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The original documents are located in Box B34, folder "Eurodollars, 1970-73 (2)" of the
Arthur F. Burns Papers at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald R. Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
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copyright claim, please contact the Gerald R. Ford Presidential Library.
BOARD OF GOVERNORS
11/20 - 3:45
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date November 20, 1970.
To
Board of Governors
Subject: Eurodollar Problem.
From Robert Solomon
CONFIDENTIAL (FR)
Attached are two memoranda dealing with the problem of
Eurodollar repayments by U.S. banks.
The first memorandum, under my name, discusses the
advantages and disadvantages of permitting the outflow to con-
tinue as against taking action to discourage it.
The second memorandum, prepared by Robert Gemmill, dis-
cusses alternative methods of discouraging Eurodollar outflows.
RS
Attachments,
FORD i LIBRARY GERALD
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
CONFIDENTIAL (FR)
November 17, 1970.
TO:
Board of Governors
FROM:
Robert Solomon
SUBJECT: Dealing with the Overhang of Eurodollar Liabilities:
Laissez-faire VS. Taking Action to Discourage Outflows.
The differential between U.S. and Eurodollar interest rates
has led some banks to decide to give up a part of their reserve-free
bases and is leading many other banks to think seriously about doing
the same.
The reserve-free base has value to a bank insofar as the
bank now believes that it may, in the future, wish to have recourse
to the Eurodollar market to meet some of its needs for funds in the
United States. From the bank's viewpoint this could come about as
FORD LIBRARY
the result of a future squeeze under Regulation Q ceilings or as the
result of higher costs of funds at home than in the Eurodollar mar-
ket. Thus the banks are willing to pay some cost--in the form of
holding Eurodollars at interest rates higher than those on domestic
liabilities (Federal funds, CD's, and commercial paper) --as an in-
surance premium to preserve all or part of the reserve-free base.
But a number of the banks have decided that the current
cost is too high and this is leading them to think seriously about
reducing the size of the insurance policy.
Consideration of whether or not the Board should do some-
thing to discourage the outflow of funds should be preceded by an
estimate of the likely magnitude of the outflow in the absence of
Board action.
-2-
Magnitude of Potential Outflow
The outlook for the U.S. economy is such that one must
expect declining short-term interest rates here for some period
of time; at the least, short-term rates, after falling further
from present levels, are unlikely to rise substantially for quite
a while. Meanwhile, short-term yieldsin Europe are considerably
higher than ours. Even if Europe has reached, or passed, the peak
of intensity in the use of tight money during this cyclical upswing,
the easing of monetary conditions there is likely to lag ours by a
substantial margin. Thus European countries (notably but not only
Germany and Italy) will be exerting a demand on the Eurodollar mar-
ket for some time. This is a major reason why the $5 billion of
Eurodollar repayments that has already occurred this year has not
eliminated the differential between U.S. and Eurodollar yields.
Whether further repayment of Eurodollar liabilities by
U.S. banks would be self-arresting, as the result of a decline in
Eurodollar rates, thus depends importantly on the strength of demand
for Eurodollar in other countries.
While no one can be sure about the duration of tight money
in Europe, it is not to be ruled out that a significant differential
in short-term interest rates between the United States and Europe would
persist for at least a year--and possibly much longer.
FORD i LIBRARY GERALD
-3-
A related question is this: assuming a persisting differ-
ential in interest costs between the United States and the Eurodollar
market, is there a level below which the banks would hesitate to re-
duce their liabilities to branches and, correspondingly, their re-
serve-free bases?
One consideration here is that more and more banks are
likely to come to the view that Regulation Q will not be used in the
future as it was in 1966 and 1968-69. If the Board lifts the re-
maining ceilings on large CD's, and even if it uses the term "suspension,"
the view is more than likely to spread that the suspension is permanent.
As this happens, banks will reduce what they regard as a minimum desir-
able reserve-free base.
On the other hand, banks are unlikely to reduce their Euro-
dollar liabilities to zero. For one thing, they may wish their branches
to maintain a balance with the head office. Furthermore, the future
is uncertain and banks will hedge their bets regarding the probable
reimposition of Regulation Q ceilings.
In 1967, when credit conditions eased here, banks reduced
their liabilities to branches--which had grown from $1.7 billion in
January 1966 to $4 billion at the end of 1966--only moderately, from
a peak of $4 billion to $3 billion. On the other hand, that period
of ease was rather short-lived and it is therefore difficult to draw
reliable conclusions as to bank behavior from it.
FORD is LIBRARY
-4-
Even if there is an upward trend in the long run in liabilities
to branches, banks could temporarily dip below that trend when interest
rate differentials make that course profitable, just as they went far
above the trend in 1969.
A11 things considered, it is possible to imagine a potential
outflow of as much as $500 billion from the present level of $9 billion.
The term "potential" is used here for more than one reason: (1) to
denote a possible outer-limit, (2) to indicate what could happen in
the absence of an effect of this very outflow of U.S. funds on European
interest rates. It is possible that the outpouring of U.S. funds, by
flooding the Eurodollar market and in turn European money markets, would
drive down short-term rates abroad before $6 billion flows out. But one
of the presumed U.S. objectives, as discussed below, is to avoid flooding
European money markets in a way that undermines the efforts of European
central banks to combat inflation.
Thus while a $6 billion outflow may not be the most likely
estimate, because European rates will decline more than European
central banks wish them to decline, it is a possible outflow that U.S.
banks might be willing to tolerate if the differential cost of Euro-
dollars remains relatively high.
Advantages and Disadvantages
Assuming a possible outflow over a period of 6 to 12 months
of, say $6 billion--or even $4 billion--what are the disadvantages to
FORD & LIBRARY GERALD
-5-
the United States of permitting it to happen?
Disadvantages
The official settlements deficit has amounted to $7 billion
in the first 9 months of 1970. This is much larger than the official
settlements surplus in 1968 and 1969 combined ($4.3 billion). After
5 years--1965-69 inclusive-- in which the official settlements deficit
averaged out at zero, we have suddenly provided reserves to the rest
of the world, in 9 months, at a rate equal to more than three-fourths
of the SDR creation agreed to for a three-year period.
If this enormous rate of deficit should go on for a con-
siderable period of another six months or a year--several un-
fortunate consequences can be foreseen.
1. Heavy conversions of foreign dollar accruals
into U.S. reserve assets (IMF position, SDR, gold)
which could in turn trigger off a burst of specula-
tion against the dollar. If this happened, the re-
flow of dollars to foreign official reserves from the
Eurodollar repayments would be magnified, since for-
ward discounts on the dollar would encourage greater
reconversions by Europeans out of Eurodollars into
their own currencies and since interest arbitrage
reflows would be supplemented by speculative inflows
into European currencies.
FORD & LIBRARY GERALD
-6-
2. The chances of getting agreement on further
creation of SDRs by January 1973 (which requires
negotiations in 1972) would become very slim. This
in turn would lead to a growing view that the SDR
experiment had failed and that an increase in the
price of gold is necessary--not only to let the United
States pay off its debts but also to put the monetary
system on a "sound" basis. The progress that has been
made in recent years in de-emphasizing gold and moving
the international monetary system toward a managed basis
might be lost.
Apart from these dire results, the United States
cannot turn its back on a commitment it accepted when
it promoted the SDR agreement: we accepted and, in fact,
supported the proposition that the international monetary
system should not depend heavily on further additions to
official dollar reserves. It was agreed that it is
neither in the U.S. interest nor in the interest of other
countries that our official dollar liabilities should
continue to increase rapidly.
3. Europeans already feel resentment at being buffeted
in a magnified way by U.S. monetary policy. In 1968-69, we
imposed pressures on them when we let our banks drive Euro-
FORD i LIBRARY 838870
-7-
dollar interest rates up to as high as 13 per cent.
Now we will be pushing rates down, undermining their
tight money policies and adding to their holdings of
official dollar reserves.
This resentment has been a catalyst in the drive
toward European monetary integration. Whether or not
such integration is advantageous to the United States,
the anti-American impulses behind it are not.
There are many reasons why the United States should
make some effort to maintain cordial and cooperative re-
lations with Europe and Japan. If we sit by and per-
mit a further outflow of $4-6 billion without being seen
to have tried to stem it, there will be a growing acceptance
of the view, already held in Europe, that the United States
has adopted the Friedman-Haberler-Houthakker prescription
that our only duty is to try to contain inflation and
maintain full employment, while the rest of the world
adjusts to whatever volume of dollars flows out of the
United States.
One result of a deterioration in the cooperative
attitude of the Europeans- which may occur anyway if the
Mills' bill gets through Congress and is signed by the
President- would be less willingness of European countries
to revalue their currencies when in substantial surplus.
FORD is LIBRARY GERALD
-8-
The balance, in European minds, would tend to be tipped
against such action and toward actions or non-actions
that put increasing pressure on the United States.
4. Finally, it can be argued that the medium-term
outlook for the U.S. balance of payments is rather favorable
(see my submission to the Commission on Trade and Investment).
One can imagine a gradual working down of the Eurodollar over-
hang over the next 2 or 3 years as the rest of our balance
of payments improves. Given this prospect, one can also
argue against letting the Eurodollars flow out now in
massive volume. Providing an incentive to hold does not
saddle us with these liabilities forever.
The very fact that the medium-term outlook is favorable
argues for preventing a crisis atmosphere from being created
now. After our poor domestic management in 1965-69, we may
be on the road back to a sounder domestic economy and a
stronger balance of payments. But we can't persuade the
Europeans and the markets of this. We can only demonstrate
it and that takes time. Between now and when the demonstra-
tion becomes evident there is something to be said for
temporary measures to hold things (including confidence in
the dollar) in place.
FORD & GERALD LIBRARY
/ Trade, Investment and the Balance of Payments Adjustment Process,
August 6, 1970, Washington, D. C.
-9-
Advantages
Is there a case in favor of doing nothing and letting
the Eurodollar liabilities run off?
1. It can be argued that, having accumulated the
overhang, we have to face repayment eventually and we
ought to get it behind us. A variant of this argument
is that we ought to get a part of the repayment behind
us, by standing still for a further outflow of, say
$2 billion or so, hoping meanwhile that this will
narrow the interest rate differential between U.S. and
Eurodollar rates.
