Ask the Scholar
Document scope · 1 page
Scholar
Ask about this object, its catalog metadata, its source description, or the page inventory.
For page-specific OCR and visual context, open one of the page chats.
Scholar Source Context
Document identity
localId
324801950
label
Swap Arrangements - General, 1970-75 (2)
core
doc
dtoType
document
citationUrl
pageCount
1
Source metadata
id
324801950
contentType
document
title
Swap Arrangements - General, 1970-75 (2)
citationUrl
collections
Arthur F. Burns Papers
Federal Reserve Board Subject Files
subjects
Foreign exchange
thumbnailUrl
largeImageUrl
imageCount
1
hasImages
yes
source
import
hasTranscription
no
Source extras
naId
324801950
coverageEndDate
logicalDate
1976-12-31
month
12
year
1976
coverageStartDate
day
1
logicalDate
1970-12-01
month
12
year
1970
levelOfDescription
fileUnit
recordType
description
ocrSource
nara-archive
Single page context
seq
1
pageIndex
0
type
document
mediaId
40aa4215fc29a86e
ocrText
The original documents are located in Box B98, folder "Swap Arrangements - General,
1970-75 (2)" 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States of America his copyrights in all of his unpublished writings in National Archives collections.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--F.R.
Date: January 9, 1971
To: Chairman Burns, Vice Chairman Hayes
Subject: Mechanics of
and Governor Robertson
present and proposed swap
Federal Open Market Committee
procedures
From: David E. Bodner
This memorandum sets forth as simply as possible the comparative
mechanics of the present and proposed swap procedures. Examples are presented
for each of the two principal ways in which the United States obtains foreign
currency to repay swap drawings: through a market reversal (Table 1), and
through a United States Treasury International Monetary Fund drawing
(Table 2)
System Swap Drawing
(Steps 1-3, and Step 9, Table 1, or Step 8, Table 2)
Both examples begin with the purchase by the Netherlands Bank- of
dollars from the exchange market when the dollar has reached the Bank's
lower intervention point (Step 1). This is followed by a Sytem drawing
of guilders, at the same rate, under its swap arrangement with the Netherlands
Bank (Step 2), and System use of these guilders to purchase from the Netherlands
Bank, again at the same rate, an amount of dollars equal to the initial
Netherlands Bank purchase (Step 3). Under the swap arrangements, the
United States drawing, unless renewed, is to be repaid in three months
using the same rate of exchange at which it was contracted (the final step
1/ The memorandum is most easily understood if the tables are
detached so they can be read in conjunction with the text.
FORD is LIBRARY 076835
2/ Used as a proxy for any bank in the swap network with which
the System might negotiate modification of current procedures.
-2-
in both examples). Note that these steps are identical under both current
and proposed procedures. The new proposal makes no change in the funda-
mental operation of the swap mechanism.
These arrangements protect the dollar swap proceeds of the Nether-
lands Bank from loss in the event of a devaluation of the dollar, since
it has the forward contract to sell dollars to the System in repayment
of the swap (Step 9) at the established dollar/guilder rate. These arrange-
ments also provide the Netherlands with an interest return on its dollar
proceeds based on the United States Treasury bill rate, or about the same
return it would have earned had it held the dollars uncovered.
Should the guilder be revalued during the term of the drawing, the
arrangements require the Netherlands to sell the System guilders against
dollars at the pre-revaluation rate.
The System may acquire the guilders for swap repayment in two
principal ways.
First case: Market Reversal (Table 1)
If the dollar spot rate rises in the Netherlands market, the Nether-
lands Bank may sell dollars for guilders in the exchange market to moderate
the rate movement. As illustrated in Table 1, assume that the dollar
strengthens and the Netherlands Bank sells $50 million at a rate of 3.60
guilders to the dollar (Step 4). Under current procedures, the Nether-
lands Bank may then agree to sell guilders to the System (Step 5)
at the same rate and in the same amount as its dollar sale to
the market. (Thus the Netherlands Bank repurchases from the
System the dollars it sells to the market.) These procedures may be
FORD i LIBRARY 076839
-3-
repeated if the dollar strengthens further. This is shown in Steps 6
and 7 as another $50 million transaction, this time at a rate of 3.62
guilders/dollar.
At this point the System has acquired $100 million equivalent
of guilders, enough to repay the swap drawing, and it does so (Step 9).
As a result of this series of transactions, the Netherlands Bank
is left without gain or loss, while the System is left with a profit.
The System profit arises because its purchases of guilders from the
Netherlands Bank in Steps 5 and 7 (corresponding to that bank's trans-
actions with the market in Steps 4 and 6) were at better rates for the
dollar than the original spot sale of the swap proceeds (Step 3).
The proposed procedures (Table 1 B) would modify the scenario
outlined above by adding a new forward contract to current swap arrange-
ments as an alternative way for the System to acquire the guilders ultimately
required to repay the swap. This new contract, made at the same time
as the original swap, would provide for the sale by the Netherlands Bank
to the System of the guilders needed for the swap repayment at the same
rate as the original swap and spot sale. This new contract (Step 8) could
replace the spot transactions shown as Steps 5 and 7. With this change,
System transactions with the Netherlands Bank would all be made at the
same rate, and neither party would have a net profit or loss from swap
associated transactions. Thus, in essence, instead of acquiring cover
1/ The Netherlands Bank, however, would have a profit in guilders
(not shown in the example) on its market transactions, for it sells
359.25 million guilders in Step 1, buys 180 million guilders in Step 4, and
buys 181 million guilders in Step 6 for a net gain of 1.75 million guilders
and no dollar loss. This is precisely the profit that the System earns
under current procedures (see Table 1 A).
GERALD FORD FIBRARY
-4-
for its swap through a series of spot transactions at various rates, the
System would acquire the cover through a single forward transaction.
The addition of this new forward contract, however, would in and
of itself remove the protection against possible dollar devaluation given
the Netherlands Bank under current procedures. With the new forward
contract, the Netherlands Bank must sell the System the guilders needed
for repayment at the same rate as that of the swap. If there were a
dollar devaluation, the Netherlands Bank would thus find that it had lost
the protection of having a zero net dollar position, that is, its dollar
holdings equal the amount to be repaid under the swap, because the new
forward contract requires that it buy additional dollars from the System
at the pre-devaluation rate. Thus, as indicated in my December memoran-
dum, the whole rationale of the swap would be negated. For this reason,
it would be necessary to make the new forward contract conditional upon
there being no devaluation of the dollar. In addition, the System has been
asked to agree that a formal suspension of gold sales by the United States
Treasury, without an official change in the price of gold, would also
result in a cancellation of the new forward contract The exercise of
this cancellation clause would restore the situation to exactly what it is
under present arrangements and thus undertakes no new commitments on
1/ The position changes of the Netherlands Bank given by Steps 1, 2,
3, and 9 in Table 1, column A, sum to zero. If the new forward contract
(Step 8) is included, as under the proposed procedures, the sum is +100
(column B).
2/ The reference to suspension of gold sales would be handled through
a separate letter and would not be incorporated in each swap drawing cable.
The proposed language for this reference has been cleared with the Treasury.
GERALD FORD LIBRARY
-5-
the part of the System. That is, the System would be subject to any
loss arising out of having swap drawings outstanding at a time of
devaluation of the dollar. Moreover, the existing revaluation clauses
in swap agreements would be unaffected by the proposed change and
would remain operative in the event of cancellation of the new forward
contract.
The new forward contract would be in the form of an option to
buy up to the amount of the swap drawing, thus leaving the System the
possibility of acquiring through other transactions, at market rates,
currencies needed to repay the swap drawing, in line with current pro-
cedures. Thus in the case of a market reversal, the System would not
be bound to exercise the new forward contract for any particular amount,
but could use it to cover only that portion of the outstanding swap that
had not been liquidated through normal operations at rates advantageous
to the System. This would leave open the possibility of a System profit,
while guaranteeing that the System would never have to purchase the
needed currency at rates involving it in a loss. It is possible--even
likely in the case of some countries--that the proportion of a swap
drawing to be covered through market transactions and that through
exercise of the new contract would be a subject for ad hoc agreement.
Second case: Drawing from IMF (Table 2)
If the System cannot obtain the foreign currency needed for swap
repayment through a market reversal, it normally turns to the United
States Treasury to provide the currency for liquidation. Typically,
the Treasury has drawn on the International Monetary Fund.
FORD & LIBRARY 977839
-6-
Under current procedures the Treasury draws from the Fund at
par (Step 4) and sells the foreign currency to the System at the
prevailing market rate (3.5925 guilders/dollar in the example-Step 6).
When the swap is repayed, neither the Netherlands Bank nor the System
shows a net spot foreign exchange profit or loss on the series of
transactions / The Treasury, however, has a profit arising from the
fact that it draws at par and sells currency to the System at a rate
above par.
The proposed procedures would change this arrangement by
providing for the Treasury to sell the currency proceeds of the Fund
drawing directly to the foreign central bank at par, rather than to the
System at the market rate. The foreign central bank--its dollar holdings
having been reduced by the purchase of the currency from the Treasury--
would, in turn, then be in a position to sell its currency to the System
(purchase dollars from us). If that sale took place under the proposed
new forward contract, it would result in the final unwinding of the
initial swap drawing with no profit or loss accruing to the Netherlands
Bank, the System or the Treasury.
The $100 million gain shown for the Netherlands Bank is an
improvement in the Netherlands' IMF position reflecting its balance of
payments surplus which gave rise to the initial dollar inflow.
2/
The Treasury has not yet accepted this proposal.
FORD is LIBRARY GERALD
Table 1
SYSTEM SWAP DRAWINGS WITH
THE NETHERLANDS BANK
First Case: Swap Repayment Through Market Reversal
A
B
Current Procedures
Proposed Procedures
Rate G/$
NB ($mn.)
FRS (Gmn.)
NB ($mn.)
FRS (Gmn.)
1. Spot acquisition by
3.5925
100
100
the Netherlands Bank
2.
Swap drawing by System
3.5925
100
359.25
100
359.25
3. Sale of swap proceeds
to Netherlands Bank
3.5925
-100
-359.25
-100
-359.25
4. Market transaction
3.60
-50
-50
5. Sale of G. to System
3.60
50
180
by Netherlands Bank
6. Market transaction
3.62
-50
-50
7. Sale of G. to System
3.62
50
181
by Netherlands Bank
8. New forward
3.5925
100
359.25
9.
