S. authorities, primary
consideration falls on the activities of U.S. residents in moving
funds from or toward the United States; there are also important
flows resulting from movements of funds among foreign countries
by corporations or others under U.S. jurisdiction, and from the
movement of funds controlled by decisions of foreigners. This paper
deals primarily with flows of funds to and from the United States at
the initiative of U.S. residents and gives less attention to the
GERALD FORD LIBRARY
other flows.
At times of exchange crisis attention is directed primarily
to flows of funds motivated by a desire to obtain a capital gain
(or avoid a loss) in the event of a large change in the exchange rate
between the U.S. dollar and one or more foreign currencies. Such
flows are the prime focus of this discussion, rather than flows of
liquid capital in response to differences in interest rates. (Flows
of the latter type have exchange market effects, and sometimes contribute
to the building up of a crisis situation. This paper does not deal with
that problem -- which is part of the general problem of achieving and
maintaining balance of payments equilibrium -- but only with the
problem of controlling flows in a crisis situation. The two motivations
may coincide in times of crisis, however, adding to the difficulty
of establishing an effective deterrent.)
STRICTLY CONFIDENTIAL (FR)
-2-
The following paragraphs discuss the principal forms of
capital flows, or channels for such flows, which can be important
when the market expects, rightly or wrongly, that a substantial
depreciation of the dollar against one or more foreign currencies is
imminent (the same channels work in reverse if a depreciation of other
currencies against the dollar is expected).
(1) Movements of U.S. owned liquid funds from holdings of
dollar assets in the United States to liquid assets denominated in
foreign currencies. Such flows could be effected readily by any U.S.
resident, but would in principle be subject to some restraint if carried
out by direct investors subject to the OFDI regulations, or by banks
subject to the Federal Reserve ceilings (VFCR). (See Appendices A and B).
An individual or company can make such a transfer at present
simply by instructing a U.S. or foreign bank to purchase foreign
currency for his account and deposit it in a foreign bank, or to
purchase money market paper abroad. A direct investor corporation would find
it especially easy to do this, either directly or through a foreign affiliate,
since its normal business practices call for maintaining substantial accounts
abroad.
(2) Purchases by U.S. residents of other types of assets
denominated in foreign currencies. In the caseof securities (or debt
instruments with a maturity of one year or more) the purchase would be
subject to the Interest Equalization Tax, as well as to the VFCR in the
case of banks, and to the OFDI regulations if the securities were issued by
a foreign affiliate and purchased by a U.S. head office. However, other less
GERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-3-
marketable types of assets, such as real estate, would not be restricted
if purchased by member of the general public not subject to the
control programs.
(3) Changes in the timing of payments and receipts (commonly
known as leads and lags.) Shifts in accounts receivable from or
payable to foreigners enabling transactors to avoid potential losses,
or speculate on capital gains (commonly known as leads and lags).
This type of transaction is readily available to U.S. residents engaged
in foreign trade or other activities which normally lead to a main-
tenance of open accounts. For example, a U.S. importer may come to
believe that the dollar may be devalued against one or more currencies,
so that his imports will cost more in the future. To reduce this
extra cost he may order well in advance and pay the foreign exporter
immediately for goods that would ordinarily be paid for on or after
delivery. Alternatively, the U.S. importer may purchase foreign
exchange immediately and invest it abroad for an interim period, or he
may accelerate his actual imports as much as possible. Similarly, the
exporter may allow his foreign customer to delay dollar payment until
after an expected appreciation of the foreign importer's local currency
in return for acceptance of an increase in the dollar price.
It should be noted that multinational corporations account
for a major share of U.S. trade -- including trade with their own
affiliates and trade with independent foreigners. Dealings with
affiliates would be affected by the OFDI regulations, but there are no
restraints on credit arrangements with other foreigners.
GEBALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-4-
(4) Transfers of funds by U.S. residents into dollar-denominated
assets abroad. U.S. residents may increase their holdings of dollar-
denominated liquid assets abroad -- principally in the Euro-dollar
market -- at times of speculation, because at such times Euro-dollar
interest rates are pushed up by speculators wishing to borrow dollars
in order to buy foreign currencies. While the U.S. investor is not
speculating directly, he is supporting speculation in a strong currency
by reducing the cost of the financing to speculators. This type of
outflow may often be easier to accomplish than type (1) since it does
not involve a foreign exchange transaction. Again, financial institutions
and direct investors (U.S. companies owning and operating affiliated
firms in foreign countries) covered by the VFCR and OFDI control programs
are inhibited in making such dollar transfers. The general public,
being subject to no restrictions -- except the IET on purchases of foreign
equities and long-term debt instruments -- is free to make these transfers.
(5) Increased borrowing by foreigners from U.S. sources.
Foreigners expecting upward revaluations of their currencies may borrow
dollars from U.S. sources in greatly increased amounts. This may take
the form of drawdowns on existing credit lines with U.S. banks (which
would be subject to the VFCR) or it may be possible for those with
direct investment affiliates in the U.S. to have those affiliates borrow
here and remit to the foreign parent through the inter-company account
(which is not covered by any U.S. Government specific restriction).
GERALD FORD LIGRABY
STRICTLY CONFIDENTIAL (FR)
-5-
(6) Liquidation by foreigners of assets in the United States.
Foreigners normally holding liquid assets in the United States, such as
working balances in banks, can reduce them to a minimum; they can also
either liquidate, or hold back from normal purchases, of such marketable
assets as U.S. corporate stocks. There is no restriction on such
activities by foreigners.
II. Which Types are Most Important?
One of the most frustrating aspects of speculative episodes,
such as those experienced in May and August 1971 and mid-June to mid-
July 1972, is that normal statistical reporting programs fail to pick
up specific information about the large flows that are occurring. This is
so even though many of the types of flows that are the most likely vehicles
are covered in part by the reporting programs. This difficulty
in identifying the flows that are occurring is found in all countries;
typically, much if not most of the flow of capital at times of crisis
appears under "errors and omissions" in the balance of payments accounts.
In the U.S. statistics it is believed the data are quite
accurate for assets and liabilities of banks and nonbank financial
institutions. U.S. direct investors supply much more information
on their foreign activities than do their counterparts in other
countries, but it is quite possible that short-term flows in crisis
periods escape the normal monthly or quarterly reports. Information
on short-term capital flows of corporations that are not direct
investors is probably poor, as is information on trade credits;
GERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-6-
information on transactions by the general public, apart from
transactions in foreign securities or certain other items that can be
reported by U.S. banks or securities dealers, is very scanty.
Most of the information available is based on data giving
outstanding asset or liability positions at the ends of months or
quarters. Consequently, there is virtually no information available
on gross credit flows, or on the terms on which credit is extended; at
best, the net capital flows between reporting dates can be computed.
In the attached Table 1 the flows of capital reported in
the U.S. balance of payments are shown in some detail for a number of periods,
including the quarters in 1971 when speculation was strong, and
the first quarter of 1972. The table also shows the quarterly errors and
omissions in the accounts (line D). Table 2 gives an indication of the magnitude
of speculative pressure in crisis weeks and months. Table 3 provides
information on the amounts of outstanding assets and liabilities of
various types to the extent they can be measured or estimated.
The following are some of the main features of the capital
outflows in 1971; other crisis periods are likely to center on similar
problem areas.
a) Outflows covered by the various control programs showed
some sizable increases, but did not account for a major share of the
total outflow. Direct investment outflows (covered by the OFDI except
for Canada) rose by $0.6 billion; purchases of foreign securities
(covered by the IET, though Canada and certain other borrowers are exempt)
GERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-7-
did not rise; foreign claims reported by U.S. banks rose by nearly
$3 billion, including an increase of $1.5 billion in the crisis period
in the third quarter when banks temporarily exceeded their VFCR
ceilings. Some of the outflow reported by banks is exempt because it
is on behalf of their customers, another large part involving their
own funds is also exempt (including export credits after October 1971,
claims on Canada, participations in Export-Import Bank loans, etc.),
and some part of the reported outflow is accounted for by U.S.
agencies and branches of foreign banks.
b) Outflows of U.S. capital of types not covered by
restrictions are reflected partly in claims on foreigners reported
by nonbanks. The reported increase in such claims was about $1.1
billion in 1971 -- fairly large but not greatly above the $650 million
annual outflow in 1968-70. Nearly all of this outflow in 1971 was in
liquid or other short-term forms including permitted changes in liquid
foreign assets of direct investors subject to the OFDI. It is important
to note that the increase was primarily in foreign assets denominated
in U.S. dollars -- there was very little recorded outflow directly into
foreign currency assets abroad.
c) A significant part of the adverse shift in the U.S.
capital accounts in 1971 reflected the behavior of foreign holders
of U.S. assets. These investors withdrew large amounts of funds from
the United States via their affiliates here (who were probably borrowing
from U.S. banks) and by reducing their working balances in U.S. banks.
FORD & LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
-8-
In addition, foreign investors sharply cut back their lending to U.S.
direct investor corporations. At such times the U.S. corporations, who
use most of the proceeds of such loans to finance their direct investments
abroad, tend to substitute U.S. funds, at least for an interim period.
Finally, there was a significant decrease in the net volume of foreign
purchases of U.S. equity securities until the last days of the year,
following the Smithsonian meetings. However, there was little sign
of any eagerness to unload foreign holdings of U.S. corporate stocks,
which have a market value of about $20 billion.
d) Most striking in the 1971 experience was the jump in
the negative errors and omisstions from the $1.3 billion average of
1968-70 to a total of $10.9 billion. Such an increase is generally
attributed to a shift in volatile capital flows. As far as can be
judged from an examination of the statistical evedence at hand, these
unrecorded outflows were primarily either by persons -- domestic or
foreign -- not covered by the existing programs or by direct investors
through their transactions with non-affiliated foreigners. Within the
year, however, there may have been sizable outflows at crisis periods
by direct investors of types covered by the restraints.
Any attempt to break down the components of the errors and
omissions item is obviously highly conjectural. The most difficult kinds
of capital flows to capture in the normal statistical apparatus are the
changes in accounts of U.S. traders with their foreign counterparts,
(although there exists a quarterly Treasury reporting form on which
GERALD FORD VIBRARY
STRICTLY CONFIDENTIAL (FR)
-9-
certain important types of trade credit are in principle reportable)
and the flow of liquid funds and even longer-term investment
capital on the part of individuals or the many thousands of businesses
that are not direct investors and therefore escape also the reporting
of their activities to regulatory agencies. It is believed, though
it cannot be proven, that a large if not dominant part of the outflow
from the United States in crisis periods is by transactors not covered
by present controls, and another substantial part may result from
transactions of direct investors other than transactions reportable
to the OFDI.
FORD is LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
-10-
III. Effectiveness of Existing Control Programs
The prime consideration in this paper is whether the
existing control programs could be made more effective in dealing
with outflows in crisis periods, rather than the question of their
effectiveness over longer periods or in more normal times.
The VFCR appears to keep banks' foreign lending (and
position in foreign liquid assets) under reasonable control over-all,
but there are exemptions and the banks do go over their voluntary
ceilings when, in crisis periods, they find their large credit lines
to foreigners drawn upon. It might be possible to avoid these surges
in lending by computing ceilings on a daily average basis (see Appendix
B). Such a stricter rule would imply large penalties when banks'
outstanding credits to foreigners bulged within a monthly reporting
period, and would force banks to be more restrained in entering into
commitments to lend to foreigners. Weaknesses in the VFCR controls
did not seem to be a major factor in last year's crises. In the
future, however, the export exemption could be an important weakness
if pressure is exerted on capital flows through other channels.
The IET appears to be an effective barrier to purchases
by Americans of foreign securities in this market, apart from those
that are specifically exempt, such as Canadian issues and those of
international institutions. However, it is not known to what extent
Americans may evade the tax by purchasing securities directly in
FORD & LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
-11-
foreign markets. Even a strict exchange control regime would have
difficulty stopping that kind of illegal activity.
It is much more difficult to appraise the effectiveness
of the OFDI controls on multinational corporations (see Appendix A).
The fact that there is some overall restraint on the use of U.S.
funds for direct investment abroad is clear enough from the fact
that the companies do borrow large amounts abroad when U.S.-source
funds would be cheaper and readily available in large quantities.
For present purposes the question is whether the OFDI controls can
prevent, or even detect, large flows that occur between reporting
periods, but which are off the books on month-end or quarter-end
reporting dates. A method of daily-average balancing of inter-
company accounts is probably not feasible because of the seasonal
and other irregularities that arise in the normal course of business
in the accounts between a U.S. parent company and its many foreign
affiliates. As noted in Appendix A, however, it might be possible
to prevent direct placement of liquid funds abroad by U.S. parent
companies. There is some suspicion that such placements are
important, but there is little direct evidence to substantiate
this belief.
On the whole, while some tightening of existing programs
to avoid large disturbing outflows is possible, the necessary
measures would add considerably to the reporting and management
FORD is LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
-12-
burdens of banks and corporations, not only in crisis periods but in
the conduct of normal operations. An important gap would remain
unless there were changes in the legislation exempting export credit
from the VFCR. What is more important, it is likely that the major
disturbing flows originate with transactions not now subject to any
controls, such as shifting payment terms on international trade in
goods or services, or placing of liquid assets abroad by individuals.
Moreover, existing programs do not restrict foreigners in their
decisions to move funds to or from the United States.
In sum, modification of existing control mechanisms is a
difficult step and it would affect only part of the flows that occur
in periods like May and August 1971, or mid-June to mid-July 1972,
or that might develop in the future. To attempt to tighten these
controls while leaving other channels uncontrolled might only have
the effect of inducing larger outflows through uncontrolled channels.
It might be useful to add a few words on probably the most
important form of uncontrolled capital flow - the shifts in leads
and lags already mentioned above. This avenue for flows might be
used by any business engaged in foreign trade. This would include
the multinational corporations, since they are dealing with non-
affiliated foreign customers as well as with their own affiliates,
where the OFDI regulations would have some effect.
The potential size of the flows involved is greatest when
it involves U.S. imports. At present U.S. imports amount to over
FORD is LIBRARY 938970
STRICTLY CONFIDENTIAL (FR)
-13-
$4 billion per month, and are mainly invoiced in dollars. When
traders become convinced that there is a sizable risk of a
revaluation of other currencies against the dollar there is a
mutual interest on the part of the U.S. importer and the foreign
exporter in effecting payment as soon as possible. The foreign
exporter will wish to receive advance payment to avoid any loss
on future dollar receipts, while the U.S. importer may wish to
protect himself against an increase in the dollar prices of imports,
or to accommodate the exporter. Consequently, in a few days or
weeks U.S. importers may order ahead and pay for imports they are
expecting over several following months. This shift in the timing
of payments could by itself potentially produce a flow involving
some multiple of $4 billion. For that part of U.S. imports paid
for in foreign currencies, foreign exporters would be indifferent
as to advance payment, but U.S. importers would wish to pay in
advance. Typically, in times of exchange market crisis, covering
of potential exchange risk in forward currency markets is likely
to be expensive and difficult to obtain.
On the side of U.S. exports, there is less scope for
sudden outflows of funds from the United States at times when a
devaluation of the dollar is feared. For exports denominated in
dollars -- the usual case -- foreign importers will wish to delay
payment, while the U.S. exporter will have no special incentive to
FORD is LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
-14-
delay receipts. However, if U.S. exporters accommodate their
foreign customers by agreeing to delay receipts, the immediate
effect is only the amount of export proceeds that would otherwise
have been received. In a week, at current levels of exports,
such a delay could amount to $1 billion, if applied to nearly all
exports.
It is important to recognize that the shifts in leads
and lags described above do not represent outright speculation
against the dollar (such as switching into foreign currencies by
an American not normally doing any foreign business) but would be
characterized by the transactors as a form of risk aversion. Of
course, the disruptive effect is the same.
IV. Alternative Regulatory or Restraint Programs
From time to time there have been a number of suggestions
for replacing the present set of controls with a more uniform or
market-oriented system. Some of these suggestions are reviewed
here, primarily with regard to their ability during a crisis to
cover transactions not now subject to the existing programs and there-
by help prevent massive speculative outflows. The principal possi-
bilities (apart from actual exchange control) seem to be:
a. Application of a tax of the IET type to a much broader
range of transactions.
FORDO & LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
-15-
b. Application of a reserve requirement to a broad
spectrum of foreign assets.
c. Shifting the VFCR program to a control over the net
foreign position of banks (rather than the present ceiling on the
gross amount of foreign assets outstanding).
d. Devising an auction system under which certain foreign
payments could be made only through the purchase of shares of an
over-all total of permissible payments.
e. With respect to foreign assets in the United States,
variable incentives through reserve requirements or allowable
interest rates.
The most plausible of these measures for general application
would be a form of tax extended over a wide range of capital flows,
and perhaps over all of them. Such a plan has been intensively
studied with respect to direct investments, but for many technical
and other reasons (see Appendix A) an effective and administratively
feasible tax seems out of reach. There are also a number of more
general problems with a tax on capital outflows that raise serious,
if not fatal, doubts about its utility against speculative flows:
(i) To be a deterrent when a sizable capital gain was
expected in a short time a tax rate would have to be very high;
but such a rate, unless it could be varied with blinding speed and
foresight, would clearly interfere with normal transactions. Moreover,
BERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-16-
it would be extremely difficult to tax only certain types of
transactions; e.g., if export credit were exempt but holdings
of Euro-DM deposits were not, the tax would be helpless to prevent
evasion unless there were also a strict system of exchange control.
(ii) If a tax were applied to extensions of export credit
it would clearly damage the interests of U.S. exporters, and would
be inconsistent with the legislative action exempting such credits
from the VFCR.
(iii) If a tax were applied to each transfer from direct
investors to foreign affiliates, so as to cover shipments of
machinery and parts on credit as well as cash transfers, it would
be extremely severe and might only cause the affiliates to turn
to offshore sources of machinery and supplies. If applied only
to cash transfers to affiliates it would be ineffective, since
non-cash transfers could easily be substituted. Moreover, a tax
would have to be designed so as to apply also to undistributed
profits of the foreign affiliates.
(iv) A tax on capital outflows, collected at the time
FORD is LIBRARY GERALD
the transaction takes place, assumes that a capital outflow can
be clearly identified. This would not be the case in crisis
situations, when the person remitting funds abroad may be willing
to tell a bank or other withholding agent that the payment was
for goods or services received. It would probably take a tight
exchange control rather than a tax to deter this kind of evasion.
STRICTLY CONFIDENTIAL (FR)
-17-
(v) A tax on capital outflows other than types covered
by the IET would require new legislative action.
The use of reserve requirements against increases in
foreign assets involves many of the same difficulties as the
tax proposal. As applied to corporations, it would be necessary
to have a rate high enough to deter speculation at times of crisis --
which would then cut across the legitimate business needs of direct
investors and exporters. Moreover, the vast size and number of
U.S. business enterprises -- very much larger than in Germany,
for instance -- would require an extensive reporting and surveillance
system. It is clearly a great deal easier and more politically
acceptable to apply such a reserve requirement to funds borrowed
abroad, as is done in Germany, or by the Federal Reserve respecting
Euro-dollar borrowing by U.S. banks, than to apply the reserve
GERALD FORD LIBRARY
requirement against foreign assets. Even in the German case there
is an exemption for credits related to foreign trade, and a variety
of evasive techniques soon developed.
Apart from the possible application of reserve requirements
against banks' foreign assets, it would be difficult to stretch any
existing authority, such as the Trading with the Enemy Act, to cover
such a device as applied to persons or corporations.
Although auction systems have been proposed, they are
usually intended either to limit direct investment outflows (would-be
STRICTLY CONFIDENTIAL (FR)
-18-
investors would be allowed to export capital only on the basis of
chits they had purchased from either the Government or, perhaps,
exporters, in an auction market) or to restrain imports (importers
could only import if they had purchased chits derived from export
proceeds). Apart from the rather obvious deficiencies of these
devices for these specific purposes, they imply an exchange control
environment, since it would still be open to a trader or speculator
to shift funds through banking channels unless presentation of a
chit was required for all transfers to foreign accounts.
