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The original documents are located in Box B34, folder "Eurodollars, 1970-73 (4)" 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States of America his copyrights in all of his unpublished writings in National Archives collections.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
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copyright claim, please contact the Gerald R. Ford Presidential Library.
THE FEDERAL reserve SYSTEM
DATE
Apr. 29, 1971
Chairman Burns
TO
FROM ROBERT SOLOMON
Here is a record of our Saturday
morning meeting in Basle on the Euro-
dollar problem, which led to the one
page proposal that was before you on
Sunday afternoon.
You probably would not wish to
read this through, but I thought you would
be interested to know how the BIS listed
the participants on the last page.
RS
Attachment.
FORD & LIBRARY GERALD
Confidential
INFORMAL RECORD OF THE SECOND MEETING OF THE
AD HOC GROUP ON THE EURO-CURRENCY MARKET,
HELD AT THE BIS ON 17th APRIL 1971
The Chairman opened the meeting by introducing the document
which appears in Annex I. He said that he had put down in it, on the
basis both of the informal record of the Amsterdam meeting and of the
various papers that had been circulated since then, what he believed
were the main questions that they ought to take up, to serve as a basis
for their discussion. After the present meeting he proposed to draw up
a document for the Governors to consider at their May meeting, in which
the creation of a standing committee would be suggested and its terms of
reference laid down. He then asked if members of the group agreed to
the procedure he had suggested.
Dr. Emminger said that in his opinion the Chairman's paper
provided an excellent guide for their discussion. Perhaps at a later
stage of the meeting they could discuss the suggested timetable for the
creation of a standing committee.
The Chairman then proposed to take his paper paragraph by para-
graph. After saying that he thought everyone would be able to agree on
what was in the opening paragraph, he then asked for comments on Point 1.
POINT 1
Mr. Solomon said that in his view that point was well stated.
Dr. Emminger, after the Chairman had confirmed that BIS placings
in the Euro-currency market were covered by Point 1, said that they had
now had material which showed a $3 milliard shift of dollar assets by
the BIS into the market.
Mr. Morse said that, so far as Point 1 was concerned, the most
interesting thing would be to analyse what the central-bank inputs into
the market were.
The Chairman then commented that those inputs would have to be
studied by the future standing committee. All he wanted to know now was
that they agreed with what was said under Point 1 of his paper.
DECLASSIFIED
AUTHORITY Fed. Res. Emptem th, 11/16/82
BY lula NARA, DATE 9/10/09
guidding
QERALD FORD LIBRARY
- 2 -
Dr. Emminger replied that he fully agreed. Probably this was
the most important aspect of the Euro-dollar for their group, since they
could have a major influence on it. He was not sure that they should
simply hand this topic to the standing committee for study, since he did
not think that there was much more that they would learn about it. Instea
they should make concrete proposals to the Governors on this point at a
much earlier stage.
The Chairman then suggested that this point could be taken up by
the standing committee at its first meeting.
Dr. Emminger commented that, if the committee were set up after
the May Basle meeting, its first meeting could not be held until June.
But he felt that this problem was a very urgent one and referred to Germany
as "a burned child".
The Chairman said he was not against the idea of finalising matters
for the Governors at once. He added, however, that it might not be easy
to draw up a report for the Governors by the following day.
Dott. Ossola said that it might be dangerous to suggest concrete
action without knowledge of the different magnitudes involved in the
market. One thing they might do, however, was to put a stop immediately
to further central-bank contributions to the Euro-market.
Mr. Solomon said that the remarks of both Dr. Emminger and
Dott. Ossola were quite consistent with the US view of the problem of
central-bank contributions to the market. A massive reversal of them
would be disruptive, but equally he thought that the idea of studying
them at leisure was inappropriate. As a first step they could adopt
Dott. Ossola's suggestion.
The Chairman said that he would prefer to go through all the points
contained in his paper first, before they asked themselves if they were in
a position to act more quickly than he himself had anticipated.
Dr. Gilbert was disturbed by the form of Point 1 in the Chairman's
paper. The present ad hoc group was set up to see if there was agreement
to propose to the Governors the creation of a standing committee. Final
action was up to the Governors and the present group could not put things
in a form that told the standing committee what the answers to the various
problems were. He thought that they might be able to say to the Governors
tomorrow that there was agreement on the setting up of a standing committee.
BERALD FORD LIBRARY
- 3 -
The Chairman repeated that his paper was meant simply to guide
the present meeting. After discussing it, they could decide what to
propose to the Governors and what sort of terms of reference the standing
committee should be given.
Mr. Morse then said that in that case it would be desirable to
discuss the substance of Point 1 in the Chairman's paper. He then dis-
tinguished the following types of central-bank placement in the market:
1 (a) when a central bank takes dollars from New York and places
them in the Euro-dollar market;
(b) when a central bank takes dollars from New York, converts
into another currency (recently, notably the Deutsche Mark)
and places that other currency in the Euro-currency market;
2. The practice of swapping dollars out through commercial
banks. In this connection he specifically mentioned the
Deutsche Bundesbank, adding that some other central banks,
too, had done the same thing.
He then asked the question, what was wrong with these placements?
Two criticisms in particular had been made of them. The first was that
they produced expansionary or inflationary monetary effects. That remark
applied to all the types of placement that he had mentioned. The second
criticism, which he described as presentational, was that they produced an
exaggeration of the size of currency reserves in relation to the size of
the US payments deficit. That effect was only produced by 1(a) and (b)
above.
The suggestion that had been put forward for limiting these
placements amounted to a self-denying ordinance on the part of central
banks represented around the table, while recognising that other central
banks, too, were putting funds into the market. He added that the BIS
had a very special position in all this and they would have to see what
the effects of its actions were.
Dr. Gilbert then asked whether the suggestion of limiting central-
bank placements was intended as something permanent, or whether its purpose
was simply to handle some current difficulty.
FORD is LIBRARY BERALD
- 4 -
Mr. Coombs commented that the appropriateness of such a limitation
depended entirely on the circumstances at any given time.
Mr. Solomon asked what was meant by describing the second of the
criticisms mentioned by Mr. Morse as being presentational.
Mr. Morse replied that in describing it in that way he had not
meant to play it down. On the contrary it was a very real problem. On
the other hand, he was not convinced that the first criticism was a very
important one.
Mr. Inoue agreed that central-bank placements in the market could
lead both to double counting of international liquidity and to excess
creation of domestic liquidity. But if they started restricting such
placements that would mean controlling where reserves were placed. In his
opinion countries should be free to place their reserves where they wished.
Mr. Joge said that Sveriges Riksbank had never placed dollars in
the Euro-dollar market. That was not because of the effects on inter-
national liquidity, but because it would amount to allowing the use of
monetary reserves for investment purposes. He thought the problem was
therefore a permanent one. Could they not agree to refrain permanently
from placing more of their dollar reserves in the market and, in the more
distant future, actually withdraw what was already placed there? Further-
more, could this rule not be recommended to all central-bank shareholders
of the BIS and not just to those represented at the present meeting?
Mr. Morse asked whether Mr. Joge had meant that in the longer term
central-bank dollars should only be placed in US Treasury bills.
Mr. Joge replied that if a central bank placed dollars anywhere
in the US money market he presumed that the Federal Reserve took it into
account as regards its effect on the domestic money supply. Central banks
should therefore be free to place dollars in any US money-market instrument.
Mr. Hay said he saw great advantage in the creation of a standing
committee. It could discuss what they were at present discussing, in
order to see what central-bank policy should be at any point in time. He
did not, however, see how they could influence the policies of central banks
outside their own group, except perhaps those who were BIS shareholders. As
to whether or not central banks should buy commercial paper, he thought that
was hard to say. Finally, as regards central-bank swaps with commercial
banks, he thought that they were somewhat different in nature, especially
if they were very short-term.
FORD LIBRARY BERALD
- 5 -
The Chairman then said that he concluded that, if the Governors
decided to set up a standing committee, the problems mentioned under
Point 1 of his paper would be a very important and useful item for the
committee to discuss. It should follow developments in this field and
if necessary suggest action. He then asked whether the group agreed with
what he had just said.
Mr. Solomon asked whether that meant that all problems would have
to wait until the standing committee was set up.
Professor Kessler, referring to central-bank swapping of dollars
with commercial banks, asked if it was not true that this was very
different from central-bank deposits of dollars in the Euro-dollar market.
Such swaps meant, from the commercial banks' point of view, the conversion
of domestic liquidity into foreign liquidity. In the case of central-bank
deposits, however, the commercial banks received increased resources, and
in such a way that those resources would find outlets through the granting
of credits to non-residents. He added, as regards the timetable of work,
that even if they could not draw up a mandate for a standing committee by
the following day, perhaps some group could do some thinking and drafting
during the next weeks in order to gain time. Otherwise, as Dr. Emminger
had said, discussions would begin only in June.
Dr. Emminger then said that, in order to be clear as to whether
speedy action was needed, they had to go into the substance of Point 1
in the Chairman's paper. He agreed with the distinctions between types
of central-bank inflow that Mr. Morse had made. But for him the most
important aspect of these inflows was not the statistical inflation of
reserves but rather their potential inflationary effects and the way in
which they undermined countries' credit policies.
Referring to the first type of inflow distinguished by Mr. Morse,
they had to include the BIS in considering this. He then asked whether
the BIS should not look at the monetary effects of its actions and not
just at relative interest rates. Of course if no monetary problems were
at stake, that would be a different matter.
Turning to the second type of inflow distinguished by Mr. Morse,
Dr. Emminger said that during 1970 the shift into Deutsche Mark reserves had
amounted to the equivalent of $1 milliard. And it was probable that
FORD & GERALD LIBRARY
- 6 -
another $1 milliard had been added to official DM holdings so far this year.
These shifts, unless the funds were held with the Bundesbank, undermined
German policy. At the same time, they led to double-counting of foreign
exchange reserves. The German authorities had considered reciprocating these
actions of other countries, by converting some of its own reserves into the
currencies of such countries. To do that, however, would produce a further doubl
counting, and this process could go on without limit. He concluded that
the major central banks should do such things only in consultation with one
another, so as to avoid working at cross-purposes. The public would become
alarmed if the volume of reserves were escalated in this way.
So far as concerned the third type of inflow to the Euro-market
distinguished by Mr. Morse, he mentioned the recent experience of the
Bundesbank. There had been a huge inflow of funds into Germany on 1st April
this year and the Bundesbank's first reaction had been to swap the dollars out
again with the banks, so as to avoid an alarmingly large rise in reserves.
They had now had time to see the effects of these swaps, and it had in
fact turned out that there had been no increase at all in the foreign assets
of the German banks. All that had happened was that there had been a
completely circular flow of funds, with no shift of the banks' domestic
liquidity into foreign liquidity, and that the banks had earned some extra
money. Consequently, that would be the last time that the Bundesbank would
try the policy of swapping inflows out to the banks.
As for whether the proposed limitation on central-bank placements
should be temporary or permanent, he had some sympathy with Mr. Joge's
analysis. But he suggested that they should leave that question aside.
Any decision taken should be on the basis of the existing circumstances,
and should be subject to possible review and change.
The Chairman then said he thought the group would agree that
(1) if a standing committee were set up, Point 1 should
be included in its terms of reference;
(2) problems of timing should be left to the end of their meeting.
M. Janson said that in his opinion it would be a good idea to
try and visualise what the consequences of central-bank deposits were for
the Euro-dollar market. If central-bank attitudes to the market were to
change, e.g. if they were to withdraw their deposits, that might create
GERALD FORD LIBRARY
- 7 -
a new problem by stimulating further outflows from the United States.
He agreed that better supervision of the market was called for, but
warned against creating new problems in the course of dealing with
existing ones.
The Chairman then proposed that they should turn to Point 2
in his paper.
POINT 2
Mr. Morse asked what was meant by gross and net outflows in
Point 2(a).
Professor Kessler replied that the paper entitled "The supply
of international short-term credit" submitted by the Federal Reserve
mainly looked at the net supply of funds. His impression was that in
that paper two different flows were netted out, viz. on the one hand
lending by Euro-banks to non-banks or deposits by Euro-banks with other
banks and on the other hand deposits made in Euro-banks of the country
to which the lending was directed. In his opinion it was important to
look at the gross outflows and not deduct any return flows that might
occur. Of course, such return flows were of some importance since they
could enable the gross outflows to continue. He added that, in looking
at gross outflows, lending to non-banks was more expansionary than the
making of deposits with other banks. This was because non-banks received
extra funds which they could spend, while banks that received funds were
always under the supervision of their own monetary authorities.
Mr. Solomon said that to him it was clear that inflows to Euro-bank
were just as important as outflows from them. Furthermore, he did not
think that it was for the present group to make judgements. What it had
to do was to agree on what the tasks of the proposed standing committee
should be. As regards Point 2(b), what was important from the point of
view of monetary policy was lending to, and receipt of funds from non-banks.
Dr. Emminger then remarked that while the German authorities had
some means of countering unwanted inflows to the banking system, it was
much harder to offset money going to non-banks. He agreed that the dis-
tinction between these two types of flows that was made in Point 2(b)
should be retained.
FORD i LIBRARY GERALD
- 8 -
Dott. Ossola asked if by outflows was meant outflows from
the Euro-market to national markets.
Professor Kessler said that outflows included a Euro-bank making
deposits with commercial banks in other countries, or its making additional
loans to residents of other countries. It could also include a Euro-bank
increasing domestic credit with the use of Euro-deposits; but he added that
the latter was under the control of the monetary authorities. Until now,
they had all not bothered about their commercial banks' lending to non-
residents, since they had thought that it did not affect them. However,
they had now found out that it did.
Mr. Solomon said that in his opinion Point 2(a) should include the
effects of inflows from the countries of the group into the market.
The Chairman then proposed that they should move on to Point 3.
POINT 3
Mr. Solomon remarked that here too a conclusion seemed to be being
suggested. Some study would be required before he could agree to this
point and in any case it seemed to him a little hard for the present group
to suggest what the conclusion should be.
The Chairman then said that if Points 1 and 4 from his paper were
put into the standing committee's terms of reference, sooner or later what
was in Points 2 and 3 would come up for discussion. So Points 2 and 3 did
not need to be mentioned in the standing committee's terms of reference.
He then proposed that they go on to Point 4 in his paper.
POINT 4
Mr. Morse, commenting on Point 4, said that they ought to get not
only the wording of it, but also its atmosphere and flavour right. It was
possible to exaggerate, as well as to minimise, the problems arising out
of the Euro-currency market. He then listed the following exaggerated
fears that had been expressed about it.
1. The idea that its size has grown with terrifying rapidity.
He thought that the BIS paper "Joint Supervision of the Euro-currency
Market" put this in the right perspective by comparing the growth of
Euro-dollar credit with the growth of private credit in all OECD countries.
Furthermore, not all of the growth in the Euro-currency market represented
an increase in credit.
GERALD FORD LIBRARY
- 9 -
2. The idea that the market was something quite new. The problems
of flows between countries were bound to arise anyway in a system of con-
vertibility and freedom. The most that could be said about the Euro-
currency market was that it amplified these flows.
He added that non-banking flows, and in particular those of funds
belonging to multi-national corporations, created just as many problems
as did more strictly banking flows. They should therefore approach this wl
matter in a cool way. He agreed with Mr. Solomon that the paper to be
presented to the Governors should not contain leading questions. And he
was not sure either that the right way to tackle the problem was by reducing
the market's credit-creating potential or that by doing so they would
reduce the problem. He would therefore like Point 4 to be expressed in
a much more general way.
Dr. Gilbert agreed that what the group should present was not
conclusions, but rather suggestions for the work of the standing committee.
Referring to Mr. Morse's remark that in a convertible world flows of funds
between countries were to be expected anyway, he said that flows took
place through the Euro-dollar market precisely because of limitations and
restrictions on convertibility. There was a broader convertibility in the
Euro-market than elsewhere; that was why it grew so fast.
Mr. Morse again denied that the growth of the Euro-dollar market
had been so extraordinary.
Dr. Gilbert replied that $50 milliard in ten years seemed a big
figure to him.
Mr. Coombs then asked how much world trade had grown during those
ten years.
Mr. Solomon said he supposed it would be agreed that in 1969 the
flows through the Euro-dollar market had had a contractionary rather than
an expansionary effect. He therefore concluded that Point 4 should be
more broadly stated.
The Chairman agreed.
Dott. Ossola then asked why in Point 4 the use of exchange
controls had been excluded?
The Chairman replied that he had left that out for practical reasons
He did not think that, for the group as a whole, the use of exchange con-
trols would lead them very far, though it might be useful for a particular
country.
GERALD FORD LIBRARY
- 10 -
Mr. Solomon said that restrictions could take various forms, and
need not necessarily consist of exchange controls or restricting borrowers'
access to the market.
Mr. Hay then raised the matter of interest rate policy. In his
view, that was the fundamental question for the proposed standing committee.