Swap repayment
3.5925
-100
-359.25
-100
-359.25
Net transactions
0
1.75
0
0
G - Guilders
NB - Netherlands Bank
FRS - Federal Reserve System
QUEALO FORD LIBRARY
Table 2
SYSTEM SWAP DRAWINGS WITH
THE NETHERLANDS BANK
Second Case : Swap Repayment Through United States IMF Drawing
Current Procedures Proposed Procedures
NB
FRS U.S.T.
NB
FRS. U.S.T.
Rate G/$
($mn.)
(Gmn.)
(Gmn.)
($mn.)
(Gmn.)
(Gmn.)
1. Spot acquisition by the
3.5925
100
100
Netherlands Bank
2.
Swap drawing by System
3.5925
100
359.25
100 359.25
3. Sale of swap proceeds to
Netherlands Bank
3.5925
-100 -359.25
-100 -359.25
4.
IMF drawing by
/
U.S. Treasury
3.62
100
362
100¹/
362
5. Treasury sale of
drawing proceeds to
Netherlands Bank
3.62
-100
-362
6.
Treasury sale of
drawing proceeds to
System
3.5925
359.25 -359.25
7. Sale of G. to System
by Netherlands Bank
3.5925
100
359.25
Swap repayment
3.5925
-100 -359.25
-100 -359.25
Net transactions
100¹/
0
3.75
100¹/
0
0
G-Guilders
NB-Netherlands Bank
FRS-Federal Reserve System
U.S.T.-United States Treasury
1/ Improvement in Netherlands IMF position
FORD is 939470 LIBRARY
STRICTLY CONFIDENTIAL--F.R.
Date: January 9, 1971
To: Chairman Burns, Vice Chairman Hayes
Subject: Mechanics of
and Governor Robertson
present and proposed swap
Federal Open Market Committee
procedures
From: David E. Bodner
This memorandum sets forth as simply as possible the comparative
mechanics of the present and proposed swap procedures. Examples. are presented
for each of the two principal ways in which the United States obtains foreign
currency to repay swap drawings: through a market reversal (Table 1), and
through a United States Treasury International Monetary Fund drawing
(Table 2)
System Swap Drawing
(Steps 1-3, and Step 9, Table 1, or Step 8, Table 2)
Both examples begin with the purchase by the Netherlands Bank of
dollars from the exchange market when the dollar has reached the Bank's
lower intervention point (Step 1). This is followed by a Sytem drawing
of guilders, at the same rate, under its swap arrangement with the Netherlands
Bank (Step 2), and System use of these guilders to purchase from the Netherlands
Bank, again at the same rate, an amount of dollars equal to the initial
Netherlands Bank purchase (Step 3). Under the swap arrangements, the
United States drawing, unless renewed, is to be repaid in three months
using the same rate of exchange at which it was contracted (the final step
1/ The memorandum is most easily understood if the tables are
detached so they can be read in conjunction with the text.
FORD & GERALD LIBRARY
2/ Used as a proxy for any bank in the swap network with which
the System might negotiate modification of current procedures.
-2-
in both examples). Note that these steps are identical under both current
and proposed procedures. The new proposal makes no change in the funda-
mental operation of the swap mechanism.
These arrangements protect the dollar swap proceeds of the Nether-
lands Bank from loss in the event of a devaluation of the dollar, since
it has the forward contract to sell dollars to the System in repayment
of the swap (Step 9) at the established dollar/guilder rate. These arrange-
ments also provide the Netherlands with an interest return on its dollar
proceeds based on the United States Treasury bill rate, or about the same
return it would have earned had it held the dollars uncovered.
Should the guilder be revalued during the term of the drawing, the
arrangements require the Netherlands to sell the System guilders against
dollars at the pre-revaluation rate.
The System may acquire the guilders for swap repayment in two
principal ways.
First case: Market Reversal (Table 1)
If the dollar spot rate rises in the Netherlands market, the Nether-
lands Bank may sell dollars for guilders in the exchange market to moderate
the rate movement. As illustrated in Table 1, assume that the dollar
strengthens and the Netherlands Bank sells $50 million at a rate of 3.60
guilders to the dollar (Step 4). Under current procedures, the Nether-
lands Bank may then agree to sell guilders to the System (Step 5)
at the same rate and in the same amount as its dollar sale to
the market. (Thus the Netherlands Bank repurchases from the
FORD & GERALD LIBRARY
System the dollars it sells to the market.) These procedures may be
-3-
repeated if the dollar strengthens further. This is shown in Steps 6
and 7 as another $50 million transaction, this time at a rate of 3.62
guilders/dollar.
At this point the System has acquired $100 million equivalent
of guilders, enough to repay the swap drawing, and it does so (Step 9).
As a result of this series of transactions, the Netherlands Bank
is left without gain or loss, while the System is left with a profit.
The System profit arises because its purchases of guilders from the
Netherlands Bank in Steps 5 and 7 (corresponding to that bank's trans-
actions with the market in Steps 4 and 6) were at better rates for the
dollar than the original spot sale of the swap proceeds (Step 3).
The proposed procedures (Table 1 B) would modify the scenario
outlined above by adding a new forward contract to current swap arrange-
ments as an alternative way for the System to acquire the guilders ultimately
required to repay the swap. This new contract, made at the same time
as the original swap, would provide for the sale by the Netherlands Bank
to the System of the guilders needed for the swap repayment at the same
rate as the original swap and spot sale. This new contract (Step 8) could
replace the spot transactions shown as Steps 5 and 7. With this change,
System transactions with the Netherlands Bank would all be made at the
same rate, and neither party would have a net profit or loss from swap
associated transactions. Thus, in essence, instead of acquiring cover
1/ The Netherlands Bank, however, would have a profit in guilders
(not shown in the example) on its market transactions, for it sells
359.25 million guilders in Step 1, buys 180 million guilders in Step 4, and
buys 181 million guilders in Step 6 for a net gain of 1.75 million guilders
and no dollar loss. This is precisely the profit that the System earns
under current procedures (see Table 1 A).
GERALD FORD LIBRARY
-4-
for its swap through a series of spot transactions at various rates, the
System would acquire the cover through a single forward transaction.
The addition of this new forward contract, however, would in and
of itself remove the protection against possible dollar devaluation given
the Netherlands Bank under current procedures. With the new forward
contract, the Netherlands Bank must sell the System the guilders needed
for repayment at the same rate as that of the swap. If there were a
dollar devaluation, the Netherlands Bank would thus find that it had lost
the protection of having a zero net dollar position, that is, its dollar
holdings equal the amount to be repaid under the swap, because the new
forward contract requires that it buy additional dollars from the System
at the pre-devaluation rate. Thus, as indicated in my December memoran-
dum, the whole rationale of the swap would be negated. For this reason,
it would be necessary to make the new forward contract conditional upon
there being no devaluation of the dollar. In addition, the System has been
asked to agree that a formal suspension of gold sales by the United States
Treasury, without an official change in the price of gold, would also
result in a cancellation of the new forward contract. The exercise of
this cancellation clause would restore the situation to exactly what it is
under present arrangements and thus undertakes no new commitments on
1/ The position changes of the Netherlands Bank given by Steps 1, 2,
3, and 9 in Table 1, column A, sum to zero. If the new forward contract
(Step 8) is included, as under the proposed procedures, the sum is +100
(column B).
2/ The reference to suspension of gold sales would be handled through
a separate letter and would not be incorporated in each swap drawing cable.
The proposed language for this reference has been cleared with the Treasury.
BERALD FORD LIBRARY
-5-
the part of the System. That is, the System would be subject to any
loss arising out of having swap drawings outstanding at a time of
devaluation of the dollar. Moreover, the existing revaluation clauses
in swap agreements would be unaffected by the proposed change and
would remain operative in the event of cancellation of the new forward
contract.
The new forward contract would be in the form of an option to
buy up to the amount of the swap drawing, thus leaving the System the
possibility of acquiring through other transactions, at market rates,
currencies needed to repay the swap drawing, in line with current pro-
cedures. Thus in the case of a market reversal, the System would not
be bound to exercise the new forward contract for any particular amount,
but could use it to cover only that portion of the outstanding swap that
had not been liquidated through normal operations at rates advantageous
to the System. This would leave open the possibility of a System profit,
while guaranteeing that the System would never have to purchase the
needed currency at rates involving it in a loss. It is possible--even
likely in the case of some countries--that the proportion of a swap
drawing to be covered through market transactions and that through
exercise of the new contract would be a subject for ad hoc agreement.
Second case: Drawing from IMF (Table 2)
If the System cannot obtain the foreign currency needed for swap
repayment through a market reversal, it normally turns to the United
States Treasury to provide the currency for liquidation. Typically,
the Treasury has drawn on the International Monetary Fund.
GERALD FORD
-6-
Under current procedures the Treasury draws from the Fund at
par (Step 4) and sells the foreign currency to the System at the
prevailing market rate (3.5925 guilders/dollar in the example--Step 6).
When the swap is repayed, neither the Netherlands Bank nor the System
shows a net spot foreign exchange profit or loss on the series of
/
transactions
The Treasury, however, has a profit arising from the
fact that it draws at par and sells currency to the System at a rate
above par.
The proposed procedures would change this arrangement by
providing for the Treasury to sell the currency proceeds of the Fund
drawing directly to the foreign central bank at par, rather than to the
System at the market rate. 2/ The foreign central bank--its dollar holdings
having been reduced by the purchase of the currency from the Treasury--
would, in turn, then be in a position to sell its currency to the System
(purchase dollars from us). If that sale took place under the proposed
new forward contract, it would result in the final unwinding of the
initial swap drawing with no profit or loss accruing to the Netherlands
Bank, the System or the Treasury.
The $100 million gain shown for the Netherlands Bank is an
improvement in the Netherlands' IMF position reflecting its balance of
payments surplus which gave rise to the initial dollar inflow.
2/
The Treasury has not yet accepted this proposal.
FORDO is LIBRARY GERALD
Table 1
SYSTEM SWAP DRAWINGS WITH
THE NETHERLANDS BANK
First Case: Swap Repayment Through Market Reversal
A
B
Current Procedures
Proposed Procedures
Rate G/$
NB ($mn.)
FRS (Gmn.)
NB ($mn.)
FRS (Gmn.)
1.
Spot acquisition by
3.5925
100
100
the Netherlands Bank
2.
Swap drawing by System
3.5925
100
359.25
100
359.25
3. Sale of swap proceeds
to Netherlands Bank
3.5925
-100
-359.25
-100
-359.25
4.