Remodeling the VFCR by substituting the use of reserve
requirements, or the balancing of net foreign positions, deserves
consideration as a more permanent form of restraint to help establish
and maintain balance of payments equilibrium, but it is doubtful that
such a change would help in a crisis situation to deal with the kinds
of capital outflow that cause the greatest disturbance.
Finally, while measures providing market incentives or
deterrents for the placement of foreign funds in various types of
U.S. assets might have a useful role in overall management of the
balance of payments during "normal" periods, there is no feasible
way to block foreigners from withdrawing assets they hold in the
United States when they wish to do SO. The United Kingdom is a
striking example of a reserve currency center that had its most
acute problems at times of crisis because of withdrawals of funds
&
FORD
by nonresidents.
GERALD
LIBRARY
STRICTLY CONFIDENTIAL (FR)
-19-
None of these alternative forms of regulation of capital
outflows seems to have much of a chance of shutting off the kinds
of outflow that develops in crisis periods, since they do not
effectively prevent placement of liquid funds abroad by individuals
or the stretching of payment terms on foreign transactions by those
regularly engaged in foreign transactions. There seems to be no
remedy capable of reaching such transactions other than an extensive
exchange control system under which permits would be required for
virtually all foreign payments.
V. Consideration of Exchange Controls
The distinctive feature of an exchange control system
FORD in LIBRARY GERALD
is that all private payments to foreigners, whether for goods or
services or capital outflows would be subject to Government
permit. Further, receipts for exports of goods or services,
or from investment income, would be registered to ensure prompt
repatriation. This system is not to be confused with the types
of controls now enforced by the OFDI and the Federal Reserve (VFCR).
In both these programs there is no surveillance over individual
transactions -- instead there are over-all ceilings within which
the direct investor, or the bank, can operate as its business
judgment dictates. (In practice, this has tended to mean continuing
to expand abroad, but substituting offshore financing for U.S. funds).
STRICTLY CONFIDENTIAL (FR)
-20-
An exchange control system, however, is designed to insure, for
instance, that exporters could not speculate against the currency
by leaving their export proceeds abroad, or importers speculate
by making advance payments for imports. In its more comprehensive
forms, there would also be limitations on the amount of currency
a traveler could take abroad, and specific permits required for,
e.g., payment of royalties to foreigners or for personal remittances.
To illustrate the elements of an exchange control system
as it might operate in the United States, the following steps could
be involved:
(i) All payments to foreigners by U.S. residents, perhaps
above some minimum, would be required to be effected through an
authorized bank. (Certain banks would be "authorized" so as to avoid
involving too large a number of banks in the paperwork required).
GERALD FORD LIBRARY
The purpose of the payment would be given, and the recipient
identified. Banks would maintain the necessary record keeping in
automated form so that information from all banks on each transactor
could be collated (see also Appendix B).
(ii) Designated banks would be generally authorized to
effect payments for goods and services, except that such payments
must stipulate that the goods or services would be delivered to the
transactor within, say, 30 days of payment, and documentary evidence
to that effect presented to the bank when delivery is received.
STRICTLY CONFIDENTIAL (FR)
-21-
Exceptions would have to be referred to a special Government
office (SGO), presumably established by the Treasury.
(iii) Payments to purchase foreign securities would be
authorized if the IET applies, or if the security is specifically
exempt from the IET; otherwise permission would be referred to
the SGO.
(iv) Payments to foreign affiliates would be authorized,
in addition to those covering imports, if the direct investor
stipulates that the payment is included in his reports to the OFDI
and is covered by his ceiling. (Copies of such documents would be
forwarded to the OFDI).
(v) All other payments to foreigners, above a minimum
amount, would not be authorized without clearance by the SGO.
Even in skeleton outline it is obvious that such controls
over outpayments would require a good deal of extra work by the
banks, and a large Government and private bureaucracy. One indication
of the paper work involved in checking on whether the rules on import
payments are being observed is the following data on import clearances:
Total import documents processed each month 250,000+
Valued at over $1 million each:
Number
200
Value
$675 million
Percent of monthly import value
15%
Valued at over $50,000 each:
Number
8,000
Value
$2.5 billion
Percent of monthly import value
55%
BERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-22-
In addition to the import documents actually processed
each month there are about 300,000 that cover shipments of $250 or
less which are merely sampled to derive an estimated overall value.
Under such a system banks would be required to match individual
transfers of funds against the proof of an import document, or a
comparable evidence of payment for services or income.
Ensuring that Americans who are receiving funds from
foreigners (from exports, interest and dividends, fees, etc.)
actually return those funds to the United States rather than
holding them abroad, is an even more difficult task. In this
case, the transactor does not need to take any positive action
with any U.S. financial institution to achieve his objective --
though he must take the chance that he will have difficulty when
he ultimately remits his foreign-source earnings.
One obvious possibility would be a requirement that each
exporter file each export document with an authorized bank, and
present that bank with proof that he received payment not more
than, say, 30 days from date of shipment. Again, some idea of the
wlume of transactions may be useful:
Total export documents processed each month
350,000+
Valued at over $100,000 per document
Number
3,500
Value
$1.5 billion
Percent of monthly export value 40%
Valued at over $20,000 per document
Number
25,000
Value
$2.5 billion
Percent of monthly export value 60%
FORD is LIBRARY 076839
STRICTLY CONFIDENTIAL (FR)
-23-
In addition to the export documents actually processed
there are about 200,000 per month covering small value shipments
that are only sampled to established an estimated overall value.
The volume of paperwork would be evidently very large
unless only shipments over a minimum size were covered. A simple
form of evasion would involve splitting shipments to get below the
minimum. The special difficulty with exports is that any such
exchange control program cannot help but be an additional deterrent
to potential American exports. Exporters would have to take the extra
steps of validating. each transaction with a bank, and adjusting
their payment terms. Many firms for whom export business is
marginal would probably give it up.
Even greater difficulties of enforcement would be encountered
it if were desired to force prompt repatriation of income from foreign
investments (apart from direct investments, where the OFDI might be
made more effective). In fact, the most likely procedure would be
in connection with the tax collection apparatus, but that would be
totally ineffective against delays of a few weeks or months in
effecting remittances.
While it is possible for those due to receive payments
from abroad to delay receipts, and thus speculate on a capital
gain, the amount of such potential remittances that would accrue
in a short time is less than would be involved in advance payments
LIBRARY GERALD ? FORD
STRICTLY CONFIDENTIAL (FR)
-24-
for imports. The total of exports (other than Government shipments)
and income receipts (apart from direct investment and U.S. Govern-
ment receipts) in a month is roughly $4 billion, so that while
cumulative delays in making remittances could have a very substantial
effect, the effect in a week or two of even total failure to remit
might not by itself exert decisive pressure at that time. This
might appear to be an argument in favor of stricter surveillance
over outpayments than on receipts from abroad. However, such an
unbalanced system would soon lead to a situation where importers
avoided controls by obtaining the foreign exchange they needed, at
a premium rate, from those with uncontrolled foreign-currency
earnings.
It is not difficult to envision the myriad forms of
evasion of exchange controls that would quickly emerge. Obvious
problems arise from exports of currency; this is the principal form
of evasion of the Italian exchange controls, amounting to over
$2 billion in 1969. Controls on receipts and payments connected
with merchandise transactions would lead to the use of false values --
exports underinvoiced so as to accumulate uncontrolled funds abroad,
and imports overinvoiced for the same purpose. Just as with the
existing control programs there would be pressures to exempt certain
countries or types of transactions, but this would open even greater
opportunities for evasion if it were done in an exchange control
environment. For instance, if Canada were exempt there would be
GERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-25-
enormous pressure for funds to move through Canada, and it is
highly unlikely that the Canadians would be willing to erect an
exchange control barrier to prevent it -- especially when their
exchange rate is floating.
In some cases of very severe exchange controls countries
have limited the freedom of nonresidents as well as residents to
move funds out of the country, or to acquire new assets. Even the
United States blocked certain foreign assets here in World War II,
and still blocks foreign assets of some Communist countries. This
point is raisedebecause the potential for large disturbing flows of
funds rests in considerable part with decisions of foreigners about
their holdings of assets in the United States. As shown in Table 3,
private foreigners had investments in the United States valued at
$69 billion at the end of 1971.
Even this summary consideration of exchange controls exposes
a formidable problem in terms of administrative difficulty. It
would also be necessary to explore much more carefully whether
authority to take these steps can be found in the Trading with the
Enemy Act, the Recordkeeping Act of 1970, or in some other statute.
Some measures would clearly require new legislation if they involved
new types of taxes. To adopt a control mechanism of this type
overnight without leaks being made to the public would be extremely
difficult.
QERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-26-
One of the problems with an exchange control system is
that to be operative in times of crisis it must also be operative
to some degree at other times. For reasons already presented, this
could not fail to result in inequities and differential impacts
on various types of normal commercial and financial transactions.
Damage to exporting interests probably could not be avoided.
Importers would certainly encounter difficulties, which would
probably lead to political problems with foreign countries, especially
if there were discriminatory aspects to the controls.
Even if it were possible to follow other countries in
designing controls that met the IMF rule that current account
payments should not be affected, such an action by the United States
would go a long way toward encouraging resort to exchange controls
as an acceptable way of dealing with "temporary" balance of payments
pressures.
FORD is LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
-27-
VI. Notes on Foreign Experience with Control Programs
In recent years the amplitude of the back-and forth move-
ment of liquid capital among industrial countries has increased
considerably and has at times threatened the stability of
exchange rates and the management of monetary policy. The growth
in these flows was permitted by a progressive liberalization of
restrictions on capital movements, which began in the late 1950's.
The relaxation of these restrictions helped to accommodate the
financing requirements of rapidly expanding international trade and
investment. Contributing to the expansion of international capital
movements were innovations in the techniques of international
banking, which resulted in a closer linkage of national financial
markets as financial transfers across borders were handled with
increasing efficiency, and growth of multinational corporations.
The beneficial aspects of these developments are clear,
but with these benefits came also an increasing disequilibrating
potential. In recent years the disturbing elements of these flows
halted the trend towards liberalization of capital controls and
led governments to adopt a host of measures aimed at influencing the
volume and direction of international capital movements. Experience
with these measures shows that they can aid in the achievement of
various policy goals, particularly in the case of domestic investment
targets, and also in assisting controlling domestic liquidity or in
smoothing temporary balance of payments difficulties. However, at
FORD & GERALD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-28-
times when the underlying situation was itself unstable, controls
have not been effective. An evaluation of the efficiency of
countries' experience with various instruments aimed at "controlling" --
in the sense of "guiding" -- capital flows depends entirely on what the
controls were intended to achieve. If the aim was to smooth temporary
fluctuations in situations which in themselves were not volatile,
they probably can be said to have had a fair modicum of success.
If they were intended to prevent speculation when the market was
convinced of a more basic disequilibrium they were clearly not
adequate, as indicated by the discussion of the experience of France
and the United Kingdom given in Appendix C.
In the Swedish case, for example, capital controls are used
as an auxiliary instrument to fiscal and monetary policy, primarily
in order to achieve certain domestic investment objectives. As such,
they have worked very well, but in times of instability in the inter-
national payments situation they have not been able to protect the
international reserve position of the Bank of Sweden -- nor were they
designed to do SO.
Methods of control
A large variety of types of controls have been employed
at various times (for a listing of those applied by selected
individual countries as of June 1, 1971, see Appendix C). They can
subdivided into the following general categories:
FORD & GERALD LISRARY
STRICTLY CONFIDENTIAL (FR)
-29-
Direct measures
a) exchange controls
b) quantitative limitations on banks' foreign assets
and liabilities
c) controls on purchases and sales of domestic financial
and fixed assets by non-residents
Indirect measures
a) dual exchange markets instituting a special rate of
exchange for capital transactions
b) selective restrictions on interest payments or rates
at which interest is paid on non-resident financial
assets
c) special reserve requirements against banks' or non-
banks' foreign assets or liabilities
d) intervention in forward exchange markets or limitations
on use of forward cover
e) selective tax measures applying to treatment of foreign-
earned income or income accruing to non-residents.
Controls designed to achieve balance of payments or domestic
liquidity objectives have in one way or other led to increasingly
comprehensive exchange control mechanisms -- if only for administrative
purposes in order to gain information needed for the enforcement.
This stems in part from the fact that, at times of stress, so-called
volatile capital movements spill over into transactions which are
normally considered to be of a more stable nature, i.e. commercial
transactions and transactions legally considered to be of a long-term
nature.
With respect to the substitutability of transactions in
bonds or stocks for those in short-term assets, it is clear that
countries which have maintained a special foreign exchange market for
all capital transactions, such as Belgium and France, have generally
GERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-30-
been more successful in moderating disturbing capital movements than
have countries using mainly monetary instruments. However, when
exchange rate differentials between the market for capital and that
for current account transactions widen appreciably, this type of
control also can be counterproductive in raising questions about the
feasibility of maintaining these differentials. The administrative
machinery necessary to achieve the separation of foreign exchange
markets for different types of transactions is illustrated in the
quotation below.
"In order to implement the separation of markets, authorized
banks keep separate accounts in free and official foreign exchange
for their customers, and maintain separate positions (both spot and
forward) in foreign currencies in the two markets. Under the re-
gulations, they are responsible for ascertaining the nature of
any receipt or payment, and this in turn determines whether they
have to buy for or sell from their own "official" or 'free' foreign
exchange holdings, or, as the case may be, debit or credit an 'official'
or 'free' account for the transferor or transferee. For nonresidents
the banks keep so-called 'financial' accounts in Belgian francs
which can be used only for transactions that may or must be made
through the free market. Every day the main banks submit to the
exchange control authority (the Belgium-Luxembourg Foreign Exchange
Institute -- IBLC) information on their transactions with foreign
countries, and every month all banks submit statements of their
assets and liabilities by market, of the accounts which they keep in
official and free exchange for residents, and of the 'financial
accounts' and other accounts in Belgian francs which they keep for
nonresidents, as well as of their transactions in each market,
classified by type of operation. This information enables the IBLC
to reconcile their transactions with changes in the accounts of
banks and thus helps to detect irregularities. In addition, IBLC
controllersperiodically visitbanks to supervise their procedures;
these controls are undertaken with increasing frequency in periods
1/ Ralph Wood, "Dual Exchange Markets, Key Facts and Questions"
internal Federal Reserve Board paper dated April 14, 1971. Mr. Wood
quotes an internal IMF paper on the Belgian dual exchange market
system, DM/70/45 dated June 11, 1970.
GERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
-31-
when the discount on the Belgian franc in the free market tends to
widen. Finally, a direct check on import payments and on the sur-
render of export receipts is possible through the customs declaration
of which a copy is remitted to the IBLC."
This type of machinery, in principle, could also provide
the framework for controlling swings in financing arrangements for
commercial transactions. In times of doubt about exchange rate
stability, foreign transactors have hedged their foreign exchange
risks by either speeding up, or delaying, payments on export and
import transactions. Shifts in these "leads and lags" associated
with the financing of commercial transactions have at times contributed
importantly to increases in the amplitude of the ebb and flow of
international capital movements. Table 4 illustrates, in the case
of France in the 1968 crisis, how important these shifts can be (captured
mainly in the errors and omissions and the non-bank short-term
items). These flows occurred despite long experience with and the
tightening of that system when difficulties started. The British
experience in 1966-1967 before the devaluation of the £ sterling also
illustrates this point.
Table 4
France: Private Capital Flows (non-Franc area)
(In millions of U.S. dollars)
QERALD FORD LIBRARY
1965
1966
1967
1968
1969
1970
Private long-term
361
156
168
-681
394
423
Non-bank short-term
-352
-223
-251
-1,384
-284
957
Bank short-term
-253
80
369
-501
565
450
Errors & omissions
171
93
-205
-260
172
341
Total
-73
106
81
-2,826
847
2,171
Source: OECD
1/ For a description of the French and British control systems see
Appendix C.
STRICTLY CONFIDENTIAL (FR)
-32-
In recognition of how changes in payment methods for commercial
transactions can substantially affect financial flows, the Dutch
government has moved recently to curb this influence: financing
arrangements for periods longer than usual, as well as prepayments
for exports, now require Central bank approval.
Almost all the administrative burden required for the
controls discussed above devolves upon the banking system. Consequently,
efficacy of such measures is undermined when a substantial amount
of business is transacted outside the banking system, e.g., through
inter-company transfers.
The same problem arises in connection with attempts to
control capital movements by regulating foreign asset and liability
positions of the banking system. This type of regulation has
proved to be more palatable to many authorities than have more
stringent direct controls. However, possibilities for avoiding these
controls, for example by carrying out transactions without the use
of domestic banking facilities, are relatively ample, so that the
incentive does not have to be very great for loopholes to be
utilized. Consequently, these measures have generally led to more
direct and comprehensive types of controls. The German experience
is a recent and telling example.
In moving to more comprehensive systems of controls,
countries generally have not made extensive use of selective
tax measures. The IET in the United States and the German
FORD is LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
-33-
withholding tax on interest on bonds held by non-residents are
examples of this type of measure. But there are no examples, to
our knowledge, of a wider application of variable ad valorem taxes
on foreign lending or borrowing.
FORD is LIBRARY GERALD
July 23, 1972.
Table 1
PRIVATE CAPITAL FLOWS: U.S. and FOREIGN
(millions of dollars, seasonally adjusted, outflow (-))
1968-70
1971
1972
1968
1969
1970
Average
1971
Qtr.1
Qtr.2
3
Qtr.4
Qtr.1
Qtr.2
A. TOTAL PRIVATE CAPITAL: U.S. and FOREIGN
+4,679
+8,134
-7,868
+1,648
-14,332
-4,304
-2,665
317
-2,047
-1,456
B. U.S. PRIVATE CAPITAL
-5,383
-5,424
-6,886
-5,898
-9,781
-2,203
-1,954
3,521
-2,104
-2,879
NONLIQUID
-4,826
-5,586
-7,137
-5,850
48,710
-1,931
-2,049
-2,966
-1,764
-2,186
LONG-TERM
-4,297
-4,855
-5,753
-4,968
5,348
-1,659
-1,813
-1,927
-949
-1,654
U.S. direct investments abroad
-3,209
-3,254
-4,400
-3,621
,765
-1,290
-1,277
-1,410
-788
-994
U.S. purchases of foreign securities
-1,226
-1,494
-942
-1,221
-909
-361
-372
-249
+73
-388
Changes in U.S. claims on foreigners
reported by U.S. banks
+358
+317
+175
+283
-565
+25
-153
-237
-200
-198
reported by U.S. nonbanks
-220
-424
-586
-410
-109
-33
-11
-31
-34
-74
SHORT-TERM
-529
-731
-1,384
-881
-2,362
-272
-236
-1,039
-815
-532
Changes in U.S. claims on foreigners
reported by U.S. banks
-44
-658
-1,023
-575
-1,807
-139
-91
-892
-685
-566
reported by U.S. nonbanks
-485
-73
-361
-306
-555
-133
-145
-147
-130
+34
LIQUID
-558
+162
+252
-48
-1,072
-272
+95
-555
-340
-693
Changes in U.S. claims on foreigners
-34-
reported by U.S. banks
-61
-209
-99
-123
-566
-94
+32
-392
-112
-518
reported by U.S. nonbanks
-497
+371
+351
+75
-506
-178
+63
-163
-228
-175
C. FOREIGN PRIVATE CAPITAL
+10,063
+13,558
-983
+7,546
-4,550
-2,101
-711
-1,796
+57
+1,423
NONLIQUID
+6,254
+4,896
+5,257
+5,469
+2,141
+475
+129
+200
+1,336
+895
LONG-TERM
+5,495
+4,805
+4,355
+4,885
+2,199
+737
+208
+44
+1,209
+892
Foreign direct investment in U.S.