Mr. Bouey said that, while they had concentrated their attention on
the Euro-dollar market, in his opinion interest differentials were the most
important factor that propelled funds through the market.
Dr. Emminger pointed out that there was no reference in the Chairman's
paper to what might be called open-market policy for the Euro-dollar market.
That might be more useful than exchange controls. He suggested that
illustrative examples of the "ways and means" mentioned in Point 4 should
be included in brackets.
*
*
*
The Chairman then said that he thought the discussion had been
carried far enough to enable him to prepare a paper for submission to the
Governors. So far as concerned the timetable, should they postpone every-
thing until May or were some problems too urgent for that?
Mr. Morse asked what there was to prevent the standing committee
being set up by the Governors at their present meeting. With reference
to Point 1 in the Chairman's paper, he added that it was clear that some
members of the group would like the Governors to agree at once on their
being no net increase in the Euro-placements of their central banks pending
the standing committee's study. While he could not commit his Governor
on that matter, he wondered whether the Chairman could not put this suggestion
to his fellow Governors.
Dr. Emminger agreed with Mr. Morse's suggestion and added that if
the Chairman did not make that suggestion to the Governors his President
would put forward some such idea.
The Chairman said that such a decision, which could have far-
reaching implications, would not be easy to take. They could however
try to settle the whole matter now and not leave it over until May.
Dott. Ossola then raised the question of the composition of the
standing committee.
The Chairman gave it as his opinion that it should be of the
same level as the ad hoc group, at any rate to begin with.
GERALD FORD LIBRARY
- 11 -
Dott. Ossola then said that, for the work of analysis, perhaps
another sort of group would be better.
The Chairman replied that the standing committee would be free
to delegate some problems to another group. But the committee as
such should start on the same level as the present group.
Dr. Emminger very much agreed. Otherwise there would be perhaps
six months of simply analytical study.
Following a short discussion on the desirability of avoiding
publicity, the Chairman then closed the meeting by saying goodbye to
the other members of the group in his capacity as their Chairman and by
thanking them for the work they had done.
FORD LIBRARY
Annex I
Dr. J. Zijlstra
17th April 1971
BIS Working Group
The papers submitted to the working group since its meeting of
17th February 1971, and the record of this meeting, clearly indicate that
the Euro-currency market can have an important impact both on the effective-
ness of domestic monetary policies and on the working of the international
monetary system. Although the papers show certain differences with respect
to theoretical analysis and practical evaluation there seems to be enough
common ground to list the following questions as those that may be con-
sidered to be the most relevant for consideration.
1. On the supply side of the market there seems to be broad agree-
ment that the inflow of funds on account of deposits of central banks
entrusted to Euro-banks has been an important expansionary (or inflationary)
factor. The question therefore arises whether a study should be made of
ways and means to reduce, to stop or, if this were considered appropriate,
even to reverse this inflow.
2. There also seems to be broad agreement that even without the in-
flow from central banks the market can generate expansionary (inflationary)
outflows. In this respect it may be worthwhile to concentrate on two
specific questions:
(a) Would there be agreement that it is useful to distinguish between
net outflows and gross outflows and that, from the point of view
of the expansionary (inflationary) impact of the transactions,
gross outflows are more relevant than net outflows?
(b) Would there also be broad agreement that among gross outflows the
outflows to non-banks (lending to non-resident end-users) have to
be distinguished from interbank outflows, the former, from the
point of view of the expansionary (inflationary) impact of the
transactions, being more relevant than the latter?
3. With respect to the gross outflow to non-banks, would there be
broad agreement that it is unlikely that the monetary impact of these out-
flows is fully compensated by a reduction in domestic credit expansion in
the receiving country (and possibly also in the lending country)?
FORD
LIBRARY
annex I -
- 2 -
4. If there is broad agreement with the propositions under 2. and
3. it would appear appropriate that - lacking adequate possibilities to
cope with the expansionary (inflationary) effects of the Euro-currency
market by the use of exchange control - a study should be made of ways
and means (e.g. some form of liquidity requirement) to reduce the Euro-
currency market's potential for generating expansionary (inflationary)
outflows?
BERA FORD LIBRARY
Annex II
PARTICIPANTS
Chairman:
Dr. J. Zijlstra
Belgium:
M. G. Janson
M. P. André
Canada:
Mr. G.K. Bouey
France:
M.M.Théron
Germany:
Dr. O. Emminger
Italy:
Dott. R. Ossola
Japan:
Mr. S. Inoue
Netherlands:
Professor G.A. Kessler
Sweden:
Mr. S. Joge
Switzerland:
Mr. A. Hay
United Kingdom:
Mr. C.J. Morse
Mr. J.L. Sangster
United States:
Mr. C.A. Coombs
Mr. R. Solomon
BIS:
Dr. M. Gilbert
Mr. M.G. Dealtry
GERALD FORD LIBRARY
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date May 12, 1971
To
Governor Daane
Subject: Relation of Project for BIS With-
drawal from Eurodollar Market to U.S.
From
A. B. Hersey
Balance of Payments Policy
CONFIDENTIAL (FR)
The fundamental objections to the Coombs project of selling
special securities to the BIS as an inducement to the BIS to withdraw
from the Eurodollar market are:
(1) tightening the Eurodollar market in this way will
not be effective in defeating speculators on the mark;
(2) it is not in the U.S. interest to defeat European
speculators on the mark, though we would be happy
to see U.S. speculators out of the thing as far
as possible.
Tightening the Eurodollar market in this way will not be effective
in defeating mark speculation because:
(1) speculators can get financed elsewhere, including
the United States;
(2) funds will always be obtainable in the Eurodollar
market, no matter how tight it gets, because funds
will be drawn in from other sources where interest
rates are lower, including the United States.
U.S. balance of payments policy in a very short-run frame of
reference has three conceivable strategies:
(1) exchange controls, IET on short-term capital, etc.
(widely regarded as unworkable, and under present
exchange market conditions probably counterproductive
even if confined to moral suasion and "voluntary"
programs);
(2) action on interest rates (see below);
(3) hands off, letting the markets force a revaluation
of the DM as soon as possible -- giving the specu-
lators their profits -- in the expectation that
much of the speculative money coming out of the
DM will move back to the United States.
FORD is LIBRARY CERALD
Governor Daane
-2-
CONFIDENTIAL (FR)
The only actions on interest rates that make sense in this
situation are actions that raise U.S. rates or reduce European rates.
Raising Eurodollar rates makes no sense because it widens the spread
favoring movements out of the United States.
It is not in the U.S. interest to defeat European speculators
on the German mark, because:
(1) any revaluation of the German mark now, even if
too small, is better than none;
(2) any revaluation of the German mark would put
additional pressure on Japan to revalue the yen.
FORD & LIBRARY GERALD
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE
FEDERAL RESERVE SYSTEM
BANK - NEW YORK
Office Correspondence
Date
May 21, 1971
To
Chairman Burns
Subject:
Euro-dollar problem--
From
C. A. Coombs
a possible action program.
CONFIDENTIAL
1. As of the moment we have the agreement of the European
central banks to refrain from further placements of dollars in the
Euro-dollar market, either directly or via the BIS. The question
now arises whether we should push ahead from this base to bring
about a gradual contraction of existing central bank placements in
the Euro-dollar market on the grounds that such central bank
dollar investments should, in the general interest, be placed
in U.S. Government securities or deposited with the head offices
of U.S. banks, thereby avoiding the possible recycling and double
counting effects of placement of central bank reserves in the Euro-
dollar market.
2. The earlier Exim Bank and Treasury issues of 3-month
paper to the London branches of U.S. banks has served to mop up
Euro-dollar debt owed by U.S. banks, which otherwise would have
been repaid. This has been a useful but expensive operation for
the U.S. Treasury and I would be inclined to the view that we
FORD LIBRARY & GERALD
Chairman Burns
- 2 -
should not go appreciably further in this direction, but should not
shrink from rolling over such paper at maturity until a more
favorable opportunity for liquidating such issues comes along.
3. I continue to favor Treasury issuance of special secu-
rities to the BIS, designed to divert BIS placements of central
bank funds from the Euro-dollar market to the U.S. Treasury.
Such an operation would obviously be far less profitable to the
BIS management than its current placements of funds in the
Euro-dollar market. But if the deposit interest rate available
to the European central banks under such an arrangement were
reasonably attractive, I would hope that they would push the BIS
management into acquiescence.
4. I have become increasingly impressed with the
magnitude of funds available to the oil-producing countries
for placement directly or indirectly in the Euro-dollar market.
For example, I have heard that during the third week of April,
oil company payments to the oil-producing countries amounted
to no less than $1. 5 - $2 billion. Moreover, as a result of the
recent negotiations between the oil companies and the producing
countries, the dollar receipts of the producing countries will
FORD is LIBRARY GERALD
Chairman Burns
- 3 -
rise from $5 billion in 1970 to $15 billion in 1975. Imports by
these countries, such as Libya, will probably lag far behind,
thus increasing still further their already large reserves in
dollars and sterling. Here, I think, the BIS could serve a
useful purpose if it could solicit deposits from the central banks
of the oil-producing countries for placement in CD's in the New
York market. While the central banks of the oil-producing
countries would probably be less appreciative than the European
central banks of the risks of central bank placements in the
Euro-dollar market, a concerted effort to persuade them by
the BIS management, together with representatives of the U.S.
and European central banks, might well succeed in channeling
a goodly part of the dollar and sterling reserves of the oil-
producing countries away from the Euro-dollar market into New
York and sterling placements in London.
5. Such efforts to shift central bank funds from the Euro-
dollar market into New York CD's would tend to maintain or widen
the present spread between Euro-dollar and U.S. rates and
thereby create the risk of generating new flows of short-term
FORD & LIBRARY UERALD
Chairman Burns
- 4 -
private funds from the U.S. into the Euro-dollar market. Pending
a closer convergence of U.S. and foreign interest rates, strong
action to tighten up the OFDI and VFCR regulations and to extend
the IET to short-term investments is essential.
We can tolerate
for a while either U.S. rates substantially below European levels
or slack enforcement of short-term capital controls, but not
both at the same time.
6. All European countries experiencing inflows of
foreign money should be pressed to institute controls designed
to reduce to zero the interest paid on such foreign deposits,
or even to institute a penalty provision.
7. We should also press for the introduction of controls
in each European country designed to limit, when appropriate,
borrowing in the Euro-dollar market by their banks and business
corporations. Such controls already exist in France and the
United Kingdom and in various less stringent forms in certain
other countries. In the absence of such controls, German
industrial borrowing abroad alone accounts for $6 billion of
the increase in the Bundesbank reserves during the past
GERALD R. LIBRARY FORD
Chairman Burns
- 5 -
year. The hard line being taken by Schiller is being financed
by borrowed money.
8. The 20 percent reserve requirement on Euro-dollar
borrowing by U.S. banks in excess of their bases no longer serves
a useful purpose and should be eliminated. From time to time,
New York banks may well find short-term Euro-dollar rates
attractive enough to bid for Euro-dollar funds if the reserve
requirement were eliminated.
9. At the April meeting of the BIS the question was raised
whether central bank placements of dollars with their commercial
banks on a swap basis should be included in the agreement to
avoid placing new funds in the Euro-dollar market. (In such swap
contracts, the commercial bank would normally place the funds
acquired from its central banks in the Euro-dollar market.) It
was agreed, however, that such operations should be exempted
from the holding operation since certain central banks felt
that they were an essential instrument of central bank credit
policy. I think we should now move to prevent such central
bank swaps with their commercial banks from injecting new
FORD & LIBRARY GERALD
Chairman Burns
- 6 -
funds in the Euro-dollar market by generalizing to the extent
necessary our recent operations with the Swiss National Bank,
which enabled the National Bank to sell part of its dollar reserves
to the Swiss commercial banks for placement via the BIS in the
New York CD market.
10. Finally, I think we should intensively explore possi-
bilities of instituting a uniform reserve requirement on commercial
banks operating in the Euro-dollar market. I doubt that this could
be accomplished effectively by Bank of England action, which
O'Brien would probably sternly resist, to impose such reserve
requirements on all banks conducting Euro-dollar operations in
London. The best avenue would lie in uniform action by each
major country to place such a reserve requirement checkrein
on the Euro-dollar operations of its commercial banks, more
particularly the operations of their foreign branches.
11. With acertain amount of negotiating effort, I should
think we could get a general endorsement by the European
central banks of points 1 - 9 outlined above. Point 10 is bound
to stir up sharp controversy and I would not place much hope
in early action in this area.
FORD & LIBRARY 03RALD
FEDERAL RESER VE
BANK - NEW YORK
May 21, 1971
Chairman Burns
Euro-dollar problem--
C. A. Coombs
a possible action program.
CONFIDENTIAL
1. As of the moment we have the agreement of the European
central banks to refrain from further placements of dollars in the
Euro-dollar market, either directly or via the BIS. The question
now arises whether we should push ahead from this base to bring
about a gradual contraction of existing central bank placements in
the Euro-dollar market on the grounds that such central bank
dollar investments should, in the general interest, be placed
in U.S. Government securities or deposited with the head offices
of U.S. banks, thereby avoiding the possible recycling and double
counting effects of placement of central bank reserves in the Euro-
dollar market.
2. The earlier Exim Bank and Treasury issues of 3-month
paper to the London branches of U.S. banks has served to mop up
Euro-dollar debt owed by U.S. banks, which otherwise would have
been repaid. This has been a useful but expensive operation for
the U.S. Treasury and II would be inclined to the view that we
FORD i LIBRARY 937870
Chairman Burns
- 2 -
should not go appreciably further in this direction, but should not
shrink frommolling over such paper at maturity until a more
favorable opportunity for liquidating such issues comes along.
3. I continue to favor Treasury issuance of special secu-
rities to the BIS, designed to divert BIS placements of central
bank funds from the Euro-dollar market to the U.S. Treasury.
Such an operation would obviously be far less profitable to the
BIS management than its current placements of funds in the
Euro-dollar market. But if the deposit interest rate available
to the European central banks under such an arrangement were
reasonably attractive, I would hope that they would push the BIS
management into acquiescence.
4. I have become increasingly impressed with the
magnitude of funds available to the oil-producing countries
for placement directly or indirectly in the Euro-dollar market.
For example, I have heard that during the third week of April,
oil company payments to the oil-producing countries amounted
to no less than $1. - $2 billion. Moreover, as a result of the
recent negotiations between the oil companies and the producing
countries, the dollar receipts of the producing countries will
FORD is LIBRARY GERALD
Chairman Burns
- 3 -
rise from $5 billion in 197 to $15 billion in 1975. Imports by
these countries, such as Libya, will probably lag far behind,
thus increasing still further their already large reserves in
dollars and sterling. Here, I think, the BIS could serve a
useful purpose if it could solicit deposits from the central banks
of the oil-producing countries for placement in CD's in the New
York market. While the central banks of the oil-producing
countries would probably be less appreciative than the European
central banks of the risks of central bank placements in the
Euro-dollar market, a concerted effort to persuade them by
the BIS management, together with representatives of the U.S.
and European central banks, might well succeed in channeling
a goodly part of the dollar and sterling reserves of the oil-
producing countries away from the Euro-dollar market into New
!
York and sterling placements in London.
5. Such efforts to shift central bank funds from the Euro-
dollar market into New York CD's would tend to maintain or widen
the present spread between Euro-dollar and U.S. rates and
thereby create the risk of generating new flows of short-term
FORD & LIBRARY GERALD
Chairman Burns
- 4 -
private funds from the U.S. into the Euro-dollar market. Pending
a closer convergence of U.S. and foreign interest rates, strong
action to tighten up the OFDI and VFCR regulations and to extend
the IET to short-term investments is essential. 1 We can tolerate
for a while either U.S. rates substantially below European levels
or slack enforcement of short-term capital controls, but not
both at the same time.
6. All European countries experiencing inflows of
foreign money should be pressed to institute controls designed
to reduce to zero the interest paid on such foreign deposits,
or even to institute a penalty provision.
7. We should also press for the introduction of controls
in each European country designed to limit, when appropriate,
borrowing in the Euro-dollar market by their banks and business
corporations. Such controls already exist in France and the
United Kingdom and in various less stringent forms in certain
other countries. In the absence of such controls, German
industrial borrowing abroad alone accounts for $6 billion of
the increase in the Bundesbank reserves during the past
FORD is LIBRARY GERALD
Chairman Burns
- 5 -
year. The hard line being taken by Schiller is being financed
by borrowed money.
8. The 20 percent reserve requirement on Euro-dollar
borrowing by U.S. banks in excess of their bases no longer serves
a useful purpose and should be eliminated. From time to time,
New York banks may well find short-term Eure-dollar rates
attractive enough to bid for Euro-dollar funds if the reserve
requirement were eliminated.