2. Another consideration relates to the distribu-
tion of foreign official dollar gains resulting from
Eurodollar repayments by U.S. banks. A very large
proportion of the increase in U.S. liabilities to
foreign monetary authorities in 1970 is accounted
for by Germany and Canada. For a part of 1970 Germany
may have welcomed the additions to its reserves, follow-
ing the enormous decline in reserves it experienced
following the October 1969 revaluation. Even if Germany
no longer welcomes additions to its dollar holdings (and
ignoring the undermining of the Bundesbank's policy re-
FORD & LIBRARY GERALD
ferred to earlier) there is little that Germany can do
about it. Apart from buying back the $500 million of
gold that it sold to the United States in the fourth
-10-
quarter of 1969, Germany is bound by the Blessing
letter not to buy gold from the United States.
Given the touchiness of the problems regarding U.S.
troops in Europe, Germany is unlikely to ask for a
revision of the Blessing letter now.
Other European countries would also share in
the reserve gains reflecting a further massive out-
flow of Eurodollars. Belgium, Holland, Italy, Switzer-
land even France and possibly Britain--could experience
sizable reserve increases if another few billion of
Eurodollars were repaid. But we do have reserve assets
and should be ready to use them.
Conclusions
A weighing of these arguments can lead to the following
judgments:
1. The concern about the undermining of
monetary policy abroad is not allayed by the fact
that Germany can do little about converting un-
wanted dollars into gold. In fact, if it became
evident that the U.S. was leaning heavily on this
constraint on Germany, that fact itself would
worsen our cooperative relations with the rest of
the world.
Numerous contacts with Bundesbank officials
indicate that they would be disturbed by a massive
outflow of Eurodollars from the United States,
which would provide financing to German companies
that find credit unavailable or too expensive in
Germany.
FORD & LIBRARY GERALD
-11-
2. The argument that the United States should
be seen to be trying to moderate the impact that its
changing policies have on the rest of the world is
hard to challenge. When we finally announced the
Eurodollar reserve requirement in mid-1969 we gained
some good will and put an end to an acrimonious debate.
3. If a balance of payments crisis should occur--
for whatever reason--the United States will be in a
better position to deal with Europeans and therefore
to see to it that the outcome of the crisis favors
our long-run interests if we have a record of taking
actions within our power. No one abroad in a re-
sponsible position is asking the United States to
deflate excessively in order to strengthen our bal-
ance of payments. But neither European nor Japanese
officials regard restrictions on capital flows as
undesirable and in some circumstances they advocate
such restrictions. Absence of any action by the United
States to shore up a crumbling Eurodollar regulation
could lead officials of other countries to believe
that we think the world is on a dollar standard and
do not concern ourselves with our balance of payments.
If they come to this belief, they would be more likely
to follow those in Europe who would like to push the
continental countries back toward a gold bloc. This
would hardly be a congenial environment in which to
try to work out of a crisis--or, for that matter, to
work on a day-to-day basis even if there is no crisis.
4. The existing attitude toward the dollar is
hardly a healthy one. The improvement we see in the
underlying balance of payments--and in its prospects--
is not evident yet to the rest of the world or to the
markets. Since we must expect some deficit next year
even if there is no repayment of Eurodollars--and the
deficit could be aggravated temporarily if Europe slumps
after its current boom--we have a good reason to re-
strain dollar outflows where and when possible. This
need not mean simply a delay in facing the music--if
we are right in our optimistic view of the medium-term
outlook. And even if we are wrong, the chances of
inducing revaluations by surplus countries in Europe
will be greater if we are seen to do what we can to
hold down our overall deficit.
GERALD FORD LIBRARY
November 20, 1970
To:
Board of Governors
From:
Division of International Finance
(Robert F. Gemmill)
Subject: Alternative Methods of Discouraging
Euro-dollar Outflows
CONFIDENTIAL (FR)
The Board may seek to induce banks to retain Euro-dollar
borrowings by reducing the costs of borrowings up to specified limits,
by increasing the benefits to be derived from retention of specified
amounts of borrowings, and by use of moral suasion.
This memorandum examines the essential elements of four pro-
posals for reducing costsof or increasing benefits from retention of
Euro-dollar borrowings. Any of these proposals (with the possible
exception of #4) could be supplemented by moral suasion, and any of
them could be supplemented by an announcement that the marginal reserve
requirement above reserve-free bases could be raised above 10 percent
in the future.
1. The method with the greatest prospect for success in re-
ducing Euro-dollar outflows is the establishment of a special reduced
rate of reserve requirement on a part of a bank's demand deposits equal
in amount to the bank's Euro-dollar borrowing up to specified limits.
This method would reduce the cost of Euro-dollar borrowing, and need
not depend for success on banks' expectations of future benefits from
use of reserve-free bases. Initially, the rate would be set at 10 per
cent for reserve city banks; at the present cost of reserves this
FORD & LIBRARY GERALD
Board of Governors
-2-
CONFIDENTIAL (FR)
special reduced rate of requirement would save a bank about 40 basis
points on the cost of Euro-dollar borrowing. The principal argument
against such a measure is the precedent-setting nature of such an
amendment to Board regulations.
2. A number of proposals would depend importantly for
success on banks' expectations regarding future reserve-free borrow-
ings. One of these proposals would provide the banks with leeway to
reduce Euro-dollar borrowings to a specified extent below the level
of the reserve-free historical base with no loss of that base. The
cost to banks of retaining the full reserve-free historical base would
be reduced, and banks that were planning to reduce Euro-dollar borrow-
ings below the new level specifically authorized as leeway might limit
their reduction in borrowings in order to preserve the reserve-free
base. This proposal would probably sanction some repayments that
would otherwise not occur; it might, therefore, have an uncertain
balance of payments impact. Moreover, it would tend to perpetuate
and strengthen the role of reserve-free bases.
3. Another proposal would increase the benefits to banks
from retention of the full amount of their historical bases by es-
tablishing a new, higher reserve-free base for banks that retained
Euro-dollar borrowings at the historical base level. Reserve-free
bases would thus be expanded (e.g. to 120 per cent of current levels).
This proposal would be successful only if banks attached a reasonably
FORD i LIBRARY GERALD
Board of Governors
-3-
CONFIDENTIAL (FR)
high probability to the prospect of using the expanded reserve-free
base in the future. Variants of this proposal would involve a com-
bination with #2, above.
4. The Board could attempt to reinforce the lock-in effect
by applying the automatic downward adjustment feature to minimum bases
(3 per cent of deposits for banks with foreign branches) as well as to
historical bases. This might dissuade some banks from relinquishing
historical bases and repaying borrowings below the level of minimum
bases; it might also induce some banks now using minimum bases to
increase their borrowings to preserve these reserve-free bases. A
moderate net balance-of-payments gain could be expected. This pro-
posal would tend to reduce the role of reserve-free bases, by elimi-
nating all bases not used. The principal drawback would be the
potential inequity involved in withdrawal of reserve-free bases from
banks that were planning to expand their foreign branch operations
gradually in future years. This proposal could be combined with #1.
However, it would not appear equitable to combine a probable reduction
in minimum bases with measures (#2 and/or #3 above) that enhance the
status of reserve-free historical bases.
5. The Board could make it clear to the banks that the
marginal reserve requirement on borrowings above the reserve-free
base might be increased above 10 percent in the future. This would
presumably increase the present value of retaining reserve-free bases
FORD i LIBRARY GERALD
Board of Governors
-4-
CONFIDENTIAL (FR)
for those banks that have some expectation of resorting to future
Euro-dollar borrowings. This measure could be combined with any of
the other proposals.
6. The Board could, in addition, make a direct statement
to the banks pointing out the adverse effects of a substantial re-
duction in outstanding Euro-dollar borrowings, and calling for restraint
in reducing these borrowings. The success of such an appeal might be
enhanced if it were accompanied by an action that provided the banks
with some tangible benefit, which would represent a quid pro quo. Thus,
moral suasion might successfully be used to reinforce any of the first
three proposals outlined above. (Since #4 provides no benefits to
banks, moral suasion would probably have relatively little impact in
combination with that proposal.) It might also be combined with Board
action to place Regulation Q ceilings completely on a standby basis, if
that action were to be taken on domestic grounds. However, it should
be noted that such action regarding Regulation Q would probably contribute
to readiness of banks to repay Euro-dollar borrowings.
The first four proposals are examined in more detail below. The
impact of the various proposals can best be illustrated by indicating
the way in which they change a simplified example of the cost-benefit
calculation confronting an individual bank under present regulations.
FORD & LIBRARY GERALD
Board of Governors
-5-
CONFIDENTIAL (FR)
Cost benefit calculation under present regulations.
(a) Bank A is assumed to have an historical base of
$100 million and borrowings of the same amount. If this
bank expects that over the next year Euro-dollar rates will
average 1 percentage point higher than the rate on alter-
native domestic liabilities, and if in the absence of the
lock-in effect, the bank would reduce its outstanding Euro-
dollar borrowings to $60 million in the coming year, the
bank's expected cost of retaining the historical base for
the coming year would be $0.4 million (1 per cent of $40
million). If the bank expects to have to resort to Euro-
dollar borrowing again in the second year, retention of
the historical base would save it roughly 1 percentage
point (assuming market rates on alternative sources of
funds of roughly 10 per cent) on $40 million of its
expected Euro-dollar borrowings--that is, about $0.4
million.
Under these circumstances, the bank would
doubtless decide that the investment of $0.4 million
to retain the historical base was worthwhile, since the
investment required to retain the historical base might
well yield returns beyond the second year as well as
the return of $0.4 million in that year.
(b) But, if the bank had only a relatively remote
expectation of using Euro-dollar borrowing in the second
year--perhaps only a 50 per cent chance--then the expected
return would be less: if the bank weighted the return by
the probability, the return might be estimated at $0.2 mil-
lion. Under these circumstances, the bank might decide that
the immediate cost of retaining the historical base was too
high.
This cost calculation will be changed in various ways by the
proposals outlined earlier.
GERALD FORD LIBRARY
Board of Governors
-6-
CONFIDENTIAL (FR)
Special reduced rate of reserve requirement. Under this
proposal, the Board would amend Regulation D to provide that reserve
city banks would maintain reserves of 10 per cent against an amount
of demand deposits equal to their Euro-dollar borrowings (compared
to a regular requirement of 17-1/2 per cent.) The percentage could
be raised or lowered if experience indicated that a different rate
of requirement would be better suited to Board objectives.
The proposal would, in effect, provide that the Government
(through the Federal Reserve) share a part of the cost to banks of
retaining Euro-dollar borrowings in order to protect the balance of
payments from a massive outflow of short-term funds.