+319
+832
+1,030
+727
-67
+124
+1
-374
+181
-335
Foreign purchases of U.S. securities
+4,389
+3,112
+2,190
+3,230
+2,282
+559
+196
+606
+921
+1,066
Corporate stocks
(+2,096)
(+1,565)
(+697)
(+1,452)
(+849)
(+78)
(-3)
(+230)
(+544)
(+679)
New foreign issues by corporations
(+2,129)
(+1,029)
(+822)
(+1,326)
(+1,161)
(+317)
(+263)
(+225)
(+356)
(+309)
FORD
Other
(+163)
(+518)
(+671)
(+451)
(+272)
(+164)
(-63)
(+151)
(+20)
(+78)
Changes in U.S. liabilities to foreigners
reported by U.S. banks
+72
+160
+23
+85
-249
-152
-61
-71
+35
+204
reported by U.S. nonbanks
+715
+701
+1,112
+843
+233
+206
+72
-117
+72
-43
GERALD
SHORT-TERM
Changes in U.S. liabilities to foreigners
reported by U.S. nonbanks
+759
+91
+902
+584
-58
-262
-79
+156
+127
+3
LIQUID
+3,809
+8,662
-6,240
+2,077
-6,691
-2,576
-840
-1,996
-1,279
+528
Changes in U.S. liabilities to:
Commercial banks abroad
+3,387
+9,166
-6,508
+2,015
-6,908
-2,928
-892
-1,775
-1,313
+438
International and regional institutions
+48
-63
+181
+55
+682
+280
+198
+149
+55
+29
Other private foreigners
+375
-441
+87
+7
-465
+72
-146
-370
-21
+61
D. ERRORS AND OMISSIONS
-399
-2,470
-1,174
-1,347
-10,927
-944
-2.586
-5,380
-2,018
+480
Source: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, June 1972.
STRICTLY CONFIDENTIAL (FR)
July 24, 1972.
GERALD FORD
Table 2
U.S. Official Settlements Balance, Total and
Distributed by Major Countries, Selected Periods 1971 and 1972
(In millions of dollars)
Official
Major Countries
settlements
Total of
United
Month
balance
countries
Germany
Japan
Kingdom
France
Netherlands
Switzerland
Canada
Belgium
Italy
(deficit -)
shown (inc.+)
1971 Jan.
-874
1,270
210
14
279
216
66
-4
16
204
269
Feb.
-1,931
2,098
750
190
601
52
125
181
49
78
72
Mar.
-2,632
2,843
1,059
823
474
86
151
8
74
34
134
Apr.
-2,349
2,229
790
266
683
69
-92
349
17
56
91
May
-5,320
4,857
2,224
1,185
310
344
203
294
47
307
-57
June
1,204
-1,581
-2,367
475
635
59
8
-257
-22
-25
-87
July
-2,480
1,748
277
324
354
694
-8
-34
78
58
5
Aug.
-8,759
8,498
-310
4,373
252
741
280
2,045
264
577
276
Sept.
-1,465
1,759
247
1,180
463
-399
4
25
-12
-3
254
I
Oct.
-1,228
1,172
251
576
589
-183
-7
8
68
-64
-66
Nov.
-1,780
1,812
139
616
919
195
--
-7
280
-37
-293
Dec.
-2,874
2,616
762
547
869
309
-15
-28
270
-65
-33
1972 -Jan.
-868
694
396
536
16
-18
8
-80
-6
-1
-157
Feb.
-1,321
1,258
766
411
-21
-4
95
-17
7
52
-31
Mar.
-1,071
909
78
430
97
-31
419
-96
71
66
-125
Apr.
-267
-64
255
88
-590
33
59
-45
129
--
7
May
554
-731
2
-457
4
-3
-24
-253
135
-78
-57
June 2/
/ -1,200
552
1,096
-463
-225
446
-34
-200
173
-4
-237
Week ending
1971 - May 12
-4,270
4,579
2,207
842
113
242
312
674
37
150
2
Aug. 11
-2,018
1,006
-178
455
-539
.189
296
212
213
355
3
18
-3,853
3,989
51
1,054
754
281
3
1,616
47
185
-2
25
-1,486
1,883
3
1,748
-6
27
-1
97
15
1
-1
Sept. 1
-1,184
1,224
--
1,175
22
29
--
3
-2
-2
-1
1972 - June 28
-1,258
1,036
1,013
-24
-163
118
1
--
92
--
-1
July 5
-340
-219
332
-36
-130
-9
-10
1
-45
--
-322
12
-1,173
1,251
569
146
-10
231
193
105
6
21
-10
19
-3,188
3,038
1,338
62
86
232
300
993
5
19
3
/ Estimate.
1/ Includes increase or decrease (-) in foreign official
2/ Difference between official settlements balance and total
holdings in the United States and increase (-) or decrease
of countries shown reflects mainly changes in official holdings at
in U.S. reserve assets. Data on official holdings for Jan.
commercial banks, for which country breakdown is not yet available
1971 - May 1972 are total holdings and for June 1972 and weekly
for June 1972 and not available for weekly periods, and changes
periods are holdings at F.R. Bank of N.Y. only.
in countries not listed,
-36-.
Table 3
INTERNATIONAL INVESTMENT POSITION OF THE UNITED STATES
In billions of dollars
Item
1950
1960
1969
1970
1971°
U.S. assets and investments abroad
54.4
85.6
158.1
166.6
181.0
U.S. private investments
19.0
49.3
110.4
119.9
134.9
Long-term, total
17.5
44.5
96.3
104.7
116.0
Direct investments
11.8
31.9
71.0
78.1
86.0
Foreign securities
4.3
9.6
18.7
19.6
22.3
Banking claims and other
1.4
3.1
6.6
7.0
7.6
Short-term, total
1.5
4.8
14.1
15.2
18.9
Reported by banks
.9
3.6
9.7
10.8
13.4
Other
.6
1.2
4.4
4.4
5.5
U.S. Govt. credits and claims 1
11.1
16.9
30.7
32.2
34.0
U.S. monetary reserve assets
24.3
19.4
17.0
14.5
12.1
Monetary gold
22.8
17.8
11.9
11.1
10.2
Other
1.4
1.6
5.1
3.4
1.9
Foreign assets and investments in U.S
17.6
40.9
90.8
97.5
122.5
U.S. liabilities to private foreigners
12.9
28.2
71.4
71.1
69.2
Nonliquid
8.7
19.0
42.5
48.5
53.3
Direct investments in U.S.
3.4
6.9
11.8
13.2
13.4
U.S. corporate securities
3.1
10.0
22.9
25.6
30.4
Corporate and other bonds
.2
.6
4.8
6.9
8.6
Corporate stocks
2.9
9.3
18.1
18.7
21.8
Other long-term liabilities
1.5
1.6
4.8
6.0
5.9
Short-term reported by nonbanks
.7
.6
2.9
3.7
3.6
Liquid
4.2
9.1
28.9
22.6
15.9
To foreign banks (incl. U.S. bank branches)
2.1
4.8
23.6
17.1
10.3
To others
2.1
4.3
5.3
5.5
5.6
U.S. liabilities to foreign official accounts
4.7
12.7
19.5
26.4
53.2
Reserve liabilities
4.6
11.9
17.1
24.4
51.8
Of U.S. banks
2.4
4.0
8.5
6.5
7.4
Of U.S. Govt
2.2
7.9
8.5
17.9
44.4
Nonreserve liabilities of U.S. Govt. 2
.1
.8
2.4
2.0
1.4
1 Other than U.S. monetary reserve assets.
2 Includes small amounts of liabilities to private foreigners.
€ Estimated.
NOTE-Data for 1950, 1960, 1969, and 1970 are as published by the Bureau of Economic Analysis,
U.S. Dept. of Commerce; data for 1971 are estimates based on capital flows as reported by the BEA
plus rough allowances for reinvested earnings, and changes in market valuations. The basis of valuation
is as follows: direct investments at book values as appearing, in principle, on the books of the affiliates
rather than the head offices; securities at market values; other assets and liabilities at stated values
in the accounts of banks and other debtors or creditors. For more detailed data see Survey of Current
Business, U.S. Dept. of Commerce, Oct. 1971. Details may not add to totals because of rounding.
This table only reflects assets or liabilities
for which some record or estimate is available; it
does not reflect assets or liabilities arising
from unrecorded capital flows.
GERALD FORD LIBRARI
STRICTLY CONFIDENTIAL (FR)
APPENDIX A
Activities of Multinational Corporations
At times of international financial turmoil attention
tends to focus on the role of the large corporations which operate
various types of businesses in more than one country -- multinational
corporations. At such times it is generally believed that the
multinationals are either initiators or at least major participants
because of their ample financial resources (including their ability
to borrow), their current and expected need for various foreign
currencies, their financial sophistication which leads them to
minimize any possible exchange losses, and to occasionally seek
a profit, and their complexity, which defies the ingenuity of
would-be controllers. Apart from their possible role in times of
crisis, multinationals are commonly subject to some degree of
control either because their capital outflows put a strain on the
balance of payments even in normal times (the basis for the U.S.
controls), or because they are regarded as threats to domestic
control over basic industries (as is the case in a great many
countries, both developed and less developed). In the context of
sudden shifts of mobile funds, therefore, it seems useful to
indicate briefly the specific problems of applying restraints to
these enterprises.
1) Scope of U.S. multinationals
The magnitude of the operations of U.S. multinationals can
be indicated with a few key statistics:
FORD i LIBRARY 97V839
APPENDIX A
STRICTLY CONFIDENTIAL (FR)
-2-
a) Their present book value is on the order of
$85 billion -- market value would be larger.
b) Total assets of the foreign affiliates are probably
twice as large as the parent company investment -- the difference
representing some minority foreign equity interest but mainly derived
from long and short-term borrowing abroad.
c) Shipments to the foreign affiliates of these
corporations account for about one quarter of U.S. exports, and they
supply a substantial part of U.S. imports of materials, plus a lesser
share of U.S. imports of manufactures.
d) The U.S. share in the earnings of these controlled
foreign affiliates is now well over $9 billion; receipts entering
the U.S. balance of payments in 1971 as dividends, interest, branch
profits, royalties, and fees totaled $9.4 billion -- by far the
largest current receipt other than merchandise exports.
e) Capital outflows from the U.S. to the foreign
affiliates, after deducting the use of funds borrowed abroad, reached
$3.4 billion in 1971, about $1.0 billion more than in 1970.
2) Operation of present controls
The present control system operated by OFDI is based on
a recognition that there is a constant enormous flow of receipts
and payments between U.S. head offices and their foreign affiliates,
which are not readily or even meaningfully divisible into capital
GERALD FORD
APPENDIX A
STRICTLY CONFIDENTIAL (FR)
-3-
flows and payments and receipts connected with the flow of goods,
services, and income within the corporate structure. In practice
this flow of payments is largely reflected in a set of inter-
company and branch account balances, supplemented of course by
much less frequent changes in the ownership accounts carried as
stock ownership or long-term creditor interests. Moreover, a
large part of the increase in U.S. parent company investment each
year derives from retained foreign profits which do not appear as
capital flows in the U.S. balance of payments. Consequently, control
over these investments is maintained not by detailed records of
individual transactions but instead by limitations on the aggregate
annual amount by which the sum of net balances in intercompany
accounts, capital transfers in the form of purchases of stock or
bonds of the foreign affiliates, and retained earnings of foreign
affiliates are permitted to increase. In addition, direct investors
are subject to a limit on the amount of liquid funds they can hold
directly abroad, tied to their historical experience.
As is well known, the main effect of this system of controls
is to cause companies that wish to expand abroad at a rate faster
than their OFDI ceilings would allow to do so by borrowing abroad.
The amount of the ceilings is computed either on a historical base,
or in relation to earnings of the foreign affiliates, and complex
provisions have emerged in an effort to differentiate among groups
FORD & 039470 LIBRARY
APPENDIX A
STRICTLY CONFIDENTIAL (FR)
-4-
of foreign countries and to provide exemptions or special allowances
for certain problem situations -- for instance, the provision of
credit coveringexports from the U.S. parent to the foreign affiliates.
Although the OFDI and others have given the most serious
consideration to replacing the present quota system with a system
based on a tax, or some other market-oriented device, the very
multiplicity of the relations between the head offices and their
foreign affiliates, plus the need to cover foreign earnings (which
introduces great legislative problems) has frustrated such efforts.
It is not the purpose of this discussion to evaluate the
general effectiveness of this system of controls, but rather to
consider its effectiveness at times when the companies would have
a strong reason to move mobile funds from weaker into stronger
currencies. On the whole, the OFDI program is not likely to detect
or prevent such flows -- if in fact they are occurring.
Under the present system, reports to OFDI covering trans-
actions with foreign affiliates (which could include large cash
flows) are rendered quarterly, but they are at least 3 months after
the event, and they reflect only end-of-quarter positions. It is
only considerably later that the reports are analyzed, and it is
notoriously easy in any case to reduce end-of-month positions by
short-term borrowing abroad. While this sounds like loose practice,
the only effective way to prevent large bulges in these intercompany
QERALD FORD LIBRARY
APPENDIX A
STRICTLY CONFIDENTIAL (FR) -5-
accounts between reporting dates would be to introduce some form
of daily average balance reporting. Because these intercompany
accounts are the locus for all types of flows not only between the
parent companies and the foreign affiliates, but also in many cases
among the foreign affiliates, they are subject to a great many
seasonal and other irregularities beyond the control of the parent.
Consequently, daily average balancing would impose a most significant
additional reporting and management burden on the companies. Since
this is only one of a multiplicity of channels for moving funds,
it would seem to be unwise to exact such a cost for a highly dubious
benefit.
Apart from movements of funds through their affiliates,
multinationals hold liquid assets abroad in their own accounts --
and, as noted above, they are limited in what they can hold at the
GERALD FORD LIBRARY
end of any month by the amount held on a monthly average basis in
1965-66. Reports on these end-of-month amounts are sent to OFDI
on a quarterly basis, about six weeks after the end of a quarter.
Clearly this leaves room for sizable outflows between month ends,
and it would probably be possible to institute daily-average report-
ing for these assets. Here again, however, the question arises
whether this is worth doing if there remain other channels readily
available -- either to multinationals or persons not covered by any
controls. For instance, to require daily-average balancing for
directly-held liquid funds, but not to go to a similar system for
intercompany accounts (which would be infinitely more difficult)
APPENDIX A
STRICTLY CONFIDENTIAL (FR) -6-
would not be effective, since cash funds could be invested abroad
via the foreign affiliates and the intercompany accounts.
As noted in the main body of this paper, the multinational
corporations are also probably responsible for a large part of the
flow that takes the form of shifts in leads and lags vis-a-vis
nonaffiliated foreigners -- which is not covered by OFDI regulations.
In the absence of a reporting procedure that would detect short-
term speculation, the OFDI has conducted telephone surveys and
does some regular spot-checking with major reporters. It is
estimated that there are now about 3,500-4,000 direct investors
with about 25,000 foreign affiliates, About 400-500 of these
direct investors are large enough to be required to file quarterly
reports with OFDI. Present plans are to make further reductions in
reporting requirements for the smallest firms. Whether these
arrangements could succeed in detecting short-term positioning
by the companies is very doubtful. Indeed, it is extremely
GERALD FORD LIBRARY
difficult to verify the accuracy of reports received from the
companies in any case.
3) Flows among foreign affiliates
Apart from their potential for moving funds from the U.S.
at times of crisis, the multinationals can also exert pressure on
foreign currencies by arranging their foreign affiliates' asset
composition. For instance, a firm with an affiliate in the U.K.
and an affiliate in Germany could arrange advances of cash from the
APPENDIX A
STRICTLY CONFIDENTIAL (FR) -7-
former to the latter, or, if the affiliates have a sizable volume
of bilateral dealings, the parent can shift funds through changes in
their current account payables and receivables. Moreover, the
multinationals can readily borrow Euro-dollars and switch them
into foreign currencies, perhaps more easily than can be done
by other market participants.
There has been no suggestion that the U.S. Government
should intervene in these offshore movements of funds -- other
countries have attempted to control them with varying success.
It would seem that any effort to dampen these flows, whether by
multinationals or others, would require a concerted effort on the
part of many countries, since discrepancies in control arrangements
would merely shift the pressure from one country to another.
4) Summary of considerations
It would be a major task to attempt to exercise control
over flows of mobile funds originating with multinational corporations,
and it would be extremely difficult to do so without adding substantial
complications to their normal business procedures. The least difficult
part of such a tightening of surveillance would be a requirement for
more effective reporting on liquid assets held abroad, but this would
be only a gesture if other channels for short-term flows are
available either to these companies or the general public,
GERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
Appendix B
Activities and Role of Commercial Banks
1) Summary. The present control system probably operates
fairly well to restrain outflows of banking funds in periods of
stress, and could be made somewhat more effective if desired. However,
the exemption of export credit required by law leaves a sizable
potential avenue for such flows, and tightening up on banks alone
would not prevent speculation through other channels. To close all
potentially important channels would require some form of exchange
control.
In an exchange control regime, banks would probably be
called on for a major share of the surveillance burden. This might
very well impair their ability to conduct their regular domestic
and foreign business.
2) Restraints on Capital Outflows by Banks and Financial
Institutions. The VFCR program in effect since 1965 has been broadly
effective in restraining capital outflows by banks and other financial
institutions. It is a voluntary system, which could be made mandatory
if desired. However, the program has not prevented abnormal and
largely temporary outflows at times of great speculative pressure
(a) because these outflows in large part result from foreign banks
drawing against unused credit lines with U.S. banks, and the U.S.
banks cannot immediately adjust their positions by reducing other
FORD i LIBRARY GERALD
APPENDIX B
STRICTLY CONFIDENTIAL (FR)
-2-
foreign assets, and (b) because compliance is only measured at
month-ends, although banks are requested to remain in compliance
throughout the month. Although since November 1971, the program
has not been applied to export financing, outflows under this
heading have not risen sharply. By and large, outflows from
nonbank financial institutions have not been substantial.
According to the VFCR reports, the largest increases in
foreign assets subject to VFCR restraint amounted to $600 million
in May1971 and $1.2 billion in August 1971. In both cases the
bulge was eliminated in a month or two. Investigation into the
August increase showed that at least $0.5 billion represented
drawdowns on credit lines by Japanese banks. It is interesting
to note that banks did not report significant increases in short-
term foreign assets held by their customers in these crisis periods,
suggesting that if U.S. persons were adding to their liquid assets
abroad they were not holding them in custody at U.S. banks where they
could readily be identified if they were subject to control.
If it were considered desirable to institute a control
program that would minimize the possibility that large capital
outflows by U.S. banks would occur at any time during the month,
it would be necessary to establish the bank control program on a
daily (or daily average) basis -- as was done in the case of the
Board's Euro-dollar reserve requirements. In principle, that
could be done with the present technique of the VFCR but some
FORD & GERALD LIBRARY
banks maintain that it would be very difficult, if not impossible.
APPENDIX B
STRICTLY CONFIDENTIAL (FR)
-3-
If this were done, and if the banks were required to
avoid overages or were subject to a sizable financial cost on
any overages, it is likely that the costs charged by U.S. banks
on foreign credit lines would be set at levels that would prevent
surges of foreign drawings on these credit lines at times of
speculation. (The rates set by U.S. banks would have to be high
enough to induce foreign banks and other foreign customers to
obtain credits elsewhere -- e.g., in the Euro-dollar market.
While overnight rates in the Euro-dollar market have soared to
astronomical levels in periods of peak speculative activity
they have not remained at those levels for more than a day or
to. Consequently, it would probably be feasible for U.S. banks
to prevent very short-term use by foreigners of credit lines by
specifying that drawings be outstanding for a somewhat longer period.)