9. At the April meeting of the BIS the question was raised
whether central bank placements of dollars with their commercial
banks on a swap basis should be included in the agreement to
avoid placing new funds in the Euro-dollar market. (In such swap
contracts, the commercial bank would normally place the funds
acquired from its central banks in the Euro-dollar market.) It
was agreed, however, that such operations should be exempted
from the holding operation since certain central banks felt
that they were an essential instrument of central bank credit
policy. I think we should now move to prevent such central
bank swaps with their commercial banks from injecting new
FORD is GERALD LIBRARY
Chairman Burns
- 6 -
funds in the Euro-dollar market by generalizing to the extent
necessary our recent operations with the Swiss National Bank,
which enabled the National Bank to sell part of its dollar reserves
to the Swiss commercial banks for placement via the BIS in the
New York CD market.
10. Finally, I think we should intensively explore possi-
bilities of instituting a uniform reserve requirement on commercial
banks operating in the Euro-dollar market. I doubt that this could
be accomplished effectively by Bank of England action, which
O'Brien would probably sternly resist, to impose such reserve
requirements on all banks conducting Euro-dollar operations in
London. The best avenue would lie in uniform action by each
major country to place such a reserve requirement checkrein
on the Euro-dollar operations of its commercial banks, more
particularly the operations of their foreign branches.
11. With acertain amount of negotiating effort, I should
think we could get a general endorsement by the European
central banks of points 1- 9 outlined above. Point 10 is bound
to stir up sharp controversy and I would not place much hope
in early action in this area.
FORD is LIBRARY GERALD
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date June 2, 1971
To
Subject: Dealing with the Euro-
From
Robert C.
dollar market problem.
STRICTLY CONFIDENTIAL (FR)
Attached for your reference is a memorandum dated
May 28, 1971 from Mr. Coombs combining in one document the ideas
he has expressed regarding the possible establishment of a
money-employed account in the Exchange Stabilization Fund to
provide an alternate investment vehicle for dollars owned by
leading central banks. This proposal is under review by Treasury
officials, who would have the primary responsibility in proceeding
with any such proposal.
Copies to: Gov. Robertson
Mitchell
Maisel
Brimmer
Sherrill
bc: Mrs. Mallardi (2) - for information
FORD & LIBRARY
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date June 2, 1971
To
Robert C. Use
Subject: Dealing with the Euro-
From
dollar market problem.
STRICTLY CONFIDENTIAL (FR)
Attached for your reference is a memorandum dated
May 28, 1971 from Mr. Coombs combining in one document the ideas
he has expressed regarding the possible establishment of a
money-employed account in the Exchange Stabilization Fund to
provide an alternate investment vehicle for dollars owned by
leading central banks. This proposal is under review by Treasury
officials, who would have the primary responsibility in proceeding
with any such proposal.
Copies to: Gov. Robertson
Mitchell
Maisel
Brimmer
Sherrill
bc: Mrs. Mallardi (2) - for information
FORD & LIBRARY GENALD
CONFIDENTIAL--F.R.
May 28, 1971
TO:
Chairman Burns
SUBJECT: Dealing with the
FROM: C. A. Coombs
Euro-dollar market problem
As you will recall, on May 14 I sent to Under Secretary Volcker
and Governor Daane the following memorandum entitled "Euro-dollar
Market Problem", which recommended the issue of a special Treasur
security to the B.I.S. with the objective of diverting present deposits of
G-10 central banks with the B.I.S. from the Euro-dollar to the U. S. market.
"Re the Euro-dollar market, we face the problem
of how to avoid the recycling effect and double counting of
dollar reserves arising from BIS placement of central bank
funds in the Euro-dollar market. The G-10 central banks
have agreed to a holding operation under which they will not
place additional funds with the BIS for deposit in the Euro-
dollar market. The question now arises whether some with-
drawal of BIS funds from the Euro-dollar market would not
serve to keep Euro-dollar rates at a high enough level to
exert pressure on speculative positions recently built up in
German marks and other European currencies. This could
conceivably be accomplished by a special Treasury issue to
the BIS along the lines sketched out below.
1. The BIS has been offering central banks 3-month
deposit facilities with a two-day call at rates roughly 1/4 percent
below the New York 3-month CD rate, thus yielding the depositor
central banks roughly 4 3/4 percent, as compared with Treasury
bill rates ranging around 4 percent. The BIS has reportedly been
FORD & LIBRARY GERALD
placing such central bank funds in the Euro-dollar market, thus
gaining for itself the spread between its deposit rate of 4 3/4
percent and the Euro-dollar rate.
2. The U. S. could take the position that central banks
should normally place reserves in U. S. Treasury bills, thus
avoiding recycling via the Euro-dollar market. To facilitate the
transition back to such a normal procedure, the Treasury should
issue to the BIS 2-year paper with a two-day call feature, available
to both parties, at 5 percent, from which the BIS might take 1/8
percent as its commission, thus leaving 4 7/8 percent to its G-10
depositors. Macdonald of the BIS is asking 1/4 percent as the
BIS commission.
DECLASSIFIED
AUTHORITY Ged. Res. Eubstum Hr. 11/16/82
State gindlines
BY Wh NARA, DATE 9/10/09
2.
3. Such an operation would create for the BIS
two types of liquidity problems. First, individual central
banks depositing funds with the BIS might encounter reserve
drains necessitating the withdrawal of their deposits. This
liquidity problem could probably be taken care of by the BIS
itself, with the possible assistance of drawings on the BIS -
Fed swap line at 5 percent.
4. The second, and potentially more difficult,
liquidity problem is the risk that the central banks depositing
with the BIS might generally become dissatisfied with a 2-year
arrangement at 4 7/8 percent, if the broad spectrum of short-
term rates, including the Treasury bill rate, should rise well
above 4 7/8 percent before the 2-year term is up.
5. Macdonald of the BIS has suggested that this
second liquidity problem could be solved by incorporating in
the 2-year Treasury bill issue a provision for renegotiating
the interest rate every six months. I have suggested instead,
that the depositing central banks should be content with a
guaranteed deposit rate of 4 7/8 percent for the entire 2-year
period, unless the U. S. Treasury bill rate should rise so
much above this level as to convert the whole operation into
a losing proposition for the foreign central banks. If such a
precipitous rise of the bill rate should in fact occur, perhaps
the best way out would be for the U.S. Treasury itself to exercise
the call feature, on the grounds that the 2-year issue was a
transitional device designed to deal with a situation in which
European central bank money was being diverted from its normal
placements in U. S. Treasury bills. With the Treasury bill rate
having moved to attractive levels, the European central banks
could then be encouraged to shift from placements with the BIS
into direct placements in the U. S. Treasury bill market."
As noted above, my preliminary discussions with Macdonald of the
B.I.S. have suggested that we might run into a time-consuming bargaining
encounter with the B.I.S. management over the question of the B.I.S. commission
as well as over the issue of whether the rate on a special Treasury security
should be variable during its lifetime. More generally, I sense that Macdonald
will prove resistant to any scheme which locks his operations into U. S. Treasury
decisions as to whether or not to issue special securities. We do, however, have
the alternative of dealing directly with the G-10 central banks making deposits
with the B.I.S., and with this in mind I sent off, on May 25, 1971, a cable to
GERALD FORD LIBRARY
3.
Messrs. Volcker and Daane, through the Consulate in Munich, which ran
as follows:
"Regarding my earlier suggestion of a special
Treasury issue to the BIS, which BIS management might
resist on various grounds, it might be useful to have an
GERALD FORD LIBRARY
alternative proposal available, namely, creation of a
money employed' account at the Federal Reserve Bank of
New York, as agent of the Stabilization Fund, which might
offer time deposit facilities to G-10 central banks comparable
to those provided by BIS. Basic feature of such an account
would be a two-day call provision on 3-month deposits generally
yielding slightly less than the 3-month bill in which such central
bank deposits would normally be invested. As part of a special
cooperative effort to shift to the U. S. market present central
bank placements in the Euro-dollar market via the BIS, however,
we might temporarily offer on such deposits a rate somewhat
higher than the bill rate by investing part of the deposits in
special Treasury issues of somewhat longer maturity. Liquidity
of the money employed account could be readily assured by
domestic and foreign trading desks of the Federal. DE
I should now like to spell out in somewhat more detail the above
proposal for a money-employed account.
1. The Federal Reserve Bank of New York could offer to the
G-10 central banks which now have dollars placed via the BIS in the Euro-
dollar market, a time deposit account on a "money-employed" basis; that is,
the deposit would be placed into a pooled account yielding a uniform interest
rate, which would be higher than might be possible on an individual investment
basis.
2. The Federal Reserve Bank of New York would offer this
facility as fiscal agent for the U. S. Treasury, and the deposits would be
placed on the books of the Exchange Stabilization Fund of the U. S. Treasury.
3. The foreign central bank dollars so pooled could be invested
both in U. S. Treasury marketable securities of various maturities an
in
special nonmarketable securities, with an average maturity well in excess of
three months. Thus, the yield on the overall account could be set higher than
the 3-month bill rate, perhaps as much as 1/2 percent higher.
(See Appendix A
for a sample portfolio.
4.
4. Deposits in the account would have a two-day call feature,
with relatively mild penalty provisions against exercising the right of call.
5. The prospective interest rate on such a "money employed"
account, combined with the call provision, would make this facility comparable
with deposit facilities now being offered by the BIS.
6. So long as the U. S. Treasury bill rate remains below the rate
on the money-employed account, I think it probable that foreign central bank
deposits in the money-employed account would prove relatively stable. Foreign
central banks suffering reserve drains would clearly be inclined to cash in first
their lowest yielding reserve assets.
7. Nevertheless, from time to time some central banks might
find themselves compelled to draw on the money-employed account. I think,
however, the liquidity of the account could be assured by any one of the following
techniques, or by a combination of them:
(a) Investment of, say, 25 percent of the funds
in the money employed account in 90-day Treasury bills
with staggered maturities;
(b) Investment of another 25 to 50 percent of
the funds in the money-employed account in special Treasury
securities providing a call feature;
(c) Arrangements for direct purchases when
advisable by the domestic Trading Desk of marketable
securities held in the money-employed account;
(d) Spot purchases against forward sales by the
foreign Trading Desk of the Federal of foreign currency
balances now totaling $220 million on the books of the
Stabilization Fund.
FORD is LIBRARY 9ERALD
5.
8. There remains the risk that a general upsweep of interest
rates might call for periodic adjustments upward in the yield offered by
the money-employed account. Such interest rate flexibility could be achieved
by devoting, as suggested above, roughly 25 percent of the investments of the
money-employed account to short-term Treasury bills.
9. The main risk I see in the money-employed account proposal
is that it could be construed as a move to take the BIS completely out of
business. I would think it would be possible, however, to reassure the BIS
and its supervisory central banks on this score, more particularly since we
should hardly be inclined to push a money-employed account facility so far
as to undercut our own bill market to which the bulk of central bank dollar
reserves should continue to flow. I can rather see useful possibilities of such
a money-employed account being operated in parallel fashion with BIS operations
with the general objective of regulating the Euro-dollar market in the interests
of all of the central banks concerned.
FORD & LIBRARY 077830
APPENDIX A
SAMPLE PORTFOLIO
(Maximum maturity of 2 1/2 years)
Amount
(in millions
*
of dollars)
Securities
Yield
$ 300
U.S. Treas. Bills due within 6 mos.
4.50
10
U.S. Treas. Bills due in 1 year
5.25
25
U.S. Treas. Notes and Bonds due in 1-2 yrs.
5.30
25
U.S. Treas. Notes and Bonds due in 2 - - 2 1/2 yrs.
5.65
70
U.S. Govt. agencies due in 1-2 yrs.
5.90
70
U.S. Govt. agencies due in 2 - - 2 1/2 yrs.
6.03
500
U.S. Treas. Special C of I - - 2 1/2 yrs.
5.63
$1,000
5.33
average yield
* Based on 5/26 prices.
LIBRARY GERALD R FORD
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
DATE
June 9, 1971
Chairman Burns
TO
In connection with the discussion
of Euro-dollars at luncheon on Monday,
June 7, it occurred to me that you might
be interested in the attached effort to
jot down some tentative extra curricular
thoughts on the subject.
Attachment.
P.S.P
F.S.
FORD is LIBRARY GERALD
FREDERIC SOLOMON
ROUGH DRAFT FOR COMMENT
(Frederic Solomon-5-19-71)
1920s STOCK MARKET, 1970s EUROMARKET
From time to time significant new profit possibilities are dis-
covered (or imagined). If there is an available supply of funds, the
two can combine to produce a greatly increased flow of funds throughout
the economy. The increased flow occurs when funds are placed in the newly
profitable outlets, are disbursed to flow back through the economy, are
drawn back into the profitable outlet by the high yields offered, and the
process is repeated over and over again. The increased flow can continue
until something interrupts it, such as disappointed expectations, or some
other constraint on the flow at some point. (In some cases there can be
an actual reversal of the flow, as when a speculative bubble bursts.)
As the flow continues there are a number of effects. An immediate
inflationary effect is reflected in the increased prices that result from
the increased demand in the area where the flow is most sharply focussed,
that is, in the newly profitable area. A stockpiling or blance sheet effect
follows when there is a build-up of obligations that reflect the flow that
has occurred. Since the capacity or willingness of the total economy to
hold obligations usually will not increase as rapidly as the increased flow
generates extra obligations, there usually is a displacement effect when
the new obligations generated in the newly profitable area tend to crowd
out other obligations.
Banks usually play a prominent role in the process, although they
may act largely as agents or arrangers, without the resulting obligations
appearing on their own balance sheets.
GERALO, FORD LIBRARY
- 2 -
The process outlined above appears most frequently, but not
exclusively, in speculative activities such as trading in land or securi-
ties. The stock market of the 1920s is an outstanding example. However,
as indicated below, there are striking similarities in the Euromarket of
the 1970s.
1920s STOCK MARKET
1970s EUROMARKET
NEW PROFIT POSSIBILITY
Several factors contributed to
Several factors contributed to the
suddenly increased attractiveness
increased attractiveness of loans
of investment in common stocks, among
in the Euromarket, among them, the
them, the campaigns that sold war
profitability of American businesses
bonds in World War I, the profita-
entering the cartelized European
bility of the auto industry, and
markets, and investments by American
publicity regarding common stock
businesses seeking to establish them-
profits. Rises in common stock
selves inside the tariff walls of the
prices attracted new funds and made
common market. Later, credit restraint
"street loans" highly profitable.
in the United States led many large
U.S. businesses to finance themselves
directly or indirectly through the
Euromarket, even for their U.S.
activities.
FORD & LIBRARY GERALO
- 3 -
IMMEDIATE INFLATIONARY EFFECT
The principle initial impact was on
Since the Euro-borrowers used the funds
stocks and street loans. Since the
to finance their activities, the im-
supply of the former was rather
pact probably was spread widely through-
inelastic, prices soared. The
out the economies of the European
high yield and presumed safety
countries and also the U.S. This may
of street loans attracted large
have been a significant but little noted
amounts into them from around the
cause of world-wide inflationary
world.
pressures.
STOCKPILING (BALANCE SHEET) EFFECT
The volume of street loans in-
The volume of Eurodollars increased
creased greatly, reaching an
greatly, reaching an estimated $50
estimated $11 billion.
billion. There also were large amounts
of Eurobonds.
ROLE OF BANKS
Very few of the street loans were
By definition, none of the borrowings
made directly by the banks and
were made directly by domestic offices
appeared on their balance sheets.
of U.S. banks, and none appeared on
However, virtually all the others
their domestic balance sheets. However,
were made by the banks acting as
the U.S. banks borrowed and loaned large
agents for nonbank lenders.
amounts of Eurodollars at their
FORD is LIBRARY 07V839
foreign branches, and later had
their foreign branches borrow Euro-
dollars for the head offices. Non-U.S.
- 4 -
banks also borrowed and loaned Euro-
dollars.
DISPLACEMENT EFFECT
Street loans tended to displace other
Eurodollars tended to displace what
forms of investment, causing reduced
they most resembled and considerably
demand for such other investments.
out-yielded, namely, State-side dollar
Farmers charged that credit was being
obligations (U.S. dollars). Reduced
denied them (i.e., there was reduced
demand for U.S. dollars caused dollar
demand for their obligations) and that
weakness and gold drain.
funds were being drained from agricul-
ture.
REMEDIAL EFFORTS
General monetary restraint and
Problem seems to remain even though many
"direct pressure" were both tried,
remedies have been tried, including
with little effect. Securities
general monetary restraint, VFCR, IET,
Exchange Act of 1934 placed margin
restraint on transfers of funds abroad
requirements on stock market loans,
by U.S. corporations, currency swap
thus restraining the flow by limit-
arrangements, and reserve requirements
ing the demand for borrowed funds to
on Eurodollars transferred to head office
enter the area.