Market transaction
3.60
-50
-50
5. Sale of G. to System
3.60
50
180
by Netherlands Bank
6.
Market transaction
3.62
-50
-50
7. Sale of G. to System
3.62
50
181
by Netherlands Bank
8. New forward
3.5925
100
359.25
9.
Swap repayment
3.5925
-100
-359.25
-100
-359.25
Net transactions
0
1.75
0
0
G - Guilders
NB - Netherlands Bank
FRS - Federal Reserve System
FORD is LIBRARY GERALD
Table 2
SYSTEM SWAP DRAWINGS WITH
THE NETHERLANDS BANK
Second Case : Swap Repayment Through United States IMF Drawing
Current Procedures Proposed Procedures
NB
FRS U.S.T.
NB
FRS. U.S.T.
Rate G/$
($mn.)
(Gmn.)
(Gmn.)
($mn.)
(Gmn.)
(Gmn.)
1. Spot acquisition by the
3.5925
100
100
Netherlands Bank
2. Swap drawing by System
3.5925
100
359.25
100
359.25
3. Sale of swap proceeds to
Netherlands Bank
3.5925
-100 -359.25
-100 -359.25
4. IMF drawing by
U.S. Treasury
3.62
100¹/
362
100¹/
362
5. Treasury sale of
drawing proceeds to
Netherlands Bank
3.62
-100
-362
6. Treasury sale of
drawing proceeds to
System
3.5925
359.25 -359.25
7. Sale of G. to System
by Netherlands Bank
3.5925
100 359.25
Swap repayment
3.5925
-100 -359.25
-100 -359.25
Net transactions
100¹/
0
3.75 100¹/
0
0
G-Guilders
NB-Netherlands Bank
FRS-Federal Reserve System
U.S.T.-United States Treasury
1/ Improvement in Netherlands IMF position
GERALD FORD CIBRAST
[ 1-71? ]
Federal Reserve Bank of New York
New York, New York
Attn: C. A. Coombs, Senior Vice President
Gentlemen:
Under procedures adopted between us for the execution of
drawings on the reciprocal currency arrangement, when you make a
drawing at our request we will give you a standing order to buy the
Belgian francs you will require to cover that drawing in the form
of the following cable:
"We give you a standing order, for value
to sell us up to $ million at a rate of (rate
of swap drawing). It is understood and agreed
that this order would only be executed by the
Federal Reserve Bank of New York at our request
pursuant to understandings between us."
We agree that, regardless of other circumstances under which we may
or may not make such a request, we will do so if the Belgian franc/
dollar spot rate at the time of liquidation of a drawing is below
(that is, less francs per dollar) the rate of the drawing when this
results from movement of the rate within the present exchange margins
or adjustment of the dollar/franc margins. Nothing in these arrange-
ments precludes liquidation of swap drawings by the Federal Reserve
through acquisition of Belgian francs in the market or from the U.S.
Treasury, or from us when market conditions or other factors result
in a reduction in our dollar reserves.
[National Bank of Belgium]
FORD & LIBRARY 076839
STRICTLY CONFIDENTIAL -- F.R.
January 27, 1971
TO:
Chairman Burns,
SUBJECT: Proposed modification
Vice Chairman Hayes
of procedures to be employed in
and Governor Robertson
transactions under certain swap
Federal Open Market Committee
lines
FROM: David E. Bodner
This memorandum outlines the basic proposal for modifica-
tion of swap procedures that was set forth in my memoranda of
December 8, 1970 and January 9, 1971. Fundamentally, the question
is one of establishing a mechanism for fixing a rate for liquidation
of swap drawings that is satisfactory to both parties. As the arrange-
ments now work, the System (or the U. S. Treasury) generally makes a
profit on the repayment of outstanding Federal Reserve swap drawings
regardless of whether conditions in the market turn around during
the period in which the swap is outstanding. Profits made by the
System on operations generally have come at the expense of profits
foregone by the foreign central bank. In some cases, the other swap
partner has actually suffered losses. Moreover, even where the
System's profit accrues at the expense of the market (and is thus a
profit foregone by the foreign central bank) this takes the form
FORD & AIBRARY GERALD
either of an increase in the short-term liabilities to official for-
eigners of the foreign central bank or of a reduction in its out-
standing dollar holdings. (The mechanics of these operations under
the swap were described on pages 2 and 3 of my memorandum of Jan-
uary 9.) A number of European central banks have become increasingly
unhappy with this situation. As you know, the EEC countries agreed
-2-
to the latest round of swap line renewals only on condition that the
question of the rate for liquidation of swap drawings be resolved
promptly. Moreover, the Swiss National Bank has expressed a strong
interest in joining in any new arrangements.
The mechanism that we propose to resolve the question, and
to which most of the Europeans have already indicated their general
agreement in the course of discussions that have taken place to date,
is as follows: At the time of the initiation of a swap drawing by
the Federal Reserve, we would simultaneously enter into a contract
to cover the outstanding commitment through a forward purchase of the
amount of the foreign currency needed to liquidate the swap at the
exchange rate used for the swap drawing itself. To the extent that
this contract was finally executed, no profit or loss would accrue to
either party under the swap arrangement.
The cable outlining this contract would read as follows:
"For value (Date -- 3 months forward)
we buy from you up to (Amount of foreign
currency drawn) at rate of (Spot Rate, as
per swap contract) "
Note that this contract is in the form of an option to buy
"up to" the amount of the swap drawing. To the extent that there was
a reversal in the market situation, it would still be possible for
the System to cover an outstanding swap commitment in the market as
it does at present. The new forward contract in that case would be
GERALD FORD TIBRARY
-3-
executed only to cover that portion of the commitment that had not
proved reversible. Thus, the System would not be bound to exercise
the new forward contract for any particular amount, but could use
it to cover only that portion of the outstanding swap that had not
been liquidated through normal operations at rates advantageous to
the System. This would leave open the possibility of a System profit,
while guaranteeing that the System would never have to purchase the
needed currency at rates involving it in a loss.
From the point of view of the Federal Reserve, therefore,
the proposal has two distinct advantages: 1) it resolves a question
which has caused increasing irritation with some of our swap partners
and has been an occasional problem with others, while in no way alter-
ing the basic mechanics of the swap network and, 2) the new contract
would guarantee the System against any risk of loss arising from a
swap drawing. The risk of loss generally has not been significant
to date (although there have been a few large losses and some dif-
ficult negotiations to avoid losses), but is likely to become increas-
ingly important in the future as the EEC countries move to contain
their exchange rates in a narrow band moving within the EMA limits.
The cost to the System would be foregoing some profits that have
accrued to us in the past as a result of operations.
1/ This question is discussed in some detail on page 5 of my
December 8, 1970 memorandum.
FORD is LIBRARY 076835
-4-
For reasons outlined in my earlier memoranda, the writing
of the proposed new forward contract has the effect of short circuit-
ing the protection against a dollar devaluation given to the foreign
central bank by a swap drawing. Therefore, we proposed to specify
in a background letter (to be referred to in the cable along the
lines of the attached draft) that the contract would be considered
cancelled in the event of a devaluation of the dollar. It should
be noted that in the event this was to happen, the cancellation of
the new forward contract would restore the situation to exactly
what it is at present when the System has a swap drawing outstand-
ing. The Europeans have asked that this cancellation agreement
also be activated by a formal suspension of gold sales by the
United States. The letter would also encompass that understanding
(see attached draft). This would avoid unduly burdening the cable
that would be sent routinely once the new contract was in force
and would avoid putting this language in wide circulation on a
routine basis. The Treasury has been consulted with respect to the
language of the proposed background letter and has no objection.
To achieve the objectives outlined above, the Special
Manager recommends that the Committee amend Paragraph 3 of the
Authorization for System Foreign Currency Operations to read as
follows: "Currencies to be used for liquidation of System swap
commitments may be purchased forward from the foreign central bank
FORD is LIBRARY GERALD
-5-
drawn on at the same exchange rate as that employed in the drawing
to be liquidated. Otherwise unless otherwise expressly authorized by
the Committee, all transactions in foreign currencies undertaken under
Paragraph 1(a) above shall be at prevailing market rates and no
attempt shall be made to establish rates that appear to be out of
line with underlying market forces. "
In the course of discussions, the Belgian National Bank
has indicated that, although in basic agreement with the proposed
outlined above, it cannot accept the language that appears to be
acceptable to the others. The Belgians, uniquely among the central
banks, include outstanding forward contracts in their weekly bal-
ance sheet and have taken the position that the forward contract
described here--which is in effect a one-way option running in
favor of the Federal Reserve--would have to be reflected in that
balance sheet. The cables received from the National Bank regard-
ing recent swap drawings have included the following paragraph:
"WE GIVE YOU A STANDING ORDER, VALID DURING THE PERIOD
IN WHICH THE PROPOSED DRAWING WILL BE OUTSTANDING, TO
SELL US UP TO $
MILLION AT A RATE OF
... IT IS
UNDERSTOOD AND AGREED THAT THIS ORDER WOULD ONLY BE
EXECUTED BY THE FEDERAL RESERVE BANK OF NEW YORK AT OUR
REQUEST. "
1/ The amount has been the amount of the swap drawing in question
and the rate the rate of that drawing.
GERALD FORD LIBRARY
-6-
Because this option runs entirely at their discretion the Belgians
apparently would not have to reflect such an order in their balance
sheet. From the System's point of view the difficulty with this
approach is that it does not guarantee that, in the event the spot
rate at the time of liquidation of the contract was disadvantageous
to the System, the Belgians would ask us to execute the contract.
Thus, the principal benefit that we would obtain from the new arrange-
ment, i.e., protection against loss, conceivably might be foregone.
An alternative formulation that would meet the System's objective
would be to add an additional sentence to the order as defined by
the Belgians so that it would read as follows:
"IT IS UNDERSTOOD AND AGREED THAT THIS ORDER WOULD ONLY
BE EXECUTED BY THE FEDERAL RESERVE BANK OF NEW YORK AT
OUR REQUEST. WE AGREE THAT WE WILL MAKE SUCH REQUEST
EVEN IF AT THE TIME OF REPAYMENT OF THE SWAP DRAWING THE
BELGIAN FRANC RATE HAS APPRECIATED ABOVE THE RATE SPECIFIED
IN THIS ORDER."