A rate of requirement of 10 per cent would release 7-1/2
cents of reserves for each dollar of Euro-dollar borrowing covered; at
the present cost of reserves, a bank would save about 40 basis points
on each dollar of such borrowings. At present banks can obtain call
Euro-dollars and very short-term maturities at rates very close to
those on Federal funds; for maturities of around 3 months, the cost of
Euro-dollars exceeds that of CD's with comparable maturities by 3/4
percentage point or more. In relation to these magnitudes, a cost
saving of something less than 1/2 percentage point would be a significant
one; the excess cost of Euro-dollar borrowings of certain maturities
might well be completely eliminated.
FORD & LIBRARY 037470
In terms of the illustration presented above, the amendment
would reduce the present cost to Bank A of retaining Euro-dollar borrow-
ings from about 1 percentage point to about 00 basis points; the net
Board of Governors
-7-
CONFIDENTIAL (FR)
cost of retaining the reserve-free base would thus decline from $0.4
million to $0.24 million. Under these circumstances, a bank that
estimated the potential return from a reserve-free base in the second
year at $0.2 million (paragraph (b), page 5) might well retain Euro-
dollar borrowings to preserve its base.
Adoption of a selective reserve requirement based on Euro-
dollar liabilities might make it more difficult for the Board to resist
proposals for special reserve requirements based on desirable social
purposes--for example, a lower reserve requirement to the extent that
banks finance housing. One answer to this is that the present proposal
applies only to the composition of bank liabilities and has no effect
on the composition of assets. A second point is that the proposed amend-
ment would be designed to benefit the economy generally (rather than
to favor any particular sector of the economy) by strengthening the
balance of payments.
Leeway for banks to reduce Euro-dollar borrowings with no
loss of historical base. An amendment of the lock-in effect to permit
banks to reduce Euro-dollar borrowings to a limited extent without
loss of reserve-free historical bases would represent sanctioning of
some repayments in order to prevent greater repayments. For example,
the Board might provide that banks could reduce borrowings to 90 per
FORD & LIBRARY CERALD
cent of the current reserve-free historical base level by the end of
1970, and to 80 per cent of the current base by mid-1971, without
sustaining any loss of current reserve-free bases. The amount of leeway
to be provided would depend upon an assessment of potential repayments
in the absence of Board action.
Board of Governors
-8-
CONFIDENTIAL (FR)
In the illustrative cost-benefit calculations presented on
page 5 the amendment of the lock-in effect would reduce the cost of
retaining the reserve-free historical base.
In the earlier example, Bank A would have reduced its
borrowings from $100 million to $60 million in the absence of
the lock-in effect, and the cost to it of retaining its reserve-
free base for one year was calculated at $0.4 million (1 percent-
age point applied to $40 million of borrowings retained solely
to preserve the reserve-free base.) Unless expected future
benefits approximated this amount Bank A might well repay $40
million of Euro-dollars.
If the Board were to sanction a reduction in borrowings
to 80 per cent of the reserve-free base (a leeway of 20 per
cent) Bank A might cut its borrowings to $80 million rather than
going all the way to $00 million; the cost of retaining the
reserve-free base would then be $0.2 million (1 percentage point
applied to the $20 million of borrowings retained for the purpose
of holding the historical base.) By permitting a reduction of $20
million, the amendment of the lock-in effect might change the
cost-benefit calculation for Bank A sufficiently to avert net
repayments of $20 million.
If most banks were in roughly similar positions with roughly
similar expectations, the Board might be able to establish a level of
leeway that would permit a tolerable volume of repayments, while still
protecting the balance of payments. However, Euro-dollar practice has
varied substantially among banks, and we have no reason to expect
relative uniformity in policies with respect to repayments. The
amendment under consideration therefore runs a significant risk of
sanctioning repayments by some banks that would otherwise not likely
be made. This result occurs in part because a bank would no longer obtain
any benefit from retaining borrowings above the minimum level sanctioned
in the amendment; repaymentswould continue so long as Euro-dollars
involved even a slightly higher cost than domestic funds.
GERALD FORD LIBRARY
Board of Governors
-9-
CONFIDENTIAL (FR)
For each 10 percentage points of leeway provided banks, there
would be a reduction in borrowings of about $1 billion. Four banks that
earlier indicated plans to relinquish portions of their reserve-free
bases planned an average reduction of 30 per cent. It appears probable
that leeway of 20-25 percent would have to be provided in order to fore-
stall full repayments according to plan by these banks, if the Board were
to resort to the amendment under consideration.
Board sanction of a net repayment of $2-2-1/2 billion of Euro-
dollar borrowings would not necessarily be regarded by foreign central
banks as an adequate measure to stem reflows. Thus, there is no as-
surance that this type of amendment of the lock-in effect would provide
the desired balance of payments benefits.
Moreover, the amendment should be evaluated against a long-
term objective of placing all banks on the same footing with respect
to reserve-free liabilities--and probably ultimately eliminating all
reserve-free bases--as soon as this could be achieved without sacrificing
an important policy goal. The Board has no reason to provide large money
market banks with "permanent" reserve-free bases, apart from balance-of-
payments objectives. Thus a reduction in borrowings of $2 billion that
resulted from failure of the Board to take action (and that resulted in
a corresponding reduction in reserve-free bases of the banks involved)
would clearly be preferable to a reduction of $2 billion under an amended
lock-in effect that left the historical bases intact.
FORD i LIBRARY 076839
Board of Governors
-10-
CONFIDENTIAL (FR)
Expanded reserve-free bases. Expansion of reserve-free bases
(e.g. to 120 per cent of the current historical base) for banks that
maintained borrowings at current historical base levels would avoid the
sanctioning of net repayments, and thus avoid the potential balance of
payments risks involved in the preceding method. But expansion of
reserve-free bases would only be successful if banks attached a high
probability to the prospect of using the reserve-free base.
By and large, it appears that banks that are now relinquish-
ing portions of their reserve-free historical bases are acting on the
expectation that they would have access to other sources of funds on
terms no worse than (or not much worse than) those on which they could
borrow Euro-dollars. For example, these banks are assuming that there
is small likelihood of a squeeze on bank liquidity through operation of
Regulation Q ceilings, as occurred in 1969. Such banks would attach a
relatively small probability to advantageous future use of Euro-dollars
to bolster liquidity.
The proposal would seek to overcome this small probability
(in the calculations of an individual bank) by allowing the prospective
benefit, ifthat small probability should be realized, to be obtained on
a larger volume of borrowing. By and large it would appear that the
small probability would be governing--if a bank has little or no expec-
tation of using its reserve-free historical base, it is unlikely to be
influenced significantly by a measure that provides it with a larger
reserve-free base.
FORD : LIBRARY 076870
Board of Governors
-11-
CONFIDENTIAL (FR)
It might be noted that these banks' desires to preserve
reserve-free bases would probably not be significantly strengthened
by the Board's giving an indication that the marginal reserve require-
ment on Euro-dollar borrowings might exceed 10 per cent in the next
period of credit stringency. Only banks that attach a significant
probability to the future use of Euro-dollars would be affected by
that expectation.
Even though expansion of reserve-free bases would probably
have a relatively small impact on banks' decisions to repay borrowings,
and thus might not avoid some curtailment of historical bases, there
would be disadvantages in having Board regulations appear to perpetuate
and reinforce the inequities inherent in reserve-free historical bases.
Application of automatic downward adjustment to minimum bases.
The Board could reinforce the lock-in effect by applying the automatic
downward adjustment feature to minimum bases (currently 3 per cent of
deposits for banks with foreign branches and 4 per cent of deposits for
banks that borrow directly from foreign banks), with an appropriate
grace period to permit banks to adjust borrowings to the new regulations.
The extension of the lock-in effect to minimum bases could not be ex-
pected to influence repayments by banks generally; instead, its impact
would be to encourage banks currently using minimum bases to raise
1/ In any even the staff would propose that the Board amend Regulation D
to establish the same minimum base for borrowings directly from foreign
banks as for borrowings through foreign branches.
FORD i LIBRARY 038870
Board of Governors
-12-
CONFIDENTIAL (FR)
borrowings to levels equal to 3 per cent of deposits, and to discourage
repayments by banks now using historical bases that are so near their
minimum bases that they would be able to reduce borrowings substantially
without significant loss of future benefits. (Two banks with historical
bases only slightly higher than minimum bases have already shifted to
minimum bases; their aggregate borrowings in the most recent computation
period were $13 million, compared to aggregate historical bases of $38
million.)
The potential balance of payments benefit from the measure
might be conservatively at roughly $1/2 billion, representing in
approximately equal measure (a) increased borrowing by banks using
minimum bases, and (b) retention of existing borrowings by banks using
historical bases, which might otherwise shift to minimum bases. This
balance of payments gain would represent a partial offset to
reductions that would occur in borrowings by banks with Euro-dollar
borrowings (and historical bases) well in excess of minimum bases if
no other action were taken. The balance of payments gain could be
greater if many banks using minimum bases acted to protect their bases;
aggregate bases of these banks total almost $1-1/2 billion.
An issue to be weighed is the potential inequity involved in
removing minimum bases to the extent that they are not used. The minimum
bases were established as a measure of equity for banks that were not
large-scale borrowers of Euro-dollars in May 1969. The choice of 3 per
FORD & LIBRARY GERALD
Board of Governors
-13-
CONFIDENTIAL (FR)
cent of deposits represented a purely pragmatic judgment as to a figure
which (while not negligible) would not permit an excessive reserve-free
inflow at a time when it was Board policy to discourage the inflow.
Relatively few banks are now borrowing Euro-dollars under minimum bases
to supplement domestic liquidity positions; if it is not Board policy
to provide all banks with rëlatively permanent access to minimum amounts
of Euro-dollar borrowings for liquidity purposes, it would be appropriate
to eliminate bases for banks that do not use them. Banks that had not
yet established foreign branches might be given a grace period--e.g.,
90 days--after establishment of an initial foreign branch in which to
establish a minimum base, if required on grounds of equity. Any bank
could, of course, borrow directly from foreign banks and thereby preserve
a minimum base under Regulation D.
A different issue of equity arises to the extent that branch
balances with head offices were required as working balances by the
branches. Banks that had not yet developed an extensive foreign branch
business would be at a disadvantage compared to those with substantial
reserve-free branch balances at head offices. There is some indication,
however, that only relatively small branch balances with head offices
are essential to effective branch operations. If so, the potential
inequity would be relatively small, and it might be judged a cost worth
bearing in the interest of (a) achieving some balance of payments gain
and (b) reducing the role of reserve-free bases in the banking structure.
GERALD FORD LIBRARY
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date November 23, 1970.