Current efforts to issue special EX-IM
and Treasury securities probably will, in
a static sense and at some cost to the
FORD is LIBRARY 070835
U.S., absorb some of the Eurodollars gen-
erated by past operations of the process.
- 5 -
However, there is a serious question
whether such special securities can
restrain the dynamic process by which
additional Eurodollars are created, and
whether such securities may not even
contribute to further expansion of the
process.
FORD & LIBRARY 078838
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date June 23, 1971
To
Chairman Burns
Subject:
From A. B. Hersey
aBlt
Attached is a memorandum by Miss Logue reporting on
testimony on the Eurodollar market given yesterday by Messrs.
Gilbert, Klopstock and de Vries.
Attachments.
Cc: Governor Brimmer
Governor Daane
Governor Mitchell
FORD & 078110 LIBRARY
June 23, 1971.
To:
Mr. Hersey
Report on Hearings before the Reuss
Subcommittee on International
From: Ruth Logue
Exchange and Payments, Tuesday,
June 22, 1971, Afternoon Session.
Congressmen present:
Henry S. Reuss (D-Wis.), Chairman
William B. Widnall (R-N.J.) After 3:00 PM
Witnesses:
Milton Gilbert, Economic Adviser, Bank for International Settlements
Fred H. Klopstock, Manager, International Research, FRB of NY
Rimmer de Vries, Vice President, Morgan Guaranty Trust Company
Topic: The Size, Functioning and Economic Significance of the Euro-
dollar Market
Dr. Milton Gilbert described the Euro-dollar market as arising
in part from effort of banks to avoid various domestic monetary controls,
and he called for multilateral supervision of the market. Among the
factors causing the large increase in official Euro-currency holdings
in 1970-71, he mentioned a shift in the relative composition of reserve
holdings from dollars to Deutsche Mark.
Fred H. Klopstock praised the Euro-dollar market as "a funnel
through which temporarily unemployed funds in virtually all parts of
the world are quickly and efficiently transmitted to banks in major
financial centers, and through them, to borrowers in need of loan
accommodation". Mr. Klopstock dismissed fears that the dollar balances
held in the Euro-dollar market represent a potential claim on the
United States, saying that only the small fraction of total deposits
FORD is LIBRARY 076870
-2-
employed in the United States constituted a claim on United States
reserves. He was also of the opinion that only a small part of the
proceeds of Euro-dollar credit is redeposited in the market, and
therefore the multiplier effect must be quite small. Mr. Klopstock
said the market was already subject to national controls. While he
thought central bank coordination of policies with respect to the
Euro-currency market would increase, he doubted that a system of
supranational control could be effective.
Mr. Klopstock also touched on the rapid growth of medium-term
lending of Euro-dollars, and he mentioned the concern of some bankers
about the easing of Euro-dollar lending criteria.
Rimmer de Vries attributed the growth of the Euro-dollar
market mainly to interest differentials. He also praised the market
for its efficiency in gathering liquidity, but looked more favorably
on the idea of imposing restrictions. De Vries thought the Euro-dollar
market tended to magnify the short-term capital outflow from this
country during the recent crisis. He mentioned that this outflow
had been broadly based, and emphasized that foreign-related entities,
i.e., U.S. agencies and branches of foreign banks, and U.S. subsidiaries
of foreign companies had been as active in bringing about the outflow
as U.S. banks and corporations.
FORD is LIBRARY GLRALD
-3-
Chairman Reuss summarized the statements by saying he
gathered that the three thought (1) the Euro-dollar market a good
thing, that it equilibrates interest rates; (2) that U.S. controls
increased the scope of the market; (3) that the Euro-currency deposits
of central banks were not in a major way responsible for the May crisis,
and (4) that the June 14 statement of Zijlstra was constructive.
Rimmer de Vries agreed with (1) and (2), but not with (3).
He said European central bankers had complained of the U.S. following
a passive policy, but there was a long history of European central
banks following a passive policy. Their tight money had attracted
funds to Europe. He thought the depositing of funds in the Euro-dollar
market "a magnificent error" on their part.
Fred Klopstock said that the equilibration of interest rates
had not been successful, but it had facilitated the evening out of
supplies of funds. He agreed with (3) but said we need a greater
degree of cooperation on monetary policy.
Milton Gilbert thought the fact that the market made banks
act more competitively good. He attributed the disparity of interest
rates to the effectiveness of controls.
Chairman Reuss asked the panel to comment on his proposal
to close the gold window, and have a period of temporary float for
the dollar while the IMF worked out a new alignment of currencies.
De Vries thought the Reuss program too drastic.
FORD is LIBRARY GERALD
-4-
Reuss asked what the panel would do in view of the under-
valuation of the yen: (1) Nothing; (2) quotas and embargos on trade;
(3) the Reuss plan. Gilbert praised Reuss' plan as being the first
to take account of economic realities; it was not Gilbert's policy,
but is economics. Reuss asked for his program. Gilbert said he
didn't like floating; it would create a severe monetary crisis.
He asked to speak off the record, and then told Reuss that the IMF
Executive Directors didn't have the power to realign rates over the
week-end; it could be done only by negotiations among governments.
Representative Widnall asked de Vries about the participation
of U.S. banks in the flow of funds to Europe in the week of May 12
(quoting Governor Brimmer). De Vries replied that he couldn't explain
the outflow by looking at American banks. Widnall said that we have
to understand more fully the passage of funds through the banks.
De Vries said we need to know more about short-term capital movements,
that the Subcommittee should bear on the Federal Reserve and the
Treasury to gather and publish more data on short-term capital move-
ments -- that they now collect more than they publish.
Representative Widnall asked Mr. Klopstock about the
deterioration in the quality of credit he had spoken of on p. 12 of
his statement. Klopstock said there was a need for medium-term
credit in the world, but there had been some worsening of credit
FORD LIBRARY
quality at the margin. Rep. Widnall asked if borrowing short and
lending long were a trend. Klopstock said yes, there were basic
-5-
pressures to provide term loans. Widnall asked it it weren't true
that each liquidity crisis had been caused by same phenomenon --
lending long; borrowing short. He asked if there weren't measures
to control this. Milton Gilbert replied that the banks in the Euro-
dollar market were the very best banks, that it was inconceivable
that they would get in trouble because the authorities wouldn't let
them. He said liquidity crises were not always a matter of lending
long and borrowing short. Klopstock mentioned the huge pool of
Euro-dollar funds as a safety factor, and De Vries said there were
very few demand deposits in the Euro-dollar market.
Widnall then asked the panel if they agreed with Houthakker
that the U.S. balance of payments was not in such bad shape. Klopstock
was hopeful, citing the rise in receipts from direct investments and
price rises abroad. Gilbert thought it was worse than the officials
say it is.
The three statements are attached.
GERALD R. FORD LIBRARA
Statement before the Subcommittee on
International Exchange and Payments of the
Joint Economic Committee, U.S. Congress
on June 22, 1971
by Dr. Milton Gilbert
Economic Adviser and Head of the
Monetary and Economic Department
Bank for International Settlements
Basle, Switzerland
The essence of the Euro-currency market is financial interme-
diation by commercial banks in foreign currency. And, the market
itself may be defined as the group of banks outside the United
States which actively bid for foreign currency deposits in order
to off-lend the funds to other banks or to final borrowers. The
market is very well-organized, very competitive and has an excel-
lent communications network.
The BIS statistics of the size of the Euro-currency market
cover the outstanding amount of foreign currency credits chan-
neled through the commercial banks of eight reporting European
countries, namely, the United Kingdom, Belgium, France, Germany,
Italy, the Netherlands, Sweden and Switzerland. Our measure of
the market's size is thus based only on those credit flows which
on their way from the original suppliers to the ultimate users
pass at some stage through the banks of the reporting European
countries. The banks of other countries are not really excluded,
as they come into the picture as suppliers of funds to or receivers
of funds from the reporting European banks. This limitation of
the statistics to the banks of the European Group of Ten countries
is partly dictated by the availability of information, but is also
largely justified by the dominant role of these banks as Euro-
currency intermediaries - including of course the European
branches of US banks. Thus, while we have data for Japanese and
Canadian banks, the Japanese banks are not included as Euro-dollar
intermediaries, since we regard them only as end-users of Euro-
funds which they obtain from the market. The Canadian banks are
left out because we believe it more useful for analytical purposes
GERALD FORD LIBRARY
- 2 -
to group them together with the banks in the United States,
thereby showing them as suppliers of funds to or takers of funds
from the reporting European banks. No figures are available for
the bookkeeping offices of US banks in the Bahamas or similar
outposts, but, in any case, these branches are really part of the
US banking system, rather than independent foreign currency
intermediaries.
In our estimates we seek to eliminate the double-counting
which arises from interbank deposits within the reporting area.
On the other hand, to the extent that the reporting banks create
Euro-dollars by switching out of domestic or third-currency funds,
or employ Euro-dollars for conversion into domestic or third cur-
rencies, they are themselves considered as suppliers or users
respectively of Euro-currency funds. Moreover, we try to adjust
the banks' assets and liabilities vis-à-vis the United States for
amounts unrelated to the Euro-dollar market.
The size of the Euro-currency market at the end of 1970 may
be put at $57 billion, and at about $60 billion at the present
time. The dollar component is estimated at $46 billion, and per-
haps $47 billion on these two dates.
I may make a few remarks on the meaning of these figures.
Firstly, contrary to what is often thought, these dollars do not
represent a corresponding potential liability of the United States.
In fact, the US international financial position is in general af-
fected only insofar as US bank and non-bank residents have borrowed
from or lent to the market. After the large repayments made by US
banks to the market in 1970-71, probably not much more than 20 per
cent. of the Euro-banks' dollar assets by now represent claims on
the United States. The remaining 80 per cent. mainly reflect
capital flows between third countries. The fact that these credit
transactions happened to be denominated in dollars, at least on
part of their way, does not really make them different from other
capital flows that occur outside the United States. I may add that
the "potential" claims on US reserves are indicated by the private
and official liabilities to foreigners reported by the US banking
GERALD FORD LIBRARY
- 3 -
system - which have no fixed relation with the Euro-market.
Secondly, it follows from the above, paradoxical though it
may sound, that the economic significance of the market does not
derive from the fact that the credit flows are largely denominated
in dollars, but from the effect the market has on the internation-
al mobility of short-term funds. The Euro-dollar is, in a way,
only the device which has helped to bring about this increased in-
ternational mobility of short-term capital. For example, by ac-
cepting deposits and extending loans in dollars, banks outside the
United States have been able to avoid exchange controls, reserve
requirements, or interest restraints that they would have encoun-
tered if they had tried to do the same thing in domestic currency.
Similarly, by moving to London, US banks have been able to do in-
ternational business which might otherwise have been ruled out by
the US balance-of-payments restraint program, the Regulation Q
ceilings, or reserve requirements.
The increased international mobility of capital resulting
from the Euro-dollar market has of course important policy
consequences. For one thing, it magnifies the force of interna-
tional interest rate differentials and thus limits national auton-
omy with respect to monetary policy. This holds true even for the
United States, but to a much greater extent for other countries.
It is partly a matter of relative size. Although the Euro-market
is quite large by absolute standards, it is relatively small in
relation to the total US credit supply, and thus the US monetary
authorities can fairly easily neutralize the domestic monetary
effects of Euro-dollar inflows or outflows. The same cannot be
said of smaller countries where the amount that might be obtained
from the Euro-currency market is very large in relation to the
domestic credit supply.
In addition, because of the status of the dollar as an inter-
national reserve currency, capital flows into or out of the
United States do not have an immediate and direct effect on the
nation's official reserves, as is the case with other countries.
FORD is LIBRARY GERALD
- 4 -
All this implies that the Euro-dollar market tends to increase
the degree to which the slant of US monetary policy is imposed on
the rest of the world; while other countries, even if their mone-
tary policies were all to move in the same direction, would not
have the same effect on the United States.
Another point to be made regarding the significance of the
Euro-currency market is that, although the market has increased the
international mobility of short-term funds, it would be very un-
realistic to assume that none of the credit flows effected through
the market would have occurred without the facilities of the
market. For example, given the international constellation of in-
terest rates and the Regulation Q ceilings, there would in any
case have been a substantial flow of short-term funds to the United
States in 1969 and a reversal of this flow, with a substantial in-
flow into Germany, in 1970-71. It appears evident, however, that
the Euro-currency market facilitated these flows. In a way, of
course, the Euro-currency market is just one aspect of a much
broader development towards greater international interdependence
and reduced national autonomy.
A related point is that the large volume of Euro-currency
credit outstanding cannot be regarded as adding that amount to
the world supply of credit to non-banks. To some extent, naturally,
this is so; but part of it is only a substitute for credits in
domestic currency, or merely entails a reallocation of credit,
and some of it might even have caused a reduction in the world
supply of credit to non-banks. The actual impact of the Euro-
currency market on the world supply of credit will depend, above
all, on the direction of the Euro-credit flows. If the Euro-
market contributes, as it did in 1969, to a capital flow to the
United States, its overall impact will tend to be a contractive
one, since the tightening effect of such flows on the rest of the
world is likely to be larger than the expansionary impact on the
United States. Conversely, when, as in 1970-71, the Euro-market ac-
centuated capital outflows from the United States, its overall im-
pact on the world supply of credit to non-banks tends to be an
GERALD, FORD LIBRARY
- 5 -
expansionary one. To the extent that the Euro-currency market adds
to capital flows between third countries, the situation is less
clear. In the absence of exchange rate speculation and high rates
of inflation these capital flows will, however, in general respond
to differences in the degree of credit tightness, and their over-
all impact is likely to be expansionary because money will move
from countries with easy monetary conditions to countries with a
tight monetary situation.
I have been asked to what extent dollars have been "recycled"
by official monetary institutions back into the Euro-dollar market.
I am not sure of the meaning of "recycled" in this connection and
I doubt that it is a measurable concept. In any case, I believe
a more straightforward question is the magnitude of total place-
ments in the market by official institutions - whatever their
source.
Precise statistics in this matter are not available, but I
have made estimates which I believe give the approximate order of
magnitude. I estimate the total placement of funds in the market
as of the end of April 1971 at roughly $10 billion. This was
mostly dollars but included other currencies as well. The Group
of Ten central banks, Switzerland and the BIS accounted for $3.7
billion, while $6.3 billion (obtained as a residual) was accounted
for by other countries around the world. These figures may be
compared with the net size of the Euro-market which we estimate
to be at present of the order of $60 billion - $47 billion in dol-
lars and $13 billion (equivalent) in other currencies.
More important than the present total of official placements
in the market has been the increase in their volume over the past
year and a half or so. I estimate the official funds in the mar-
ket as of early 1970 at about $3 billion, which means that the
increase over this period was about $7 billion. This is quite a
large increase for a 16-to-17-month period and is what has caused
concern in official circles. Of this total increase, about $2.5
billion may be attributed to the Group of Ten, Switzerland and
the BIS, and about $4.5 billion to the rest of the world. By
GERALD FORD LIBRARY
- 6 -
comparison, the expansion of the net Euro-market over the same
period was about $16 billion.
One may explain the large increase in official Euro-currency
holdings by three factors:
(1) At the end of 1969 a sizable volume of official funds
that would normally be in the Euro-market was being held in US
banks because, with such funds exempted from Regulation Q ceilings,
higher interest rates were paid on them in the United States than
in the Euro-market. When US interest rates declined in 1970-71,
the funds moved back naturally to the Euro-market.
(2) A second, more important factor, besides the shift of
funds, was the huge increase in foreign exchange reserves. From
the beginning of 1970 to the end of May 1971 this increase was
probably about $20 billion and it certainly accounted for the
bulk of the new official placements in the Euro-market.
(3) A third factor, I believe, was a shift in the relative
composition of reserve holdings from dollars to Deutsche Mark.
This tended to increase official funds in the market because a
much larger proportion of D-Mark reserves than of dollar reserves
are held in the Euro-market. Total D-Mark deposits in the Euro-
market rose by about $4.6 billion (equivalent) in 1970 and the
first quarter of 1971, and the figure certainly increased signifi-
cantly in April and May. However, I have no way of estimating
the amount of official funds there may have been in this increase -
though I believe they were a factor.
The rapid expansion of the Euro-currency market and of the
volume of official funds placed in the market has crystallized the
view in official circles that the market should be subject to
multilateral supervision. I myself have been of this opinion for
the last five years or so, as it was clear to me that the rapid
growth of the market would continue and that it should be brought
under official consideration at an early stage.
In his speech at the Annual General Meeting of the Bank for
International Settlements on June 14, 1971, the Chairman of the
GERALD R.FORD LIBRARY
- 7 -
Board of Directors, Dr. J. Zijlstra, made the following statement:
"
it is becoming increasingly clear that the Euro-
currency market needs guidance and supervision. The
group of Governors meeting regularly in Basle decided
to set up a study group under my chairmanship to analyse
the problem and to work out terms of reference for a
standing group which might suggest policies to be adopted
by the Governors. I am confident that the Governors
will be able to bring the Euro-currency market into bet-
ter harmony with the proper functioning of the interna-
tional monetary system. I may say, in fact, that we have
already decided for the time being not to place addition-
al official funds in the market and even to withdraw
funds when such action is prudent in the light of market
conditions."