This would make for a rather complex and perhaps an even overburdened
cable, but would meet the System's basic objective under the new
procedures. An alternative would be to accept the Belgians' language
as given, and have the understanding that is outlined in my proposed
additional language covered instead in the background letter that
would be exchanged with the Belgian National Bank. In any case,
what is at issue with the Belgians is only the form of the proposed
GERALD LIBRARY FORD
-7-
new contract, not its substance. I request, therefore, that if
the Sub-committee approves the amendment to the Authorization pro-
posed above, it authorize the Special Manager to negotiate with the
Belgians to reach mutually acceptable language to achieve the same
purposes, on the understanding that he would refer back to the
Committee if it was not possible to reach agreement without sub-
stantive change in the Committee's position.
FORD & LIBRAS 07V839
DRAFT
LETTER
February 1, 1971
De Nederlandsche Bank
Amsterdam
The Netherlands
Attention: Mr. P. C. Timmerman
Deputy Director
Gentlemen:
Pursuant to the understanding between us,
we agree that if at any time forward contracts
between the Federal Reserve Bank of New York and the
Nederlandsche Bank are qualified by the clause:
"This contract will be governed by the
conditions specified in our letter of
February 1, 1971"
those conditions are as follows:
The contract will be considered cancelled in
the remote event of a devaluation of the
United States dollar or in the event of a formal
suspension of gold sales by the United States
Treasury.
Sincerely yours,
Charles A. Coombs
GERALD LIBRARY R FORD
DRAFT
CABLE
DE NEDERLANDSCHE BANK
AMSTERDAM
I. FOR VALUE (DATE - Three Months Forward)
WE BUY FROM.YOU AT OUR OPTION UP TO NG (AMOUNT of guilders
drawn) AT RATE OF (SPOT Rate, as per Swap Contract).
II. THIS CONTRACT WILL BE GOVERNED BY THE
CONDITIONS SPECIFIED IN OUR LETTER OF
FEBRUARY 1, 1971.
III, PLEASE CONFIRM.
FEDERAL RESERVE BANK OF NEW YORK
FORD & 074835 LIBRARY
BOAR JF GOVERNORS OF THE FEDERAL RESERV YSTEM
January 29, 1971
STRICTLY CONFIDENTIAL (FR)
TO:
Chairman Burns
Governor Robertson
FROM:
Robert Solomon and A. B. Hersey
SUBJECT: Proposed Modification of Procedures Under Federal
Reserve Swap Lines with Central Banks
Mr. Bodner's memorandum of January 27, 1971, transmits
a recommendation of the Special Manager that the Subcommittee of
the Federal Open Market Committee (authorized at the FOMC meeting
of December 15, 1970, to deal with this matter) amend Paragraph 3
of the Authorization for System Foreign Currency Operations to
read as follows:
"Currencies to be used for liquidation of System
swap commitments may be purchased forward from the
foreign central bank drawn on at the same exchange
rate as that employed in the drawing to be liquidated.
Otherwise, unless otherwise expressly authorized by the
Committee, all transactions in foreign currencies under-
taken under Paragraph 1(a) above shall be at prevailing
market rates and no attempt shall be made to establish
rates that appear to be out of line with underlying
market forces. "
GLRALD FORD LIBEARY
To: Chairman Burns
-2-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
Discussion: general background
As explained by Mr. Bodner, the purpose of the recommended
amendment is to permit the Special Manager to work out, with foreign
central banks on which the System draws under the swap arrangements,
certain procedures that would end what some of those banks find a
source of irritation under present procedures: namely, the fact that
they give up many opportunities of making normal profits through
purchases and sales of dollars if they ask us to make a swap drawing
(to give them exchange risk cover on the dollars they acquired from
the market).
In the absence of a swap drawing such profits arise as follows.
A central bank gaining reserves, as the result of a strong balance of
payments, makes market purchases of dollars at an exchange rate below
par. Subsequently, if there is a reversal in the balance of payments
and its currency is less strong on the exchange market, it will sell
dollars in the market at a higher rate in terms of its own currency.
Or, if there is no reversal, it may use the dollars it had acquired
cheaply to buy, at par, gold or SDRs from the U.S. Treasury. Depending
on its accounting practices, a central bank may write up the book
value of the new reserve asset immediately to par in terms of its own
currency, with resultant profit on its books, or it may wait for a
future sale of the reserve asset to realize the potential profit.
Under existing procedures for swap drawings by the System
the foreign central bank forgoes these normal profits in both cases,
as explained in the next four paragraphs.
FORD is LIBRARY 076839
To: Chairman Burns
-3-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
(a) In the case of a reversal in the country's balance of
payments, the foreign central bank's profits through market transactions
are shifted to the System, since (1) its initial acquisitions of
dollars cheaply are matched by its sale at the same rate of those
dollars to the System in exchange for the foreign currency the System
gets by a swap drawing, and (2) its subsequent sales of dollars to the
market at a higher rate are offset by the sale of its currency to
(purchase of dollars from) the System to provide us with the currency
we need to liquidate the swap drawing. The last of these transactions
is made, under present rules, at the spot market rate prevailing at
the moment. If there is an interval of time between the foreign
central bank's sales of dollars to the market and its sale of currency
to the System, during which the dollar's value rises further, the
foreign central bank may even suffer a loss. (If the System is able
to acquire through its own market operations the currency needed to
liquidate the swap drawing, the foreign central bank will not have
to sell its currency to the System at a rate relatively unfavorable
to it, but it will have less occasion to sell dollars in the market
GERALD FORD LIBRARY
at a profit before the cycle is completed.)
(b) In the case of no reversal in the balance of payments,
transactions must be arranged to take place at the maturity of the
swap drawing, whereby the System will obtain the foreign currency
needed to liquidate the swap drawing and the foreign central bank will
obtain (1) dollars to hold uncovered, or (2) dollars with which to buy
gold, SDRs, or U.S. Treasury obligations denominated in a foreign currency
(Roosa Bonds), or (3) an addition to its reserve position in the Interna-
tional Monetary Fund.
To: Chairman Burns
-4-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
In subcases 1 and 2, the foreign central bank sells the
System its currency (and thereby acquires dollars) at the prevailing
spot market rate. Its exchange profits for the whole cycle depend
on this rate, since its original dollar acquisitions when the dollar
was at its floor were passed over to the System in a "mop-up" trans-
action at the same rate, and since the original swap drawing and its
reversal at the end of the cycle are also at the same rate. If the
prevailing spot market rate at the time of liquidation is still the
floor rate for the dollar, the foreign central bank ends up with a
realized or potential profit just equal to what it would have had in
the absence of a swap drawing. If, however, the rate for the dollar
has improved at all, the foreign central bank finds itself giving
up part or all of its profit to the System.
In subcase (3) -- a Fund drawing by the United States --
the System acquires the foreign currency to liquidate the swap drawing
at the prevailing spot market rate from the U.S. Treasury. The Treasury,
having obtained the foreign currency from the IMF at par, has a profit
if that currency is still above par in the exchange market. The
foreign central bank has no profit, realized or potential, from the
whole cycle, because it acquires the addition to its reserve position
in the Fund at par in terms of its own currency.
The proposed amendment of the Authorization would permit a
modification of procedures whereby a foreign central bank would in
some cases be able to obtain normal exchange market profits, realized
is
FORD
GERALD
To: Chairman Burns
-5-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
or potential. The cases in which it would still not be able to
make a profit that would have been available in the absence of a
swap drawing are the following. (1) In case of a balance of pay-
ments reversal, the System would have an option to acquire the currency
needed to liquidate a swap drawing through purchases in the market if
that were feasible rather than from the foreign central bank at the
contract rate. (2) In the case of no reversal in the balance of
payments and a U.S. drawing on the Fund, the System would exercise its
option not to buy from the foreign central bank, since it would acquire
the needed foreign currency from the U.S. Treasury.
Mr. Bodner's memorandum states that in the discussions that
have taken place most of the European central banks have indicated their
general agreement with the proposed procedures. He also points out
that the proposed procedures would ensure that the System would never
have losses in its swap drawing operations caused by variations in
exchange rates. The System would give up profits that it gets under
present procedures in certain cases -- namely, where it acquired
foreign currency (needed to liquidate a swap drawing) from the foreign
central bank and could no longer use a spot market rate better for the
dollar than the original market rate used for the swap.
1/
The statement on page 2 of Mr. Bodner's memorandum of January 27,
1971, that "to the extent this contract was finally executed, no
profit or loss would accrue to either party under the swap arrangement"
/emphasis added/, does not take account of the foreign central banks'
market profits through initial acquisitions in the market at the
dollar's floor rate and subsequent resale at a higher rate (the
benefit of which would no longer have to be passed over to the System).
GERALD
Agencit
To: Chairman Burns
-6-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
Pros and cons
A case for amending the Authorization as recommended can
be made on the following grounds. The underlying purpose of the swap
arrangements -- so far as System drawings on foreign central banks
are concerned -- is and always has been to prevent hasty purchases of
gold or SDRs by the foreign central banks from the United States.
Profit considerations have never entered into Federal Reserve policy
making regarding the swap arrangements. So long as no Federal Reserve
losses are entailed, it is perfectly reasonable that the System should
accede to the foreign central banks' desires with regard to normal
exchange market profits in order to maintain the friendliest possible
relations.
A case against adopting the proposed amendment would have to
be based on a view that sacrifice of normal exchange market profits is
a proper price for a central bank to pay for the insurance that the
swap drawing provides against potentially large losses in certain
contingencies -- namely, in the event of devaluation of the dollar or a
suspension of gold sales by the United States. This argument is even
stronger if at the maturity of the swap the foreign central bank is
going to convert its dollar reserve gains into gold, SDRs, or U.S.
Treasury securities denominated in foreign currency. We are informed
that it is mainly for considerations of this kind that the U.S. Treasury
has not agreed to the plan, mentioned in Mr. Bodner's two earlier
memoranda, for new procedures in connection with Fund drawings to
liquidate swap drawings.
GERALD FORD LIBRARY
To: Chairman Burns
-7-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
In rebuttal of the foregoing argument, two things may be said.
First, there may be some validity to the thought that benefits to the
United States of postponement of foreign gold purchases outweigh the
satisfaction foreign central banks may gain from having dollar holdings
temporarily covered by a swap drawing. Second, rejection of the
recommendation might be regarded by some of the foreign central banks
as inviting a termination of friendly cooperative efforts to avoid or
at least postpone a serious deterioration of market confidence in the
GERALD FORD LIBRARY
exchange value of the dollar.
Another disadvantage of the proposal should be pointed out.