Board CI Governors
To
Subject: Coombs' Proposal re Eurodollar
Robert Solomon
From
Flows.
CONFIDENTIAL (FR)
Attached to this memorandum is a letter, from Mr. Coombs
to Chairman Burns, outlining a proposal for dealing with Eurodollar
repayments by American banks. The Board will no doubt wish to con-
sider this proposal along with those that are outlined in Mr. Gemmill's
memorandum of November 20 (transmitted under cover of a note from me
as of the same date).
Attached also is a note outlining the advantages and dis-
advantages, as I see them, of Mr. Coombs' proposal.
25
Attachments.
FORD & LIBRARY GERALD
ATTACHMENT I
FEDERAL RESERVE BANK OF NEW YORK
NEW YORK, N.Y. 10045
AREA CODE 212 732-5700
CHARLES A. COOMBS
SENIOR VICE PRESIDENT
November 19, 1970
CONFIDENTIAL (F.R.)
The Honorable Arthur F. Burns
Chairman
Board of Governors of the
Federal Reserve System
Washington, D. C. 20551
GERALD FORD LIBRARY
Dear Mr. Chairman:
As you requested, there follows a rough outline of a technical
arrangement designed to insulate somewhat the European money markets
and central banks against the effects of a continuing repayment of U. S.
bank liabilities to their European branches.
As you may know, the BIS has in a number of operations raised
Swiss francs on the Zurich money market to provide financing for longer
term Swiss franc credits to the U. S. Treasury in the form of Swiss franc
denominated securities. It has occurred to me that this technique might
be adapted to the Eurodollar market in such a way that the BIS could
absorb new dollars flowing onto the market as the U. S. banks repay
debt to their branches, mainly in the relatively short-term maturity range.
Such Eurodollars with maturities ranging up to, say, 30 days, thus absorbed
by the BIS might then be reinvested by the BIS in a U. S. dollar certificate
with a maturity of, say, 15 to 24 months with the option, which is present
in most foreign currency securities, of a call of two days' notice by either
party.
At present, we see a sequence of U. S. bank repayment of
Eurodollar debts with the funds thereby released moving on to German
industrial borrowers, in turn necessitating Bundesbank purchase of the
dollars for subsequent investment in U. S. Treasury bills. This inflates
both the German money supply and the dollar reserves of the Bundesbank,
but in the end provides a source of dollar financing for the U. S. Treasury.
-2-
If other European central banks acquire the dollars, even more difficult
operational problems could well occur. If, on the other hand, the BIS
could more or less passively absorb the new dollars in the short maturity
range coming onto the Eurodollar market, the detour of such funds to the
German market and the Bundesbank would be avoided, but the U. S.
Treasury would still have an equivalent source of dollar financing.
Two problems immediately come to mind. First, whether
an appropriate rate relationship between BIS short-term borrowings on
the Eurodollar market and the rate available on subsequent BIS investment
in a longer-term U. S. security could be maintained. Secondly, there is
the related problem whether the BIS might find itself from time to time
unable to fully renew its short-term borrowings on the Eurodollar market.
The answers to these questions would necessarily involve
exploration of the possibilities of such an arrangement with the BIS
itself, but I would think it likely that continuing payoffs by U. S. banks
of Eurodollars should exert more downward pressure on the short than
on the longer Eurodollar maturities. Regarding the risk that the BIS
might find itself unable to renew fully earlier short-term borrowings
in the Eurodollar market, any resultant temporary shortfall in the BIS'
cash position could be covered by their drawing on the $1 billion swap
line they have with the Federal as an alternative to calling its investment
in a U. S. Treasury certificate.
Such BIS absorption of some of the return flows of Eurodollars
from U. S. banks would obviously tend to keep the short-term Eurodollar
rate somewhat higher than it would otherwise be. The same result would
occur, of course, if new regulatory arrangements were introduced which
made it profitable for the U. S. banks to maintain their borrowings of
Eurodollars at or about their present level.
May I say how pleased all of us were to have the opportunity
to welcome you to this Bank today. I thought your comments to our
directors were most helpful in many ways.
With best regards.
Sincerely,
Clantin
Charles A. Coombs
FORD & LEBRARY o
ATTACHMENT II
Advantages and Disadvantages of Mr. Coombs' Proposal
The proposal is presented in Mr. Coombs' letter of November
19, 1970 to Chairman Burns (Attachment I).
A thorough analysis of the proposal must await answers to a
number of questions that can be raised about it. Among these questions
are:
1. Would the BIS be content to hold additional dollar claims--
that could amount to several billions of dollars--without an
exchange rate guaranty or gold value guaranty? It is diffi-
cult to see how the United States could give such a guaranty
to the BIS without giving it to foreign central banks on their
dollar holdings.
2. Would the BIS insist on a two-day call provision on
the 15 to 24 month certificates it would buy from the U.S.
Treasury?
3. How would the interest rate on the 15 to 24 month
Treasury certificates be determined?
Advantages
1. The proposal would keep dollars out of the hands of foreign
central banks by siphoning the funds that U.S. banks were repaying to the
Treasury.
2. By standing ready to absorb short-term Eurodollars, the BIS
would be keeping interest rates on short maturity Eurodollars from falling.
This in turn would help insulate monetary conditions in European money
markets; that is, it would lessen the extent to which monetary restraint
in Europe was undermined by the Eurodollar repayments by U.S. banks
GERALD, FORD LIBRARY
-2-
Attachment II
3. The proposal would be a first step toward multilateral
action to regulate the Eurodollar market--a step that many observers
have been calling for. The BIS, representing the central banks of the
major countries, would be acting in their behalf, in cooperation with
the U.S. Treasury, to shield other countries from the impact of a
massive reflow of Eurodollars from U.S. banks.
Disadvantages
1. Under the proposal, banks could repay Eurodollars in
volume but the self-arresting mechanism of downward pressure on Euro-
dollar rates would not be operative. The BIS would provide a floor, or
at least a cushion, and thus the banks incentive to repay might remain
undiminished, It is true that a part of the intention of the other
proposals before the Board is to limit downward pressure on Eurodollar
rates by reducing the incentive banks have to repay their borrowings.
The difference between the present proposal and those in Mr. Genmill's
memorandum is that insofar as the latter proposals failed to stem Euro-
dollar repayments, a self-arresting mechanism would be at work.
2. The proposal would keep dollars out of the hands of foreign
central banks but it would put them in the hands of the BIS. If the
BIS had a two-day call, as suggested by Mr. Coombs, the U.S. authorities
would be presenting the BIS with rather weighty leverage against the
United States.
FORD & LIBRARY GERALD
-3-
Attachment II
3. The proposal depends on a positive yield-curve in the
Eurodollar market, so that the BIS can borrow short at relatively low
interest rates and re-lend to the U.S. Treasury at higher rates. Several
problems could arise in this connection, depending on the understanding
between the Treasury and the BIS on the determination of the interest rate
on the certificates. For example, if short-term Eurodollar rates should
rise toward or above the rate the Treasury is paying the BIS, the BIS
would be likely to exercise its two-day call.
4. Although the arrangement would keep dollars out of the
hands of foreign central banks, it would not prevent the Eurodollar
repayments from showing up as an official settlements deficit in the
balance of payments statistics, since the BIS is regarded as an official
reserve holder. Furthermore, BIS holdings of dollars would no doubt be
counted as official reserves in the negotiations regarding the next
creation of SDRs. An attempt to change the balance of payments accounting
practices would invite the charge that, once again, we are window-dressing
our statistics.
FORD LIBRARY & GERALD
AGENDA ITEM of 5
NOV $5 25 5 1970
CHAIRMAN (DATE) BURNS 11/27
#3
FOR INFORMATION
PRIOR TO CONSIDERATION AT A
11/30
MEETING OF THE BOARD.
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date November 25, 1970.
To
Board of Governors
Subject: Governor Mitchell's Euro-
From
Robert Solomon and Robert Gemmill
dollar Proposal.
CONFIDENTIAL (FR)
Attached is a commentary hastily prepared--on
Governor Mitchell's proposal for dealing with the Eurodollar
problem.
Attachment.
FORD & LIBRARY GERALD
CONFIDENTIAL (FR)
November 25, 1970.
The purpose of this memorandum is to examine Governor
Mitchell's proposal that the Federal Reserve stand ready to offer
branches of American banks an asset that would absorb the funds
they receive as repayments from their head offices. The asset
offered by the Fed would bear a rate of interest attractive enough
to induce the branches to continue to maintain their liabilities
to Eurodollar depositors.
Under this proposal, U.S. banks would continue to have
the option of maintaining their reserve-free bases, or a part
of them, but there would be no additional inducement to the banks.
As banks decided to let their liabilities to branches run down,
the branches would be offered an alternative asset by the Federal
Reserve. As a result the Federal Reserve would acquire liabilities
to U.S. branches abroad.
Mr. Holland has suggested that the Federal Reserve might
implement the proposal by carrying out matched sale-purchase
FORD i LIBRARY GERALD
agreements with the banks. Thus the Federal Reserve would regularly
offer securities for repurchase in 15 or 30 days, the combined operation
providing a yield to the banks sufficient to attract the amount of
funds the Federal Reserve wishes to absorb. In order to achieve its
objectives, the plan should ensure that the funds so invested represented
the proceeds of Eurodollar borrowings, either by a foreign branch of a U.S.
bank or by a U.S. bank directly.
-2-
In order for the plan to be successful, the asset in
which Eurodollars would be invested must not be readily transferable
from one investor to another--i,e,, it cannot be one that could be
readily resold to domestic U.S. investors and it must be one that
cannot readily be acquired by U.S. investors except with Euro-
dollars. For the transferability to be limited, it would be necessary
that U.S. Government securities sold by the Federal Reserve to foreign
branches of U.S. banks (or to other banks) be held in custody by the
Federal Reserve.
Questions about the Proposal
1. What are the various implications of the Federal Re-
serve taking a position in the Eurodollar market? The Federal Re-
serve would become a debtor, perhaps up to some billions of dollars,
to the foreign branches of American banks. Would this action highlight
the weakness of the dollar? The extent of Federal Reserve liabilities
to the Eurodollar market would be a readily measurable quantity that
would be identified as overhanging the market and that many observers
would add to the measured official settlements deficit. The present
level of U.S. bank liabilities is also an overhang but no one knows
how much of these liabilities is unwillingly held.
GERALO FORD LIBRARY
2. How will it be possible to limit the offer by the Fed-
eral Reserve so that U.S. resident banks or others do not have access
to the preferential arrangement? The scheme could be limited so that
-3-
only branches receiving repayment from head offices were eligible.