This study of the Euro-currency market in all its ramifications
has only recently been initiated and it is, therefore, too early
to say how any multilateral supervision over it may be exercised.
Legal powers among the countries differ considerably, as do their
interests in the market as a functioning institution. I may add
that whatever may be done within the Basle group of central banks
will not necessarily influence the large number of other central
banks in the world.
However, even at this stage we can put the problem of joint
supervision of the Euro-market into a logical framework. If one
thinks of direct controls, there seem to be three possibilities for
acting upon the market:
(1) Control over the foreign currency positions of commercial
banks vis-à-vis non-residents. Such control may be over either the
gross or the net foreign currency positions of banks vis-à-vis non-
residents. In its net form, this instrument is used from time to
time by all the principal European countries and, indeed, by
many other countries as well. For example, a central bank may
direct its commercial banks to maintain a balanced position in
foreign currencies vis-à-vis non-residents, so that the domestic
credit market is not affected either by net borrowing from, or net
lending to, abroad in this form. At other times, the banks might
be permitted, or indeed encouraged, to have an unbalanced position
in foreign currency vis-à-vis non-residents when that suited the
GERALD FORD LIBRARY
- 8 -
central bank, for reasons either of monetary policy or reserve
policy.
Control over the gross foreign currency positions of commer-
cial banks has, up till now at any rate, been much rarer. Indeed,
the only example I can think of among the major countries is the
guidelines on foreign lending by banks in the United States. In
the countries where the Euro-currency banks are located it could
only be introduced simultaneously and in the same way in all of
them, as an act of international co-operation. Moreover, there
would be the likelihood that such measures would push the Euro-
currency market to other countries without controls.
(2) Control over outflows of resident-owned non-bank funds
which may go to the Euro-currency market. This instrument is
available to any countries that have some sort of exchange control
apparatus. It is in fact currently used, to a greater or lesser
extent, by many of the countries of the Basle group. As examples,
I may cite (a) the controls, under the balance-of-payments program,
over US corporations' holdings of liquid assets abroad, and (b)
the general control in the United Kingdom over outflows of resi-
dent funds, except through what is known as the investment dollar
market, where a very substantial premium has to be paid to obtain
foreign exchange.
(3) Control over non-bank residents' borrowing from abroad,
including from the Euro-currency market. This is also an exchange
control power which is widely available in European countries.
And in fact during the past year both France and the United Kingdom
have acted to restrain business from borrowing in foreign currency
ruro
from abroad when there were ceilings on borrowing from banks at
GERAL
LIBRARY
home. The main European country where this control does not exist
is Germany. Had the German authorities had such power last year,
they would have been able to limit the heavy foreign borrowing in
the Euro-currency market by German corporations in the months be-
fore the recent exchange crisis.
On the general subject of controls, I may say that some au-
thorities are skeptical about their efficiency, particularly when
- 9 -
they are used over long periods of time. And no country believes
that it is able entirely to insulate itself from the rest of the
world through direct controls. Furthermore, many believe that
the aim of controls should be to alleviate specific problems with-
out losing the benefits of the Euro-currency market. These include
the stimulus that it has given to banking competition, both inter-
national and domestic; the efficiency with which the market handles
large transactions; and the advantages which result from the inter-
nationalization of available liquidity.
A second line of thought for managing the Euro-currency mar-
ket, which would avoid using direct controls, is to put banking
in domestic currencies on an equal footing with banking in
foreign currencies. One of the main reasons for the existence of
the Euro-market is the relative absence of regulations on Euro-banks'
foreign currency operations, coupled with the regulations that
govern banks' domestic currency operations both in the United
States and elsewhere. An obvious example of this is that the de-
posit rates of US banks are subject to Regulation Q, whereas those
of Euro-dollar banks are not. Thus, if the provision of Regula-
tion Q that prohibits the payment of interest on deposits made
for periods of up to thirty days were abolished, US banks would be
able to compete more effectively for funds with Euro-banks.
(Because many foreign branches of American banks have been estab-
lished just to avoid such limitations, it has been said that the
United States is exporting its banking system.) Similarly, for-
eign currency deposits with European banks are in general not
subject to the reserve requirements that apply to their deposits
in domestic currency, thereby giving a competitive edge to banks'
foreign currency operations over their operations in domestic
currencies.
I would like to say, finally, that a very important factor
in keeping the expansion of the Euro-currency market in check would
be a fundamental readjustment of the United States' balance-of-
payments deficit. While it is possible to imagine there being a
Euro-currency market without this persistent deficit, I believe the
deficit has been a major force which explains the dynamic expansion
of the market.
GERALD FORD LIBRARY
For release on delivery
Statement by
Fred H. Klopstock
Manager, International Research Department
Federal Reserve Bank of New York
before the
Subcommittee on International Exchange and Payments
of the
Joint Economic Committee
June 22, 1971
FORD i LIBRARY 018470
It is a pleasure and a privilege to appear before this distinguished
Committee which has made such an important contribution to the public's under-
standing of the international financial mechanism. Your committee has already
added substantially to our knowledge of the subject under review this afternoon
by commissioning the intensive study of the Eurodollar market that was prepared
by Ira 0. Scott, Jr. who was at that time Professor of Finance and Dean of the
Arthur T. Roth School of Business Administration at the C.W. Post Center of Long
Island University. This highly informative study, which your parent committee
published last year, provides a full description of the Eurodollar market, how
it operates, its structure and the policy questions its existence has raised.
Therefore, with your permission, I will skip over the history of the market and
its functioning, and instead will focus on some problem areas of the market that
have recently surfaced. I would like to comment in particular on those aspects
of the market that continue to puzzle and worry the international financial community.
In this context I plan to comment briefly on the implications of the phenomenal
growth of the Eurodollar market for the international position of the dollar,
and on some proposals for the supervision and control of the market.
There is no doubt in my mind that the Eurodollar market has made a
major contribution to the financing of economic growth in this past decade.
Perhaps its outstanding merit is that it has enabled banks outside the U.S.
including the overseas branches of U.S. banks--to draw huge amounts of balances
originating in many parts of the world into the financing of international trade
transactions and the operations of large private and public corporations. The
market has become a funnel through which temporarily unemployed funds in virtually
all parts of the world are quickly and efficiently transmitted to banks in major
GERALD R. FORD
2
financial centers and, through them, to borrowers in need of loan accommodation.
It has added immensely to the ability of banks in Europe, Canada and even in the
United States through their overseas branches to provide financing of their
customers at advantageous rates. The Eurodollar market has been an efficient
transmission belt for the movement of vast amounts of funds from low interest to
high interest rate countries and has made a major contribution to evening out
surpluses and shortages in national money markets.
It is nevertheless true that many central bankers and other members of
the international financial community have become increasingly disenchanted with
the market. Many close observers of the market are appalled by its huge dimensions,
and fearful of its proven ability to set into motion capital flows that are capable
of undermining domestic monetary policies. While not disregarding the market's
valuable contributions to the financing of world trade they increasingly have come
to look upon the huge capital movements associated with it as a major source of
domestic and international monetary instability.
The market is also often severely criticized because it has financed
speculative attacks on currencies that are vulnerable and speculative flows into
countries whose currencies are candidates for revaluation. In view of the market's
gigantic size and the destabilizing capital flows which it has financed, a prominent
central banker recently referred to the Eurodollar market as a "monster". Other
European central bankers have suggested that much of the Eurodollar market's
explosive growth is due to multiple credit creation within the market and that
this uncontrolled credit expansion has been an important factor in furthering
world inflation.
Several central bankers, notably Governor Carli of the Bank of Italy,
have called for control of the Eurodollar market. Federal Reserve Board Chairman
Arthur Burns has warned against the practice of central banks' recycling their
FORD
GERALD
LIBRARY
3
reserve gains into the market. The market has increasingly become a source of
medium-term loans to borrowers in many corners of the world, but these loans
are almost entirely financed with short-term money, often under terms and conditions
that have caused a number of prominent commercial bankers to raise questions about
the quality of credit in the market.
There is thus a great deal of evidence that many leaders of the international
financial community are deeply worried over recent developments in the market. I
believe some of this concern is justified, but it is also true that the central
bank community is making a major cooperative effort to prevent the market from
undermining international monetary stability and at the same time to retain and
strengthen the market's valuable role in the financing of a large variety of the
world's credit needs.
With your permission, I will now briefly comment on several of the
market's aspects that have raised concern and uncertainties here and abroad.
First a few words about the recent growth of the market and the fact that the
market's net size now surpasses foreign liquid dollar holdings in the United
States.
Linkage of Market's Size to Foreign Dollar Balances in the U.S.
During the past three years, the Eurodollar market has grown by leaps
and bounds; this growth continued in 1970, contrary to expectations. Many
observers had felt that the market would shrink as United States banks and
corporations repaid their heavy Eurodollar borrowings incurred during the tight
money era in 1969. However, huge borrowings by corporations in Germany in
response to tight money market conditions in that country and by banks in Italy
absorbed the Eurodollars set free by U.S. repayments. Heavy medium-term borrowings
by multinational corporations and public and semi-public institutions in the
less developed countries also added significantly to the demand for Eurodollar
FORD i LIBRARY GERALD
4
loan facilities. Most of the added supplies in the Eurodollar market may be
attributed to the rapidly growing placements by central banks, primarily those
in the less developed countries, but also by several Western European countries
that in the past had stayed away from the market.
After making allowance for double counting arising from interbank
deposits within the Eurodollar area, dollar deposits in banks outside the
United States now exceed $50 billion, $46 billion of this huge amount represents
dollar deposits in eight European countries which make up the core of the Euro-
dollar system and regularly report their dollar liabilities to the Bank for
International Settlements. It is on the basis of these reports, that the BIS
computes the net size of the market which reflects commercial bank liabilities
of these eight countries vis-a-vis monetary institutions, commercial banks and
non-banks outside the area and vis-a-vis central banks and non-bank residents
inside the area. But my $50 billion plus estimate also includes sizable amounts
of similar net dollar liabilities of banks in several countries outside Europe
that have become increasingly important participants in the Eurodollar market,
notably banks in Canada, Japan and Nassau.
At more than $50 billion, the Eurodollar market far exceeds foreign
liquid dollar holdings in the United States, which at the end of 1970 amounted to
$43 billion. The market has grown much more rapidly than the dollar accruals
to foreign accounts resulting from our balance-of-payments deficit. Some
members of the financial community have expressed puzzlement over these facts and
concern about their implications for the dollar's international position. They
have expressed fear that dollar balances held in the Eurodollar market represent
a potential claim on the United States and, therefore, on our diminishing monetary
reserves. These fears are not well founded. Only those Eurodollar deposits
FORD & LIBRARY GERALD
5
that Eurodollar banks have employed in the United States or that they retain in
U.S. banks for reserve and transactions purposes constitute a claim on United
States reserves.
Presently such balances represent no more than a small fraction of total
deposits employed in the market. Eurodollar deposits that are not passed on to
United States banks or borrowers in the United States give rise to claims only
on the banks abroad in which they are lodged. In the event of withdrawal of
these deposits, the banks would have to either acquire dollars in the foreign
exchange market or fall back upon maturing Eurodollar deposits and loans, most of
which are obligations of foreign banks and corporations.
To many observers it appears puzzling that the market's size exceeds
foreign liquid dollar holdings in the United States, especially since each
Eurodollar deposit involves a transfer of foreign dollar deposits from one account
in a United States bank to another. But upon further reflection the excess of
Eurodollar deposits over U.S. liquid liabilities need not evoke surprise. The size
of the market is not limited by outstanding foreign dollar holdings. It is
primarily determined by the cash holdings denominated both in domestic currencies
and in dollars that a large variety of investors throughout the world wish to
place in the market. The explanation of the discrepancy between foreign liquid
holdings in the U.S. and net holdings in the Eurodollar market is that one and
the same foreign-held dollar balance can be repeatedly employed for making Euro-
dollar deposits. Dollar balances acquired by investors for placement in the
market to the extent that they are not employed in the United States are almost
instantaneously returned to the foreign exchange market as the dollar-accepting
banks, or borrowers from these banks, or those to whom they make payments, convert
FORD & LIBRARY GERALD
6
these dollar balances into third currencies in foreign exchange markets. Some or
all of these balances may be acquired by central banks. These same dollar balances,
after passing through the hands of several holders--possibly in several countries--
as a result of a series of transactions outside the Eurodollar system, may again
become vehicles for Eurodollar deposits as investors desirous of making additional
deposits reacquire them in the foreign exchange market. The repeated utilization
of some part of the existing stock of foreign dollar balances associated with the
recurrent reinjections of the same dollars into the market that had previously
been ejected from it also explains why the increase in the size of the market during
recent years far exceeds the dollar balances obtained by foreigners as a result of
our balance-of-payments deficit.
It is, of course, true that certain Eurodollar placements, primarily those
by United States residents, add to our liquid liabilities. Some Eurodollar deposits,
notably those that are borrowed by U.S. banks or are invested by the overseas
branches in U.S. Treasury or Export-Import Bank securities, as well as reserve and
transaction balances of Euro-banks, are reflected in our liquid liabilities. Some
portion of foreign-held dollar balances--actually no more than a small portion--
performs a vehicle role in the placing of Eurodollar deposits. But the great bulk
of Eurodollar deposits does not affect our short-term liabilities and the growth
rates of the two magnitudes are therefore to a large extent independent of each
other.
FORD i LIBRARY GERALD
Multiple Credit Creation in the Eurodollar Market
Several central bankers as well as some prominent members of the academic
profession have attributed the enormous expansion of the market to the process of
multiple credit creation. They have suggested that the Eurodollar system functions
in the same way as the U.S. banking system where, as borrowers disburse loan
proceeds, the recipients have virtually no choice but to redeposit them in the
same or another American bank. This bank, as a result of the attendant reserve
gains, may find itself in a position to make additional loans and investments.
7
Those who believe that this phenomenon is also a characteristic of the Eurodollar
market claim that a very substantial amount of Eurodollar deposits represents
balances that can be traced directly to Eurodollar loan proceeds. In fact, concern
over multiple credit creation in the market has caused some of its close observers
to support recommendations that Eurodollar borrowing be made subject to reserve
requirements. I have argued elsewhere that at least until the end of 1969 multiple
credit creation has played no more than a minimal role in the expansion of the
Eurodollar market. This argument is supported by the fact that the market
experienced its most impressive rate of growth in the late 1960's when most new
Eurodollar deposits were pulled out of the market by U.S. banks and corporations
that borrowed heavily in it. These funds were used in the United States and thus
could not serve as a base for multiple credit expansion in the Eurodollar market.
In 1970, the credit multiplier tended to increase inasmuch as several central
banks during the year acquired sizable dollar balances that originated in the
GERALD FORD LIBRARY
Eurodollar market and redeposited them in the market. But even now the great
bulk of Eurodollar borrowings is either paid to U.S. residents or converted in
foreign exchange markets into local and third-country currencies and not returned
to the market by those who acquire these balances. Altogether, the available
evidence on worldwide uses of Eurodollars suggests that only a small part of the
proceeds of Eurodollar credit is redeposited in the market, and in my view the
multiplier remains only a fraction of the figures that have recently been publicized.
Central Bank Participation in the Market
Another question widely discussed by Eurodollar market participants is
the placement by official monetary institutions of part of their dollar holdings
in the Eurodollar market. In any appraisal of central bank participation in the
Eurodollar market, a sharp distinction should be drawn between (a) dollar balances
recycled by Western European central banks that deposit part of their dollar gains
either directly in European banks or in the Bank for International Settlements,
8
and (b) deposits in European banks by monetary authorities throughout the world,
notably in lesser developed countries and also in Eastern Europe. According to
the Bank for International Settlements, during the past year central bank deposits
in the Eurodollar market have increased by approximately $7 billion. A large
portion of these deposits was placed by European central banks, but a very sub-
stantial part originated in less-developed countries. Many central banks in these
countries, dependent as they are on the income from their exchange reserves,
found it difficult to resist the relatively attractive yields available in the
Eurodollar market.
Undoubtedly, as Federal Reserve Board Chairman Arthur Burns recently
pointed out in Munich, central banks as they place funds in the Eurodollar market
have aggravated their own problems. Such deposits have added to the explosive
growth of monetary reserves in Europe, flooded European economies with unwanted
liquidity, expanded money supplies and thus contributed to inflationary pressures.