To explain this, we note first that under the proposed procedures the
foreign central bank and the System would be in exactly the same
position as under present procedures in the event that certain specific
happenings were to occur. If the United States were to reduce the
parity of the dollar against gold or were to suspend sales of gold,
the System would be obligated exactly as it is under present procedures,
by any swap contract that might be outstanding at the time, to pay to
the foreign central bank a fixed amount in terms of the foreign currency
-- whatever its value then, in terms of gold or dollars -- and would have
no assurance of being able to acquire the currency for dollars at any
particular rate. The technical feature required to make the proposed
arrangements exactly equivalent in this respect to present procedures,
is a cancellation, in the event of the specified contingencies, of the
forward contract for sale to the System of the needed amount of the
foreign currency (this forward contract being the new feature desired
for reasons of normal exchange profits).
To: Chairman Burns
-8-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
Under Mr. Bodner's recommendation, a letter would be sent
to the foreign central banks stating that the forward contract "will
be cancelled in the remote event of a devaluation of the United States
dollar or in the event of a formal suspension of gold sales by the
United States Treasury."
Under existing procedures such an explicit statement of
possible U.S. actions is unnecessary, though it is these contingencies
against which the foreign central banks are protected by our swap
drawings.
It can be argued, on the one hand, that our swap partners
are well aware of the nature of the risks, however small, that swap
drawings protect them against, so that no harm is done if these
contingencies are made explicit. On the other hand, it can be
imagined that receipt and dissemination within foreign central banks of
such a letter at this time might strengthen the belief that the United
States is giving serious consideration to a basic and far-reaching
change in its policies.
Perhaps this danger could be lessened if a sentence were
added to the proposed letter as follows: "This letter is provided
solely for the purpose of completing technical arrangements under our
reciprocal currency agreement. It implies no change in long-standing
U.S. policies."
GERALD FORD VIBRARY
To: Chairman Burns
-9-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
Postscript
If either of the events specified above seemed likely to
cease being only remote contingencies, it would be urgently desirable
for the System to reconsider its use of swaps and to reach an under-
standing with the U.S. Treasury as to how the System might fulfill
its obligations under swap contracts. The present proposal reminds
us of these questions, but it does not require that immediate answers
be given to them.
aBH RS
GERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
January 29, 1971
To:
Chairman Burns,
Subject: Proposed modification
Vice Chairman Hayes,
of procedures to be employed in
and Governor Robertson,
transactions under certain swap
Federal Open Market Committee
lines.
From: David E. Bodner
During the course of this morning's meeting to review
the proposal outlined in my memorandum of January 27, there was
extensive discussion of the possibility of handling the problem
through the use of a standing order that would avoid the need for
a background letter from the Federal Reserve along the lines of
my draft letter. During these discussions it was perhaps not fully
appreciated that what was being proposed is in fact what has been
proposed to us by the Belgian National Bank. The Belgians' version
of our proposal, as outlined on pages 5 and 6 of my January 27 memo-
randum, is for a standing order to cover the amounts needed by the
System to liquidate a swap at the rate of that swap. The order
runs entirely at the option of the Belgians and, therefore, does
not require any background letter from us regarding the possibility
of devaluation. As I noted in my memorandum, in the form specified
by the Belgians the System would still be exposed to possible losses.
This could be resolved either by amending their cable along the lines
I indicated or by a background understanding running from them to us.
Therefore, as I interpret the group's discussion this morn-
ing, it would recommend that we adopt the Belgian proposal as the
general one in place of our original version. Thus we still have
only two proposals in front of us.
FORD & LIBRARY 07V839
BOAR IF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
January 29, 1971
STRICTLY CONFIDENTIAL (FR)
TO:
Chairman Burns
Governor Robertson.
FROM:
Robert Solomon and A. B. Hersey
SUBJECT: Proposed Modification of Procedures Under Federal
Reserve Swap Lines with Central Banks
Mr. Bodner's memorandum of January 27, 1971, transmits
a recommendation of the Special Manager that the Subcommittee of
the Federal Open Market Committee (authorized at the FOMC meeting
of December 15, 1970, to deal with this matter) amend Paragraph 3
of the Authorization for System Foreign Currency Operations to
read as follows:
"Currencies to be used for liquidation of System
swap commitments may be purchased forward from the
foreign central bank drawn on at the same exchange
rate as that employed in the drawing to be liquidated.
Otherwise, unless otherwise expressly authorized by the
Committee, all transactions in foreign currencies under-
taken under Paragraph 1(a) above shall be at prevailing
market rates and no attempt shall be made to establish
rates that appear to be out of line with underlying
market forces. "
GERALD FORD LIBRARY
To: Chairman Burns
-2-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
Discussion: general background
As explained by Mr. Bodner, the purpose of the recommended
amendment is to permit the Special Manager to work out, with foreign
central banks on which the System draws under the swap arrangements,
certain procedures that would end what some of those banks find a
source of irritation under present procedures: namely, the fact that
they give up many opportunities of making normal profits through
purchases and sales of dollars if they ask us to make a swap drawing
(to give them exchange risk cover on the dollars they acquired from
the market).
In the absence of a swap drawing such profits arise as follows.
A central bank gaining reserves, as the result of a strong balance of
payments, makes market purchases of dollars at an exchange rate below
par. Subsequently, if there is a reversal in the balance of payments
and its currency is less strong on the exchange market, it will sell
dollars in the market at a higher rate in terms of its own currency.
Or, if there is no reversal, it may use the dollars it had acquired
cheaply to buy, at par, gold or SDRs from the U.S. Treasury. Depending
on its accounting practices, a central bank may write up the book
value of the new reserve asset immediately to par in terms of its own
currency, with resultant profit on its books, or it may wait for a
future sale of the reserve asset to realize the potential profit.
Under existing procedures for swap drawings by the System
the foreign central bank forgoes these normal profits in both cases,
as explained in the next four paragraphs.
GERALD FORD LIBRARY
To: Chairman Burns
-3-
STRICTLA CONFIDENTIAL (FR)
Governor Robertson
(a) In the case of a reversal in the country's balance of
payments, the foreign central bank's profits through market transactions
are shifted to the System, since (1) its initial acquisitions of
dollars cheaply are matched by its sale at the same rate of those
dollars to the System in exchange for the foreign currency the System
gets by a swap drawing, and (2) its subsequent sales of dollars to the
market at a higher rate are offset by the sale of its currency to
(purchase of dollars from) the System to provide us with the currency
we need to liquidate the swap drawing. The last of these transactions
is made, under present rules, at the spot market rate prevailing at
the moment. If there is an interval of time between the foreign
central bank's sales of dollars to the market and its sale of currency
to the System, during which the dollar's value rises further, the
foreign central bank may even suffer a loss. (If the System is able
to acquire through its own market operations the currency needed to
liquidate the swap drawing, the foreign central bank will not have
to sell its currency to the System at a rate relatively unfavorable
to it, but it will have less occasion to sell dollars in the market
FORD is LIBRARY 038870
at a profit before the cycle is completed.)
(b) In the case of no reversal in the balance of payments,
transactions must be arranged to take place at the maturity of the
swap drawing, whereby the System will obtain the foreign currency
needed to liquidate the swap drawing and the foreign central bank will
obtain (1) dollars to hold uncovered, or (2) dollars with which to buy
gold, SDRs, or U.S. Treasury obligations denominated in a foreign currency
(Roosa Bonds), or (3) an addition to its reserve position in the Interna-
tional Monetary Fund.
To: Chairman Burns
-4-
STRICTLY ONFIDENTIAL (FR)
Governor Robertson
In subcases 1 and 2, the foreign central bank sells the
System its currency (and thereby acquires dollars) at the prevailing
spot market rate. Its exchange profits for the whole cycle depend
on this rate, since its original dollar acquisitions when the dollar
was at its floor were passed over to the System in a "mop-up" trans-
action at the same rate, and since the original swap drawing and its
reversal at the end of the cycle are also at the same rate. If the
prevailing spot market rate at the time of liquidation is still the
floor rate for the dollar, the foreign central bank ends up with a
realized or potential profit just equal to what it would have had in
the absence of a swap drawing. If, however, the rate for the dollar
has improved at all, the foreign central bank finds itself giving
up part or all of its profit to the System.
In subcase (3) -- a Fund drawing by the United States --
the System acquires the foreign currency to liquidate the swap drawing
at the prevailing spot market rate from the U.S. Treasury. The Treasury,
having obtained the foreign currency from the IMF at par, has a profit
if that currency is still above par in the exchange market. The
foreign central bank has no profit, realized or potential, from the
whole cycle, because it acquires the addition to its reserve position
in the Fund at par in terms of its own currency.
The proposed amendment of the Authorization would permit a
modification of procedures whereby a foreign central bank would in
some cases be able to obtain normal exchange market profits, realized
GERALD FORD LIBRARY
To: Chairman Burns
-5-
STRICTLY NFIDENTIAL (FR)
Governor Robertson
or potential. The cases in which it would still not be able to
make a profit that would have been available in the absence of a
swap drawing are the following. (1) In case of a balance of pay-
ments reversal, the System would have an option to acquire the currency
needed to liquidate a swap drawing through purchases in the market if
that were feasible rather than from the foreign central bank at the
contract rate. (2) In the case of no reversal in the balance of
payments and a U.S. drawing on the Fund, the System would exercise its
option not to buy from the foreign central bank, since it would acquire
the needed foreign currency from the U.S. Treasury.
Mr. Bodner's memorandum states that in the discussions that
have taken place most of the European central banks have indicated their
general agreement with the proposed procedures. He also points out
that the proposed procedures would ensure that the System would never
have losses in its swap drawing operations caused by variations in
exchange rates. The System would give up profits that it gets under
present procedures in certain cases -- namely, where it acquired
foreign currency (needed to liquidate a swap drawing) from the foreign
central bank and could no longer use a spot market rate better for the
dollar than the original market rate used for the swap.
1/
The statement on page 2 of Mr. Bodner's memorandum of January 27,
1971, that "to the extent this contract was finally executed, no
profit or loss would accrue to either party under the swap arrangement"
/emphasis added/, does not take account of the foreign central banks'
market profits through initial acquisitions in the market at the
dollar's floor rate and subsequent resale at a higher rate (the
benefit of which would no longer have to be passed over to the System).
GERALD FORD VIBRARY
To: Chairman Burns
-6-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
Pros and cons
A case for amending the Authorization as recommended can
be made on the following grounds. The underlying purpose of the swap
arrangements -- so far as System drawings on foreign central banks
are concerned -- is and always has been to prevent hasty purchases of
gold or SDRs by the foreign central banks from the United States.