For U.S. banks without branches, presumably the special RP's would
be offered up to the extent of their borrowings from the Eurodollar
market. It would be necessary to supervise the arrangement so that
U.S. banks did in fact retain Eurodollar borrowings up to the amount
of the preferential RP's.
Advantages
first two
In addition to the/advantages that were cited for Mr.
Coombs' proposal (in my memorandum of November 23), the following
advantages might be realized:
1. One advantage of RP's with frequent roll-overs, is
that the Federal Reserve could take advantage of changes in Euro-
dollar interest rates for different maturities and over time. As
compared with a special reduced reserve requirement, the Federal
Reserve would have increased flexibility in adjusting the incentive
offered to banks.
2. The proposal would help to eliminate historical
reserve-free bases. To the extent that banks gave up their bases
and permitted their branches to invest in the special RP's, historical
bases would decline. Furthermore, at some future point, historical
bases might be reduced sufficiently so that a uniform reserve-free
base (related to, say, total deposits) could be introduced.
FORD & LIBRARY
-4-
Disadvantages
1. The plan would have an effect on bank reserves. As
the Federal Reserve sold securities (with a commitment to repurchase)
it would absorb reserves and the Desk would have to offset this
effect.
2. This plan would be more costly to the U.S. Government
than the proposed reduced reserve requirement against demand deposits.
Under the latter scheme, the Federal Reserve would share with the
banks the differential between the interest rate on CD's and the
interest rate that branches pay on Eurodollar deposits. But the
differential would not have to be eliminated, since banks attach
some value to the reserve-free base. Under Governor Mitchell's
proposal, the Federal Reserve would be trying to attract the funds that
become available as banks give up their reserve-free bases. Thus
the yield on the matched sale-repurchase deals would have to
be at least equal to what branches are paying for Eurodollar
deposits. Furthermore, the Federal Reserve would be borrowing at
the same interest rate that banks pay for deposits in the Eurodollar
GENNED FORD LIBRARY
market, whereas normally the Government can borrow at lower rates,
just as the Treasury bill rate is below the rate on CD's.
3. As indicated earlier, eligibility of purchasers of
the RP's would probably have to be limited in order to prevent funds
from moving from the United States into the RP's. Thus just as
the special reduced reserve requirement would benefit mainly (though
not only) the largest banks, so would this proposal. In both proposals,
-5-
however, any smaller bank that wished to acquire Eurodollar
smaller
bank
that
wishe
liabilities could benefit from the incentive offered.
[iabilities could benefit from the il
FORD i GERALD LIBRARY
//STRICTLY CONFIDENTIAL (FR) 11
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
12/1/70
DATE
Chairman Burns
TO
FROM ROBERT SOLOMON
The attached memorandum reports on
the latest data on the Eurodollar positions
of U.S. banks.
RS
Attachment.
FORD i LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
To:
Mr. R. Solomon
Subject: Change in Gross Liabilities
to Foreign Branches in the week
From: Robert C. Bradshaw and
ended November 25, 1970 and in
Ralph W. Smith
Average Wednesday Gross Liabilities
for the Four Weeks Ended 11/25/70
from the Four Weeks Ended 10/28/70.
Gross liabilities of U.S. banks to their own foreign branches
declined $332 million in the week ended Wednesday, November 25, 1970,
reducing total gross liabilities to foreign branches (including domestic
loan participations) to $8.74 billion.
The most recent four-week computation period for calculation
of required reserves against Euro-dollar positions ended Wednesday,
November 25. The attached table shows the change in (average) gross
liabilities to foreign branches for the four Wednesdays through
November 25, 1970, compared to the four Wednesdays through October 28,
1970 (the last day of the previous computation period)
The table also shows this change in (four Wednesday average)
gross liabilities to foreign branches as a percentage of reported daily
average net liabilities to foreign branches plus assets sold to foreign
branches in the computation period ended October 28, 1970. It should be
noted that the changes calculated from Wednesday gross liabilities data
alone have, in our past experience, often not accurately reflected
changes in daily average net liabilities.
DERALD FORD LIBRARY
STRICTLY CONFIDENTIAL (FR)
STRICTLY CONFIDENTIAL (FR)
Change in (Four Wednesday) Average Gross
Liabilities to Foreign Branches from the
Computation Period Ended October 28, 1970
to the Computation Period Ended November 25,
1970. (Millions of dollars)
Avg. Net BranchesT/
Change in Avg. Gross 27
Historical
Foreign
Liab. to Branches-
Per cent
Base Banks
10/1/70 to 10/28/70
through 11/25/70
Change
First Nat. Boston
450
-33
-7
The Bank of New York
81
--
--
Banker's Trust
810
-137
-17
Chase
2,240
-112
-5
Chemical
854
-30
-3
F.N.C.N.Y.
1,182
-244
-21
Irving
558
-142
-25
Mfg. Han.
586
+53
+9
Marine
281
+2
+1
Morgan
1,255
-13
-1
Mellon
126
-8
-6
Union, L.A.
96
+3
+3
Bk. of America
762
+7
+1
F.N. of Chicago
352
-17
-5
Continental Ill.
670
-41
-6
Total
10,304
-712
-7
All other banks
4163/
-87
-21
All banks
10,706
-799
-8
1/ As reported on a daily average basis for the computation period
ended 10/28/70; also includes assets sold to foreign branches.
2/ Change calculated from average Wednesday gross liabilities in the
four weeks ending 11/25/70, compared to average Wednesday gross lia-
bilities in the four weeks ended 10/28/70; F.R.B.N.Y. series.
3/ Based on incomplete data for banks using a 3 per cent of deposits
base.
HALD LIBRARY ? FORD
OF
The Department of the TREASURY
NEWS
WASHINGTON, D.C. 20220
TELEPHONE W04-2041
DEPARTMENT THE TREASURY THE
1789
FOR IMMEDIATE RELEASE
December 3, 1970
THIRD QUARTER REPORT ON PURCHASES AND SALES
OF GOLD AND OTHER RESERVE ASSETS
(JULY-SEPTEMBER 1970)
U. S. reserve assets declined by $801 million in the third
quarter to $15.5 billion. The change in the components during
the quarter and the amounts held on September 30 were as follows:
(In millions of dollars.)
Change (3rd Qtr.)
Balance Sept. 30,1970)
Gold
$ -395
$11,494
SDR
+34
991
Foreign Exchange
-34
1,098
Res. Pos. in IMF
-406
1,944
$ -801
$15,527
The major changes, as indicated, were reductions in gold
holdings and in the U. S. position (drawing rights) in the
International Monetary Fund. The U. S. position in the Fund
declines as the Fund builds up its holdings of dollars. The
Fund accumulated dollars as a number of countries made repay-
ments to the IMF of their earlier drawings and also when the
GERALD FORD LIBRARY
IMF acquired dollars through the sale of gold and SDR to the
U. S. Treasury.
Transactions in gold are as set forth in the attached table.
The largest transactions were those with the IMF, which were
explained in the Treasury Press Release of September 16, involving
the distribution to the U. S. of $132 million in gold and SDR and
the resale by the Treasury of $400 million in gold to the IMF.
K-542
- 2 -
The gold sales in the third quarter listed in the attached
table, other than those to the Netherlands, Switzerland/Muscat, and
but including the nearly $60 million sale to the Republic of
China, were all to countries which had gold payments to make
to international institutions.
OF
Attachment
a
brus to TMI
to
at
,TMI
bns
at
to
UNITED STATES NET MONETARY GOLD TRANSACTIONS WITH FOREIGN
COUNTRIES AND INTERNATIONAL INSTITUTIONS
January 1-September 30, 1970
(In millions of dollars at $35 per fine troy ounce)
First
Second
Third
Area and Country
Total
Quarter
Quarter
Quarter
Europe
Denmark
-
-
-2.0
-2.0
Greece
-
-0.3
-
-0.3
Iceland
-0.1
-0.1
-0.1
-0.2
Ireland
+2.2
-
-
+2.2
Malta
+2.5
-
-
+2.5
Netherlands
-
-
-20.0
-20.0
Spain
-
-
+50.8
+50.8
Switzerland
-
-
-50.0
-50.0
Turkey
-0.3
-2.1
-5.5
-7.8
Vatican City
-
+1.2
-
+1.2
Yugoslavia
-
-
-0.4
-0.4
Total
+4.4
-1.3
-27.2
-24.1
Latin America
Argentina
-5.0
-
-
-5.0
Bolivia
*
-
-
*
Chile
-0.8
-0.5
-0.2
-1.5
Colombia
-1.1
-0.1
-
-1.2
Dominican Republic
-0.1
-0.1
-0.1
-0.3
El Salvador
-0.1
-0.1
-0.1
-0.2
Guatemala
-0.1
-0.1
-0.1
-0.3
Haiti
-
-0.1
-
-0.1
Nicaragua
-
-
*
*
Peru
-0.1
-0.2
-3.4
-3.7
Uruguay
-0.1
-8.0
-
-8.1
Total
-7.3
-9.1
-3.9
-20.3
Asia
Afghanistan
-0.2
-0.2
-
-0.3
Burma
-
*
+20.8
+20.8
Ceylon
-
-
-0.4
-0.4
China
-
-
-59.8
-59.8
Cyprus
-
-
*
*
Indonesia
-
-0.8
-0.9
-1.7
Korea
*
-
-
*
Kuwait
+24.9
-
-
+24.9
Muscat
-
-
-1.1
-1.1
Pakistan
-0.4
-
-
-0.4
Philippines
+1.2
-0.4
+2.7
+3.5
Syria
*
*
*
-0.1
Yemen Arab Republic
-1.5
-
-
-1.5
Total
+24.0
-1.4
-38.7
-16.1
Africa
Cameroon
-
-0.2
-
-0.2
FORD
Central African Republic
-
-0.1
-
-0.1
Gabon
-
-0.1
-
-0.1
Ghana
-
-0.6
-0.2
-0.8
Guinea
*
*
*
*
GERALD
LIBRARY
Liberia
-0.1
-
-
-0.1
Morocco
-0.2
-
-
-0.2
Rwanda
-
-
*
*
Sierra Leone
-
*
*
*
Sudan
-0.4
-0.4
-0.4
-1.2
Tunisia
*
-0.2
-0.2
-0.4
United Arab Republic
-
-0.6
-2.7
-3.3
Total
-0.7
-2.2
-3.5
-6.5
IMF
+23.7
-
-321.7
-298.0
TOTAL
+44.0
-14.0
-395.1
-365.1
*Under $50,000.