A major difficulty would arise if it were considered
necessary to prescribe the terms on which banks could make export
credits. For instance, if an effort were made to restrict extensions
of credit directly by U.S. exporters, or delays in normal collections
for exports, exporters might shift to the use of commercial bank
credit. To avoid enterference with normal business practice, while
at the same time limiting outflows, the controls would involve banks
in determing whether the terms they were asked to provide were
consistent with normal practice in the trade.
FORD is GERALD LIBRARY
APPENDIX B
STRICTLY CONFIDENTIAL (FR)
-4-
However, the Federal Reserve is prevented by statute from
taking steps to limit banks' financing of U.S. exports, and
inauguration of such a control program would require substantial
amendment of the Export Expansion Financing Act of 1971. In the
absence of such action, one would expect that restrictions on the
ability of U.S. exporters to extend credits would merely result in
a shift of the financing to U.S. banks. Thus, barring legislative
action, potential credit outflows related to U.S. exports would be
likely to occur. At current levels of U.S. exports a potential
incremental outflow of $4-6 billion could take place over 2-3
months as a result of a one-time shift in terms of payment. It
should be noted that up to now banks have not reported major
increases in exempt export credits.
On the whole, speculation or hedging operations by U.S.
banks would not appear to involve a substantial threat of outflows,
although banks may contribute to destabilizing developments by
engaging in forward exchange transactions that shift market rates
and thereby create profitable arbitrage opportunities for transactions
by others. So far as is known, U.S. banks maintain relatively close
controls over the foreign exchange transactions of their head offices
and have stated limits on the extent of positions in particular
currencies. A requirement that banks report daily on their home
office foreign exchange ledgers -- corresponding to the daily data
GERALD FORD LIBRARY
APPENDIX B
STRICTLY CONFIDENTIAL (FR)
-5-
required on their foreign credits -- coupled with substantial
penalties for overages on these accounts, would probably be
adequate to ensure that banks did not generate large outflows.
Although legally the Board could probably apply similar
restraints on foreign branches of U.S. banks under the authority of
Regulation M, the extension of a control program extraterritorially
could involve extensive negotiations with foreign authorities.
Such a restraint on the foreign branches of U.S. banks could only
be effective, if at all, as part of a general program (undertaken
by all countries) to regulate Euro-dollar market activity of all
banks. Pending a general agreement on the need for such a concerted
effort, and also on the techniques to be employed to make it effective,
it would be advisable to limit any U.S. program to the domestic offices
of U.S. banks, and to recognize explicitly that all major international
banks in the world conduct transactions in dollars that can affect
reserve inflows by foreign central banks. (It might be noted that
the activities of foreign branches of U.S. banks for their own
accounts do not appear to have been a principal factor in exchange
rate speculation during the past 2-1/2 years. Balance sheet data
show that for all foreign branches of U.S. banks, month-to-month
swings in the net foreign currency positions were $400 million or
less, except in October 1971, when the swing was about $600 million --
this single shift represented about 1-1/2 percent of the total dollar
assets and about 3 percent of the total foreign currency assets of the
GERALD FORD LIBRARY
APPENDIX B
STRICTLY CONFIDENTIAL (FR)
-6-
branches. How much of the shift resulted from initiatives by the
branches and how much from customer initiative cannot be deter-
mined.)
In sum, it would be possible, but difficult, to prevent
large outflows through non-export bank credit and/or short-term
placements of funds by institution of a control program covering
the daily position of each U.S. bank. It would require legislative
changes to develop a program covering bank export credits. Any
program would have to be extended to U.S. agencies and branches of
foreign banks to the extent that they establish net foreign asset
positions (a concept that might have to be defined differently for
different groups to take account to their different modes of
GERALD FORD
operation). In principle, such a program would permit banks to
continue to finance trade and some customary non-trade transactions.
In practice there would doubtless be frequent administrative decisions
to be made concerning the appropriate terms for- financing of export
transactions that did not fit neatly into the rules, there would be
a significant increase in documentation required, and some adverse
effect on exports seems almost inevitable. Further, unless the Canadian
exemptionswere removed the efficiency of U.S. controls would depend to
a considerable extent on continued cooperation by the Canadian authorities.
It is important to note that limiting banks' financing of
exports or other transactions would be ineffective in crisis periods
if comparable financing by nonbanks continued unrestrained.
3) Use of Banks in Administration of Programs for Nonbanks.
APPENDIX B
STRICTLY CONFIDENTIAL (FR)
-7-
Any comprehensive U.S. exchange control program applied to nonbank
businesses and individuals could probably be successfully administered
only if part of the burden of administration were placed on the
banking system. Most countries that have employed extensive control
systems rely heavily on banks, and in the case of the United States
the enormous volume of transactions and numbers of transactors that
would be covered would make it essential to make use of the record-
leeping facilities of the U.S. banking system. Whether it would also
be advisable to assign to banks some responsibilities for ensuring
compliance by nonbanks is less certain.
Under the Financial Recordkeeping and Currency and Foreign
Transactions Reporting Act of 1970 (which came into effect on July 1,
1972) U.S. banks and other specified types of financial institutions
are required, inter alia, (a) to keep for five years records of all
transfers into or out of the United States involving more than $10,000,
and (b) to make reports to the U.S. Treasury of unusual currency trans-
actions involving amounts of more than $10,000. (The issue of whether
banks can make available the information to Government agencies is
currently being tested in the courts.)
Such information on financial transfers would be required
for effective administration of a comprehensive control program. But,
in addition, it would be necessary to identify the financial transfer
with the other elements of the transaction -- e.g., the payment for
imports, an "authorized" remittance, etc. -- which would have to be
BERALD FORD LIBRARY
APPENDIX B
STRICTLY CONFIDENTIAL (FR)
-8-
represented by pieces of paper authenticating the purpose of
the transfer. Of course, alternatives could be suggested, such
as a direct filing with a U.S. Government agency which would then
sample financial data reported by banks to see whether there were
records of financial transfers for which there were no authorizations.
This alternative might have the merit of reducing the amount of paper
work required of the banks, and thereby helping avoid an overloading
of the financial system that could cause disruptions in domestic
payments as well. However, it would almost certainly be ineffective
in catching speculative flows as they occur.
It should be noted that shipments of currency would escape
such a control system. The Recordkeeping Act of 1970 does require
all persons to report shipments of currency in amounts in excess of
$5,000 and as well as requiring financial institutions to report all
unusual transactions of more than $10,000; but individuals or
businesses desiring to ship currency abroad could doubtless accumulate
substantial amounts in relatively small individual transactions. If
the export of currency became a significant problem, restrictions
could be placed upon the repatriation of currency from abroad, and
this would doubtless result in the development of a separate market
abroad for U.S. currency at a more depreciated rate than applied to
GERALD R. FORD
other transactions.
The use of "counterpart" bank accounts could develop into
a significant avenue for evasion if controls here and abroad proliferate.
APPENDIX B
STRICTLY CONFIDENTIAL (FR)
-9-
Essentially a French business, for example, could set up a franc
account in its name, but to be used only to make payments on
behalf of a U.S. firm, and correspondingly the U.S. company would
set up a dollar account in a U.S. bank from which it would draw
on order of the French company. Such practices were characteristic
of the control period of the late 1940's in foreign countries; given
the enormous growth in number of companies with international
experience and the growth in their financial resources, the practice
could become much more extensive today. Whether that would occur
would depend upon whether U.S. and foreign companies believed that
they might be sufficiently disadvantaged by U.S. and foreign control
programs to warrant setting up such accounts.
FORD & LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
Selected Material on Foreign
Experience with Controls
DECLASSIFIED
AUTHORITY Federal loure ; State gindult ms
Treasury Hs. 8/22/06
BY th
NARA, DATE 9/2/09
FORD & LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-1-
GERALD
LIBRARY
Main Forms of Capital Control Applied in Selected Industrial Countries
as of June 1, 1971 1/2/
Nether-
United
United
BLEU
Canada
France
Germany
Italy
Japan
lands
Norway
Sweden
Kingdom
States
Exchange control2
X
-
X
-
X
X
X
X
X
X
-
Direct controls (not exchange controls)
X
-
X
-
X
X
X
X
X
X
X
Voluntary programs, guidelines, gentlemen's agreements
-
X
-
-
X
X
X
X
-
X
%
Special foreign exchange market for some or all capital transfers
X
-
X
as
-
-
-
-
-
X
-
Taxes on capital outflows
-
-
-
-
-
-
-
-
-
Taxes on capital inflows
-
-
-
-
-
-
-
-
MOT
-
-
Special taxes on income only from nonresident-owned capital
-
-
-
X
-
no
:
-
-
-
1
Certain outward direct investment subject to special exchange rate
(x)
-
-
-
-
-
-
-
-
X
-
Outward direct investment restricted
-
-
X
-
X
X
-
X
X
X
-
Restrictions relaxed or intensified
-
-
R
-
-
R
-
-
I
R
R
Certain inward direct investment subject to special exchange rate
(x)
-
-
-
and
-
MR
-
-
-
-
Inward direct investment restricted
-
-
X
-
-
X
-
X
-
-
$
Restrictions relaxed or intensi ed
--
-
R
-
-
R
-
-
...
$
-
Outward portfolio investment subject to special exchange rate
X
-
X
-
-
-
as
-
-
X
"
Outward portfolio investment restricted
-
-
X
-
-
X
-
X
X
X
-
Restrictions relaxed or intensified
-
-
-
-
-
R
-
-
-
R
*
Inward portfolio investment subject to special exchange rate
X
-
-
-
-
-
-
-
-
-
-
Inward portfolio investment restricted
-
-
-
-
-
X
-
X
X
-
-
Restrictions relaxed or intensified
-
-
-
-
-
R
-
3
-
-
-
Residents free to issue securities abroad
X
-
-
-
-
-
-
-
><
Restrictions relaxed or intensified
-
-
R
-
R
I
-
-
-
R
-
Free access for nonresidents to domestic capital market5/
-
X
-
X
-
-
-
-
-
R
X
Such access tightly restricted
X
-
X
-
X
X
X
X
X
X
-
Restrictions relaxed or intensified
-
-
R
-
I
R
R
-
-
-
-
Long-term borrowing from nonresidents restricted
-
-
X
-
X
X
X
X
X
X
-
Restrictions relaxed or intensified
-
-
R
-
R
I
-
R
E
R
-
Long-term lending to nonresidents restricted
-
-
X
-
X
X
X
X
X
X
X
Restrictions relaxed or intensified
-
-
R
-
-
,
R
-
-
:
R
Preferential capital controls for associated monetary area
-
X
X
-
-
-
-
-
,
X
Preferential capital controls for EFTA countries
-
-
-
.
-
-
-
-
-
-
Preferential capital controls for EEC countries
X
-
X
-
X
-
X
NO
-
:
Personal investment in real estate abroad subject to special exchange rate
X
-
-
-
-
-
-
as
-
-
Personal investment in real estate abroad restricted
-
-
X
-
X
X
-
X
X
-
Restrictions relaxed or intensified
-
-
-
-
-
-
-
-
I
-
-
Emigrants' transfers restricted
-
-
X
-
X
X
-
X
X
X
-
Restrictions relaxed or intensified
-
-
-
-
-
R
-
-
R
-
$
Export of domestic banknotes by travelers restricted
-
-
X
-
X
X
-
X
X
X
-
Restrictions relaxed or intensified
-
-
R
-
I
-
title
-
-
R
-
Import of domestic banknotes by travelers restricted
-
-
-
-
6
ou
-
X
X
H
-
Restrictions relaxed or intensified
-
-
-
1
-
-
-
-
-
-
,
Restrictions on acceptance from foreign banks relaxed or intensified
-
-
R
-
I
-
-
-
I
-
-
FORD
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-2-
GERALD
LIBRARY
Main Forms of Capital Control Applied in Selected Industrial Countries
as of June 1, 19711/2 (concluded) a
Nether-
United
United
BLEU Canada France Germany Italy Japan lands Norway Sweden Kingdom States
Export of gold by travelers restricted
-
-
X
-
X
X
-
X
X
X
X
Import of gold by travelers restricted
-
!
X
-
X
X
-
X
-
X
Import and export of gold at special exchange rate only (specified transactions)
(x)
-
-
-
-
-
-
-
-
-
-
Private persons free to hold domestically any amount of gold coins
X
X
X
X
X
-
X
X
X
X
X
Collection of export proceeds required
X
-
X
-
X
X
X
X
X
-
Surrender of export proceeds required
-
-
X
-
-
X
-
X
-
X
-
Maximum period for collection and/or surrender prescribed
X
-
X
-
X
X
10
X
-
X
-
Collection/surrender requirements relaxed or intensified
-
-
R
-
-
-
-
-
-
R
-
Nonbank residents' forward cover restricted to permitted underlying transactions
-
-
1
X
X
-
Nonbank residents entirely free to engage in forward transactions with nonresidents
-
X
-
X
-
-
X
-
:
-
X
All borrowing and lending between residents and nonresidents subject to special
or general permission
-
-
X
X
X
-
Some such borrowing and lending restricted or subject to guidelines
X
X
X
X
X
X
X
X
X
X
All individual borrowing and lending between residents and nonresidents uncontrolled
-
X
-
X
-
-
-
-
-
-
X
Some borrowing and lending between residents and nonresidents uncontrolled only through
special exchange market
X
-
-
-
-
-
-
-
-
-
-
Nonresidents' access to domestic bank credit restricted
X
X
X
-
X
X
X
X
X
X
X
Residents' access to foreign bank credit restricted
X
-
X
X
X
X
X
X
X
X
-
Nonresidents (including banks) free to establish nonresident accounts in domestic currency
and withdraw balances in foreign currency.
X
X
X
X
X
X
X
-
-
Banks free to borrow foreign currency from nonresidents
X
X
-
X
X
:
X
X
X
X
X
Banks free to lend to nonresidents foreign currency borrowed from nonresidents
X
X
X
X
X
X
X
X
X
X
X
Banks free to switch borrowed foreign currency into domestic currency
(x)
X
-
X
X
-
X
X
-
-
Controls over banks' short-term foreign assets or liabilities (specified below)
X
X
X
-
X
X
X
X
X
X
Guidelines or voluntary program for banks' borrowing from or lending to nonresidents
-
-
-
X
-
-
-
X
Controls over foreign position of banks
X
-
X
-
X
X
X
X
X
X
Controls relaxed or intensified
R
R
R
-
R
-
R
I
-
R
-
Reserve requirements against bank foreign liab'lities
-
-
X
X
-
X
-
-
X
-
Ceilings or otherlimitations on banks foreign a .t position
X
-
X
-
X
X
X
X
X
X
X
Banks' foreign assets included in de facto or de jure ceiling on bank credit
X
-
-
-
-
-
-
X
-
X
-
Ceilings or other limitations on banks' foreign liabilities
X
-
-
-
X
X
X
X
X
-
-
Interest ceilings (or prohibition) on banks' liabilities to nonresidents
(x)
-
(x)
(x)
-
X
(x)
-
-
-
X
Parentheses indicate that substantive changes occurred in the period April 1-June 1, 1971.
Where a relaxation (R) or intensification (I) of any specific type of control is shown, the modification relates to the period January 1, 1970 through April 1, 1971.
Other than controls or restrictions imposed for security reasons.
Excludes restrictions on nonresidents' access to physical resources or strategic industries and those on foreign participation in financial institutions.
No allowance made for nonofficial queue systems.
Also covers in Canada preferential access for United States, and in United States preferential access for Canada.
Including access by nonresident-ooned or monresident-controlled companies established in the country concerned.
Accounts that may be freely credited with domestic currency proceeds from the sale of convertible currencies transferred to the country concerned and that may be freely debited
for outward transfers in convertible currencies.
a / Source: International Monetary Fund internal document SM/71/181 dated July 14, 1971.
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-3-
R.
FORD
GERALD
Control of Capital Transactions in France
I. Trends in Capital Controls
France presently maintains a system of exchange and other controls over
inward and outward capital transactions with E 1 countries other than Monaco
and the operations account countries.
The evolution of the French system of controls on capital over the last
decade displayed the following general tendencies.
Regarding the degree of restrictiveness of the system, the period
1960-67 was characterized by a virtually uninterrupted move toward liberal-
ization which culminated in the abolition of exchange control in the begin-
ning of 1967. The major exceptions in this respect were certain measures
taken in 1963 to discourage the inflow of short-term capital and the more
careful scrutiny applied in the mid-1960s to foreign applications for direct
investment in France. Following the abolition of exchange control in 1967
special controls were introduced, without prejudice to the convertibility
of the franc, over borrowing abroad by residents and over inward and outward
direct investment. Following the May 1968 crisis and the massive outflow
of capital, exchange control was reimposed in addition to the special con-
trol measures. There were several changes in the course of 1968 but the
system that eventually emerged in November of that year was more restrictive
than the one prevailing in the early 1960s, especially with regard to outward
capital transfers by residents. Controls over investments and borrowings
were further tightened in 1969. After the devaluation of the franc in
August 1969 the "security currency" (devises-titres) market, which was elim-
inated in 1962, was re-established. In 1970 and early 1971, there was a
degree of relaxation especially with respect to direct investment and the
obligations related to the net foreign currency position of authorized banks.
In May 1971, however, the French authorities increased reserve requirements
for nonresident franc accounts and announced that it might be necessary in
the future to take other measures aiming to stem an inflow of foreign capital.
With respect to methods of control employed in the last decade, the
French authorities relied heavily on direct exchange control. In the short
interval 1967-68, during which exchange control was abolished, special con-
trols outside the exchange system were introduced and since 1968 maintained
in addition to the exchange control measures, which have again been restored
1/ A summary of the exchange controls of France including those affecting
banknotes and gold, is to be found in the Annual Report on Exchange
Restrictions.
of Source: International Monetary Fund internal document SM/71/181 dated
TRICTLY CONFIDENTIAL (FR)
APPENDIX C
-4-
to their position in the over-all regulatory system. A noteworthy develop-
ment in the last three years has been the increased reliance placed on direct
and indirect regulation of banking operations. Although such controls had
been relaxed in 1970, it is only in recent months that more emphasis has
been placed on them in order to curb undesirable effects of inward capital
movements.
As regards the scope of the regulatory system, the emphasis, on balance,
was on outward capital movements especially in the early and late 1960s,
reflecting over-a'l French economic condition 3 in those years. With respect
to inward transfers, foreign direct investment was made subject to closer
scrutiny during the mid-1960s in accordance with domestic planning targets.
Following the growth and developments in the Euro-currency market, emphasis
has been placed in more recent years on the control of short-term capital
inflow.
II. Methods of Control
As mentioned above capital movements between France and all countries
other than Monaco and the operations account countries are subject to exchange
control. Certain controls that are independent of the exchange control regu-
lations are maintained over inward and outward direct investment and over
borrowing abroad; these do not apply to relations with the operations account
countries or Monaco, and since February 1971 to direct investments in and
from EEC countries.
Outward transfers of resident-owned capital generally are restricted;
the transfer abroad of nonresident-owned funds in France, including the sales
proceeds of capital assets is not restricted. However, the sale of foreign
securities in France by nonresidents is prohibited. Capital receipts from
foreign countries are permitted, provided that the foreign exchange proceeds
are surrendered. Capital assets abroad of residents are not subject to
repatriation, but income from such assets is subject to repatriation.
FORD
The current French system of controls over various forms of capital
transactions is summarized below.
GERALD
LIBRARY
1.
Direct investment
Both inward and outward direct investments are subject to exchange con-
trol which is more restrictively applied in the former case. French direct
investment abroad may be financed, within certain limits, by purchases on
the exchange market, and foreign direct investment in France must generally
be financed with an inflow of foreign exchange. In addition foreign direct
investments in France and French direct investment abroad, implying control
of a company require prior authorization by the Minister of Economy and
Finance, who in practice gives an answer within two months from receipt of
the declaration. Analogous provisions apply to the liquidation of direct
French investments abroad, but liquidation of foreign investments in France
is subject only to a declaration made a posteriori.