Profit considerations have never entered into Federal Reserve policy
making regarding the swap arrangements. So long as no Federal Reserve
losses are entailed, it is perfectly reasonable that the System should
accede to the foreign central banks' desires with regard to normal
exchange market profits in order to maintain the friendliest possible
relations.
A case against adopting the proposed amendment would have to
be based on a view that sacrifice of normal exchange market profits is
a proper price for a central bank to pay for the insurance that the
swap drawing provides against potentially large losses in certain
contingencies -- namely, in the event of devaluation of the dollar or a
suspension of gold sales by the United States. This argument is even
stronger if at the maturity of the swap the foreign central bank is
going to convert its dollar reserve gains into gold, SDRs, or U.S.
Treasury securities denominated in foreign currency. We are informed
that it is mainly for considerations of this kind that the U.S. Treasury
has not agreed to the plan, mentioned in Mr. Bodner's two earlier
memoranda, for new procedures in connection with Fund drawings to
liquidate swap drawings.
GEXATO FORD DIBRARY
To: Chairman Burns
-7-
STRICTLY COMPIDENTIAL (FR)
Governor Robertson
In rebuttal of the foregoing argument, two things may be said.
First, there may be some validity to the thought that benefits to the
United States of postponement of foreign gold purchases outweigh the
satisfaction foreign central banks may gain from having dollar holdings
temporarily covered by a swap drawing. Second, rejection of the
recommendation might be regarded by some of the foreign central banks
as inviting a termination of friendly cooperative efforts to avoid or
at least postpone a serious deterioration of market confidence in the
exchange value of the dollar.
Another disadvantage of the proposal should be pointed out.
To explain this, we note first that under the proposed procedures the
foreign central bank and the System would be in exactly the same
position as under present procedures in the event that certain specific
happenings were to occur. If the United States were to reduce the
parity of the dollar against gold or were to suspend sales of gold,
the System would be obligated exactly as it is under present procedures,
by any swap contract that might be outstanding at the time, to pay to
the foreign central bank a fixed amount in terms of the foreign currency
-- whatever its value then, in terms of gold or dollars -- and would have
no assurance of being able to acquire the currency for dollars at any
particular rate. The technical feature required to make the proposed
arrangements exactly equivalent in this respect to present procedures,
is a cancellation, in the event of the specified contingencies, of the
forward contract for sale to the System of the needed amount of the
FORD
foreign currency (this forward contract being the new feature desired
GERALD
for reasons of normal exchange profits).
To: Chairman Burns
-8-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
Under Mr. Bodner's recommendation, a letter would be sent
to the foreign central banks stating that the forward contract "will
be cancelled in the remote event of a devaluation of the United States
dollar or in the event of a formal suspension of gold sales by the
United States Treasury."
Under existing procedures such an explicit statement of
possible U.S. actions is unnecessary, though it is these contingencies
against which the foreign central banks are protected by our swap
drawings.
It can be argued, on the one hand, that our swap partners
are well aware of the nature of the risks, however small, that swap
drawings protect them against, so that no harm is done if these
contingencies are made explicit. On the other hand, it can be
imagined that receipt and dissemination within foreign central banks of
such a letter at this time might strengthen the belief that the United
States is giving serious consideration to a basic and far-reaching
change in its policies.
Perhaps this danger could be lessened if a sentence were
added to the proposed letter as follows: "This letter is provided
solely for the purpose of completing technical arrangements under our
reciprocal currency agreement. It implies no change in long-standing
U.S. policies."
GERALD FORD LIBRARY
To: Chairman Burns
-9-
STRICTLY CONFIDENTIAL (FR)
Governor Robertson
Postscript
If either of the events specified above seemed likely to
cease being only remote contingencies, it would be urgently desirable
for the System to reconsider its use of swaps and to reach an under-
standing with the U.S. Treasury as to how the System might fulfill
its obligations under swap contracts. The present proposal reminds
us of these questions, but it does not require that immediate answers
be given to them.
ORK RS
FORD & 617470 LIBRARY
Boo Robertson mil hand
February 12, 1971
To:
Chairman Burns and Governor Robertson
From: A. B. Hersey, A. L. Broida, and D. B. Hexter
OBIT
and
Hat
Attached for your consideration is a draft memorandum to the
FOMC concerning the problem relating to System swap arrangements on
which Mr. Bodner reported at the December meeting, from the sub-
committee that was authorized to deal with this matter.
In our judgment distribution of a memorandum along the lines
of the draft would be helpful not only in giving the full Committee
information on the current status of the matter but also in providing
the members with the kind of background material they might want to
have before they are asked to vote on an enabling amendment to the
foreign currency authorization.
We will be available to discuss the proposed memorandum with you,
if you so desire. Mr. Bodner has a copy of the draft and will be
discussing it with President Hayes early next week.
Attachment
LIGRASY GERALD ? FORD
DRAFT
2/12/71
To: Federal Open Market Committee
Procedure for liquidation of
drawings under reciprocal
From: Chairman Burns, Vice Chairman Hayes
currency arrangements
and Governor Robertson
R.
FORD
GERALD
LIBRARY
STRICTLY CONFIDENTIAL (FR)
Acting under authority delegated by the Committee at its
meeting on December 15, 1970 to us as a subcommittee, we have authorized
the Special Manager to negotiate with central banks on which the System
draws under its reciprocal currency (swap) arrangements, regarding certain
new procedures in connection with liquidation of swap drawings. These
negotiations were started last week and are still in process.
Under the present terms of paragraph 30ofhthe Authorization
for System Foreign Currency Operations, express authorization by the
Committee would be required on each occasion the new procedures were to
be used, as is explained below. To avoid the need for repeated Committee
actions, we plan to recommend an appropriate amendment to that paragraph
as soon as the currentynegotiations reach a stage at which such an amendment
appears desirable.
This action is designed to meet a problem that was raised by the
central banks of Belgium and the Netherlands, among others, as described
in a memorandum from Mr. Bodner to the Committee dated December 8, 1970,
entitled "Proposed Modification of Procedures to be Employed in Trans-
actions under Certain Swap Lines," a copy of which is attached. Copies
are also attached of memoranda to us from Mr. Bodner dated January 9 and
27, 1971 and a memorandum to us from Mr. Robert Solomon and Mr. Hersey
-2-
STRICTLY CONFIDENTIAL (FR)
dated January 29, 1971. The problem is to establish a mechanism for
fixing a rate satisfactory to both parties at which -- if there had been
no change in the parity rate -- the System would purchase from a central
bank the foreign exchange needed for liquidation of a System swap drawing
on that bank, in case there had not been a market reversal or a U.S.
drawing on the IMF. It is contemplated that the rate for such purchases
would be fixed at the time of the swap drawing and would be the same as
the rate of the swap, rather than either the spot market rate at the time
the currency would be needed or the forward market rate at the time of the
swap. Fixing of the rate in this manner requires either express authori-
zation or an amendment of paragraph 3 of the Authorization, which at present
allows (in the absence of express authorization) only transactions "at
prevailing market rates."
The particular procedures that we approved are a modification of
the procedures proposed by the Belgians, discussed on pp. 5-7 of Mr. Bodner's
memorandum of January 27. These procedures avoid the disadvantage, pointed
out in the January 29 memorandum, of the New York Reserve Bank's having to
mention explicitly in correspondence with foreign central banks certain
contingencies (devaluation, and suspension of gold sales) in which a
forward contract for the System's acquisition of the other currency would
not be used. The procedures that we approved would (1) enable the foreign
central bank to avoid any loss (in terms of its own currency) attributable to use
of the swap arrangement, (2) allow it to retain normal exchange rate profits
in certain circumstances, (3) protect the System from any loss arising from
exchange rate changes within the present margins or within adjusted margins
FORD & LIBRARY
-3-
STRICTLY CONFIDENTIAL (FR)
(as well as from a parity revaluation by the foreign country, as under
existing arrangements -- which would be unchanged in this respect), and
(4) not preclude the System's acquisition of the needed foreign currency
in other ways. The final attachment to this memorandum is a copy of the
draft letter reflecting these understandings, as submitted to the foreign
central banks concerned in the course of the current negotiations. These
procedures would be authorized for use, if desired by the other party, in
connection with System swap drawings on any of the central banks in the
swap network.
Attachments
R. FORD LIBRARY
STRICTLY CONFIDENTIAL--F.R.
GERMED FORD LIBRARY
DATE: December 3, 1970
TO: Federal Open Market Committee
SUBJECT: Proposed modifica-
tion of procedures to be
FROM: David E. Bodner
employed in transactions
under certain swap lines
At the time of the November meeting of the B. I. S., representatives
of some of the EEC central banks approached Mr. Coombs to discuss the way
in which operations under the swap lines have affected their profit and loss
positions. It was agreed that representatives of the two central banks most
concerned about this question would come to New York to review it in greater
detail. On November 10 and 19 Messrs. P. Timmerman of the Nederlandsche
Bank and F. Heyvaert of the Banque Nationale de Belgique met with Mr. Coombs
and other officers of the Foreign Department at the New York Bank. The two
representatives noted that, in the normal course of events, the debtor country
in the swap arrangements tendsto make a profit on operations. Thus, given
the usual cycle of market developments, a country would draw when its currency
was weak and repay when it was strong and insofar as it operated in the market
at current rates it would make a profit over the cycle. They pointed out, however
that given the small size of the Dutch and Belgian foreign exchange markets, in
general it has not proved possible for the System to reconstitute foreign exchange
balances it acquired and disbursed under the swap arrangements except through
direct transactions with the two central banks. Consequently, profits made by
the System on operations have come at the expense of foregone profits by the two
central banks. Moreover, in some cases in which System purchases or sales
of exchange with the central banks have not been exactly matched by offsetting
operations of those central banks with the market, the two central banks have,
in fact, suffered some losses. More generally, when it has not proved possible
to reverse the swaps through changes in market conditions and we have unwound
--2-
our debtor position through IMF drawings by the Treasury, the Treasury has
made substantial windfall profits. These arise because the Treasury draws the
foreign currency at par from the IMF, while we repay swap drawings made at
or close to the ceiling. In the first instance, these windfall profits come at
the expense of the foreign central bank through a reduction in its foreign
exchange position. The two representatives expressed the view that these costs
in foregone profit opportunities and, on occasion, in actual bookkeeping losses,
had raised more and more questions within their banks, especially in view of
the existence in the swap arrangement of the revaluation clause in a context
in which they felt under pressure from the U. S. Government to revalue their
currency.