Figures may not add to totals because of rounding.
OF
The Department of the TREASURY
NEWS
WASHINGTON, D.C. 20220
TELEPHONE W04-2041
THE TREASURY THE
1789
December 3, 1970
FOR IMMEDIATE RELEASE
Commendation of Two Top Bank Officials
Acting Secretary of the Treasury Charls E.
Walker today sent separate telegrams to
Mr. Richard P. Cooley, President of Wells Fargo
Bank in San Francisco, and Mr. A. W. Clausen,
President of Bank of America in San Francisco,
commending them for their reduction in consumer
lending rates:
"Secretary Kennedy, who is
abroad, asked me to commend your
reduction in consumer lending rates
as both consistent with underlying
market conditions and very much in
the public interest. If emulated
by business and labor in general in
their price and wage decisions, the
road back to high employment and
growth, without inflation, would be
both shorter and smaller. "
/Charls E. Walker
Acting Secretary
of the Treasury
K-541
FORD & LIBRARY GERALD
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date December 7, 1970.
To
Board of Governors
Subject: U.S. banks' Euro-dollar
From
Ralph W. Smith & Robert C. Bradshaw
positions.
(through Mr. Hersey)
1. Attached is a table showing the positions of the nine
historical-base New York City banks with respect to their reserve-free
bases for the computation period ended November 25. Four banks gave up
a total of $521 million of their combined reserve-free base in this
period. Chemical Bank was the only bank to make an initial cut in its
base during that computation period, reducing it by $35 million.
Detail on banks outside New York will not be available
for several days.
2. In the three days (December 1-3) following the Board's
action raising marginal reserve requirements on Euro-dollars, U.S.
banks increased their liabilities to their own foreign branches by
$978 million, despite the high cost differential between Euro-dollars
and domestic funds during this period. While the daily series is quite
volatile, this is nevertheless a very large increase, and perhaps
indicative of the effect of the Board's action.
Attachment
FORD & LIBRARY GERALD
STRICTLY CONFIDENTIAL (FR)
PRELIMINARY DATA
Net Liabilities of New York City Banks to Foreign Branches Plus Assets Sold to Foreign Branches
(Four Week Computation Period Ending November 25, 1970)
(millions of dollars)
1/
Four weeks ending:
Reserve-free base
Change from
November 25, 1970
October 28, 1970
Computation
previous
Daily
Excess over
Excess over
May
period ending
computation
average
reserve-free
reserve-free
1969
10/28/70
11/25/70
period
outstanding
base
base
The Bank of New York
84.1
79.2
80.2
1.0
1.6
Bankers Trust Company
998.3
810.3
711.9
-98.4
711.9
--
--
Chase Manhattan
2,239.2
2,251.4
12.2
0.8
Chemical
853.4
818.7
-34.7
818.7
--
0.8
First Nat'l. City, N.Y.
1,453.4
1,182.2
901.3
-280.9
901.3
--
--
Irving Trust Company
838.9
358.1
451.5
-106.6
451.5
--
--
Manufacturers Hanover
583.5
586.5
3.0
2.6
Marine-Midland Grace
280.9
270.3
283.3
13.0
10.4
Morgan Guaranty
1,269.8
1,249.6
1,252.5
2.9
5.7
Total
8,591.5
7,825.8
7,305.2
-520.6
7,337.3
32.1
21.9
1/ Four week daily average of net liabilities to foreign branches plus assets sold to foreign branches.
2/ No entry indicates that the reserve-free base in the previous period shown was still in use.
FORD i LIBRARY GERALD
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
DATE
December 9, 1970.
Chairman Burns
TO
FROM ROBERT SOLOMON
Attached are two tables that you
requested:
1. The main elements of the
U.S. balance of payments in recent
years.
2. The reserve assets and major
liabilities of the United States.
RS
Attachments.
FORD & LIBRARY 9ERALD
Summary of the U.S. Balance of Payments
(millions of dollars; deficit (-))
1960-65
1966-68
1970
Average
Average
1969
Jan-Sept / Year (est.)
Over-all balances
as published
Liquidity basis
-2,547
-1,577
-7,012
-3,962
-4,300
Official settlements bal.
-2,053
-504
2,700
-7,151
-8,500
before special transactions 2/
Liquidity basis
-2,855
-3,110
-5,958
-4,110
-4,500
Official Settlements bal.
-2,259
-555
2,758
-7,438
-8,800
Selected items:
Trade balance
5,346
2,803
638
2,054
Goods and services
6,098
4,335
1,949
2,957
U.S. private capital
-4,385
-5,127
-5,233
-4,897
Foreign private capital
826
5,823
13,199
-296
(Liabilities to foreign banks)
(438)
(2,452)
(9,217)
(-3,342)
Military expenditures, net
-2,392
-3,071
-3,335
-2,616
1/ Seasonally adjusted, before allocation of $867 million of SDR's
2/ Special transactions include sales of 'hon-liquid! U.S. Government
obligations to foreign governments as well as other arrangements designed
to reduce the published deficits (primarily the liquidity deficit).
December 7, 1970.
FORD is LIBRARY GERALD
CONFIDENTIAL (FR)
U.S. Reserve Assets and Liabilities
(millions of dollars)
12/65
12/68
12/69
10/70
11/70
Reserve assets, total
15,450
15,710
16,964
15,120
14,891
Gold
13,806
10,892
11,859
11,495
11,478
IMF gold tranche
863
1,290
2,324
1,823
1,812
Special drawing rights
--
--
--
1/991
961
Convertible currencies
781
3,528
2,781
811
640
Liabilities to foreign reserve holders
16,821
18,574
17,162
22,726
Liquid2/
16,206
13,511
13,011
18,713
Non-liquid
615
5,063
4,151
4,013
Net official reserves
-1,371
-2,864
- 198
-7,606
Liquid liabilities to
foreign commercial banks
7,419
14,472
23,614
20,223
Initial allocation on Jan. 1, 1970 was $867 million.
2/
Includes IMF gold investment and gold deposits.
FORD is LIBRARY 0ERALD
December 9, 1970
CHAIRMAN BURNS
For Information Only
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date December 9, 1970.
To
Board of Governors
Subject: Corrected table on New York
From
Ralph W. Smith and Robert C. Bradshaw banks' Euro-dollar positions.
(through Mr. R. Solomon)
Please substitute this table for the one circulated on
December 7. The original table contained an error on Irving
Trust's base in the October 28 reserve computation period.
Attachment
FORD i LIBRARY OFRALD
STRICTLY CONFIDENTIAL (FR)
PRELIMINARY DATA
Net Liabilities of New York City Banks to Foreign Branches Plus Assets Sold to Foreign Branches
(Four Week Computation Period Ending November 25, 1970)
(millions of dollars)
Four weeks ending:
Reserve-free base
Change from
November 25, 1970
October 28, 1970
Computation
previous
Daily
Excess over
Excess over
2/
May
period ending-
computation
average
reserve-free
reserve-free
1969
10/28/70
11/25/70
period
outstanding
base
base
The Bank of New York
84.1
79.2
80.2
1.0
1.6
Bankers Trust Company
998.3
810.3
711.9
-98.4
711.9
--
--
Chase Manhattan
2,239.2
2,251.4
12.2
0.8
Chemical
853.4
818.7
-34.7
818.7
--
0.8
First Nat'l. City, N.Y.
1,453.4
1,182.2
901.3
-280.9
901.3
--
--
Irving Trust Company
838.9
558.1
451.5
-106.6
451.5
--
--
Manufacturers Hanover
583.5
586.5
3.0
2.6
Marine-Midland Grace
280.9
270.3
283.3
13.0
10.4
Morgan Guaranty
1,269.8
1,249.6
1,252.5
2.9
5.7
Total
8,591.5
7,825.8
7,305.2
-520.6
7,337.3
32.1
21.9
1/ Four week daily average of net liabilities to foreign branches plus assets sold to foreign branches.
2/ No entry indicates that the reserve-free base in the previous period shown was still in use.
R.
FORD
GERALD
LISBARY
BOARD OF GOVERNORS
THE OF GOVERNORS SYSTEM
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, D.C. 20551
FEDERAL
RESERVE
December 9, 1970
CONFIDENTIAL (FR)
TO:
Federal Open Market Committee
FROM: Mr. Broida
There is enclosed a copy of a memorandum to the Board
of Governors from Mr. Solomon dated November 17, 1970, and en-
titled "Dealing with the Overhang of Euro-dollar Liabilities:
Laissez-faire vs. Taking Action to Discourage Outflows." This
memorandum is being distributed to the Commitee as background
for possible discussion at the meeting on December 15.
Onthm & Bw.
Arthur L. Broida,
Deputy Secretary,
Federal Open Market Committee.
Enclosure
FORD & LIBRARY 078870
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
CONFIDENTIAL (FR)
November 17, 1970.
TO:
Board of Governors
FROM:
Robert Solomon
SUBJECT: Dealing with the Overhang of Eurodollar Liabilities:
Laissez-faire vs. Taking Action to Discourage Outflows.
The differential between U.S. and Eurodollar interest rates
has led some banks to decide to give up a part of their reserve-free
bases and is leading many other banks to think seriously about doing
the same.
The reserve-free base has value to a bank insofar as the
bank now believes that it may, in the future, wish to have recourse
to the Eurodollar market to meet some of its needs for funds in the
United States. From the bank's viewpoint this could come about as
the result of a future squeeze under Regulation Q ceilings or as the
result of higher costs of funds at home than in the Eurodollar mar-
ket. Thus the banks are willing to pay some cost--in the form of
holding Eurodollars at interest rates higher than those on domestic
liabilities (Federal funds, CD's, and commercial paper) --as an in-
surance premium to preserve all or part of the reserve-free base.
But a number of the banks have decided that the current
cost is too high and this is leading them to think seriously about
reducing the size of the insurance policy.
GERALD FORD LIBRARY
Consideration of whether or not the Board should do some-
thing to discourage the outflow of funds should be preceded by an
estimate of the likely magnitude of the outflow in the absence of
Board action.
-2-
Magnitude of Potential Outflow
The outlook for the U.S. economy is such that one must
expect declining short-term interest rates here for some period
of time; at the least, short-term rates, after falling further
from present levels, are unlikely to rise substantially for quite
a while. Meanwhile, short-term yieldsin Europe are considerably
higher than ours. Even if Europe has reached, or passed, the peak
of intensity in the use of tight money during this cyclical upswing,
the easing of monetary conditions there is likely to 1ag ours by a
substantial margin. Thus European countries (notably but not only
Germany and Italy) will be exerting a demand on the Eurodollar mar-
ket for some time. This is a major reason why the $5 billion of
Eurodollar repayments that has already occurred this year has not
eliminated the differential between U.S. and Eurodollar yields.