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-5-
Throughout the period under review both inward and outward direct in-
vestments have been subject either to exchange control or special controls
and since 1968 to both.
2.
Borrowing and lending abroad
Borrowing abroad by residents, with certain exceptions, is subject
to exchange control and requires, in addition, prior authorization by the
Minister of Economy and Finance. In July 1970 the scope of exemptions from
prior approval for borrowing abroad was reduced. Lending abroad is subject
to exchange control authorization and is restricted.
Borrowing and lending abroad by nonbanks was subject to exchange con-
trol of varying intensity in the years 1960-67. During the 1967-68 inter-
val when exchange control was abolished only borrowing abroad required
prior authorization by the authorities.
3. Portfolio investment
French and foreign securities held in France by nonresidents can be
exported under certain conditions. The exportation for the account of
residents of French securities held in France is prohibited. Purchases
of French or foreign securities abroad by residents cannot be financed
with foreign currency acquired on the French exchange market, but are
freely permitted through the "security currency" (devises-titres) market
(see below). In addition to exchange control, foreign issues on the French
capital market are subject, with certain exceptions, to prior authorization
by the Minister of Economy and Finance, which has not been granted fre-
quently up to now.
4.
The "security currency" market
GERALD FORD LIBRARY
French and foreign securities deposited by residents with an autho-
rized bank abroad may be sold abroad, the proceeds from the sale being
sold on the Security Currency Market ("Marché de la devise titre"). This
market was re-established in August 1969 and gives rise to a special rate.
Funds in the Security Currency Market are available for the purchase abroad
of French and foreign securities.
A similar market existed until 1962, when it was terminated following
the permission for residents to buy on the exchange market in France the
foreign exchange required to purchase French and foreign securities on
stock exchanges abroad.
5. The forward exchange market
Forward exchange transactions take place at freely negotiated rates,
i.e., without any official intervention in the market. Residents other
than banks may conclude forward exchange contracts for a maximum period of
three months in respect of imports of specified commodities, but forward
sales of foreign currency are free. For most imported products the term
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-6-
of the contract is generally one month. Authorized banks, which may also
act on behalf of banks established abroad, are permitted to deal spot or
forward in the exchange market in France and, also, to deal with their
correspondents in foreign markets in all currencies subject to certain
limitations on their foreign exchange positions and on credits in francs
to nonresidents (see below).
In the early 1960s, the Paris forward market was limited to trans-
actions related to trade; financial forward transactions were not per-
mitted. Authorized banks, up to 1967, were not allowed to take an open
position either spot or forward; they acted only as intermediaries, and
the total spot or forward sales of exchange by customers had to be covered
by total spot or forward purchases, respectively. These regulations were
gradually relaxed for nonbank residents, and by 1966 they could freely
conclude forward exchange contracts not exceeding one year in respect of
receipts and payments for any permitted current or capital transaction.
6.
Regulations pertaining to authorized banks
The Bank of France has since 1968 imposed limits on the foreign ex-
change positions (positions de change of the authorized banks and on
their claims in francs on foreign countries. Banks are prohibited from
making, extending, or renewing loans in French francs: with the exception
of some particular types of loans ("crédit de courrier," documentary credit
in favor of French exporters). In May 1971 it was announced that franc
accounts of foreign banks were reclassified and would be treated as sight
deposits subject to the 9.25 per cent reserve requirement. For these de-
posits, which were previously classified as time deposits, there is a
6 percentage point increase in reserve requirements. At the same time,
the Bank of France was accorded the power to raise the obligatory reserve
requirement on nonresident deposits to 100 per cent and to restrict or to
abolish the remuneration on such deposits. These developments indicate a
tendency to return to the more restrictive practices on inward capital
movements of earlier years. For example, from 1963 to 1966, French banks
were not permitted to pay interest on franc balances held by nonresidents.
Also between January 1969 and July 1970 the net foreign currency positions
(positions en devises) )2/ were under control, with banks maintaining posi-
tions above certain limits required to make U.S. dollar deposits with the
Bank of France. However, this set of controls is designed as a safety
device which does not hinder current transactions and allows nonspecula-
tive capital flows to be effected under administration control.
Total of each bank's own spot and forward positions in foreign cur-
rency vis-à-vis residents and nonresidents combined, excluding positions
of customers.
2/ Spot assets and liabilities vis-à-vis nonresidents only.
GERALO FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-7-
NOTE ON FRENCH DUAL EXCHANGE MARKET
The official market now includes merchandise export and
import transactions and all other current account transactions
except for tourism. Capital and tourism transactions are carried
out in the financial market, where the franc value is currently
about 5 per cent above the franc value in the official market.
Originally, the official market included only merchandise
exports and imports and related expenses and "current payments to
and from governments and specified public authorities. " (Quote is
from IMF, SM/72/76 April 11, 1972, P. 15.) All invisibles except
for those just noted were transacted in the financial market.
The French justification for initially including
practically all invisibles in the financial market was twofold:
First, it was maintained that the authenticity of merchandise
trade transactions could be reasonably easily verified, but that
"there might be a tendency for capital transactions to be disguised
as current invisibles" if invisibles were included in the official
market. (Ibid., p. 16.) Second, it was noted that the deficit on
invisibles just about offset the surplus on capital account, thereby
keeping the premium on the franc in the financial market relatively
small. It was held that if the premium got too high -- i.e., as
high as 10 per cent -- "the separation of markets would be difficult
to maintain for long. " (Ibid., P. 16.)
GERALD R.FORD LIBRARY
APPENDIX C
STRICTLY CONFIDENTIAL (FR)
-8-
The IMF, naturally, objected to invisibles being excluded
from the official market, as did French businessmen and financiers
who stood to gain from a lower priced franc. Thus, apparently bowing
to these pressures, the French authorities this spring transferred
transactions in all invisibles but tourism to the official market.
The French authorities are believed not to have intervened in the
financial market. French officials, according to the IMF, found the
dual market "most useful in staving off unwanted capital inflows
and in providing some insulation for the domestic monetary system. "
(Ibid., p. 16.)
GERALD ABRUSIT R. FORD
STRICTLY CONFIDENTIAL
(DK)
APPENDIX C
-9-
EXCHANGE CONTROLS IN THE UNITED KINGDOM
U.K. exchange controls in the post-war period derive
their authority from the Exchange Control Act of 1947. The powers
contained in that Act are vested in the Treasury, but controls
have generally been administered by the Bank of England, acting
as agent for the Treasury.
The controls were quite restrictive in the immediate post-
war years, but were gradually eased in subsequent years. In 1958,
nonresident holdings of sterling became freely convertible, and the
United Kingdom formally accepted the obligations of Article VIII
of the IMF Agreement in February, 1961. Beginning in 1961, the
controls were again intensified.
The discussion that follows deals with some of the con-
trols in force after 1961, and tries to give some crude assessment
of their effectiveness.
Controls on outflows of long-term capital
/
In July 1961 restrictions were imposed on direct invest-
ment in countries outside the sterling area. New investment
qualified for official exchange only if it could be shown that it
1/ Much of the description of these controls is taken from the Bank
of England Quarterly Bulletin, September 1967.
2/ For purposes of U.K. exchange control, people (and their assets)
are classified according to the country in which they reside: a dis-
tinction is made between countries in the overseas sterling areas (OSA) and
the rest of the world "non-sterling area" or (NSA). Until recently, there
was no U.K. control over payments from the United Kingdom to OSA residents.
BERALD FORD VIBRAGA
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-10-
would produce sufficient benefits to U.K. export earnings, and thus
to the balance of payments, within two or three years. Companies
which could not meet this criterion, and could not borrow abroad in
foreign currency, were thereby precluded from investing. This
caused difficulties for some companies, especially those which needed
additiona financing for existing investments. From May 1962, there-
fore, companies whose investment could not qualify for foreign
currency at the official exchange rate were allowed to buy the cur-
rency in the investment currency market (at a premium then of about
3 per cent) This was the first time that the investment currency
market was allowed to be used for other than portfolio investment.
In 1965 further restrictions were imposed on direct invest-
ment outside the sterling area. In April the criteria for obtaining
official exchange were made more stringent, in that a commensurate
return was not only required in the short run but must continue
thereafter. As of July foreign currency could no longer be acquired
GERALD FORD FIBRARY
at the official rate even if the investment met the new criteria --
all direct investment had to be financed either with investment
currency or by borrowing foreign currency abroad. In May 1966 the
rules were tightened still further: the use of investment currency
for direct investment was reserved for projects which met the
3/ Prior to May 1962, a distinction was made between dollar securities
(both U.S. and Canadian), on the one hand, the proceeds from the sale
of which could be used to purchase any non-sterling security, and non-
dollar foreign securities, on the other, which could be switched only
into other non-dollar securities. When switching from non-dollar into
dollar securities was generally permitted, in May 1962, the two cur-
rency pools merged into the one "investment currency market." Residents
could then switch freely from one currency security to another, pro-
vided it was quoted.
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-11-
criteria, SO all other investment had to be financed from foreign
currency borrowing.
In April and July 1965, the right of U.K. residents to
sell the proceeds of certain capital items, such as legacies and
gifts, in the investment currency market -- and to obtain the
premium in that market was withdrawn. The proceeds had to be
sold instead at the official rate of exchange, thus increasing
official reserves rather than the pool of investment currency.
For a similar reason, also from April 1965, 25 per cent of the pro-
ceeds from all sales of foreign currency securities including sales
abroad for the purpose of switching investments, had to be sold
in the official exchange market. At the same time, U.K. residents
were no longer allowed to buy property outside the sterling area
for private use with investment currency (which had been permissible
since April 1964). Instead, they were required either to buy the
property for sterling from another resident or to purchase foreign
currency in the "property currency" market at the current premium.
/
There was, finally, a voluntary program introduced in May
1966. U.K. companies with plans to invest in any of the four main
developed countries of the sterling area 5/ were asked to postpone
investment which did not satisfy the criteria for investment outside
the sterling area. If that was not practicable, they were asked to
4/ The property currency market was merged with the investment currency
market in August 1970.
5/ Australia, New Zealand, South Africa, and the Irish Republic.
FORD
GERALD
LIBRARY
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-12-
finance such projects from local sources. Similarly, institutional
investors were asked to insure that there be no significant increase
in their holdings of securities denominated in the currencies of
these four countries. This request was extended to holdings of
securities denominated in NSA currencies.
Most of these controls have been modified further in subse-
quent years. One notable modification, in June 1972, was the extension
of some of the controls to OSA countries.
Controls on outflows of short-term funds⁶/
Virtually all transactions of residents with nonresidents --
whether in sterling or any other currency -- are subject to control.
Notably, a resident may not buy or sell (other than from or to an
Authorized Bank 11) or hold any foreign currency. Thus, for example,
exporters may not hold foreign currency receipts abroad but must
sell the proceeds immediately to an Authorized Bank, and importers
may not buy spot foreign currency in order to hold it until payment
is due.
Banks in the United Kingdom are restricted as concerns the
amount of any net assets in foreign currencies they may hold. The
Bank of England assigns one limit on each bank's net spot assets
6/ Cf. Rodney Mills, "Regulations on Short-Term Capital Movements:
Current and Recent Techniques in Selected Industrial Countries,"
July 24, 1972.
7/ An Authorized Bank is any bank authorized by the Treasury to
deal in gold and foreign currencies and to implement certain types
of Exchange Control transactions.
FORDO is GERALD LIBRARY
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-13-
in foreign currencies that are covered forward, and a second limit
on the bank's total net assets in foreign currencies -- both spot
and forward combined. These limits were reduced in the mid-1960's
when balan of payments deficits were putting pressure on the
official reserves, and since then they have been very small. How-
ever, the limits on net spot assets C overed forward were doubled
in September 1971.
Effectiveness of controls
In trying to assess the effectiveness of these controls,
it is not sufficient to ask if they enabled the authorities to
defend the exchange rate parity -- for they clearly did not. Nor
can much be gained by asking if the controls lived up to expecta-
8/
tions
Instead, one must try to determine what the impact of the
controls actually was.
In Table 1, data on long-term flows between the United
Kingdom and the NSA countries are presented. It is these flows --
not flows to OSA countries -- that have been subject to control.
8/ It is difficult to know what the controls were expected to achieve.
One indication of official expectations is provided in the IMF Article
VIII U.K. Consultation report for 1966: "The exchange control mea-
sures taken in 1965 will have their full year effect on private long-
term capital account in 1966. The effects of these measures will be
reinforced by the voluntary program.
The U.K. representatives
expected that there would be some net inflow of private long-term
capital in 1966. As for 1967, a marked net inflow was expected
II
(SM/66/78, Part I, p. 17) The actual data for 1966 and 1967 show net
outflows of private long-term capital of £26 and £82 million, respec-
tively.
GERALD FORD
Table 1. United Kingdom: Private Capital Flows With Non-Sterling Area Countries
(in £ millions)
1964
1965
1966
1967
1968
1969
1970
1971
Long-term capital (net)
-53
+75
+121
+131
+156
+279
+231
+415
of which: U.K. investment
overseas
-212
-169
-162
-230
-373
-290
-491
-514
Overseas invest-
ment in U.K.
+159
+244
+283
+361
+529
+569
+722
+929
Short-term capital (net)
+95
-50
-437
-182
-524
-371
+643
+1,742
of which: Banking and
Money Market
-14-
Liabilities in
APPENDIX C
Sterling
-15
-2
-117
-68
-111
-5
+79
+352
other
+110
-48
-320
-114
-413
-364
+564
+1,390
Errors and Omissions
-111
+145
-61
+136
-301
+735
+547
+881
Total
-69
+170
-377
+85
-669
+643
+1,421
+3,038
Source: H. M. Central Statistical Office.
FORD & GERALD LIBRARY
STRICTLY CONFIDENTIAL (FR)
APPENDIX C
-15-
On the basis of the above description of the tightening of the
controls, we would expect to see some impact, beginning in 1965,
or certainly in 1966, on both direct and portfolio investment
abroad by U.K. residents.
Total U.K. investment abroad (net; NSA countries) was
in fact lower in the years 1965-1967 than in 1964. Looking back
several years earlier, however, it seems that 1964 was an excep-
tional year; the large outflow in that year seems related primarily
to the purchase by the Royal Dutch/Shell Group, for about £60
million, of a half interest in Montecatini's petrochemical business,
although portfolio investment abroad was also unusually high.
The turnaround in portfolio investment in 1965 and 1966
was quite sharp, but it was not sustained in 1967 and 1968, nor
was the rate of inflow in 1965 and 1966 significantly different
from rates experienced in the early 1960's.
It is difficult, in short, to find strong evidence in the
data that the investment controls resulted in lower net outflows to
NSA countries. Nevertheless, it is quite likely that, in the
absence of controls, the outflows would have been even greater.
Moreover, it is likely that a larger proportion of the direct in-
vestment abroad that did take place was financed from local sources,
thereby mitigating the drain on U.K. reserves.
GERALD FORD LIBRARY
APPENDIX C
-16-
It is even harder to determine the extent to which
controls an short-term flows have reduced the size and volatility
of outflows of resident funds. However, in terms of the overall
usefulness of the controls, two points in particular deserve
mention:
(1) The controls do not apply to nonresidents. Thus, for
example, the existence of a large volume of liquid sterling
liabilities to nonresidents means that very sizable short-term
outflows can take place -- not subject to the controls.
(2) The financial community in London derives a large
part of its international business from transactions in currencies
other than sterling -- notably in dollars. So long as banks switch
only from one foreign currency to another, rather than into or out
of sterling, the controls do not interfere with this portion of their
international business. If this business were conducted more
largely in sterling, resistance to the controls would presumably
be greater.
LIGAREY GERALD B. FORD
Appendix 1)
REGULATIONS ON SHORT-TERM CAPITAL MOVEMENTS:
RECENT TECHNIQUES IN SELECTED INDUSTRIAL COUNTRIES
by
Rodney H. Mills, Jr.
July 24, 1972
FORD i GERALD LIBRARY
CONTENTS
I.
Introduction
1
II. Techniques to Limit Inflows or Encourage Outflows
7
A. Measures Affecting Banks
7
1. Reserve requirements on foreign liabilities
7
2. Special provisions on central bank credit
16
3. Special measures for financing imports
17
4. Swaps between the central bank and
commercial banks
18
5. Limits on banks' net foreign position
24
6. Limits on banks' gross foreign liabilities
29
7. Limits on banks' net foreign-currency
position
29
8. Prohibition or reduction of interest
payments to foreigners
32
9. Negative interest on foreign deposits
35
10. Prohibition on new foreign deposits
36
11. Blocking of foreign funds
36
B. Measures Affecting Nonbanks
38
1. Reserve requirements on foreign liabilities
38
2. Exchange controls
39
C. Measures Affecting Banks and Nonbanks
41
III. Techniques to Limit Outflows
43
A. Measures Affecting Banks
43
1. Limits on banks' net foreign position
43
2. Limits on banks' net foreign-currency
position
47
FORD LIBRARY j GERALD
B. Exchange Controls on Nonbanks
48
REGULATIONS ON SHORT-TERM CAPITAL MOVEMENTS:
RECENT TECHNIQUES IN SELECTED INDUSTRIAL COUNTRIES¹/
I. INTRODUCTION
By the end of the 1950's the external positions of most of
the principal industrial countries were strong enough to allow them
to make considerable progress towards shedding the controls on capi-
tal movements that they had introduced in the 1930's and 1940's to
protect their official reserves. But in the past 15 years almost
every major industrial country has felt it necessary to impose new
regulations on capital movements, in the great majority of cases to
limit net capital inflows rather than outflows. The new measures
(here understood to include modifications of existing regulations as
well) were adopted mainly to facilitate domestic monetary management,
but sometimes for other reasons as well, notably to promote inter-
national monetary cooperation by limiting official reserve accruals.
A characteristic of the new measures is that they have been applied
almost exclusively to short-term capital flows rather than long-term,
and this paper deals systematically only with regulations on short-
term flows.
The new regulations instituted to prevent or moderate short-
term net inflows (a category that encompasses measures to encourage
outflows as well) by and large have been imposed on banks rather than
1/ This paper covers developments since the late 1950's in Belgium,
France, Germany, Italy, Japan, the Netherlands, Sweden, Switzer-
land, and the United Kingdom.
FORD is GERALD LIBRARY
-2-
nonbanks. Capital movements that take place through operations of
banks are less complex than those occurring at the direct instiga-
tion of corporations and other nonbanks, and they involve a far
smaller number of individual participants. Consequently, it is
easier in the case of banks to design regulations that are relatively
simple and that can be put in place quickly, while at the same time
being readily enforceable and fairly equitable to all those directly
involved. It appears that the regulations on banks have been quite
effective in achieving their purpose. But they have not, of course,
eliminated speculative capital inflows. For one thing, regulations
on banks do nothing about speculative flows outside the banking
system, such as shifts in leads and lags in payments for trade and
services. Moreover, monetary authorities have not wanted to keep
banks under permanent tight control, and so have generally taken
action on speculative inflows only after these have already been
set in motion.
This paper discusses, inter alia, eleven types of measures
that have been imposed on banks to prevent or moderate short-term
inflows. Four of these types involve the use of incentives and dis-
incentives to influence bank behavior. They concern themselves with
reserve requirements and access to central bank credit -- two rather
traditional tools of credit control -- as well as with swaps of
foreign currency between commercial banks and the central bank, and with
BERALD FORD CIBRARY
-3-
special measures used in Japan to finance imports. The remaining seven
types of regulations on banks are more "authoritarian," being directives
that limit, prohibit or order certain activities. Of these seven types,
it is analytically useful to distinguish the first three from the second
four. The first three have to do with limits imposed on banks' net or
gross foreign assets and liabilities, or with their net positions in
foreign currencies, and are clearly designed to affect the operations
of the banks themselves. The latter four types prohibit or order cer-
tain banking activities, but their purpose is really to influence
foreign depositors -- specifically, to discourage their placing funds
in the country. These regulations consist of prohibitions on interest
payments to foreigners, prohibitions on the opening of new deposits by
foreigners, application of negative interest on foreign deposits, and
the blocking of funds in foreign-owned accounts.