Messrs. Timmerman and Heyaert then proposed a new method
of operating under the swap arrangements. They suggested that all transactions
be handled at par, including not only drawings and repayments of the swaps
themselves, but also the secondary spot sale of the swap proceeds and final
reconstitutionof System balances to liquidate the swaps. It was explained to
them that such a solution would involve the System in extensive dealings in non-
market rates which, aside from certain legal problems which might be raised,
would constitute a fundamental change in policy on behalf of the Open Market
GERALD FORD LIBRARY
Committee. Mr. Timmerman then proposed that the same effect be achieved
by bringing the U. S. Treasury into the transactions: System swaps with the
central banks would be made as at present, but the System would then swap the
proceeds with the U. S. Treasury and the Treasury would sell the foreign
exchange balances to the central bank at par. At the time of liquidation, the
central bank would resell the currency to the Treasury at par and the swaps
between the Treasury and the System and the System and the central bank would
then be unwound. With all the swaps being reversed at the same rates at which
-3-
they were made there would be no profit or loss incurred by any party to the
swap transaction.
This proposal was put to the Treasury, which did not find it
acceptable. Moreover, it clearly had serious drawbacks from the view of
GERALD FORD VIBRARY
the Federal Reserve. An alternative proposal was then considered:
1) In any case in which the swap line has to be repaid through a
Treasury drawing on the IMF, the Treasury would resell the foreign currency
proceeds of its drawing to the central bank concerned at par, rather than, as
at present, selling them to the System at the current market rate. This sale
would reduce the central bank's dollar position correspondingly and make room
for a direct transaction with the System to unwind the swap. In this manner,
the Treasury would forego the windfall profits that now accrue to it on such
Fund drawings. This procedure would be exactly analogous to what now occurs
when the Treasury sells gold or transfers SDRs to enable the System to repay
a swap drawing. The Treasury has this proposal under consideration.
2) Recognizing that, because of the limitations imposed on operations
by the small size of the Dutch and Belgian markets, it has proved necessary for
us to acquire balances to liquidate the swap through direct transactions with the
central banks, and recognizing that when the conditions that gave rise to the swap
drawing are not reversed within the normal time span it is necessary to liquidate
the swaps through such direct transactions, we might consider fixing the rate for
such transactions at the time of the initial activation of the swap. This would be
accomplished by entering into a forward contract under which the System would.
purchase the currency needed to liquidate the swap, the rate on that contract to be
the market rate then prevailing, i.e., the same rate used for the swap drawing
itself. Thus, no profit or loss would accrue to either party to the extent a swap
was unwound in this manner. The execution of such a contract at the time of the
initial swap drawing, however, would complete the circle of spot and forward
4.
transactions in such a way that the foreign central bank concerned would lose
the protection against a possible devaluation of the dollar that is in many
cases the essence of the swap drawing by the System. (That is, the protection 1S.
afforded to the central bank by the fact that it has an outstanding contract to
sell dollars forward to the System at an established rate. If it then enters into
a forward purchase contract for the same value date at the same rate, it effec-
tively washes out its protection.) To deal with this problem it was proposed that
the new forward contract include a conditional clause indicating that in the remote
event of a devaluation of the dollar this new forward contract would be considered
to be canceled. Furthermore, it was suggested that the System might agree
that a formal suspension of gold sales by the U. S. Treasury without an official
change in the price of gold would also result in a cancellation of the contract.
3) The new forward purchase by the System would be further qualified
to leave open the possibility that the System could acquire, at market rates,
currencies needed to prepay the swap to the extent that there was a reversal
in the market. That is, the new forward contract to buy currency at the rate
of the original swap drawing would cover only that portion of the outstanding
swap that it had proved impossible to liquidate through normal operations.
This proposal appears to be acceptable to the Europeans--although
it does not meet all their desires--while offering certain distinct advantages
to the System. It would eliminate windfall profits made by the Treasury, and
to some extent by the System, at the expense of foreign central banks under present
arrangements and protect the foreign central bank against the risk of loss in
operations under the swap. At the same time, it would preserve the basic
structure of operations under the swap. lines and guarantee the System against
FORD i LIBRARY
See sample cable attached.
-5-
GERALD FORD LIBRAR
any risk of loss. At present, the System is exposed to a potential loss any
time that it makes a drawing when the spot rate for the foreign currency is
below its ceiling. If in such a case no reversal occurs and the System has to
liquidate the transaction through direct dealings with the central bank (in
association with Treasury sales of reserve assets), there is the possibility
that the spot rate could then be higher than it was at the time of the drawing,
thereby making the foreign currency more expensive for the System to acquire.
Although unusual, there have been such occurrences. Under this proposal
such a situation could not arise because the new forward contract would guarantee
that the System could acquire the necessary currency at the same rate as the
original swap. This may prove to be particularly important in coming years
when the EEC countries move to narrow the margin of fluctuation among their
currencies within the present dollar band. Under those circumstances, it is
entirely possible that the System could be called upon to make a swap drawing in
a case in which the central bank was maintaining an interim "ceiling" at a level
below the official EMA ceiling. If at the time of liquidation of the drawing, the
EEC band had been moved upward so that the currency in question, even 1f below
its formal ceiling, was above the rate at which the System had drawn, a loss would
be incurred. Such occurrences may arise, moreover, with greater and greater
frequency as the EEC succeeds in narrowing its band. The proposed new arrange-
ment would effectively protect the System against these potentially significant
losses. In addition, the new arrangement would protect the System against the
risk of loss in the event that a country to which the System was indebted under the
swap was to widen the margins against the dollar while a swap drawing was
outstanding and the spot rate was then to move above the old ceiling. Although'
from time to time informal understandings have been reached concerning the
activation of the revaluation clause in such an instance, this situation is not
-6-
covered in any formal way by the present revaluation clause. Thus, on
balance, the proposed change in procedures appears to offer significant
advantages to the System as well as eliminating a source of continuing
irritation among some of the System's swap partners.
FORD is LIBRARY 077835
DRAFT CABLE
DE NEDERLANDSCHE BANK
AMSTERDAM
I
FOR VALUE (Date - Three Months Forward) WE BUY FROM
YOU UP TO NG (AMOUNT of guilders drawn) AT RATE OF
(SPOT Rate, as per Swap Contract).
II
IN THE REMOTE EVENT OF A DEVALUATION OF THE
U. S. DOLLAR PRIOR TO THE VALUE DATE ABOVE,
THIS CONTRACT WOULD BE CONSIDERED TO BE CANCELLED.
III PLEASE CONFIRM
FEDERAL RESERVE BANK OF NEW YORK
FORD & 93RA70 LIBRARY
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date November 12, 1971
To
Chairman Burns
Subject: Renewal of swap agreements
From Samuel Katz and Robert Solomon
by FOMC
CONFIDENTIAL (FR)
The maturity of the various System reciprocal-currency agreements
during the month of December provides the opportunity for a review of
the swap network in the light of the U.S. suspension of gold convertibility.
This memorandum attempts to review the alternative decisions the FOMC
might consider under four headings:
a. Should the swap agreements be renewed?
b. Should the purposes, uses, and over-
all magnitude of the swap network be
reviewed at this time?
c. How should outstanding liabilities be
settled? and
d. Should any individual swap lines be
altered at this time?
The staff's recommendations are:
1. That the agreements be renewed; but Federal Reserve officials should
either wait for our swap-partners to take the initiative or should
raise the renewal question in a low-key manner. In either event
they should avoid any implication that the System is prepared to
provide exchange-value guarantees on any additional dollar holdings
at this time;
2. That the broad lines of policy governing repayment of outstanding
balances seem to be set and no further action of the FOMC is required
at this time;
1/ These agreements mature as follows: on December 2 (U.K.; Switzer-
land; Austria; Sweden; Japan; Denmark; Mexico; Norway; and the B.I.S.);
on December 16 (Germany); on December 22 (Belgium); on December 28
(France); and on December 30 (Italy; Netherlands; and Canada). The
details of Federal Reserve swap arrangements and the amounts and dates
of system drawings are shown in detail in Annex I.
FORD i LIBRARY
- 2 -
3. That the members of the FOMC might consider whether on the basis of
the pro and con arguments (which the staff regard as evenly-balanced)
they should undertake a cutback in the credit line with the Bank of
England; and
4. That the members of the FOMC postpone for the time being discussion
of two major issues with regard to the future role of the swap
network:
a. Changes in the purposes and uses; and
b. The desirability of a major cutback in the network credit
aggregates.
We will consider each of these recommendations in turn.
GERALO FORD TERABY
- 3 -
Renewal of swap agreements
The staff find the arguments substantially in favor of a renewal
of swap agreements at this time. The shock of a termination of the swap
network would:
1. Cloud the atmosphere for current international financial negotiations;
2. Create additional uncertainties about the direction of U.S. inter-
national policies;
3. Adversely affect prospects for international cooperation; and
4. Disturb confidence and stability in private financial markets in
the leading countries.
At this time, it is important that our swap-partners not regard
an automatic renewal of these agreements as a precedent as to future U.S.
willingness to provide exchange-value guarantees on dollar balances.
The Treasury is particularly concerned that our posture on renewal of the
swaps not prejudice in any way our negotiating position regarding future
convertibility. At the moment, the only dollar-balances protected against
an upward drift in the exchange rates of other countries are those
covered under the Federal Reserve network or by means of Treasury foreign-
currency issue of bonds. As part of the August 15 program, the Secretary
of the Treasury "requested the Federal Reserve to suspend the virtually
automatic use of its swap network for the purpose of converting dollars
into other currencies; the future operation of these and other mutual
credit facilities with foreign countries will be determined in the light
of emerging developments."
FORD i LIBRARY 9ERALD
- 4 -
The danger of a misinterpretation of the attitude of U.S. agencies
about future commitments on dollar holdings arises from the history of the
swap facilities as an instrumentality for providing an exchange-value
guarantee to foreign official dollar holders. At this time there is
uncertainty about when the United States will again be prepared to
assume a convertibility obligation, but there is every reason to expect
it to be much more limited than our pre-August commitment to provide
gold for dollars. Our swap-partners ought not to be led to expect that
they will be able to obtain the same exchange-value guarantees in the
future that they have obtained from the System in the past until the
form of U.S. convertibility has been decided upon.
Accordingly, the staff would stress that, while System
officials should avoid any threat from our side to the continuity of
the swap network, they should also take a low key posture on the ques-
tion of renewals of reciprocal-currency agreements and of Federal
Reserve drawings currently outstanding. It is important that, in the
discussions about the renewal of swap lines or of outstanding drawings,
System personnel avoid giving foreign officials any implication about
when, and to what degree, the United States is likely to resume
convertibility or be willing to grant through the network exchange-
value guarantees on additional foreign official dollar accruals.