Whether further repayment of Eurodollar liabilities by
U.S. banks would be self-arresting, as the result of a decline in
Eurodollar rates, thus depends importantly on the strength of demand
for Eurodollar in other countries.
While no one can be sure about the duration of tight money
in Europe, it is not to be ruled out that a significant differential
in short-term interest rates between the United States and Europe would
persist for at least a year--and possibly much longer.
FORD i LIBRARY GERALD
-3-
A related question is this: assuming a persisting differ-
ential in interest costs between the United States and the Eurodollar
market, is there a level below which the banks would hesitate to re-
duce their liabilities to branches and, correspondingly, their re-
serve-free bases?
One consideration here is that more and more banks are
likely to come to the view that Regulation Q will not be used in the
future as it was in 1966 and 1968-69. If the Board lifts the re-
maining ceilings on large CD's, and even if it uses the term "suspension,"
the view is more than likely to spread that the suspension is permanent.
As this happens, banks will reduce what they regard as a minimum desir-
able reserve-free base.
On the other hand, banks are unlikely to reduce their Euro-
dollar liabilities to zero. For one thing, they may wish their branches
to maintain a balance with the head office. Furthermore, the future
is uncertain and banks will hedge their bets regarding the probable
reimposition of Regulation Q ceilings.
In 1967, when credit conditions eased here, banks reduced
their liabilities to branches--which had grown from $1.7 billion in
January 1966 to $4 billion at the end of 1966--only moderately, from
a peak of $4 billion to $3 billion. On the other hand, that period
of ease was rather short-lived and it is therefore difficult to draw
reliable conclusions as to bank behavior from it.
FORD & LIBRARY 036870
-4-
Even if there is an upward trend in the long run in liabilities
to branches, banks could temporarily dip below that trend when interest
rate differentials make that course profitable, just as they went far
above the trend in 1969.
All things considered, it is possible to imagine a potential
outflow of as much as $4-6 billion from the present level of $9 billion.
The term "potential" is used here for more than one reason: (1) to
denote a possible outer-limit, (2) to indicate what could happen in
the absence of an effect of this very outflow of U.S. funds on European
interest rates. It is possible that the outpouring of U.S. funds, by
flooding the Eurodollar market and in turn European money markets, would
drive down short-term rates abroad before $6 billion flows out. But one
of the presumed U.S. objectives, as discussed below, is to avoid flooding
European money markets in a way that undermines the efforts of European
central banks to combat inflation.
Thus while a $4-6 billion outflow may not be the most likely
estimate, because European rates will decline more than European
central banks wish them to decline, it is a possible outflow that U.S.
banks might be willing to tolerate if the differential cost of Euro-
dollars remains relatively high.
Advantages and Disadvantages
Assuming a possible outflow over a period of 6 to 12 months
of, say $6 billion--or even $4 billion--what are the disadvantages to
FORD is LIBRARY 038670
-5-
the United States of permitting it to happen?
Disadvantages
The official settlements deficit has amounted to $7 billion
in the first 9 months of 1970. This is much larger than the official
settlements surplus in 1968 and 1969 combined ($4.3 billion). After
5 years--1965-69 inclusive--in which the official settlements deficit
averaged out at zero, we have suddenly provided reserves to the rest
of the world, in 9 months, at a rate equal to more than three-fourths
of the SDR creation agreed to for a three-year period.
If this enormous rate of deficit should go on for a con-
siderable period of time--another six months or a year--several un-
fortunate consequences can be foreseen.
1. Heavy conversions of foreign dollar accruals
into U.S. reserve assets (IMF position, SDR, gold)
which could in turn trigger off a burst of specula-
tion against the dollar. If this happened, the re-
flow of dollars to foreign official reserves from the
Eurodollar repayments would be magnified, since for-
ward discounts on the dollar would encourage greater
reconversions by Europeans out of Eurodollars into
their own currencies and since interest arbitrage
reflows would be supplemented by speculative inflows
into European currencies.
FORD & LIBRARY
-6-
2. The chances of getting agreement on further
creation of SDRs by January 1973 (which requires
negotiations in 1972) would become very slim. This
in turn would lead to a growing view that the SDR
experiment had failed and that an increase in the
price of gold is necessary--not only to let the United
States pay off its debts but also to put the monetary
system on a "sound" basis. The progress that has been
made in recent years in de-emphasizing gold and moving
the international monetary system toward a managed basis
might be lost.
Apart from these dire results, the United States
cannot turn its back on a commitment it accepted when
it promoted the SDR agreement: we accepted and, in fact,
supported the proposition that the international monetary
system should not depend heavily on further additions to
official dollar reserves. It was agreed that it is
neither in the U.S. interest nor in the interest of other
countries that our official dollar liabilities should
continue to increase rapidly.
3. Europeans already feel resentment at being buffeted
in a magnified way by U.S. monetary policy. In 1968-69, we
imposed pressures on them when we let our banks drive Euro-
FORD i LIBRARY 93RALD
-7-
dollar interest rates up to as high as 13 per cent.
Now we will be pushing rates down, undermining their
tight money policies and adding to their holdings of
official dollar reserves.
This resentment has been a catalyst in the drive
toward European monetary integration. Whether or not
such integration is advantageous to the United States,
the anti-American impulses behind it are not.
There are many reasons why the United States should
make some effort to maintain cordial and cooperative re-
lations with Europe and Japan. If we sit by and per-
mit a further outflow of $4-6 billion without being seen
to have tried to stem it, there will be a growing acceptance
of the view, already held in Europe, that the United States
has adopted the Friedman-Haberler-Houthakker prescription
that our only duty is to try to contain inflation and
maintain full employment, while the rest of the world
adjusts to whatever volume of dollars flows out of the
United States.
One result of a deterioration in the cooperative
attitude of the Europeans -which may occur anyway if the
Mills' bill gets through Congress and is signed by the
President--would be less willingness of European countries
to revalue their currencies when in substantial surplus.
FORD & GERALD LIBRARY
LIBRARY
GERALD
-8-
FORD
The balance, in European minds, would tend to be tipped
against such action and toward actions or non-actions
that put increasing pressure on the United States.
4. Finally, it can be argued that the medium-term
outlook for the U.S. balance of payments is rather favorable
(see my submission to the Commission on Trade and Investment)
One can imagine a gradual working down of the Eurodollar over-
hang over the next 2 or 3 years as the rest of our balance
of payments improves. Given this prospect, one can also
argue against letting the Eurodollars flow out now in
massive volume. Providing an incentive to hold does not
saddle us with these liabilities forever.
The very fact that the medium-term outlook is favorable
argues for preventing a crisis atmosphere from being created
now. After our poor domestic management in 1965-69, we may
be on the road back to a sounder domestic economy and a
stronger balance of payments. But we can't persuade the
Europeans and the markets of this. We can only demonstrate
it and that takes time. Between now and when the demonstra-
tion becomes evident there is something to be said for
temporary measures to hold things (including confidence in
the dollar) in place.
1/ Trade, Investment and the Balance of Payments Adjustment Process,
August 6, 1970, Washington, D. C.
-9-
Advantages
Is there a case in favor of doing nothing and letting
the Eurodollar liabilities run off?
1. It can be argued that, having accumulated the
overhang, we have to face repayment eventually and we
ought to get it behind us. A variant of this argument
is that we ought to get a part of the repayment behind
us, by standing still for a further outflow of, say
$2 billion or so, hoping meanwhile that this will
narrow the interest rate differential between U.S. and
Eurodollar rates.
2. Another consideration relates to the distribu-
tion of foreign official dollar gains resulting from
Eurodollar repayments by U.S. banks. A very large
proportion of the increase in U.S. liabilities to
foreign monetary authorities in 1970 is accounted
for by Germany and Canada. For a part of 1970 Germany
may have welcomed the additions to its reserves, follow-
ing the enormous decline in reserves it experienced
FORD & LIBRARY QERALD
following the October 1969 revaluation. Even if Germany
no longer welcomes additions to its dollar holdings (and
ignoring the undermining of the Bundesbank's policy re-
ferred to earlier) there is little that Germany can do
about it. Apart from buying back the $500 million of
gold that it sold to the United States in the fourth
-10-
quarter of 1969, Germany is bound by the Blessing
letter not to buy gold from the United States.
Given the touchiness of the problems regarding U.S.
troops in Europe, Germany is unlikely to ask for a
revision of the Blessing letter now.
Other European countries would also share in
the reserve gains reflecting a further massive out-
flow of Eurodollars. Belgium, Holland, Italy, Switzer-
land--even France and possibly Britain--could experience
sizable reserve increases if another few billion of
Eurodollars were repaid. But we do have reserve assets
and should be ready to use them.
Conclusions
A weighing of these arguments can lead to the following
judgments:
1. The concern about the undermining of
monetary policy abroad is not allayed by the fact
that Germany can do little about converting un-
wanted dollars into gold. In fact, if it became
evident that the U.S. was leaning heavily on this
constraint on Germany, that fact itself would
worsen our cooperative relations with the rest of
the world.
Numerous contacts with Bundesbank officials
indicate that they would be disturbed by a massive
outflow of Eurodollars from the United States,
is
FORD
which would provide financing to German companies
that find credit unavailable or too expensive in
Germany.
GERALD
LIBRARY
-11-
2. The argument that the United States should
be seen to be trying to moderate the impact that its
changing policies have on the rest of the world is
hard to challenge. When we finally announced the
Eurodollar reserve requirement in mid-1969 we gained
some good will and put an end to an acrimonious debate.
3. If a balance of payments crisis should occur--
for whatever reason--the United States will be in a
better position to deal with Europeans and therefore
to see to it that the outcome of the crisis favors
our long-run interests if we have a record of taking
actions within our power. No one abroad in a re-
sponsible position is asking the United States to
deflate excessively in order to strengthen our bal-
ance of payments. But neither European nor Japanese
officials regard restrictions on capital flows as
undesirable and in some circumstances they advocate
such restrictions. Absence of any action by the United
States to shore up a crumbling Eurodollar regulation
could lead officials of other countries to believe
that we think the world is on a dollar standard and
do not concern ourselves with our balance of payments.
If they come to this belief, they would be more likely
to follow those in Europe who would like to push the
continental countries back toward a gold bloc. This
would hardly be a congenial environment in which to
try to work out of a crisis--or, for that matter, to
work on a day-to-day basis even if there is no crisis.