Still in the context of measures to limit capital inflows,
the measures imposed on nonbanks have been, as noted, far less
numerous than those imposed on banks. With one exception, the measures
on nonbanks have been an integral part of the country's exchange con-
trols. Two countries have used exchange controls to limit certain
types of inflows on a continuing basis; two others have changed con-
trols on the timing of receipts and payments in order to forestall
undesirable shifts in leads and lags. The one measure taken outside
the exchange controls area has been Germany's recently-instituted
reserve requirement on foreign liabilities of nonbanks.
Some countries have prohibited sales of certain assets to
foreigners, a type of measure that applies to both banks and nonbanks.
GERALD FORD LIBRARY
-4-
With regard to techniques to limit short-term net capital
outflows, some measures of this kind have been placed on banks. All
of these regulations have dealt either with limits on banks' net
foreign assets (used in five countries) or limits on banks' net
foreign-currency position. Exchange controls on nonbanks were
abolished prior to the 1960's in some of the major industrial countries,
and in some others have not been effectively used to protect the
balance of payments because there has been no need. The United King-
dom, France (since 1968), Italy and Sweden have used exchange controls
on nonbanks to limit short-term outflows for balance of payments
reasons.
*
*
*
*
*
*
A few words may be appropriate concerning the historical
sequence of these various regulations. Measures to limit inflows
were adopted on an increasingly widespread scale in the period from
1958 to mid-1966. That period was, generally speaking, one of strong
economic expansion in the industrial countries as a whole, and most
of the time monetary authorities were concerned about actual or poten-
tial inflation. To reinforce policies of monetary restraint, Germany,
Italy, France, Switzerland, the Netherlands, Sweden and Japan insti-
tuted new regulations on banks, and the Netherlands and Sweden also
used exchange controls on nonbanks, to limit net capital inflows or
to encourage funds to flow out. In Germany and Italy, the objective
of contributing to international monetary cooperation by reducing
FORD is LIBRARY DERALD
-5-
official dollar holdings provided an additional stimulus for the
encouragement of capital outflows.
After mid-1966 the temporary abatement of inflationary
pressures in Europe led to the abolition or deactivation of many
of these regulations, and when inflationary pressures were renewed
about the end of 1968 there was less extensive use than before of
regulations on capital inflows as a tool of anti-inflationary policy.
One reason for this was the very restrictive monetary policy in the
United States that pulled funds from Europe, via the Euro-dollar
market, in 1968-69. However, Germany retained or revived (some-
times with modifications) all the regulations employed earlier,
partly to discourage speculative inflows generated by expectations of
the revaluation of the mark that eventually materialized in the autumn
of 1969. In Japan, several measures were used in 1969-71 to temper
the size of reserve gains, as much or more because they attracted
international attention to Japan's strong balance of payments posi-
tion as because they interfered with domestic credit policy.
There was a spate of new measures to limit short-term
capital inflows in 1971 in connection with the upheaval in exchange
markets. The floating of the German mark and the Dutch guilder in
May 1971 led to some measures to limit short-term inflows in those
countries and to steps in Belgium and France to head off or terminate
speculative inflows into their currencies. The suspension of the
convertibility of the U.S. dollar into gold or other reserve assets
BERRED FORD LIBRARY
-6-
on August 15, by generating massive flows out of the dollar into a
number of European currencies and the Japanese yen, caused the
authorities in the United Kingdom, Switzerland and Japan to act to
prevent speculative inflows, and prompted additional moves in France
and the Netherlands to the same end.
The measures instituted in the wake of the U.S. action
were motivated by two related and mutually inconsistent considera-
tions. On the one hand, it was feared that enormous reserve increases
would greatly complicate the task of domestic monetary management.
Reserve increases and their domestic monetary impacts could be avoided
by letting the exchange rate float freely. On the other hand, there
was also a reluctance to let exchange rates appreciate "too much"
because of uncertainties about the general exchange rate realignment
that by then was seen to be inevitable. The central banks of the
United Kingdom, Switzerland, and Japan intervened in the exchange
market to hold down the rise in the rate; the French chose to allow
no rise whatever in the franc relative to the dollar for trade and
government transactions, while allowing the franc to float in a
second exchange market for other transactions. (In May 1971, Belgium
had modified its already-existing dual exchange market system so as
to channel all capital flows through a "free" market with a floating
rate.)
Most of the post-August 15 measures were rescinded shortly
after the December 18 Smithsonian meeting which produced a general
KORO is JBRARY QERALD
-7-
exchange rate realignment. But in February and March of 1972, Belgium,
the Netherlands and Japan experienced undesirably large reserve in-
creases and instituted new regulations to limit short-term inflows.
In late June of 1972, following the floating of the pound sterling,
Germany, Japan and Switzerland acted to limit inflows of speculative
funds.
New regulations since the 1950's to prevent short-term
capital outflows, or intensifications of existing controls on outflows,
have made their appearance in three situations. First, the events of
May-June 1968 in France led to extraordinarily large wage increases,
seriously impaired France's international competitiveness, and
caused the reimposition of exchange controls on all outflows of
resident nonbank funds as well as new regulations affecting French
banks. The exchange controls remain (but not the bank regulations)
despite the return to health of France's external position. The
second situation was in 1969 when U.S. banks were borrowing heavily
in the Euro-dollar market and European banks and nonbanks stepped
up their lending in that market to meet part of the increased demand.
At various times in 1969 Italy, Belgium, the Netherlands and Sweden
moved to prevent further net lending abroad by their commercial
banks, or to force a reflow of funds, in order to protect their
official reserves. In the Italian case, an additional objective
was to prevent net foreign lending by banks from tightening domestic
monetary conditions. Finally, the Italian authorities acted in
February 1970 and again in June 1972 to discourage capital outflows
financed by exports of Italian banknotes.
GERALD LIBRARY R. FORD
-8-
II. TECHNIQUES TO LIMIT INFLOWS OR ENCOURAGE OUTFLOWS
A. Measures Affecting Banks
1. Reserve requirements on foreign liabilities
a. Germany. Banks in Germany have been subject to reserve
requirements on their liabilities to foreigners as well as to domestic
residents. The requirements have been used in two ways in order to
influence flows of funds between Germany and other countries. One way
has been to set reserve ratios on foreign liabilities higher than those
on comparable domestic liabilities, to discourage banks from borrowing
abroad. At most times since 1957 German banks have had to maintain
higher average reserve ratios on foreign liabilities than on domestic
liabilities, or else have been subject to an additional marginal
reserve requirement on foreign liabilities but not on domestic lia-
bilities, or both. The other way in which reserve requirements have
been manipulated so as to influence capital flows has been to allow
banks what is known as an "offset right." Since 1961, foreign lia-
bilities have usually been exempted from reserve requirements to the
extent those liabilities were offset by certain types of foreign
assets. The offset right has thus encouraged banks to place funds
abroad.
Average reserve ratios on foreign liabilities were at dis-
criminatory levels (i.e., higher than on comparable domestic
liabilities) from May 1957 through March 1959; from January 1960
through January 1962; and from April 1964 through January 1967.
GERALO R. FORD LIBRARY
-9-
When the economic downturn in Germany after the summer of 1966
eliminated the need for barriers to capital imports, the ratios on
foreign liabilities were lowered to the same levels as on domestic
liabilities as of February 1, 1967. From June 1, 1971 to the date
of this writing, discriminatory average ratios on foreign liabilities
have again been in effect. The differentials with respect to the
ratios on domestic liabilities were widened on July 1, 1972.
Whenever the average reserve ratios have been higher on
foreign than on domestic liabilities, the differentials have been
greatest as regards sight liabilities; but it has been the gap with
respect to time liabilities that has been crucial to the effective-
ness of the regulation as a deterrent to foreign borrowing. German
banks have been prohibited from paying interest on foreign-owned
deposits most of the time since 1960, but they have not been subject
to restrictions on rates payable on short-term loans from banks abroad,
which are treated as time liabilities for reserve requirement purposes.
Time liabilities are those for which the banks have been able actively
to bid, and are thus those with respect to which differential reserve
requirements influence banks' behavior. When discriminatory ratios
have been in effect, the ratios on foreign time liabilities (including
borrowings from foreign banks) have usually been 10 or 11 percentage
points higher than on domestic time liabilities for the large banks.
(In Germany, average reserve ratios rise with bank size.)
GERALD FORD LIBRARY
/ Although foreign-owned demand deposits have been of large size,
they have been kept solely on the initiative of the depositors.
-10-
Marginal reserve requirements on foreign liabilities were
imposed briefly in 1961, and have been applied almost continuously
since December 1968, when a new boom was getting under way in Germany.
By contrast, domestic liabilities have been subject to a marginal
reserve requirement only during July-August 1970. The marginal require-
ments have been additional to, not a substitute for, the average reserve
requirements. The marginal reserve ratio on foreign liabilities was 100
per cent, on all classes of liabilities and banks, from December 1968
through October 1969, in which period the base level from which increases
were measured was moved up twice. After a 6-month hiatus when no marginal
requirement was in force, the ratio was set at the lower level of 30 per
cent, and except during July-August 1970 was maintained at 30 per cent
until March 1972, when the ratio was raised to 40 per cent. A further
rise to 50 per cent occurred July 1, 1972. The base level has been
advanced several times further. At the present time, foreign time liabil-
ities of large banks carry an average reserve ratio of 35 per cent and a
marginal reserve ratio of 50 per cent, while comparable domestic liabilities
are subject only to a 10.7 per cent average reserve ratio.
German reserve requirements do not distinguish between liabilities
in marks and liabilities in foreign currencies; thus, German banks'
borrowing abroad of Euro-dollars or other Euro-currencies have not been
exempted from discriminatory treatment under the reserve requirement
regulations. To have exempted foreign borrowings denominated in foreign
currencies from the reserve requirements would, of course, have totally
SERALD FORD LIBRARY
-11-
undermined efforts to impede capital inflows by the reserve requirement
technique.
The provisions of the offset right were unchanged between
May 1961, when it was first introduced, and the end of December 1966.
In that period, banks were subject to average reserve requirements on
foreign liabilities only to the extent that the latter exceeded banks'
holdings of sight and time deposits in foreign banks and holdings of
foreign money market paper. While the main purpose of the provision
was to encourage "money exports," a question of equity may also have
been involved. The offset right allowed German banks to borrow funds
abroad and relend them abroad without incurring a penalty. Clearly,
this kind of offshore intermediation -- an important function of most
banks that borrow or lend in the Euro-currency markets -- is penalized
if a bank must maintain reserves against liabilities representing funds
that, in effect, do not enter the country to begin with.
The incentive given by the offset right to shift funds abroad
decreased as more funds were shifted in that way. This resulted from
the fact that average reserve ratios were lower on time liabilities than
on sight liabilities, and still lower on savings deposits. Banks
naturally offset eligible foreign assets against those liabilities
incurring the highest reserve ratios, and the additional reserve-reducing
benefit of the offset right declined as assets were offset against
liabilities bearing progressively lower reserve ratios.
GERALD R. FORD LIBRARY
-12-
The offset right was abolished -- temporarily, it turned
out -- on January 1, 1967. It was reintroduced effective January 1,
1969, altered in form to fit with the marginal reserve requirement
that had been imposed the previous month. Foreign liabilities were
exempted from marginal reserve requirements (but not from average
reserve requirements) if the funds were immediately relent abroad.
There have been three subsequent modifications. From August to
December, use of the offset right was restricted to foreign liabilities
denominated in foreign currencies only; this restriction was an attempt
to discourage the formation of speculative foreign-owned mark deposits.
Since August 1969 the provision has not been applicable to interest
arbitrage transactions associated with commercial bank swaps with the
Bundesbank; this restriction was designed to prevent abuse of the swap
facility (discussed on pp. 17-20). And since October 1970 the use of
the offset right has been limited to interest arbitrage transactions
involving only one foreign currency and where the resident bank and
the foreign customer are not affiliated.
b. Japan. Reserve requirements on foreign liabilities of
the Japanese foreign exchange banks were first introduced in June 1962.
One requirement has related to banks' total foreign liabilities. From
June 1962 until very recently, banks had to hold a specified percentage
of their total outstanding foreign liabilities in the form of relatively
liquid foreign exchange assets. This requirement was abolished on June 1,
1972. Effective May 16, 1972, a new requirement was imposed. Under the
GERALD FORD LIBRARY
-13-
new requirement, banks are subject to a marginal reserve ratio only
on their free yen liabilities to foreigners, and this reserve has to
be held in yen at the Bank of Japan.
One purpose of the requirements has been to limit capital
inflows that, if not so limited, might impede the attainment of domestic
monetary objectives. A second purpose of the reserve against total
liabilities was to promote sound bank management, by ensuring that banks
could meet sudden withdrawals of Euro-dollar deposits for foreign banks
better than if no foreign exchange reserve requirement existed.
The foreign currency assets eligible for satisfying the reserve
requirements against total foreign liabilities included foreign banknotes,
other cash items due from foreigners, sight and time deposits with foreign
commercial banks, call loans to foreigners, and short-term bills of
foreign governments. The required reserve ratio was initially 20 per
cent. Between January 1963 and June 1965 the requirement was a mixture:
it consisted of an average reserve requirement against deposits outstand-
ing on a certain base date (20 per cent as of December 1962 and 25 per
cent as of July 1964), together with a marginal reserve requirement (30
per cent) against increases over base-date levels. The requirement
reverted to a straight 25 per cent average requirement in June 1965, the
ratio dropping to 15 per cent in April 1966. The Japanese authorities
did not increase the ratio in the period May-December 1971, believing
that increases in the reserve ratio would be ineffective in stemming
the massive short-term capital inflows of that period.
BERALD FORD LIBRARY
-14-
The marginal reserve requirement against increases in
nonresident free yen liabilities, which is met by yen deposits at
the Bank of Japan, was instituted with an initial ratio of 25 per
cent. On July 1, 1972, after the floating of the pound, the ratio
was doubled to 50 per cent, and the base period was moved up to
May 21-June 20.
C. Switzerland. When efforts to combat inflationary
pressures in Switzerland were intensified in March 1964, one of
several measures adopted was to require banks to choose between
two alternative courses of action with respect to any increases
after January 1, 1964 in their Swiss franc liabilities to non-
residents. Banks could either convert these francs into foreign
currencies and place them abroad, or see them sterilized in a non-
interest-bearing account at the Swiss National Banks, i.e., subjected
to a 100 per cent marginal reserve requirement. The banks of course
chose the former alternative. Since the banks had been prohibited
since 1960 from paying interest on nonresident franc deposits, they
were not in any case bidding for funds in external markets for the
purpose of domestic employment. But the reserve requirement did keep
out of the banks' reserve base inflows of funds that were at the
initiative of foreign depositors, who desired Swiss franc balances,
even though no interest was paid on them, as a refuge or as a specula-
tion on a revaluation. The marginal reserve requirement was removed
in October 1966 when the threat of domestic inflation was receding.
It was used again in 1971, in very different circumstances.
FORD & GERALD LIBRARY
-15-
A new gentlemen's agreement between the Swiss banks and
the Swiss National Bank was made in August 1971 after the suspen-
sion of the convertibility of the dollar. It provided for,
inter alia, a 100 percent marginal reserve requirement on increases
in liabilities to nonresidents (in foreign currencies or Swiss
francs) above the July 31 level. But the reserve requirement did
not apply to the extent that an increase in liabilities was offset
by a rise in a bank's foreign assets in foreign currency (or in
Swiss francs if the funds were to be spent abroad). The banks of
course availed themselves of this privilege, and most of the large
volume of foreign funds that entered Switzerland in the first half
of August 1971 was thus re-exported. (However, Swiss banks' liquid
balances in Swiss francs still remained very large because the
better part of the total early-August inflow of funds from abroad
was repatriation of Swiss-owned funds.) The marginal reserve re-
quirement was tightened in early April 1972 by being given a more
restrictive interpretation, namely, that foreign currency assets
abroad that were covered forward were no longer eligible to meet
the requirement. The new interpretation was designed to soak up
excess bank liquidity (and was accompanied by the imposition of a
marginal reserve requirement on increases in domestic liabilities
over the July 31, 1971 level).
FORD & LIBRARY 976839
-16-
2. Special provisions on central bank credit
a. Germany. When the restrictive posture of German monetary
policy was accentuated in 1964, the Bundesbank announced that, effective
August 1 of that year, it would reduce a bank's rediscount quota by the
amount that its gross nonresident liabilities exceeded the average of
the first half of 1964. Banks had to make increasing use of their re-
discount quotas over the next two years, but the effectiveness of this
penalty provision was greatly blunted by the fact that those banks most
inclined to borrow abroad tended to have the least recourse to rediscount-
ing. The regulation was dropped in June 1967 but was revived in 1969
with narrow applicability. The new version related reductions in
rediscount quotas to increases (over March 1969 levels) in banks'
foreign "borrowing" only in the form of en pension transactions, i.e.,
sales of assets under repurchase agreement (which was escaping reserve
requirements).
b. Japan. To discourage the foreign exchange banks from
importing funds, since June 1970 the Bank of Japan has been granting
these banks special 4-month yen credits, which are outside their
rediscount and loan ceilings, for the purpose of financing imports.
These special credits are extended at the basic discount rate, up to
a maximum percentage of each bank's total financing of imports. The
percentage was initially 15 per cent, but is now 50 per cent. This
arrangement has formed one part of an extensive program known as "yen
shift." To hold down official reserve accruals, since the spring of
FORD
GERALD
LIBRARY
-17-
1969 the Bank of Japan has used this and a variety of other devices
as well to shift a large part of the financing of Japanese imports
from foreign banks and suppliers to Japanese banks, as is discussed
immediately below.
3. Special measures for financing imports (Japan)
The first measure taken to implement the "yen shift" program
concerned Bank of Japan "guidance" to the foreign exchange banks
regarding their domestic liquidity positions. Since April 1969 the
Bank of Japan has allowed banks to reduce their net short-term domestic
assets to levels lower than the Bank would normally permit, if the
difference results from the financing of imports by yen call loans
contracted to repay banks' Euro-dollar or other foreign borrowings,
or by yen loans extended to customers to prepay the latter's import
loans from abroad. The second measure to promote the "yen shift" was
a 3-month operation during October-December 1969. The Bank of Japan
supplied yen funds to the foreign exchange banks at call-money rates
by purchasing government, government-guaranteed, and certain other bonds
under a renewable 3-month repurchase agreement. The proceeds of these
operations, amounting to some $280 million equivalent (at the exchange
rate of the time), had to be used to finance imports, or lent in the
Euro-dollar market via renewable 3-month yen/dollar swaps with the
Foreign Exchange Special Account administered by the Bank of Japan.
The third measure was the special loan facility initiated
in June 1970 and described earlier. At the present time these special
FORD & LIBRARY
-18-
loans approximate $2 billion equivalent (at June 1972 exchange rates).
Finally, since March 1971, the Ministry of Finance has made dollar
deposits with the foreign exchange banks for use by the latter, first
for financing imports (in the months March-May 1971), then for reducing
banks' gross foreign liabilities. Currently these deposits also total
about $2 billion equivalent. The Ministry of Finance earns an interest
rate on these deposits that varies with the U.S. prime rate and the Euro-
dollar deposit rates.
4. Swaps between the central bank and commercial banks
a. Germany. Swaps of dollars against marks between the
Bundesbank and German commercial banks were at many times an important
means by which the Bundesbank has encouraged banks to place funds abroad.
In making a swap facility available to the banks, a primary objective
has been to promote domestic monetary stability by syphoning off excess
liquidity in the banking system. However, Germany has had large balance
of payments surpluses much of the time in the past 15 years, and an
additional consideration in offering swaps to the banks has sometimes
been to promote international monetary cooperation through shifts of
U.S. dollar balances from the Bundesbank to the banks.