FORD is LIBRARY 938870
- 5 -
Changing purposes and uses of swap facilities
The staff would expect that major changes will have to be
made in the years ahead in the purposes and uses of swap facilities.
It is regarded as unlikely that the network would ever again have as
a major purpose the granting of exchange-value guarantees on foreign
official dollar holdings. Instead, we would expect the swap network
to be conceived of as a mechanism for international cooperation through
which (i) capital flows could be offset or financed and (ii) official
resources could be used to stabilize private markets and even to sup-
port major currencies during political emergencies. Furthermore, it
is likely that there remains the need for some international arrange-
ments to ensure that speculative factors not overwhelm private financial
markets during periods of uncertainty merely because there is no machinery
for supportive official intervention in them.
The staff also regard it as likely that there will be major
adaptations in the uses to which swap facilities would be put in the
years ahead. On the historical record, it is evident that the over-
riding objective of swap operations between 1964 and 1967 was to avoid
the devaluation of the U.K. pound. To this end, Federal Reserve offi-
cials made System resources available to the Bank of England and they
also took a leadership role in assembling seven different packages of
international credits between 1962 and 1967 to help the United Kingdom
authorities avoid devaluation. As a result, credits to the Bank of
England accounted for nearly two-thirds of the dollar credits drawn
BERALD FORD JERARY
- 6 -
by swap-partners from the System since 1962. In turn, protracted U.K.
use of these credits raised major concern in the post-devaluation
period among FOMC officials about the liquidity of these System claims
in sterling. The Committee was forced in 1968 to make the particularly
difficult decision to extend outstanding credits beyond 12 months in
order to avoid an additional threat to the post-devaluation stability
of sterling.
But the United States is not likely to assume such broad
responsibilities to aid the United Kingdom in the years ahead. As a
member of the Common Market, the Bank of England will undoubtedly
participate in the short- and medium-term credit facilities which will
be created among the European countries. These arrangements, to which
the United States does not now adhere, would presumably serve as the
first-line defense of the pound.
Secondly, even if the United States were concerned about the
stability of the pound, it is by no means clear that we could afford
substantial dollar credits to Britain. On the contrary, about the
last thing System officials are likely to encourage would be substantial
additional dollar flows from the Bank of England to other G-10 central
banks.
Finally, the staff regard it as unlikely that the U.S. govern-
ment will return to as rigid an exchange-rate policy as was enforced --
largely through the facilities of the swap network and of the Fund --
between 1962 and mid-1967. There is now general agreement among Fund
BERALD FORD
- 7 -
members that a limited (but significant) increase in exchange-rate
flexibility is unavoidable. Mechanisms to achieve this additional
flexibility are likely to be an essential precondition before the
United States again accepts a convertibility commitment even in a
limited form.
Although modifications in the purposes, uses and magnitude
of the swap network will have to be discussed by the FOMC in the future,
a formal discussion at this time would be premature. Until the outlines
of the new world monetary structure are clarified, in fact, such a
discussion would lack focus and would probably be of only limited
utility.
FORD & 03RALD LIBRARY
- 8 -
Policies governing settlements of outstanding balances
Federal Reserve officials are in the process of working out
settlement arrangements on outstanding System indebtedness to swap-
partners. These obligations as of November 3 (in millions of U.S.
dollar equivalent) were:
Belgium
$ 535 m.
Bank of England
750 m.
Germany
60 m.
Switzerland
1000 m.
B.I.S. (Swiss francs)
600 m.
(Belgian francs)
35 m.
Total (dollar equivalent)
$2980
The general lines of policy which have thus far emerged have
two elements:
1. The System has not accepted responsibility to compensate swap-
partners on dollars covered by the swap lines held when they
BERRLD FORD LIBRARY
upvalued their parities (Switzerland, May 10, 1971);
2. The System has recognized the responsibility to compensate them
against loss (i.e. providing unchanged amounts of foreign currencies)
on dollar balances covered by swap drawings (or on liabilities
incurred) to the extent that their currencies were freed to float
upward after August 15.
Form of Belgian repayments - Thus far, the only post-August
repayments made have been in Belgian francs. The Belgian authorities
have renewed drawings as they have matured (See Annex I) and have
encouraged System officials to make moderate and steady purchases of
Belgian francs in the exchange market to reduce these obligations. To
date some $75 million of the drawings have been repaid out of balances
- 9 -
acquired in the market. Last week the New York Reserve Bank postponed
further purchases at the request of the Belgian authorities because of
advances in the franc's market quotation. The Belgian officials had
told us prior to this time that they did not regard Federal Reserve
market purchases as important in the recent rise in the Belgian franc
rate.
Experience with drawings in other currencies - The Swiss
authorities have agreed to renew each of the three System drawings
shown in Annex I. (See Annex. I.) The DM obligations have been renewed
until December 30 and $10 million was repaid on November 12 out of
System balances. The drawing on the Bank of England which matures on
November 17 has also been renewed until February 1972.
FOMC has no apparent policy options - As the staff views the
situation, U.S. officials could leave the initiative about repaying
maturing System liabilities to our swap-partners. The System can make
repayment now only (with the agreement by the swap-partner) by buying
their currency in the market. This our partners may be reluctant to
encourage where they do not wish to have their currencies pushed up in
the market. Should they wish to be paid off with reserve-assets,
settlement would then become a matter between them and the U.S. Treasury
and not with the System.
GERALD FORD LIBRARY
- 10 -
Should any credit lines be cut back?
Regardless of what decision might be made in the future about
the aggregate size of the swap network, it is evident at this time that
the Bank of England's credit line is disproportionately large. At
least four arguments can be advanced in favor of reducing this line at
this time:
1. The U.S. balance of payments cannot finance substantial credits to
the United Kingdom and we would find it embarrassing if the U.K.
payments position deteriorated (as some expect) after Britain
joined the Common Market in 1973 and asked to draw on the swap
lines;
2. The avoidance of a U.K. devaluation is not likely again to become
a priority objective of U.S. policy;
3. The vote of the U.K. Parliament to join the Common Market provides
a heaven-sent occasion to announce a reduction in this line; and
4. The U.K. balance of payments is presently strong enough to remove
any need for the full line.
Case against action - By contrast, a U.S. decision at this
time to reduce the swap-line would create an additional uncertainty in
world financial markets. This consideration would appear to be the
main argument against FOMC action at this time.
Staff recommendation - In our view, the weighing of the argu-
ments on both sides does not create a compelling case either to act or
to postpone action at this time. A decision to act at this time could
be easily justified; but a postponement decision could as easily be
defended. At the least System officials could be requested to raise
the matter informally with Bank of England officials.
BERALD FORD LIBRARY
- 11 -
On the other hand, the Committee should anticipate the need
to face the question of cutting back the U.K. line at an appropriate
time. Accession to the Treaty of Rome provides a convenient occasion
to take this decision. Thus, it could be made at any time up to the
end of 1972.
GERALIA FORD LIBRARY
ANNEX I
SChr ULEIII
November 5, 1971
SYSTEM SWAP ARRANGEMENTS AND DRAWINGS
(In millions)
ARRANGEMENTS IN EFFECT
Line in
Central
DRAWINGS OUTSTANDING
Original
Term
Maturity
continuous
Total
Bank of
Original
Maturity
Rate of
Date
Amount
(in mos. )
Date
use since
Out.
Date
Amount
Date
Drawing
Austria
10/25/62
$ 200.0
12
12/ 2/71
usized ternew to:
Belgium
1/2/72 2/10/71
45.0
6/20/62
11/10/71
49.62
5/8
600.0
12
12/22/71
6/30/70
0/75/10/71
65.0
11/10/71
49.62 1/2
/0/728/10/71
40.0
11/10/71
49.62 1/2
8/12/71
70.0
11/12/71
49.62 1/2
8/16/71
20.0
11/16/71
49.62 1/2
8/17/71
10.0
11/17/71
49.62 1/2
2/24/71
35.0
11/24/71
49.62 1/2
5/26/71
30.0
11/26/71
49.62 1/2
2/ 3/71
70.0
1/ 3/72
49.62 1/2
4/ 7/71
30.0
1/ 7/72
49.62
1/2
7/21/71
40.0
1/21/72
49.62
1/2
7/28/71
25.0
1/28/72
49.62
1/2
535.0
8/ 4/71
55.0
2/ 4/72
49.62
1/2
Canada
6/26/62
1,000.0
12
12/30/71
Denmark
5/17/67
200.0
12
12/ 2/71
England
5/31/62
2,000.0
12
12/ 2/71
8/17/71
750.0
8/17/71
750.0
11/17/71
2.4197
France
3/ 1/62
1,000.0
12
12/28/71
Germany
8/ 2/62
1,000.0
12
12/16/71
4/13/71
5/ 7/71
30.0
12/30/71
3.63
5/ 7/71
15.0
12/30/71
0.27545
60.0
5/ 7/71
15.0
12/30/71
0.27545
ANNEX I
SCHEDULE I:I
November 5, 1971
SYSTEM SWAP ARRANGEMENTS AND DRAWINGS
(In millions)
ARRANGEMENTS IN EFFECT
Line in
DRAWINGS OUTSTANDING
Central
Original
Term
Maturity
continuous
Total
Original
Maturity
Rate of
Bank of
Date
Amount
(in mos.)
Date
use since
Out.
Date
Amount
Date
Drawing
Japan
10/29/63
1,000.0
12
12/ 2/71
12
Mexico
5/17/67
130.0
12
12/ 2/71
12
Netherlands 6/13/62
300.0
12
12/30/71
300.0
12
2/20/11
Norway
5/17/67
200.0
12
12/ 2/71
Sweden
1/17/63
250.0
12
12/ 2/71
Switzerland 7/16/62 1,000.0
12
12/ 2/71
5/19/71
BNS has agreed to new to 2/10/72
8/10/71
350.0
11/10/71
4.06
8/17/71
400.0
11/17/71
4.06
1,000.0
5/19/71
250.0
11/19/71
4.09
B.I.S.
7/16/62
600.0
12
12/ 2/71
8/12/71
600.0
8/12/71
600.0
11/12/71
4.06
B.I.S.
8/ 2/65
1,000.0A/
12
12/ 2/71
8/18/71
35.0
8/18/71
35.0
11/18/71
BF
49.62
]
11,730.0
$2,980.0