The process through which this occurs is simple. Typically, a sizable part of
the central bank deposits placed in Eurobanks is used for loans to European
borrowers. These borrowers or those to whom they make payments tend to convert
all or virtually all of their dollar borrowings into local currencies. As the
borrowers sell dollar balances to their commercial banks, their domestic currency
deposits and thus their nations' money supply increase. The commercial banks--
by selling all or part of the resulting dollar accruals to their central bank--
are in turn in a position to add to their reserve balances and consequently to
their lending capacity. In this process, the central banks, in their capacity
as residual buyers of dollars in the foreign exchange market, in effect reacquire
the balances that they had placed in the Eurodollar market. According to press
reports, the major European central banks are presently reviewing the investment
GERALD FORD LIBRARY
9
of their monetary reserves with a view toward limiting their placements in the
Eurodollar market. They are reported to be ready to withdraw balances from the
market, if market conditions permit them to do SO.
Incidentally, central bank deposits in the Eurodollar market are solely
an obligation of the banks in which they are deposited. Taken together, they
are not a reserve liability of the United States and do not affect our balance of
payments.
Control of the Market
The phenomenal growth of the market together with its credit creation
potential, and its ability to mobilize massive amounts of funds that may flow
quickly from country to country and thus undermine domestic monetary policies,
have given rise to demands for a comprehensive system of international control
of the market. These demands have gained in strength in recent weeks as Euro-
dollar balances, as has happened often in the past, have again been used on a
large scale to feed speculative movements into currencies that have become
candidates for revaluation, notably the Deutsche mark.
In appraising demands for international control of the market it should
be kept in mind that presently the market is already subject to a large measure
of national controls. For many years, central banks have used a variety of devices
to regulate the flow of Eurodollars out of and into their countries. Moreover,
for many years, central bankers have exchanged views on their Eurodollar market
policies and on occasion have taken concerted action to coordinate their regulatory
activities in this area. At times, notably at year-ends, central banks have
rechannelled substantial deposits into the market either directly or through the
Bank for International Settlements, with a view to smoothing out temporary
disturbances in the market when such action did not conflict with basic monetary
policy objectives then being pursued.
GERALD FORD LIBRARY
10
Central banks are likely to strengthen their existing controls and
supervision of the market. As a matter of fact the central bank governors
meeting regularly in Basle have set up a study group to analyze the problem and
to work out terms of reference for a standing group which might suggest policies
to be adopted by the governors. There is thus every reason to expect that central
bank coordination and cooperation with respect to policies affecting the Eurodollar
market will become more intensive in the months and years ahead. For instance,
central banks could intensify cooperation so as to avoid that national controls
work at cross-purposes. They might well make even greater efforts than in the
past to coordinate their monetary policies with a view to reducing the emergence
of large scale capital movements that do not serve their purpose. But it is
difficult to visualize any system of supranational control of the Eurodollar market.
In my personal view, central control on a worldwide scale is not a practical
proposition. There is no international institution extant that can effectively
control the vast supplies in the market or restrict the worldwide demand for
Eurodollars. International control of the market would, moreover, call for
comprehensive foreign exchange regulations that many countries are unwilling to
adopt. The obstacles to control by an international institution also stem for
divergencies in national objectives of the countries whose banks play a major role
in the market. Hopefully, central bank cooperation involving primarily coordination
of national controls will serve to reduce, if not eliminate, Eurodollar flows
FORD
that tend to undermine international monetary stability.
GERALD
LIBRARY
Medium-Term Lending and the Worsening of Credit Quality
Another recent development in the Eurodollar market is the rapid growth
of medium-term lending of Eurodollars. During the last year or two, the overseas
branches and affiliates of American banks, as well as other major banks in London
and elsewhere in Europe, have been heavily engaged in extending 5 to 8 year roll-
over Eurodollar loans, usually to large commercial and semi-public corporations,
11
with the lending rate periodically adjusted in line with the interbank rate for
three or six-months Eurodollars. Typically, the banks managing such loan arrange-
ments syndicate them, placing varying portions with a number of other banks and
retaining in some cases only a small portion on their own books. Borrowers of
medium-term loans reside in many countries throughout the world. In order to
serve this rapidly growing market for Eurodollar term loans, several groups of
United States and European banks have established a large number of jointly owned
international banks.
In meeting the deep-seated need for medium-term finance, the balance
sheets of many banks operating in the Eurodollar market have become less self-
liquidating. Of course, the fact that interest rates for these loans are period-
ically readjusted in line with prevailing Eurodollar interbank rates eliminates
the risk that rates in the market will run against the lender. This risk has
been passed on to the borrower who hopefully is always in a position to assume
it. The fact that the Eurodollar market, despite its dependence on purchased
as distinct from hard-core demand deposit money, has become so large a source
for meeting the world's medium-term credit needs should not be overlooked in
any assessment of its overall position.
Quite apart from the growing maturity gap, many thoughtful bankers have
become increasingly concerned over the disregard in Eurodollar banking of the
strict lending standards that have long been in vogue in term lending in the
United States. Elaborate term loan agreements with a number of appropriately
protective covenants such as the obligation of the borrower to maintain his
working capital at minimum levels are much less common in Eurodollar banking
than in the United States. Few Eurodollar term loans include amortization
arrangements that provide for the tailoring of maturities in line with prospective
GERALE FORD LIBRARY
12
cash flows. Single-payment revolving loans stretching over five years are not
uncommon. It is probably true that as rapid an expansion in the number of
borrowers as occurred during the last two years has brought into the market
some second class names not deserving of unsecured loan facilities.
It is encouraging that prominent bankers have publicly drawn attention
to the easing of Eurodollar lending criteria. Still and all I do not believe
that there has been any fundamental deterioration of credit quality in the market.
The market continues to be dominated by the biggest and strongest banks in Western
Europe and generally these banks remain highly selective as to the borrowers to
whom they extent loan facilities.
Conclusion
In concluding my remarks, I should like to reemphasize the important
contribution of the Eurodollar market to the growth of the international economy
and the expansion of world trade. It would be most unfortunate if the widespread
demand for control of this market should give rise to restrictions on international
capital movements that would regulate it out of existence or impair its functioning
as an efficient medium for allocating credit on a worldwide scale. Meanwhile,
the obvious ill-effects of the market and some undesirable deposit and loan
practices that have recently emerged are receiving the intense attention of the
central banking community and there is every reason to expect timely action to
maintain the fundamental soundness of the Eurodollar system.
FORD LIBRARY
Statement of Rimmer de Vries, Vice President, Morgan Guaranty Trust
Company of New York, to the Subcommittee on International Exchange
and Payments of the Joint Economic Committee, U.S. Congress, Tuesday,
June 22, 1971.
1. The Euro-dollar market has been making the headlines
recently. During the recent international monetary crisis, leading
commentators accused the Euro-dollar market of being the villain of the
piece. Bankers, too, having difficulty in believing that some $5 billion
had moved out of the United States in the two weeks ended May 12, accused
the Euro-dollar market of having brought about massive movements of
funds and the crisis. The impression was created that Euro-bankers
were manufacturing Euro-dollars, a kind of counterfeit U.S. dollar,
offering them to the central banks of Germany, Japan and other countries,
which in turn handed them to the Federal Reserve to be invested in U.S.
money market instruments. As a result, U.S. liabilities to official
FORD
foreigners rose, thereby aggravating the official-settlements
balance of payments deficit. Although these views are obviously
GERALD
LIBRARY
incorrect, they do point at the need to clarify the characteristics and
the role of the Euro-dollar market, to review its benefits and short-
comings and to examine whether any action is needed to curb the market.
The views I express today are my own and not necessarily those of
Morgan Guaranty Trust Company.
2. A Euro-dollar is a dollar-denominated deposit in a bank
outside the United States. Likewise, a Euro-mark is a mark deposited in
a bank outside Germany and a Eure-Swiss franc is a Swiss franc deposited
in a bank outside Switzerland. Any convertible currency can exist in
Euro form. Euro-deposits, therefore, are not confined to dollars. In
fact, a growing proportion of the Euro-market is denominated in German
marks, Swiss francs and other strong currencies. The distinguishing
characteristics of a Euro-currency is that the currency of denomination
is foreign to the country of the bank which accepts the deposit.
-2-
The depositor himself does not have to be a foreigner: residents
can and do deposit non-native currencies in their local banks. A British
resident can deposit dollars in his British bank and a Swiss resident
can deposit German marks in his Swiss bank. Moreover, Euro-deposits
are not restricted to European banks: a sizeable share of Euro-deposits
are placed in non-European banks. This worldwide market for foreign-
currency deposits is called the Euro-dollar market or more appropriately
the Euro-currency market. This market is broader in scope than measured
by the statistics compiled by the Bank for International Settlements.
At the end of March of. this year, the size of this market -- with
interbank deposits netted out - exceeded $62 billion, of which over
$50 billion consisted of Euro-dollars.
3. The Euro-currency market can best be characterized as
an international money market. Many misunderstandings, plausible as
they may be, are created if the market is looked upon as a super-banking
structure. The market is an extension of, and has added an inter-
national layer to, the money markets in the United States, Britain,
Continental Europe, Canada, and other countries. Banks -- and to a
much lesser extent corporations and individuals -- from around- the world
deposit a portion of their liquid assets in this market. Although
there may have been a variety of reasons for making such deposits
FORD is LIBRARY 076838
through the history of the market, at present the overriding reason
is that it is attractive to do so from an interest rate point of view.
Deposit rates in the Euro-market are frequently higher than in the
domestic money markets, even on a hedged băsis. At the end of April
this was true for many European countries, the United States and Canada.
Government regulations (e.g. Regulation Q in the United States) and monetary
-3-
policies are among the main factors causing the discrepancy between
Euro and domestic deposit rates.
The same reasoning applies to the demand side of the
market. The demand for short-term and medium-term credit in the Euro-
market has been enhanced by the fact that lending rates are frequently
lower than those prevailing in the domestic credit markets. At the
end of April, the commercial bank rates to prime borrowers of Japan
and all Continental European countries, except Switzerland, were higher
than Euro-dollar lending rates.
Moreover, borrowers frequently seek credit abroad, normally
in the Euro-market, because of the lack of availability of funds
in the domestic market. Many local markets are too narrow to
accommodate adequately the demand for funds by their own residents.
Furthermore, the monetary authorities regulate -- often by imposing
quantitative limits -- domestic bank credit expressed in their
national currency, but frequently do not regulate bank credit
denominated in foreign currencies. The authorities also often shy
away from imposing controls on the activities of nonbanks. Finally,
they normally encourage foreign borrowing by their nationals to
finance their foreign operations; the OFDI controls in the United
States are a notable example.
Nevertheless, the key to understanding the rapid growth of
the Euro-market is the ability of Euro-banks to offer attractive
interest rates, both as regards deposits and loans. This reinforced
their practice of operating with much smaller margins between
deposit and lending rates than is customary in domestic markets.
BERRLE FORD LIBRARY
The larger the interest-rate differentials between national markets,
the larger will be the flows through the Euro-market.
-4-
GERALD FORD LIBRARY
4. It is important to keep in mind that the Euro-market is not a
stateless entity located outside the jurisdiction of the governments of this
globe. Every participant in the market, depositor or borrower as well as the
bank intermediary, is a resident of some country and thus falls under the
actual or potential control or supervision of its monetary authorities. By
the same token, it is wrong to call the Euro-market a completely free market.
Many central banks and governments do regulate the deposit and lending activities
of their residents in the Euro-market.
5. Another important point tc be made is that there is no relation-
ship between the level or change in U.S. liquid liabilities to foreigners to
the size of the Euro-dollar market. It is perfectly possible for the size
of the Euro-dollar market to rise sharply while U.S. liquid liabilities to
foreigners rise only modestly or even decline. The main reason for these
possible divergent developments is that U.S. liquid liabilities to foreigners --
and accordingly the liquidity U.S. balance of payments -- is affected only
if one of the participants in the Euro transaction is a U.S. resident. Even
though a Euro-dollar transfer has to go through the books of a U.S. banks,
a U.S. resident does not necessarily have to be one of the participants,
i.e, depositor or borrower. In fact -- except when U.S. commercial banks
were heavy takers of Euro-dollars such as during 1968-70 -- U.S. residents
play a relatively minor role in the many daily Euro-dollar transactions.
Most Euro-transactions take place between residents of two foreign countries.
In this case, there occurs merely a transfer of ownership of U.S. liquid
liabilities from one foreigner to another, which affect the balances of payments
of the two countries, but not that of the United States. Moreover, the
deposit and lending rates structure of a particular country and that of the
Euro-market may be such that some residents of that country deposit funds
in the Euro-market while other residents of the same countries borrow in the
-5-
Euro-market. In this case no country's overall balance of payments and
credit base is affected and yet the Euro-market's size has risen.
6. This leads me to say a few words about the creation of Euro-
dollars, particularly multiple credit creation. It is true that all financial
claims are created by the borrower or issuer. The U.S. Treasury creates
Treasury bills, General Motors Acceptance Corporation creates commercial paper,
savings banks create passbook savings accounts and Euro-dollar banks create
Euro-dollar liabilities. The important point, however, is not whether claims
are created, but whether or not these created claims are money. It is here
that we have our doubts. Payments normally are not made in Euro-dollars as such,
but only in U.S. dollars, marks, francs, guilders or other national currencies.
This is also the reason why the so-called leakage in the Euro-market is so
large: recipients of a Euro-dollar credit normally convert the proceeds thereof
immediately into some national currency or to the United States to make payments.
Demand deposits constitute only 8 very small portion in the Euro-market, and
Euro-banks function primarily as intermediaries, seeking fixed-term deposits
after they are assured of making a loan. The market facilitates more efficient
use of existing national bank reserves and money supplies. Thus, while
the market by itself does not tend to increase the world money supply, it
does increase its velocity.
7. One major exception to this analysis is when a central bank
deposits funds in the Euro-market. In that case, additional bank reserves
are created. The country of the central bank that makes the Euro-deposit
does not experience a short-term capital outflow but the country receiving
the Euro-credit registers an inflow and an increase in its credit base. Euro-
FORD & LIBRARY GERALD
deposits by central banks of free world countries are not a new phenomenon. They
-6-
occurred already in the mid-1960s when they amounted to between
$1 to $2 billion. Such deposits gradually rose to between $3 and
$4 billion at the end of 1969. However, there was a very large
increase in 1970 -- particularly in the latter part of last year --
when the amount of central bank deposits in the Euro-market
increased by almost $7 billion and reached a total of about $11
billion. The principal reason for the sharp increase during 1970
was the large divergence between rates available in the U.S. money
market and those available in the Euro-market. Although there was
also a large difference in 1969, U.S. banks then were able to offer
foreign monetary institutions interest rates competitive with those
quoted for Euro-dollars, because U.S. deposits from such instit-
utions are exempt from Regulation Ω ceilings. The recent sharp
increase has clearly been a destablizing factor in the past year,
as it seriously interfered with the anti-inflationary efforts of
many countries. A statistical appendix to this statement
contains additional information explaining the estimate mentioned
here about central bank deposits in the Euro-market.
8. Let me now turn to the recent international monetary
crisis. This country's balance of payments deficit on an official
settlements basis was over $5 billion in the first quarter of
FORD
this year, and so far during the second quarter it has amounted
GERALD
to nearly $9 billion, raising the total for the year to date to
LIBRARY
about $14 billion. During the two weeks April 28-May 12 this
deficit amounted to approximately $5 billion, which was also just
about equal to the central bank reserve increases of Europe and
Japan.
The outflow during these two weeks was very broadly based.
Banks, corporations, and individuals -- in each case both foreign
-7-
all participated in the movement of funds. It cannot be emphasized
sufficiently that foreign-related entities, i.e. U.S. agencies and branches
of foreign banks, U.S. subsidiaries of foreign companies, foreign banks and
companies themselves, and foreign investors were all just as -- if not more --
active in bringing about this outflow as U.S. corporations, banks and individuals.
My guess is that about two-thirds of this $5 billion outflow was
moved directly out of the United States to foreign countries as a reaction to
the exchange-rate uncertainties, much of which through leads and lags in
international payments. U.S. residents with short-term commitments in strong
currencies accelerated their payments to avoid large payments at a later date,
while foreigners delayed making dollar payments. The remaining one-third moved
out during these two weeks because of the widening discrepancy between Euro-
and U.S. interest rates. U.S. bank liabilities to foreign branches fell about
$500 million in the two weeks ended May 12, probably because of this interest-
rate discrepancy. U.S. agencies and branches of foreign banks -- whose assets
in the United States exceed $10 billion, 8 large part of which is held in
liquid instruments -- probably also moved very large sums of money abroad
FORD & LIBRARY 074839
because of the large interest-rate differential. Some of the $500 million
increase in loans to foreign banks and corporations reported by the weekly
reporting large U.S. commercial banks no doubt was due to the relatively low
lending rates prevailing in the United States.