The Bundesbank began to offer dollar/mark swaps to the banks
as early as October 1958, doing so on a preferential basis, i.e., charging
a premium on forward marks lower than the market premium. Over the years
the maturities of swaps have ranged from two weeks to six months, the
banks usually being offered a wide choice; the forward mark premium has
BERALD FORD LIBRARY
-19-
of course been varied in the light of market conditions, but has
always had to be lower than the market premium to make the swaps
attractive. However, there have been lengthy periods when the
Bundesbank has not made swaps available. Swaps have not been offered
since September 1969 except on one day, April 1, 1971.
German banks were offered, and took up, a considerable amount
of swaps between October 1958 and late 1962, in which period outstand-
ing swaps were the equivalent of about one-third of the banks' short-
term foreign assets. After the early months of 1962 swaps were
de-emphasized by the Bundesbank, and their outstanding volume fell
to zero by early 1963. Even though German monetary policy became
progressively tighter in 1964-66 swaps were not offered except between
March 1964 and September 1965, and the dollars could be used only to
purchase U.S. Treasury bills.
The Bundesbank resumed offering swaps in November-December
1967, during and just after the sterling crisis that forced a devaluation
of the pound and which witnessed an inflow of speculative funds into
marks. It did so again in March 1968 during the gold crisis that gave
birth to the two-tier gold market, again to encourage the exodus of
speculative funds. Finally, swaps were offered continuously from late
August 1968 to September 24, 1969, on terms that the banks found
attractive and which led them to utilize the facility heavily. This
11-month period saw massive speculative movements into the mark in
November 1968, May 1969, and September 1969, the latter culminating
QERALD FORD LIBRARY
-20-
in the interim floating of the mark and its subsequent revaluation
in October. These inflows complicated the task of monetary manage-
ment particularly since credit demand was rising strongly, and the
purpose of the swaps was to skim funds from the banking system's
reserve base.
It is generally believed, however, that during the periods
of massive speculation on the mark beginning with November 1968 the
swap arrangement led to much smaller net export of funds than their
amount implied. German banks reputedly resold on the exchange market --
in effect, resold to the Bundesbank -- the dollars received from swaps,
and used the related forward sales of dollars to the Bundesbank as
cover against forward purchases of dollars from resident customers,
since they could buy forward dollars in the market for less than the
sale price stipulated by the contract with the Bundesbank. Or, what
comes to the same thing in terms of the banks' net foreign position,
while placing abroad the dollars acquired by swaps they could borrow
abroad, sell the borrowed dollars spot, and repurchase them forward at
a large enough discount to earn them a profit. Such abuses of the swap
facility may, at least in part, explain why the Bundesbank did not offer
swaps during the May 1971 speculative rush into marks that precipitated
the seven-month floating of the currency felt necessary to preserve
domestic monetary autonomy.
b. Italy. Preferential swaps have been used extensively in
Italy where, in November 1959, facilities were set up by which banks
FORD & GERALD LIBRARY
-21-
could use lire to purchase U.S. dollars spot, at the market rate
of exchange, from the UIC (Italian Exchange Office, managed by the
Bank of Italy), and simultaneously resell the dollars forward to
the UIC at the same rate of exchange, i.e., without paying a premium
for forward lire. (Swaps with equivalent spot and forward rates are
called "flat" swaps.) The maturity of the swaps has been kept at two
or three months but the banks have had the privilege of advance repay-
ment. From 1959 until the end of 1964 swaps were continuously available,
and while the Bank of Italy assigned each bank a limit it appears that
banks obtained all the swaps desired.
The main purpose of the swap facility was not to promote
exports of funds but to provide Italian banks with dollars for internal
lending. The banks competed with each other on rates on loans to custo-
mers more vigorously as regards loans in foreign currency than on loans
in lire. To encourage lower interest rates on bank loans, the Bank of
Italy wanted the banks to have all the foreign currency they wished
(consistent with the general tenor of monetary policy). At the same
time the authorities did not want the banks to build up too much foreign
debt in the process; hence the decision to provide the foreign currency
through swaps. However, the dollars that banks acquired by swaps with
the UIC could be placed abroad, and to the extent they were so placed the
swap facility, by requiring no premium on forward lire, encouraged such
placements and a consequent shift of dollar funds from the Bank of Italy
to the banks. Indeed, an additional objective of the swaps in the early
GERALD FORD LIBRARY
-22-
1960's was to reduce Bank of Italy dollar holdings through such
shifts.
Banks' use of the swap facility in part to obtain funds
for external lending (reducing net liabilities by increasing foreign
assets rather than reducing gross liabilities) led the Bank of Italy
to restrict and then terminate the making of swaps (other than roll-
overs of existing swaps). At the end of 1965 economic activity was
still sluggish. Monetary policy was easy, and banks were building up
net foreign assets. To keep funds at home and further ease monetary
conditions, the Bank of Italy restricted the use of "flat" swaps to
those banks that still had net foreign liabilities in foreign currency;
other banks were made to pay a premium on forward lire aligned with the
market premium, except on renewals of old swaps.
New swaps were made prohibitively expensive in February 1969,
when rising rates in the Euro-dollar market were inducing Italian banks
to export funds. For a number of months prior to that time, the banks
did not renew some dollar loans to domestic customers, and also increased
their use of the swap facility, to acquire dollars for placement in the
Euro-dollar market. In February the taking up of additional swaps was
effectively discouraged by raising the forward lira premium to 5 per cent
(except on renewals). The volume of outstanding swaps, which reached a
record high in February 1969, fell sharply in the next few months when
new regulations forced Italian banks to repatriate funds. There has been
little change in the outstanding volume since mid-1969. The abrupt shift
in the swap policy and the forced repatriation of banks' foreign assets
GERALD FORD LIBRARY
-23-
(a measure described later on) were prompted by a desire to protect
the official reserves as well as by domestic considerations.
C. Switzerland. Switzerland has long been a magnet for
funds seeking safety, and on various occasions in the past 11 years
there has been strong speculation on a revaluation of the Swiss franc.
Political and financial disturbances around the world have often sent
waves of funds to Switzerland, obliging the Swiss National Bank (BNS)
to "mop up" excess bank liquidity in one way or another.
On numerous occasions in 1961-67, and more recently in May
1971, the BNS engaged in what amounted to swaps of foreign currency for
Swiss francs with Swiss commercial banks. However, this could be done
only sporadically, since these transactions had to be linked to swaps
between the BNS and other central banks by which the other central bank
had repurchased foreign currency forward. Until very recently the
statutes of the BNS prohibited it from making net forward purchases of
foreign currencies. Thus, when it wished to induce Swiss commercial banks
to employ excess liquidity abroad instead of at home, the BNS could re-
purchase forward foreign currency sold spot to the banks under a swap
arrangement only if it simultaneously sold the foreign currency forward.
Consequently, the BNS could swap out to Swiss banks only foreign exchange
that it in turn had acquired under swaps with central banks and that it
had therefore sold forward to these central banks. Over the period 1961-67
(and in May 1971) the BNS frequently swapped to Swiss commercial banks
dollars that it acquired when the Federal Reserve drew on its swap line
with the BNS; it also swapped out sterling acquired by swaps with the Bank
GERALD R.FORD VIBRARY
-24-
of England in March 1961 and November 1964, and lire acquired by swaps
with the Bank of Italy in March 1964. Now that it is authorized to make
net forward purchases of foreign currency, the BNS could make more regular
use of swaps with Swiss commercial banks in the future.
5. Limits on banks' net foreign position
a. Italy. Controls on net foreign borrowing by banks in
Italy were employed forcefully in the first half of the 1960's to limit
inflows of funds through the banking system, and they had important
effects on domestic credit conditions.
In the summer of 1960 the Bank of Italy moved to limit the
expansion of bank liquidity then occurring because of a balance of
payments surplus. Italian banks (as a whole) had built up sizeable
net foreign liabilities, and to reduce their liquidity the Bank of Italy
directed them to eliminate net foreign liabilities denominated in foreign
currencies by the end of the year. This relatively modest use of this
type of control was followed by more dramatic employment three years
later. The prohibition on net foreign liabilities was lifted in November
1962. Between then and the end of August 1963, Italian banks increased
their total net foreign liabilities very rapidly to help meet soaring
loan demand that was accompanying an inflationary domestic boom. When
it became imperative, in the summer of 1963, to bring demand expansion
in Italy under control, the tool employed was to slow bank credit
expansion by prohibiting banks from increasing their net foreign
FORD CLORARY
-25-
liabilities in foreign currencies above the August 31 levels. The
banks were also asked to reduce these net liabilities if they could;
but no actual reduction was needed to achieve a slowdown in credit
extension since a large balance of payments deficit was already putting
heavy pressure on bank liquidity.
Italian monetary policy turned easy after the economy
slipped into recession in 1964. Banks generally found it profitable
to pay off net foreign liabilities in foreign currency, and (as a
group) did so by September 1965. At the end of that year the Bank
of Italy directed that any bank with net foreign assets in foreign
currency, either then or on any future date, would not be allowed
to shift back into a net liability position. This directive,
issued to strengthen the authorities' control over bank liquidity,
prevented banks (as a group) from pulling in more than a small
amount of funds from abroad in 1967 in response to renewed economic
expansion in Italy. Since then, however, regulation of banks' net
foreign position has not played much of a role as a tool of domestic
credit control, essentially because economic conditions in Italy have
not called for policies of credit restraint; indeed, since mid-1969,
Italy has been plagued by serious underutilization of resources.
The end-1965 directive was superseded by another in late
August 1971, following the U.S. measures of August 15. To prevent
speculative flows of funds through banks, the Italian authorities
EQUA LIBRARY
-26-
instructed the banks to balance their net foreign position by Septem-
ber 15 and to maintain a balanced position thereafter.
b. Netherlands. As part of a policy of monetary restraint,
Dutch banks were prohibited, effective August 1, 1964, from incurring
net foreign liabilities in excess of a small margin of 5 million
guilders. However, this prohibition -- still in force at the present
time -- has been of little practical significance. In August 1964
Dutch banks (as a group) had a large volume of net foreign assets,
which the prohibition on liabilities could not prevent being drawn
down sharply from then until the end of 1967. Subsequently, Dutch banks
built up their net foreign assets again in response to Euro-dollar
market developments, and such assets are still large.
c. Sweden. Banks in Sweden have long been prohibited from
having net foreign liabilities. But the prohibition has been largely
irrelevant to Swedish banking practices at almost all times since
(at least) the early 1960's because Swedish banks (collectively)
have usually had substantial net foreign assets.
d. Belgium. In the spring of 1971, Belgium was experiencing
strong wage-push pressures on prices and it was not clear yet that
excess demand pressures would (as it happened) diminish fairly fast.
Monetary policy remained quite tight, and Belgian banks found it
advantageous to pull in funds from abroad. At the same time, the
current account and nonbank capital movements were already causing
a balance of payments surplus. To prevent undue additions to bank
FORD
GERALD
LIBRARY
-27-
liquidity, in March Belgian banks were requested not to allow their
net foreign position, adjusted by certain additions and exemptions,
to decrease by more than a small amount relative to the position
at the time; "decrease" here means either an increase in net
foreign liabilities or a decrease in net foreign assets. Banks
failing to comply would have their rediscount quotas reduced. In
early May, speculation on a floating or revaluation of the Belgian
franc (associated with that relative to the mark and the guilder)
caused a big increase in banks' franc liabilities to nonresidents
that was not offset by an equivalent rise in banks' foreign assets.
Since this occurred on the initiative of the nonresident depositors
rather than of the Belgian banks, the National Bank of Belgium
chose not to reduce rediscount quotas but to convert the provision
into a 100 per cent marginal reserve requirement, i.e., to require
the banks to deposit with the National Bank the franc equivalent of
the excessive deterioration in the net foreign position. This
regulation was in turn abolished in September 1971, having been
made pointless by the floating of the franc the month before.
Belgium used the same type of control in March 1972 when
speculation against the dollar was causing large reserve gains in
several countries and not insignificant ones in Belgium. The banks
were asked not to allow their net foreign position (excluding
nonresidents' holdings of francs acquired in the financial franc
exchange market) to decrease beyond the March 9 level. This
provision is in force at this time.
BERALD FORD LIBRARY
-28-
e. France. In countries where expectations of currency
appreciation became strong in the summer of 1971, and where the
central bank had not ceased to intervene on the exchange market,
the danger existed that commercial banks might borrow heavily
abroad, or liquidate foreign assets, and offer the proceeds on
the exchange market. The French authorities acted in early August
to prevent such an eventuality, by prohibiting banks in France
from decreasing their net foreign position relative to its August
4 level. This meant that banks with net foreign liabilities on
that date could not increase them and that banks with net foreign
assets were not allowed to run them down. This measure was
rescinded a few days after the December 18, 1971 currency realign-
ment.
f. Japan. The Bank of Japan has created a rather compli-
cated system of controls with reference to both the gross and net
foreign liabilities of the foreign-exchange banks, to their foreign-
currency position, and to parts and combinations thereof One of
the controls on banks' net foreign liabilities is commonly known as
the "yen conversion" control, since it applies to that part of
banks' net foreign liabilities that is denominated in foreign cur-
rencies, i.e., to banks' foreign borrowings of foreign currencies
1/ For any bank the foreign position is given by all assets and
liabilities vis-à-vis nonresidents, including those denominated
in domestic currency. The foreign-currency position is given
by all assets and liabilities in foreign currencies, including
those vis-à-vis domestic residents.
ALD FORD LIBRAR,
-29-
converted into yen on the exchange market. This control, first
instituted in February 1968, places a ceiling on each bank's cumulative
yen conversions as of specified dates. Usually the ceilings have had
to be met twice a month. However, between September 1, 1971 and
December 21, 1971, they were tightened and had to be met each day.
Another control has related to the sum of banks' net Euro-dollar liabil-
ities and gross free yen liabilities, i.e., yen liabilities to foreigners.
Each bank was assigned limits on this sum beginning in July 1964. This
control was removed January 6, 1972.
6. Limits on banks' gross foreign liabilities (Japan)
Japan is the only major industrial country known to have imposed
quantitative limits on banks' gross foreign liabilities. This was done on
August 18, 1971, when the Bank of Japan prohibited the banks from increasing
the sum of their gross foreign liabilities denominated in both foreign
currencies and free yen above the level of that date. On August 27 separate
ceilings were set relating to the free yen liabilities alone that barred
further increases. These controls were lifted soon after the December
1971 exchange rate realignment.
7. Limits on banks' net foreign-currency position
a. France. Until the end of 1966, banks in France were in
principle required to keep a balanced spot position and a balanced forward
position in every foreign currency, the positions being defined to include
positions with domestic as well as foreign residents. The purpose of the
regulation was to prevent banks from borrowing abroad for internal lending,
GERALD FORD LIBRARY
-30-
or lending abroad funds raised internally, operations the French
authorities looked on as troublesome for monetary management. However,
banks were allowed to take an open spot position (provided they covered
forward, which they would normally do anyway) at the initiative of a
foreign correspondent bank wishing to borrow or lend in France. Because
of the difficulty in identifying initiative, the regulation often proved
unenforceable and thus did not always prevent French banks from moving
funds. This could be accomplished by swap transactions. If a French
bank wished to borrow abroad it could sell dollars spot to its foreign
correspondent for francs, which the correspondent acquired by selling
the dollars on the Paris exchange market, and repurchase the dollars
forward at a rate attractive to the correspondent. When such operations
were extensive they drove the spot dollar exchange rate to its lower
limit and the Bank of France became the supplier of the needed francs.
The regulation was abolished at the end of 1966, a month before exchange
controls on nonbanks were largely done away with.
b. Sweden. Banks in Sweden have not been allowed to let spot assets
in any foreign currency fall short of spot liabilities in that currency,
except to a small extent where a spot liability is covered by a forward
purchase.
C. Japan. The Japanese foreign-exchange banks have been subject
to a control known as "position guidance" that sets maximum limits for
each bank on its overall net position in foreign currency. The overall
net position is the sum of the spot position and the forward position,
and in Japan is often called the "net overbought" or "net oversold"
GERALD FORD LIBRARY
-31-
position depending on whether the position is positive or negative.
It is clear that position guidance cannot prevent banks from being
net borrowers or net lenders of a foreign currency if the banks cover
forward their net spot position in that currency, since the spot and
forward positions together give an overall net position of zero. Posi-
tion guidance can limit net borrowing or lending of a foreign currency
where the spot position is not covered forward. But the primary purpose
of "position guidance" has been to promote sound banking practices.
d. United Kingdom. Soon after the U.S. measures of August 15,
1971, the British authorities took several actions to prevent capital
inflows, and one of these concerned the foreign-currency position of
banks. Effective August 31, banks in the United Kingdom were prohibited
from switching into sterling from foreign currencies on a covered basis,
and since they were already enjoined from doing so on an uncovered basis
this meant that switching was no longer possible. Moreover, existing net
GERALD FORD LIBRARY
liabilities in foreign currencies could be continued only until maturity.
There was an interesting difference between these controls
and the new controls imposed earlier in August in France, which prohibited
any decrease in the banks' net foreign position. Since the French measure
related to the foreign position, it took account of the banks' position
in francs (as well as in foreign currencies) vis-à-vis nonresidents. The
British regulation, which related to the banks' foreign-currency position,
ignored their external assets and liabilities in sterling. Consequently,
if expectations of a rise in the exchange value of the franc motivated
nonresidents to increase their franc deposits with French banks, or to
-32-
pay off loans from them, the banks had to offset the resulting rise
in their liquidity by acquiring foreign-currency assets abroad. The
British regulation, by contrast, made no effort to prevent upward
pressure on the exchange rate or a rise in bank liquidity stemming
from analogous actions by nonresidents with respect to sterling
deposits and loans.
8. Prohibition or reduction of interest payments to foreigners
a. Germany. Although banks may be prevented or discouraged
from borrowing abroad, short-term funds may still flow into a country's
banking system at the initiative of foreign depositors. To discourage
such inflows, in June 1960 the Bundesbank prohibited German banks from
paying interest on sight or time deposits of nonresidents except for
savings deposits of individuals. The prohibition extended to foreign
currency deposits as well as mark deposits. (German banks could still
pay interest on foreign currency funds in the form of "borrowings" from
foreign banks as opposed to "deposits.") To reinforce this regulation,
banks were also prohibited from selling domestic securities to non-
residents under repurchase agreements and from selling money market
paper to nonresidents. The interest ban was partially revoked between
May 1962 and March 1964 (when interest could be paid on some time deposits
of not less than 30 days), but it was resumed with its former intensity
in March 1964 when monetary policy was tightened. The exemption for
savings deposits was ended in November 1968. At the end of 1969, following
the October 1969 revaluation of the mark and a massive exodus of speculative
funds, the interest ban was taken off. Subsequently, however, the
FORD & LIBRARY GERALD
-33-
authorities saw fit to reimpose it on May 9, 1971, when the mark was
floated; savings accounts up to DM 50,000 were exempted. The prohibition
remains in effect at this writing.
b. Switzerland. In August 1960, after the Congo crisis caused
a heavy flow of funds to Switzerland, the Swiss National Bank entered into
a gentlemen's agreement with Swiss commercial banks, the main provision
of which was an undertaking by the banks party to the agreement not to
pay interest on Swiss francs deposited by foreigners since the previous
June 30. In addition, banks agreed not to accept foreign Swiss franc
deposits with a maturity of less than 30 days, agreed to apply a service
charge each quarter, at an annual rate of 1 per cent, on deposits with
a maturity of under 60 days, and pledged themselves to do what they could
to keep foreign funds from being invested in Swiss securities or real
estate. The interest ban did not apply to foreign-currency deposits,
which Swiss banks could thus continue to attract.
This agreement, made initially for one year only, was renewed
each year until 1964 except for the elimination of the service charge
feature in 1963. A new agreement was made, effective May 1, 1964, that
was more efficacious than the old one because it was binding on all banks.
The new agreement prevented banks from paying interest on foreign-owned
Swiss francs deposited with them after December 31, 1963. It did allow
interest to be paid on funds that had come in up to that time; but this
relaxation could not have much effect in keeping funds in Switzerland
since their presence there showed them to be interest-insensitive to
begin with.
BERALD FORD LIBRARY
-34-
The 1964 agreement remained in force until March 1967,
when it was allowed to lapse because Swiss economic conditions no
longer called for credit restraint.
A speculative rush into Swiss francs in the first half
of August, 1971 led to a new gentlemen's agreement between the
Swiss National Bank and Swiss commercial banks which, inter alia,
prohibited payment of interest on all new Swiss franc balances,
or additions to old balances, received from nonresidents since
the previous July 31. The agreement became effective August 16,
earlier than originally planned, in view of the U.S. action on
gold on August 15. It remains in effect at this writing.
c. France. Beginning in April 1963, the French authori-
ties prohibited banks from paying interest on nonresident franc
balances in order to reinforce the stabilization program launched
a few weeks earlier. This prohibition continued until November 1966.
Speculation on a possible rise in the exchange value of
the French franc broke out in July, 1971. One of the measures
taken to offset or discourage capital inflows was a voluntary agree-
ment by French banks, early in August, to forego paying interest
on nonresident franc balances of up to three months maturity,
effective August 17. This agreement was superseded on August 13
by an instruction from the authorities to the banks containing the
same provisions. This directive was abolished in late December,
after the currency realignment.
FORD & LIBRARY 038870
-35-
d. Netherlands. After the floating of the Dutch guilder
in May 1971, two measures were adopted to limit short-term capital
inflows and hold back the rise in the exchange rate. One of these
was a prohibition on interest payments on foreign-owned guilder
sight deposits. This ban was lifted after the Smithsonian meeting
in December, but was reimposed on March 9, 1972 when speculation
against the dollar was leading to very large reserve gains in the
Netherlands.
e. United Kingdom. Effective August 31, 1971, banks in
the United Kingdom were prohibited from paying interest on sterling
deposits of nonresidents of the sterling area (existing time deposits
of course being exempted from this.) This prohibition was removed
immediately after the December 18 exchange rate alignment.
f. Japan. In March 1971 the Japanese authorities agreed
to a reduction in the interest rates paid on foreigners' free yen
deposits, in an effort to hold down reserve gains.
9. Negative interest on foreign deposits (Switzerland)
As noted above, from 1961 to 1964 Swiss banks applied a
negative interest rate on foreign deposits in Swiss francs. This
type of discouragement of foreign deposits was used again in 1972.
On July 4, 1972 the Swiss Federal Council, under a law enacted in
October 1971, ordered Swiss banks to apply a negative interest rate
of 2 per cent per quarter on increments to foreign Swiss franc
FORD & GERALD LIBRARY
-36-
balances above the levels of June 30. This action was taken in
the wake of the floating of the pound sterling, to head off inflows
of speculative funds.
10. Prohibition on new foreign bank deposits
a. Germany. During the November 1968 exchange crisis,
efforts of the German authorities to stem speculative inflows into
marks included prohibiting German banks in principle from accepting
additional deposits from foreigners (as of November 25) and from
obtaining new foreign loans. The prohibition was ended in February
1969 after the speculative inflow had been reversed.
b. Netherlands. The heavy reserve gains in March 1972
that prompted the Dutch authorities to reimpose the ban on interest
payments on foreign sight deposits in guilders was accompanied by
more drastic action concerning time deposits. As of March 9, banks
were forbidden from opening new guilder time deposits for foreigners
and from renewing existing deposits at maturity. This measure is
still in effect.
11. Blocking of foreign funds
a. Switzerland. Stronger disincentives than nonpayment
of interest were applied to inflows of nonresident funds during the
long international monetary crisis of 1971, but they were rare. In
late August, the three largest commercial banks in Switzerland --
which do almost the entirety of the exchange market business --
agreed with the Swiss National Bank to place new or additional
BERALD FORD LIBRARY
-37-
Swiss franc deposits from nonresidents into accounts that would be
blocked for three months, if the funds were deemed to be specula-
tive and if the francs were acquired when the Swiss franc exchange
rate for the dollar was approximately 3.1 per cent or more above
parity. A new parity had been set when the franc was revalued by
7.1 per cent the previous May 9, but the franc was then a floating
currency for practical purposes. Some incoming funds were auto-
matically exempted: $2 million equivalent per depositor per day,
the exemption dropping to $1 million if the franc appreciated to
about 3.4 per cent or more above parity.
Early in December this agreement was terminated, but was
almost immediately replaced by a modified version of the old one.
There were two changes: the blocking would occur irrespective of
the exchange rate, and the automatic exemption was made uniform at
$1 million equivalent per customer per day. [These agreements
indicate quite clearly that the Swiss National Bank would, in the
absence of the agreements, have intervened in the exchange market,
or taken some other measure, to keep the franc from appreciating
above a certain level. After the December 18 Smithsonian meeting
the second agreement was terminated.
b. France. Towards the close of the 1971 international
monetary crisis, France acted to initiate an actual outflow of non-
resident deposits. It was announced December 3 that, beginning
GERALD FORD VIBRARY
-38-
December 10, nonresident balances in French banks would (with
certain exceptions) be usable only to make payments within the
franc area, and that such balances in excess of November 30 levels
would be subject to possible blocking and penalties. Reports
suggest that the announcement had little effect in inducing an
outflow. The measure was abolished after December 18.
B. Measures Affecting Nonbanks
1. Reserve requirements on foreign liabilities (Germany)
Although a number of industrial countries have used various
techniques to limit foreign borrowing by nonbank institutions, only
Germany has used reserve requirements for that purpose. In December
1971 the German Parliament passed the so-called Bardepot Law giving
the Government authority to have the Bundesbank impose minimum
reserve requirements, up to 50 per cent, against foreign loans con-
tracted by German companies. The maintenance of relatively tight
monetary conditions in Germany in 1969-71 induced German forms to
borrow heavily in the Euro-currency loan market and contributed
importantly to German balance of payments surpluses, which both
hampered the conduct of monetary policy in Germany and made for
greater imbalances in world payments. Even though economic activity
had leveled off a long time before, German monetary policy still
remained quite restrictive at the start of 1972. To curb enterprises'
GERALD FORD LIBRARY
-39-
foreign borrowing, effective March 1 the Bardepot Law was in-
voked, with a reserve ratio of 40 per cent against foreign loans
not already outstanding on January 1. The ratio was raised June 30, 1972
to 50 per cent, the maximum allowed under the Law.
2. Exchange controls
a. Netherlands. Inflows of short-term nonbank funds have
been subject to exchange controls imposed to protect domestic mone-
tary autonomy. Nonbank residents generally have not been allowed to
obtain loans from foreign banks. While suppliers' credit from
foreign exporters have not been subject to control, credits from
other foreign nonbanks in excess of certain limits have been allowed
only when consistent with monetary policy objectives.
b. Sweden. Sweden is the other major industrial country
that for a long time has controlled short-term nonbank funds for
monetary policy reasons. In general, short-term foreign borrowing
by Swedish nonbanks has been prohibited except for commercial credits
received by importers, advance payments received by exporters, and
loans to foreign-owned companies in Sweden from parent companies
abroad.
C. France. Most countries made no effort to control in-
flows of nonbank funds in 1971. France, however, took such a step
on August 21 when delays in payments for imports other than equipment
goods were limited to 90 days from customs clearance, there having
been no limit previously. Affected imports that had cleared customs
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at any time prior to June 21, and which had not yet been paid for,
had to be settled by September 21. This enforced a sizeable
one-time outflow of short-term capital in September.
d. Japan. During the 1971 international monetary crisis,
the Japanese took action concerning export receipts. To head off a
capital inflow in the form of a lengthening of leads in the collection
and repatriation of export receipts, effective September 1 Japanese
banks were prohibited from purchasing bills related to export pre-
payment without specific approval. After the revaluation of the
yen on December 18 this prohibition was removed. It was reim-
posed on February 25, 1972, when the Bank of Japan was again gaining
reserves.
e. Italy. In early December 1971, Italy instituted a
sweeping measure to limit speculative capital flows. Conversions
of foreign currency into lire (and vice versa) were limited to those
necessary for "normal" settlements of trade, services, and capital
movements. Italian banks were authorized to refuse to make conver-
sions not meeting those standards. The measure was withdrawn after
December 18.
f. United Kingdom. On January 12, 1971, residents were
barred from borrowing foreign currency abroad for conversion into
sterling for use in the United Kingdom or to finance current payments
to foreigners, unless the loans were for more than five years.
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Residents were also prohibited in principle from borrowing sterling
from residents of countries not in the sterling area. These actions
were taken to reinforce domestic credit restraint and to prevent
official reserves from being increased by volatile short-term funds.
C. Measures Affecting Banks and Nonbanks
a. Netherlands. On June 1, 1971 --- three weeks after
the guilder was floated -- the Dutch authorities took additional
action to hold down the appreciation of the exchange rate. Residents
were barred from selling Dutch Treasury bills and guilder-de-
nominated bankers acceptances to foreigners. This measure was
probably rescinded after the December Smithsonian meeting.
b. United Kingdom. After the U.S. measures of August 15,
1971, the United Kingdom prohibited residents from selling to non-
residents of the sterling area almost any type of short-term
financial asset denominated in sterling, the main exception being
bank deposits (on which, however, no interest could be paid). An
initial list of proscribed assets issued on August 31 was lengthened
on October 7; these assets included deposits with trustee savings
banks, building societies, local authorities and hire purchase firms,
certificates of deposit, Treasury bills, acceptances, commercial
bills, and promissory notes. Government and Government-guaranteed
bonds and bonds of local authorities were also included. The
measure was rescinded immediately after December 18.
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C. Germany and Switzerland. While formally outside the
scope of this paper, mention may be made of measures taken in
Germany and Switzerland in 1972, after the floating of the
pound sterling, to prevent inflows of long-term capital. In
Germany, effective June 29 residents were prohibited from selling
fixed-income securities to foreigners without Bundesbank approval.
In Switzerland, effective June 26 residents were barred from
selling Swiss securities (including equities), and foreign securities
denominated in Swiss francs, to foreigners, and were also pro-
hibited from selling real estate to foreigners not already residing
in Switzerland.
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III. TECHNIQUES TO LIMIT OUTFLOWS
A. Measures Affecting Banks
1. Limits on banks' net foreign position
a. France. On January 31, 1967 France abolished almost
all exchange controls, including all controls on short-term capital
flows. The grave social disturbances in France in May-June 1968
caused the reimposition of exchange controls on all outflows of
resident capital, both long-term and short-term (as well as on
French travel expenditures abroad).
In May 1968, banks in France were instructed not to increase
their net assets in foreign currencies, including the position with
residents, as a means of protecting the reserves. After this control
was ended in September there was a build-up of such net assets, and
in the wake of the November exchange market crisis the banks were
told to reduce their net assets in foreign currencies back to the
September 3 level by the end of the year. Furthermore, they were
instructed to reduce their franc claims on nonresidents to the
September 3 level by January 31, 1969; these had grown as nonresidents
borrowed francs and converted them to other currencies in expectation
of a possible profit from devaluation. More drastic action followed
in January when banks with net liabilities in foreign currencies
vis-à-vis nonresidents were told not to reduce them, while banks
with net assets in foreign currencies vis-à-vis nonresidents were
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told in principle to liquidate them by the end of the month and
to deposit any remainder with the Bank of France in installments
over a 3-month period.
The devaluation of the franc in August 1969 helped
to usher in renewed French payments surpluses. Consequently,
the banks' foreign-currency deposit requirement was reduced by
half in April 1970 and abolished in July of that year.
b. Italy. The acceleration of U.S. banks' borrowing
of Euro-dollars in the first quarter of 1969 accentuated outflows
of bank and nonbank funds from Italy that had already become quite
large in the preceding year. At the same time, changes in the
taxation of dividends in Italy also served to swell the volume
of capital outflows. Substantial reserve losses in the first quarter
prompted the Bank of Italy to instruct the banks, late in March,
to eliminate all net foreign asset positions by June 30. The
position referred to here was the overall net foreign asset
position, i.e., inclusive of the position vis-à-vis nonresidents
in lire, not just in foreign currencies (as was the case concerning
the earlier directives on net foreign liabilities). The inclusion of
the lira position somewhat softened the measure's impact, since the
banks had net foreign liabilities in lire. Even so, a large amount
of funds was involved: the banks' net foreign assets at the end of
March totaled about $750 million. Banks eliminated net asset positions
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partly by increasing their gross foreign liabilities and partly
by repatriating gross assets and using the foreign currencies to
pay off swaps with the UIC, the official reserves being bolstered
either way. As earlier remarked, it was also the desire of the
Italian authorities that tightening conditions in the Euro-dollar
and foreign money markets not hamper their efforts to promote fuller
utilization of resources in Italy, and this consideration was an
additional -- perhaps even co-equal -- motivation for the action
taken. The general prohibition on net foreign assets remains
in force -- with certain assets being exempt from the requirement --
despite Italy's renewed balance of payments surpluses since 1970.
C. Belgium. Movements of bank and nonbank funds from
Belgium into the Euro-dollar market resulted in substantial declines
in reserves of the National Bank of Belgium in the second half of
1968 and the first quarter of 1969. Although the size of the
reserves was large in relation to the rate of deficit in the balance
of payments, the uncertainty as to how much further rise would
occur in Euro-dollar rates led to action to protect the reserves.
During 1968 and the first quarter of 1969 banks in Belgium had
placed a large amount of funds in the Euro-dollar market that they
had purchased in the Belgian official exchange market, whereas in
principle their foreign currency assets acquired through that market
were not supposed to exceed the level of working balances needed to
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implement the transactions of their customers. Accordingly, in
early April the banks were instructed to reduce the sum of their
foreign currency assets acquired through the official exchange
market and their Belgian franc loans to nonresidents to specified
maximum levels by June 30, the ceilings varying from bank to bank
in relation to the volume of each bank's exchange market activity.
The allowed ceilings totaled about $180 million less than the
outstanding levels of the affected assets at the time. But as it
turned out, the benefit of this measure to the official reserves
was almost entirely offset by banks' increased holdings of foreign
currency acquired through the free exchange market.
When the devaluation of the French franc on August 11, 1969
caused speculation against the Belgian franc, new ceilings were set
on the sum of banks' holdings of foreign currency acquired in the
official market and on their Belgian franc loans to nonresidents,
equal to the actual August 14 levels. Later, on October 1, these
ceilings were lowered further, and separate ceilings set for the
foreign currency assets and the loans. The ceilings remained in
force until November 1971, although there was no evident need for
them; after early 1970 market forces in fact induced the banks
continuously to build up net foreign liabilities rather than assets.
d. Netherlands. The Netherlands Bank incurred a con-
siderable decline in reserves in the first half of 1969. Although
the loss was almost entirely the result of a build-up of net Euro-
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dollar assets by Dutch banks rather than of a balance of payments
deficit, some action to protect the reserves was felt necessary.
In early July the banks were instructed to ensure that the average
level of their net foreign assets in July-December be 10 per cent
below the May 31 level or -- at bank option -- 10 per cent below
the average of the March 31 and April 30 levels. Unlike the Italian
and Belgian actions, this directive was, for the most part, meant
only to prevent further reserve losses, rather than recoup earlier
ones as well. An improvement in the Netherlands' official reserve
position after the October 1969 revaluation of the German mark led
the authorities to liberalize the regulation in November, by per-
mitting net foreign assets to rise to 125 per cent of the base
level. It would appear that the regulation has since been rescinded,
because banks' net foreign assets have increased several fold since
1969.
e. Sweden. Informal limits were placed on the foreign
currency balances of the larger commercial banks at the end of 1968.
Because of a deterioration of the Swedish balance of payments,
formal limits on their net foreign assets were imposed in August
and September 1969. These limits have been maintained since.
2. Limits on banks' net foreign-currency position (United Kingdom)
Banks in the United Kingdom are restricted as concerns
the amount of any net assets in foreign currencies they may hold.
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The Bank of England assigns one limit on each bank's net spot
assets in foreign currencies that are covered forward, and a
second limit on the bank's total net assets in foreign currencies,
spot and forward combined. These limits were reduced in the
mid-1960's when balance of payments deficits were putting pressure
on the official reserves, and since then they have been very
small. However, the limits on net spot assets covered forward
were doubled in September 1971.
B. Exchange Controls on Nonbanks
For many years Germany and Switzerland have imposed no
exchange controls on their nonbank residents, while in Belgium
the only significant control on outflows of short-term nonbank funds
has been a limitation on advance payments for imports. The maximum
allowed period by which payments could precede imports in Belgium
was reduced from the usual three months to one month in August 1969,
when the franc was under speculative attack, and then lengthened
to three months again in June 1970.
At the other extreme, the United Kingdom, Italy, Sweden,
and Japan continue to require approval for all or nearly all exports
of short-term nonbank funds. The general practice in those countries
is to allow freely only those outflows that are necessary for
normal business operations, such as loans to foreign subsidiaries of
domestic companies, suppliers' credits to finance exports, and
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advance payments for imports, the latter two of which must accord
with standard practices in the particular trade, or fall within
fixed limits, as concerns the time period involved. Regulations
in the United Kingdom specifically prohibit switching out of
sterling for interest arbitrage purposes. For Britain the retention
of controls reflects the belief that the balance of payments is
not strong enough to allow their removal, while for Sweden the
prevalence of exchange controls manifests a basic predilection
for controls as an economic way of life. The Japanese controls
contrast with the recent inordinate strength of Japan's external
position. But they have been applied with increasing liberality
in the past year, and at present do not prevent any significant
amount of capital outflow.
In Italy, the retention of controls on capital outflows
appears to be motivated in good part by political considerations.
In any case, the controls have been widely evaded in the past de-
cade by capital outflows financed by illegal exports of Italian
banknotes (almost entirely to Switzerland). The authorities
have usually tolerated this illegal capital export, but on two
occasions have taken steps to reduce it. In February 1970, when
tax and political developments motivated increased outflows of
Italian capital, the procedures for crediting foreign banks for
remittances of Italian banknotes were changed in such a way as
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to increase the risks involved in this form of capital export,
and to reduce sharply the magnitude of these operations. New action
was taken in late June 1972, after the floating of the pound
brought pressure on the lira. On June 28 the Italian Exchange
Office directed that foreign banks could no longer convert into
foreign currency the lire credited to their accounts for remittances
of banknotes. This measure was expected to result in a depreciation
of Italian banknotes in foreign markets, and discouragement of
their export.
Although the Netherlands imposes exchange controls on
some forms of short-term capital outflows, it does so for monetary
policy reasons rather then to protect the balance of payments,
ostensibly in the belief that return flows of funds that left the
country earlier might turn out to be monetarily troublesome.
These are no restrictions on suppliers' credits or advance payments
for imports, export proceeds need not be surrendered, and since
October 1967 all residents have been free to keep accounts with
foreign banks. But nonbank residents are not free to hold foreign
Treasury bills or other short-term money market instruments.
In France, all types of outflows of short-term nonbank
capital were resubjected to exchange controls in May 1968. Limitations
on advance payments for imports were an important control on
short-term outflows, as were also limitations on delays in the
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collection and repatriation of export receipts. All the exchange
controls imposed in May were lifted on September 4 but had to be
reimposed on November 25 when the franc came under intense
speculative pressure. Despite the elimination of balance of
payments deficits after the devaluation of the franc in 1969
there has been very little liberalization of the controls on out-
flows of short-term nonbank funds. In particular, the continuation
of severe limitations on advance payments of imports, along with
unchanged regulations limiting both the maturity of supplier credits
on exports and delays in the repatriation and surrender of export
proceeds, reduce the scope for potential capital outflows in the
form of adverse shifts in leads and lags.
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