It should be added, however, that the sharp rise in Euro-dollar
rates and the resulting large differential during the heat of the crisis was
brought about by heavy borrowing in the Euro-dollar market for the purpose
of converting the proceeds into marks, francs, guilders, etc. In the absence
of this large interest-rate discrepancy, the outflow from the United States
probably would not have been as large. Therefore, one must admit that the
Euro-dollar market tended to magnify the short-term capital outflow from this
-8-
country, although these would have been very large even in the market's
absence. Nevertheless, as the London Times recently pointed out, to blame
the Euro-dollar market for the recent international monetary crisis is as
primitive as the medieval practice of executing the bringer of bad news.
9. In examining the question whether controls should be applied
to the Euro-dollar market, it should first of all be stressed that this
market has contributed significantly to the enormous growth of world trade
and investment over the past decade. It has been highly efficient in gathering
liquidity from all corners of the world and channeling credit to banks,
corporations and individuals at relatively attractive rates. Moreover, the
balances of payments of all countries -- not least the United States -- at
one time or another have benefitted by the market. Furthermore, while the
market has enhanced the movement of short-term funds, it has not been the
underlying cause of these flows.
Nevertheless, 8 country suffering from an excessive outflow to,
or inflow from, the Euro-market can impose restrictions on its residents'
deposit and lending activity in the Euro-market in order to dampen such flows.
the
This seems to be/most sensible course of action and most countries, including
the United States, have adopted some restrictions. A notable exception has
been Germany, which in'retrospect, was probably ill-advised not to have taken
more drastic action against the recent, excessive Euro-dollar borrowing activity
of its residents.
In addition, short-term capital flows through the Euro-market can
be curbed if the central banks refrain from placing their funds in the market.
At times, it may also be desirable for them to siphon off some liquidity
through direct borrowing in the market.
FORD
LIBRARY
-9-
Finally, the authorities could impose reserve requirements against
Euro-liabilities. This would strike at the raison d'etre of the market,
because it would tend to widen the margins between borrowing and lending
rates. Although this could seriously harm the market, it is doubtful whether
such reserve requirements could be applied effectively. A great many nations
would have to act in tandem and set the same obligatory rate. Without such
uniform action, the chances are great that the market, which tends to be mobile,
will simply shift elsewhere.
More important than trimming the edges of the Euro-market will be
to get at the root cause of the massive short-term capital movements. This is
the lack of confidence that prevails in the world stemming from the high rates
of inflation, the exchange-rate rigidity of the Bretton Woods system which was
predicated on a world with relatively stable prices, and the large underlying
balance-of-payments deficit of the United States. Restoring price stability
and giving IMF member countries greater flexibility in exchange-rate management,
assuring smoother parity changes, should be high on the agenda of the world
monetary authorities. The recommendations of last year's IMF report on exchange
rates should be re-examined promptly and with sympathy.
ADRO
Furthermore, considering that our present-day world is highly
LIBRARY
integrated and interdependent, monetary authorities should formulate their
policies not purely from a domestic point of view. They should develop maximum
international monetary cooperation so that their policies will be a stabilizing
rather than 8 destablizing force in the international monetary system. However,
greater coordination of monetary policies will require intensified use of fiscal
policy and the development of income policies.
Finally, with the underlying balance-of-payments deficit having averaged
about $3 billion during the past five years and certainly exceeding that level
this year, the United States should take serious steps aimed at wiping out
this large deficit.
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
to Norman
Office Correspondence
Date
July 19, 1971
To
Chairman Burns
Subject: Letter from Mr. Casey trans-
mitting information on Euro-dollar
From
Robert F. Gemmill R79.
transactions
CONFIDENTIAL (FR)
The transactions by Occidental Petroleum referred to in the docu-
ments sent by Mr. Casey appear to represent covered interest arbitrage --
primarily involving borrowings from and deposits in banks in Germany
(including German branches of U.S. banks). The documents do not indicate
whether the arbitrage possibilities arise from temporary excesses of deposit
rates over borrowing rates in a particular currency (e.g. Euro-dollar rates
or, perhaps, mark rates) or from arbitraging between currencies (e.g. switch-
ing from dollars into marks), but if more than one currency is involved it
seems fair to assume that the transactions would be hedged against foreign
exchange risk through a forward contract, since the transactions are re-
peatedly described as "risk-free." The banks involved are virtually all
"prime names" and default risk appears miniscule.
Based on the available information, there is no reason to believe
that these transactions involved speculation, or had a significant effect
on the U.S. balance of payments.
We have been in touch with Mr. Ralph C. Hocker (Associate
Director, Division of Corporation Finance, SEC) as requested by Mr. Casey,
and have passed on our interpretation of the documents. Mr. Hocker intends
to ask Occidental if any foreign currency borrowings of deposits were
involved and will inform us of the answer.
FORD if LIBRARY GERALD
CONFIDENTIAL (FR)
December 20, 1971
TO:
Board of Governors
FROM:
Division of International Finance
SUBJECT: Rate of reserve requirement on
Euro-dollar borrowings
The Board may wish to consider a reduction in the rate of
reserve requirement on Euro-dollar borrowing from foreign branches,
and on foreign branch loans to U.S. residents, from its present level
of 20 per cent to 5 per cent -- the rate currently applicable to time
deposits and to commercial paper issued by bank holding companies where
the funds are used by the parent bank.
1. The main consideration favoring a reduction at the present
time is the value of such an action as a gesture of international
cooperation; the U.S. monetary authorities would be seen to be showing
concern about the volume of dollars held abroad. By acting, the Board
would make it easier for U.S. banks and U.S. nonbanks to borrow Euro-
dollars from foreign branches. Reflows of funds from foreign countries
may add to the supply of Euro-dollars and tend to depress Euro-dollar
rates; increased borrowing by U.S. banks and nonbanks would tend to
absorb the supply of Euro-dollars. But it is unlikely that any sub-
stantial volume of Euro-dollars would be absorbed by U.S. banks'
borrowings -- rather than by foreign banks' borrowings -- unless or
until interest rates in European money markets fall below U.S. rates.
rates,
And unless European rates fall below U.S. notes, it is likely that the
absorption of Euro-dollars resulting from a reduced rate of requirement
would, at best, be a relatively short-term phenomenon, and/or concentrated
in funds of a particular maturity attractive to U.S. banks.
FORD i LIBRARY GERATO
Board of Governors
-2-
CONFIDENTIAL (FR)
2. There are two principal arguments against reducing the
rate of requirement at the present time.
a) A reduction in the rate of requirement on Euro-dollar
borrowing to 5 per cent would reduce the relative benefit to a bank of
a reserve-free base. Banks that have been preserving these bases at
some net cost might feel that the potential value of these bases had
been reduced arbitrarily -- and this could create a problem of bank
relations for the Board. The bank relations problem today would be
much less significant quantitatively than it would have been last
summer, when reserve-free bases were roughly twice as large as the
estimate for the computation period that ends on December 22. Moreover,
many banks appear to have made a decision to allow their bases to run
off completely, and in the past three weeks gross liabilities to foreign
branches have declined by $2 billion.
From the standpoint of Board Euro-dollar policy, it would be
desirable to continue to allow banks to make decisions regarding reten-
tion of bases on the same ground rules that have existed for the past
year, and to adopt a policy action that would change conditions only
after an overall review of Euro-dollar policy, which is scheduled for
next month.
b) A reduction in the requirement to 5 per cent might
have a greater effect on foreign branch loans to U.S. residents than on
head office borrowings through branches so long as the margin between
FORD is LIBRARY GERALD
Board of Governors
-3-
CONFIDENTIAL (FR)
deposit and lending rates in the Euro-dollar market was less than the
margin between the Euro-dollar borrowing rate and the domestic lending
rate (adjusted for any compensating balance requirements). Before the
Board took an action that would encourage expanded foreign branch
lending in the U.S. it would be advisable to have reviewed Euro-dollar
policy generally. One consequence of establishing regulations that
encourage foreign branch loans to U.S. residents would be a reduction
in the amount of information on bank lending to U.S. nonbanks, and a
delay in receipt of such information. (Information on foreign branch
loans to U.S. residents is currently collected on the monthly foreign
branch reports, which are available about 6 weeks after the report date,
but these include no information on type of loan, etc.)
3. It may be noted that, if the Board did not act to reduce
the 20 per cent requirement, U.S. banks could bid for foreign money but
only through issuing CD's (for maturities of 30 days or more) at their
head offices.
GERALD FORD LIBRARY
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
DATE: February 23, 1972
TO:
MRS. MALLARDI
FROM: ROBERT C. HOLLAND
B
Following up the Chairman's interest
in Fred Solomon's memo to him of last
fall, attached is a draft copy of that
memo that I have elicited from Fred. I
told him the Chairman had been interested,
and had been talking with me about the
subject.
FORD i LIBRARY GERALD
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
February 23, 1972
DATE
Mr. Holland
TO
As mentioned on the telephone.
R.
F
S.
FORD & LIBRARY GERALD
FREDERIC SOLOMON
ROUGH DRAFT FOR COMMENT
(Frederic Solomon-5-19-71)
1920s STOCK MARKET, 1970s EUROMARKET
From time to time significant new profit possibilities are dis-
covered (or imagined). If there is an available supply of funds, the
two can combine to produce a greatly increased flow of funds throughout
the economy. The increased flow occurs when funds are placed in the newly
profitable outlets, are disbursed to flow back through the economy, are
drawn back into the profitable outlet by the high yields offered, and the
process is repeated over and over again. The increased flow can continue
until something interrupts it, such as disappointed expectations, or some
other constraint on the flow at some point. (In some cases there can be
an actual reversal of the flow, as when a speculative bubble bursts.)
As the flow continues there are a number of effects. An immediate
inflationary effect is reflected in the increased prices that result from
the increased demand in the area where the flow is most sharply focussed,
that is, in the newly profitable area. A stockpiling or blance sheet effect
follows when there is a build-up of obligations that reflect the flow that
has occurred. Since the capacity or willingness of the total economy to
hold obligations usually will not increase as rapidly as the increased flow
generates extra obligations, there usually is a displacement effect when
the new obligations generated in the newly profitable area tend to crowd
out other obligations.
Banks usually play a prominent role in the process, although they
may act largely as agents or arrangers, without the resulting obligations
appearing on their own balance sheets.
FORD i LIBRARY GERALD
- 2 -
The process outlined above appears most frequently, but not
exclusively, in speculative activities such as trading in land or securi-
ties. The stock market of the 1920s is an outstanding example. However,
as indicated below, there are striking similarities in the Euromarket of
the 1970s.
1920s STOCK MARKET
1970s EUROMARKET
NEW PROFIT POSSIBILITY
Several factors contributed to
Several factors contributed to the
suddenly increased attractiveness
increased attractiveness of loans
of investment in common stocks, among
in the Euromarket, among them, the
them, the campaigns that sold war
profitability of American businesses
bonds in World War I, the profita-
entering the cartelized European
bility of the auto industry, and
markets, and investments by American
publicity regarding common stock
businesses seeking to establish them-
profits. Rises in common stock
selves inside the tariff walls of the
prices attracted new funds and made
common market. Later, credit restraint
"street loans" highly profitable.
in the United States led many large
U.S. businesses to finance themselves
directly or indirectly through the
Euromarket, even for their U.S.
activities.
FORD & LIBRARY GERALD
- 3 -
IMMEDIATE INFLATIONARY EFFECT
The principle initial impact was on
Since the Euro-borrowers used the funds
stocks and street loans. Since the
to finance their activities, the im-
supply of the former was rather
pact probably was spread widely through-
inelastic, prices soared. The
out the economies of the European
high yield and presumed safety
countries and also the U.S. This may
of street loans attracted large
have been a significant but little noted
amounts into them from around the
cause of world-wide inflationary
world.
pressures.
STOCKPILING (BALANCE SHEET) EFFECT
The volume of street loans in-
The volume of Eurodollars increased
creased greatly, reaching an
greatly, reaching an estimated $50
estimated $11 billion.
billion. There also were large amounts
of Eurobonds.
ROLE OF BANKS
Very few of the street loans were
By definition, none of the borrowings
made directly by the banks and
were made directly by domestic offices
appeared on their balance sheets.
of U.S. banks, and none appeared on
However, virtually all the others
their domestic balance sheets. However,
were made by the banks acting as
the U.S. banks borrowed and loaned large
agents for nonbank lenders.
amounts of Eurodollars at their
foreign branches, and later had
FORD i LIBRARY GERALD
their foreign branches borrow Euro-
dollars for the head offices. Non-U.S.
- 4 -
banks also borrowed and loaned Euro-
dollars.
DISPLACEMENT EFFECT
Street loans tended to displace other
Eurodollars tended to displace what
forms of investment, causing reduced
they most resembled and considerably
demand for such other investments.
out-yielded, namely, State-side dollar
Farmers charged that credit was being
obligations (U.S. dollars). Reduced
denied them (i.e., there was reduced
demand for U.S. dollars caused dollar
demand for their obligations) and that
weakness and gold drain.
funds were being drained from agricul-
ture.
REMEDIAL EFFORTS
General monetary restraint and
Problem seems to remain even though many
"direct pressure" were both tried,
remedies have been tried, including
with little effect. Securities
general monetary restraint, VFCR, IET,
Exchange Act of 1934 placed margin
restraint on transfers of funds abroad
requirements on stock market loans,
by U.S. corporations, currency swap
thus restraining the flow by limit-
arrangements, and reserve requirements
ing the demand for borrowed funds to
on Eurodollars transferred to head office.
enter the area.
Current efforts to issue special EX-IM
and Treasury securities probably will, in
a static sense and at some cost to the
GERALD FORD LIBRARY
U.S., absorb some of the Eurodollars gen-
erated by past operations of the process.
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date July 11, 1972
To
Mr. R. Solomon
Subject: Effects of U.S. Banks' Borrowing
from Eurodollar Market upon Member Bank
From
A. B. Hersey
Reserves and U.S. Interest Rates
aists.
CONFIDENTIAL (FR)
The following analysis relates to questions raised by Governor
Mitchell at the May 23 meeting of the F.O.M.C. about the importance of
Eurodollar interest rates as a factor influencing the relationship to
be expected, in an inter-meeting period, between member bank reserve
growth and the Federal funds rate.
When the overnight Eurodollar interest rate is below the Federal
funds rate -- as it has been in recent months -- it might at first glance
seem very likely that the Federal funds rate would be pulled down from
what it would otherwise be, given a particular rate of reserve growth.
A movement of funds from banks in the Eurodollar market to U.S. commercial
banks might occur as a result of U.S. banks' borrowing from their branches
abroad (who bid in the Eurodollar market for interbank and other deposits),
or it might occur as a result of lending by foreign banks to their branches
or agencies in this country. If there were a substantial cumulative flow
of overnight funds in these ways from the Eurodollar market, the balance
of supply and demand in the Federal funds market would be altered. A
particular member bank borrowing overnight Eurodollars would have less
need to borrow Federal funds; a foreign bank agency in New York receiving
funds from its head office abroad might be contributing an addition to the
supply of overnight interbank loans ("Federal funds sales") in New York.
FORD & LIBRARY
Mr. R. Solomon
-2-
CONFIDENTIAL (FR)
In neither case would there have to be any alteration in the rate of
reserve growth, which would be determined by Federal Reserve operations.
Apart from the interest rate effects directly ascribable to
the inflows, it is possible that interest rates in U.S. markets may be
influenced in a more general way by changes in conditions abroad that
lie behind such inflows. It is possible, for example, that participants
in U.S. financial markets may be influenced by their knowledge of interest
rate declines abroad in formulating their own demand or supply schedules.
Two different sorts of factors limit the extent to which the
Federal funds rate is pulled down by a change in demand and supply condi-
tions attributable to U.S. banks' borrowing from the Eurodollar market.
(1) There are institutional and regulatory factors (to be described below)
that limit the magnitude of the flow of funds from the Eurodollar market.
(2) The transmission of funds necessarily calls into action other market
forces that tend to counterbalance, in part, whatever downward pressure
the inflow tends to exert on the Federal funds rate. The next section
deals with these counterbalancing forces.
If the inflow involved purchases of dollars by holders of other
currencies who were induced to place deposits in Eurodollars,
foreign central banks might experience a drain of dollar reserves.
If this took the form of a decline in foreign central bank deposits
at the Federal Reserve or the form of gold sales to the U.S. Treasury
to replenish those deposits (producing then a rise in Federal Reserve
gold certificate holdings), additions to member bank reserves would
be generated. But the Desk would take that into account and would
modify its open market operations accordingly, buying less or selling
more in order to offset the expansive effect of these foreign operations
on member bank reserves.
FORD is LIBRARY GERALD
Mr. R. Solomon
-3-
CONFIDENTIAL (FR)
Counterbalancing forces
Whenever a bank operating in the Eurodollar market obtains
dollar funds from any source and lends them to a U.S. member bank --
this may be a U.S. bank branch advancing funds to its parent, or a
foreign bank lending in the United States through a New York agency or
branch -- the settlement of the double transaction necessarily involves
a decline in some pre-existing foreign private or official asset in the
United States. (For convenience of expression, we speak in absolute
terms of a "decline" in assets, but we mean changes relative to what
would have occurred in the absence of the particular borrowing trans-
actions being considered.) Conceivably but improbably, the person (or
institution) placing funds in the Eurodollar market is reducing his own
pre-existing assets in the United States; this is improbable at a time
when interest rate differences are tending to attract short-term investors'
funds to the United States, not away from it. More probably, he is
reducing his pre-existing assets elsewhere and buying dollars in the
foreign exchange market. If so, the sellers of dollars in the foreign
exchange market are reducing their assets in the United States. Again,
it is improbable -- given the assumed interest rate differences -- that
1/ Alternatively, there might be a decline in foreign official gold
holdings or other monetary reserve assets through sale to the U.S.
Treasury, or there might be a rise in some foreign liability to the
United States such as would result from an inter-central-bank swap
drawing. In such cases, in order to offset the resultant increase
in member bank reserves, Federal Reserve open market sales of secu-
rities would be increased (or purchases reduced).
FORD & LIBRARY GERALD
Mr. R. Solomon
-4-
CONFIDENTIAL (FR)
foreign commercial banks are the ones who are reducing their dollar
balances; as they sell dollars in the exchange market, they replenish
their holdings by buying from their central banks. The central banks
then have to replenish their working balances (these days) by reducing
their holdings of U.S. Treasury bills or (in other days) by selling
gold. (As it happened, the inflow in April and May, with the underlying
balance of payments still heavily in deficit, served to check foreign
reserve gains, and so was accompanied by a cessation of the previously
large foreign central bank purchases of Treasury bills.)
We have been looking so far at the international ("balance
of payments") part of the settlement process. At this point in the
analysis it can be seen that while downward pressure is being put on
the Federal funds rate upward pressure is being put on the Treasury
bill rate. The analysis can now be carried further, to look at the
domestic clearing part of the settlement process.
Suppose first that the Treasury bills being sold by foreign
central banks are being bought by someone other than a member bank.
As payment is made for the bills, the member bank at which the buyer
of the bills has his deposit account loses reserves to the member bank
at which the foreign central bank has its account. But simultaneously
that bank is losing reserves, and as a result of the chain of foreign
exchange and Eurodollar transactions that are taking place, the reserves
go ultimately to the member bank that is borrowing, let us say, from
FORD :- LIBRARY
Mr. R. Solomon
-5-
CONFIDENTIAL (FR)
the New York agency of the foreign bank that is drawing funds from
the Eurodollar market. Thus, intimately linked with the foreign bank
agency's adding to the supply of interbank loans, there is an additional
demand for funds in the Treasury bill market, and when someone comes
forward to buy the bills offered, a member bank somewhere becomes shorter
of reserves (through no choice of its own) than it otherwise would have
been, and very probably enters the Federal funds market as a borrower (or
as less of a seller). Thereby equilibrium of supply and demand is
established, and the decline in the Federal funds rate is minimized.
Similarly, the buyer of Treasury bills -- who conceivably is influenced
by his knowledge of a change in conditions in foreign financial markets,
and in any case finds the Treasury bill rate attractive -- minimizes the
rise in the Treasury bill rate by coming forward to buy. The process is
the same whether foreign central banks are now selling Treasury bills,
or have ceased being heavy buyers.
Suppose, alternatively, that no investor comes forward to buy
the Treasury bills and that they are bought by a dealer who finances the
purchase not by reducing a deposit balance but by borrowing. Some member
bank with funds to spare lends, by its own choice, to the dealer (perhaps
at a rate that has risen along with the Treasury bill rate) instead of
lending Federal funds, or perhaps it buys Treasury bills itself. In this
case the equilibrating reaction in the Federal funds market may perhaps
not be as strong as in the first case (where a member bank was forced
FORD is LIBRARY GERALD
Mr. R. Solomon
-6-
CONFIDENTIAL (FR)
to borrow) but still something is happening to blunt the downward
pressure on the Federal funds rate as well as the upward pressure on
the Treasury bill rate.
These two examples of what may happen in connection with an
inflow of overnight Eurodollar borrowings are only instances of a very
general proposition that private capital inflows to the United States
add neither to member bank reserves in the aggregate nor to the net
supply of total credit to the domestic economy, since their effects in
these respects are offset by the effects of the accompanying increase
in Treasury bill sales (or decrease in Treasury bill purchases) by
foreign central banks -- or by the Federal Reserve, in the case of
gold settlements in the balance of payments. Nevertheless, private
capital inflows are likely to have differential effects on different
sectors of U.S. financial markets, tending to raise Treasury bill rates
and depress other rates. But again, these differential effects on rates
may turn out to be small, because of the action of equilibrating forces
in the domestic markets.
Institutional and regulatory limits
The extent to which the Federal funds rate is pulled down by
U.S. banks' borrowing from the Eurodollar market is limited not only by
these equilibrating forces, but also by institutional and regulatory
factors that limit the size of the inflow. One of these factors which
is especially important at present is the 20 per cent marginal reserve
1/ See the preceding footnotes.
GERALD FORD VIBRARY
Mr. R. Solomon
-7-
CONFIDENTIAL (FR)
requirement against member banks' liabilities to their foreign branches.
Under the market conditions of recent months member banks have found it
advantageous to maintain average Eurodollar borrowings equal to their
reserve-free bases, but not to increase their average borrowings over
a 4-week computation period appreciably above that level. Typically they
have borrowed more heavily in the first two weeks of a period, and then
reduced their borrowings in order to avoid the cost of the reserve
requirement.
Such influence as the Eurodollar market has had on the Federal
funds market in recent months has been transmitted primarily through the
operations of foreign banks with agencies or branches in this country.
Here another institutional factor comes into play: the limits set by
bank management on the employment of resources in particular fields do
not permit an endless flow. At a time, as in recent months, when rela-
tively easy money conditions in European national markets have been
tending to hold down rates in the very short end of the Eurodollar market
below corresponding rates in the United States, there has been a strong
incentive to shift funds to the U.S. market. In fact, up to a certain
point, the willingness of the foreign banks to lend here may be strong
enough to have a clearly observable effect on U.S. money market rates
despite the existence of the equilibrating forces described above. But
the capital resources of these banks are finite, and the rule against
putting too many eggs in one basket further limits the amount of funds
that will be transferred to the United States. Thus, even though a gap
FORD & LIBRARY GERALD
Mr. R. Solomon
-8-
CONFIDENTIAL (FR)
may persist between the Federal funds rate and overnight money rates
abroad, as it has in recent months, the inflow may come to an end
fairly soon -- as indeed happened in May.
According to weekly balance of payments data maintained by
the Federal Reserve Bank of New York, foreign agencies and branches in
New York increased their liabilities to their head offices and branches
abroad by $2.3 billion between Wednesday, December 29, 1971, and Wednesday,
May 17, 1972. In the following four weeks there was a decline of about
$300 million. The increase was especially sharp in the six weeks from
March 29 to May 10, when it exceeded $1 billion. (Month-end balance sheet
data indicate an even larger increase within the month of April.) Such
information as is available indicates that an important part of this
increase in the resources made available to the foreign agencies and
branches was employed in interbank lending, including "Federal funds
sales."
FORD & LIBRARY GERALD
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date September 26, 1973
To
Board of Governors
Subject:
From
Ralph C. Bryant RCB
CONF IDENTIAL (FR)
This memorandum describes the various data we have for
liabilities of U.S. banks to their foreign branches, notes some
problems in interpreting them, and discusses recent developments.
I thought you might find it of interest.
The most recent figures we have suggest that Eurodollar
borrowings from branches, after rising somewhat in July and August,
are now back down roughly to the average levels observed in May
(see Table 1).
Attachment.
GERALD R. FORD LIBRARA
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date September 24, 1973
To
Mr. Robert Gemmill
Subject: Liabilities to Foreign
Branches: Data Comparisons and
From
R. H. Mills, Jr.
Recent Developments
CONFIDENTIAL (FR)
We have three series of data relating directly to U.S. banks'
liabilities to their foreign branches. The purpose of this memo is
to point out the basic differences among them and to offer explanations
as to why they have moved differently in recent weeks.
A. Net vs. gross liabilities
The liabilities data used for the calculation of the required
reserve deposits under Regulations M and D are on a net basis, i.e.,
gross liabilities less head office claims on branches. The net liabil-
ities figures are reported to us separately in connection with the im-
position of the reserve requirement and are daily averages for the 4-
week computation period; we do not have them for any shorter periods.
Nor do we have the gross liabilities figures from which these net lia-
bilities are derived. (Table 2 at the end of this memo shows the net
liabilities series for 1973 to date).
B. Differences between the series on gross liabilities.
The two series on gross liabilities differ as to coverage of
institutions, coverage of transactions, and frequency. One of these is
In addition, the data on assets and liabilities of foreign branches
include a series for branch claims on head offices.
FORD & LIBRARY 938870
- 2 -
the familiar "Wednesday series", which covers all banks with foreign
branches and which pertains to liabilities as of Wednesdays only. This
is the series that appears in Chart 3 included each week in the blue
folder distributed at the Board meetings in connection with the Economic
and Financial Review. The other series is the 51-bank daily series,
collected in connection with the analysis of banks' reserve position,
relating to the liabilities to foreign branches of 51 banks from which
we receive data on a daily basis. We use these figures to compute
7-day weekly averages (with Friday figures given a weight of three days
in calculating these averages). The liabilities reported by these 51
banks are nearly 100 per cent of the total liabilities to foreign branches
of all U.S. banks.
In addition to the differences in institutional coverage and
frequency just noted, these two series also differ in two other respects.
The "Wednesday series" has balance of payment coverage and does not
cover branches in Puerto Rico, the Virgin Islands, or on military bases
abroad. In addition, it does not include the so-called RP's of Chase
Manhattan Bank. These are commitments to buy back asset items, "foreign
customers' liability under acceptances", which Chase Manhattan has sold,
under repurchase agreement, to foreign branches (to reduce its foreign
assets subject to the VFCR ceilings) and for which it has debited its
branches' claims on head office. In contrast, when the Chase Manhattan
The Wednesday series is adjusted for, i.e., includes, branch
participations in domestic head office loans.
FORD & LIBRARY GERALD
- 3 -
reports its net liabilities to branches for reserve requirement purposes,
and when it reports its gross liabilities for the 51-bank daily series,
it does count these RP's as a liability to foreign branches, adding
them to its other such liabilities. These differences explain the
anomaly -- see Table 1 -- which shows the daily gross liabilities to
branches of 51 banks consistently much larger than the liabilities re-
ported once a week by all banks that are the basis of our "Wednesday
series".
C. Recent developments
The attached Table 1 compares the two gross liabilities series
for the weeks since May 16, the day on which the Board announced that
the required reserve ratio on foreign borrowings was reduced from 20
per cent to 8 per cent effective in the 4-week computation period
May 10-June 6 and that reserve-free bases would be phased out by 10 per
cent per computation period beginning in July.
The comparison shows three general differences that may be
noted here. First, for reasons already mentioned, the 51-bank daily
series is consistently greater than the "Wednesday series". Second,
the "Wednesday series" figures, and the data in the daily series with
which they are directly comparable -- which are Thursday figures, because
of a difference in reporting procedure -- do not change from week to
GERALD FORD CIGRARY
- 4 -
week by equal proportions. Third, not unexpectedly, the weekly averages
of the daily figures do not show the same relative week-to-week move-
ments as the figures for one day alone, as can be seen by comparing the
first two columns of Table 1.
In recent weeks the divergences between the two series for
gross liabilities have been particularly marked. For example, between
August 1 and August 29 the "Wednesday series" shows a rise of $575
million, while the 51-bank daily figures show the weekly average declining
by $44 million between the week of August 1 and the week ending August 29.
One reason for this difference is that once-a-week figures do not move
the same way as do weekly averages of daily figures; this is well
illustrated by the fact that, while the 51-bank weekly average shows
a drop between the week of August 1 and the week of August 29, the data
for the Thursdays that immediately follow those weeks show a rise over
the same span of time. The other reason why the movements of the
"Wednesday series" and the 51-bank daily series diverged so sharply in
August seems to be that in this period Chase Manhattan was reducing its
RP's, while the sum of its liabilities to branches excluding RP lia-
bilities, and other banks' liabilities to branches, was increasing.
3/ In the daily series liabilities are dated to correspond with the day
when they provide the borrower with Federal funds, i.e., one day after they
are entered on the balance sheet.
4/ This conclusion is supported by the figures for Chase Manhattan's
reported liabilities to branches, which declined between these dates by
much more for the purposes of the daily series than for "Wednesday series".
FORD & LIBRARY GERALD
- 5 -
This would seem to be the reason why the 51-bank daily series for
August 30 exceeded the comparable "Wednesday series" figure (for August 29)
by only $290 million, whereas the gap between the two series had been
$721 million on the basis of the comparison between the data for August 2
and August 1. (On earlier dates the gaps were still larger).
Table 2 compares the net liabilities for the 4-week computation
periods in 1973 with the averages, for the same periods, of the daily
figures for the gross liabilities of the 51 banks. Although the 51 banks
do not include every single bank with liabilities to foreign branches,
the omissions are of little importance. The Federal Reserve Bank of
New York informs me that the 51-bank data cover 95-100 per cent (and
probably closer to 100 per cent) of liabilities to foreign branches of
all U.S. banks. Consequently, the differences between the two series
in Table 2 give a good idea of the magnitude of head office claims on
branches. While these claims do change from period to period there has
been no marked tendency upward or downward this year, and the two series
do move in roughly parallel fashion.
D. Conclusion and Recommendation
Because the "Wednesday series" does not count Chase Manhattan
RP's as liabilities to foreign branches, that series understates the
extent to which U.S. banks have borrowed abroad through their branches.
And when the amount of these RP's changes, we get a distorted view of
the movement of liabilities to branches. If, for example, Chase Manhattan
&
FORD
GERALD
LIBRARY
- 6 -
winds up an RP, its liabilities to branches as reported in the
"Wednesday series" increase, but this is a statistical change rather
than a real increase in available funds. It seems that in August the
"Wednesday series", by not correcting for such transactions, was re-
cording some purely statistical increases in U.S. banks' liabilities to
foreign branches.
This problem will disappear when and if these Chase Manhattan
RP's are all wound up, and their amount seems to have been declining
rapidly since mid-August. However, there are still good grounds for
preferring the 51-bank daily series to the "Wednesday series" as a
measure of gross liabilities to branches. The daily series has the
advantage that weekly averages give a truer picture of the trend, over
relatively short periods such as a few months, than the picture given
by once-a-week figures. I recommend that we substitute weekly average
figures, based on the daily series, for the "Wednesday series" where --
as in the chart distributed for the money market review -- the figures
are used to assess their implications for domestic monetary conditions.
FORD & LIBRARY 938839
- 7 -
Table 1. U.S. Banks' Gross Liabilities to Foreign Branches:
Comparisons of the Alternative Series
(in millions of dollars)
51 banks with foreign
All banks with
branches
foreign branches
Daily series
"Wednesday series"
average for
Thursday
week ending
figure
Wednesday
Wednesday
Wednesday
only 1/
only
Col. 2 - - Col. 3
(1)
(2)
(3)
May 16
2,225
2,758
1,721
1,037
23
2,440
2,492
1,492
1,000
30
2,464
2,156
1,351
805
June 6
2,172
1,934
940
994
13
2,054
2,251
1,266
985
20
2,252
2,310
1,242
1,068
27
2,332
2,417
1,521
896
July 4
2,230
2,701
1,758
943
11
2,535
2,514
1,637
877
18
2,628
2,734
2,032
702
25
2,688
2,769
2,086
681
Aug. 1
2,734
2,939
2,218
721
8
2,414
2,914
2,270
644
15
3,051
2,482
1,894
588
GERALD FORD LIBRARY
22
2,594
2,915
2,440
475
29
2,690
3,083
2,793
290
Sept. 5
2,193
1,704
1,503
201
12
2,007
2,088
1,935
153
19
2,349
2.076
1,792
284
1/ Thursday following the Wednesday indicated. These Thursday figures
are directly comparable with the "Wednesday series" data.
- 8 -
Table 2. Gross and Net Liabilities to Branches in 1973
(averages of daily figures; in millions of dollars)
4-week computation
period ending
Gross
Net²/
Difference
January 17
2,331
1,835
496
February 14
2,395
1,776
619
March 14
2,272
1,619
653
April 11
2,403
1,567
836
May 9
2,228
1,570
658
June 6
2,325
1,378
587
July 4
2,217
1,769
448
August 1
2,645
2,143 est.
502
August 29
2,685
n.a.
n.a.
1/ 4-week averages of the daily figures from the 51-bank series.
2/ Data for 4-week computation periods collected in connection
with Regulation M and D reserve requirements.
FORD & LIBRARY