4. The existing attitude toward the dollar is
hardly a healthy one. The improvement we see in the
underlying balance of payments--and in its prospects--
is not evident yet to the rest of the world or to the
markets. Since we must expect some deficit next year
even if there is no repayment of Eurodollars--and the
deficit could be aggravated temporarily if Europe slumps
after its current boom--we have a good reason to re-
strain dollar outflows where and when possible. This
need not mean simply a delay in facing the music--if
we are right in our optimistic view of the medium-term
outlook. And even if we are wrong, the chances of
inducing revaluations by surplus countries in Europe
will be greater if we are seen to do what we can to
hold down our overall deficit.
GERALD FORD LIBRARY
FORD LIBRARY
& GERALD
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date December 10, 1970.
To
Chairman Burns
Subject:
From
Robert Solomon
STRICTLY CONFIDENTIAL (FR)
The attached memorandum spells out some of the
political effects of an international crisis. See especially
pages 12-16.
RS
Attachment.
m may fre nises
FORD s LIBRARY GERALD
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
STRICTLY CONFIDENTIAL (FR)
December 8, 1970.
To:
Chairman Burns
From: Robert Solomon and
Subject: Repercussions for the President
Ralph C. Bryant
of an International Financial Crisis.
This note tries to speculate on the political pressures that
would face the President if the United States were to find itself in the
midst of an international fiancial crisis.
Immediate Cause of Crisis
The crisis could be triggered off in a variety of ways. Most
likely it would come as the result of a spreading wave of demands for
conversion of dollars by foreign monetary authorities, consequent on a
growing belief that the U.S. external position is not viable. This be-
lief in turn, could be generated by a resurgence of inflation, by a dis-
mantling of our restraints on capital outflows, by a massive repayment
of Eurodollar liabilities by U.S. banks, or by a U.S. posture that tells
the rest of the world that we intend to ignore the balance of payments.
Frame of Reference
FORD & LIBRARY GERALD
In order to start the analysis somewhere, it is assumed that
the President has decided to suspend all gold sales and purchases. We do
not deal here with the various types of suspension that would be possible,
but simply assume complete suspension. We likewise do not discuss the
It is important to realize that several half-way houses exist.
"Complete" suspension may be defined as a situation in which there is
no convertibility at all on a systematic basis for official dollar holdings
of foreign monetary authorities. Selective redemptions of official dollar
balances might be undertaken from time to time by the U.S. Treasury, but
only on U.S. terms and conditions. The United States would not itself
take measures to maintain present dollar exchange rates with other countries.
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many questions that would arise about the timing and the handling of this
decision -- even though they are of the utmost importance.
Possible Evolution of the Crisis
What course might events initially take if the President were
to suspend gold sales and purchases?
A majority of foreign countries would initially respond by
continuing to peg their currencies to the dollar at former exchange
rates, in effect becoming members of a "dollar bloc." The Common Market
countries, together with a few other countries in Europe, would be likely
to work out arrangements so that present fixed parities and exchange
relationships within a "Eurobloc" would be maintained. Japan and the
sterling area group of countries would face difficult choices; whether
they floated independently or pegged to the dollar bloc or the Eurobloc
would depend a great deal on their expectations of the manner in which
the crisis would eventually be resolved. The exchange rate between the
dollar bloc and the Eurobloc group of countries might be maintained by
the Europeans at present parities if they foresaw a speedy resolution of
the crisis, a return to normal operations of the Fund Agreement, and a
return to full convertibility of the dollar. More likely, the dollar-
Eurobloc exchange rate would be allowed to float temporarily, with the
Eurobloc initially appreciating relative to the dollar bloc. Further
developments in the crisis, including especially the evolution of
FORD is LIBRARY GERALD
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exchange-rate relationships, would depend on the negotiating stances
of governments and on the extent of agreement (or disagreement) on the
main features of a multilaterally acceptable settlement of the crisis.
Eurobloc countries would be likely to put on some further
balance-of-payments controls, particularly on capital transactions.
But it would be very difficult to obtain the requisite intra-Eurobloc
cooperation in order to make a full-fledged multiple-rate and exchange-
control system work. The Eurobloc countries would attempt to
establish such a system only if an early and more favorable resolution
of the crisis did not seem to be in the cards.
In the period immediately following the U. S. suspension,
the price of gold in private markets would rise very sharply. There
would be no agreed "official" price of gold. Expectations that the
United States would eventually agree to a policy of buying and selling
gold at an official price significantly higher than $35 an ounce would
be widespread.
The Eurodollar market and national money markets would at best
be highly unsettled and at worst would start to unravel seriously.
There would be a general scramble for liquidity in face of all the un-
certainty. Irrational behavior would be superimposed on rational
1/ Either or both of the London and Zurich gold markets might be
temporarily closed by the U.K. or Swiss authorities, but many other
markets would remain open and activity would shift to them.
BERALE FORD LIBRARY
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precautionary behavior. Talk of bank holidays and the failure of fi-
nancial institutions -- perhaps particularly in the Eurodollar market --
would probably be rampant. Stock and bond prices would fall rapidly at
the outset. Action by individual central banks, and the presence or
absence of central bank cooperation, would be a critical determinant of
what happened after these initial reactions.
Attitudes and Responses of Foreign Governments
There are three important generalizations to be made about
the probable behavior of foreign governments. To some extent, these
generalizations also describe the likely attitude of the foreign public
and foreign press.
First, foreign attitudes and responses will be conditioned by
their appraisal of the economic policies of the U. S. Government. If
they believe the crisis can be traced in large part to "irresponsible"
U. S. demand management, they are likely to react in a much more hostile
manner than if they believe the U. S. authorities have been pursuing and
intend to pursue "reasonable" demand-management policies.
Second, foreign attitudes and responses will greatly depend
on their evaluation of long-run U. S. intentions. Foreign official judg-
ments about the outcome of the crisis preferred by the U. S. authorities
necessarily have to be a primary input into their own policy decisions.
FORD i LIBRARY GERALD
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Third, foreign attitudes and responses will be conditioned
by the timing and the handling of the U. S. decision to suspend. Can
the proximate onus for the decision to suspend be laid on the U. S.
authorities (were the U. S. authorities too quick to act?), or was the
U. S. decision taken only at the eleventh hour when certain foreign
central banks forced it on the U.S. authorities? To some extent, this
distinction is a chicken-and-egg distinction. Yet there will almost
surely be widespread public attempts to allocate the "blame" for a post-
suspension crisis. Judgments on this matter are also very likely to in-
fluence the policy decisions of foreign governments.
Congressional Reaction
There are a few Senators and Congressmen (e.g., Reuss, Javits)
who have formed strong views on how the Administration should react to
an international financial crisis of the sort posited here. But they
are numerically a small minority. The vast majority do not even have a
good grip on the issues that would be at stake in post-suspension
negotiations between the United States, the Eurobloc, and other major
countries like the United Kingdom and Japan. The mood of Congress in
this situation, it seems safe to surmise, would therefore not be dis-
similar from the reactions of a beehive split open with the sudden blow
of a heavy stick: violently roused from familiar behavior patterns, un-
certain where to turn, but worked up and looking for something to sit
on and sting.
FORD & LIBRARY 03RALD
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Public and Press Reaction
Apart from a handful of the more sophisticated papers with
able financial staffs, the press in this country will have still less
of a grip than Congress on why the crisis has arisen and what should
be done about it. Details of the crisis would be steady front-page
if not headline news. For at least the first few days balancesof pay-
ments, exchange markets, gold prices, interest rates, and financial
news in general would be thrown at the U. S. public with an intensity
never seen in the last three decades. The public will probably be less
capable of digesting this unprecedented financial news than it is able
to digest other (non-financial) types of shocks to the macrocosm.
Wars and riots are a dreary commonplace. But a "collapse of the mone-
tary foundations of the world economy": Ah! There's a really
indigestible crisis. "Are things really collapsing? What does it all
mean? Why did the President let things get so bad?"
Political Pressures on the President
It seems pretty clear that the President would feel great
pressure at home, both from Congress and from all sectors of the public,
to do something. At the outset a good deal of this pressure would be
unfocused, in the sense that it was more an outburst of concern than a
clear lobbying for specific policy responses. Part of the danger of the
1
FORD i LIBRARY GERALD
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situation lies in this very fact. Most of the ideas about the "some-
thing" to be done would be vague. And most of them would be directed
at the very short-run objective of pouring oil on troubled waters, not
at the longer-run economic and political interests of the United States.
Another dangerous aspect of the crisis situation is that it
would put the President's past economic policies under a much brighter
spotlight at home than they would otherwise ever have been. Public
opinion would be searching for scapegoats. Alleged "errors" in the
President's economic policies would be much more widely recognized and
discussed. Even if economic policies in the year or two before the crisis
had been financially conservative, it might be difficult for the President
and his advisers to avoid the political stigma that they had brought the
crisis on. The danger of a political swing against the President might
be especially great if it came to be generally believed that the President
had fueled up the economy too rapidly in order to increase his chances
for re-election in the fall of 1972.
The Issue of the Gold Price
Before the decision on suspension was many days (perhaps many
hours) old, the domestic pressure to do "something" would probably begin
to crystallize around the dollar price of gold. The most straightforward
thing to do, as far as the Congress and the public could see, might seem
FORD is LIBRARY GERALD
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to be to get the "inevitable" over with, "devalue the dollar" by sub-
stantially raising the price of gold, and restore normalcy. We believe
this tendency for the domestic pressure to crystallize around the issue
of the gold price would occur for two sorts of reasons. First, the
majority of the pressure coming from abroad -- including the views of
the major governments would be pushing for a change in the dollar
gold price. Although it is small in numbers, there is also a fairly
powerful domestic lobby that would be exerting its efforts. Second,
precisely because the great majority of the domestic press and public
do not have a good grasp of what the issues and choices are in this area,
there unfocused concern is apt to converge on the "simplest" policy option
(that step they would have the least trouble comprehending). Even if
powerful pressures from abroad and the domestic gold lobby were not
trying to push domestic opinion towards an increase in the gold price,
therefore, there is a significant danger that domestic opinion would move
in this direction of its own accord.
1/ The European (and possibly Japanese) monetary and political
authorities, it seems to us, would probably propose a "deal" that would
have the United States raise the dollar price of gold by a substantial
amount while some or all of them either did not change the price of gold
in terms of their currencies or else devalued against gold by a smaller
percentage amount than the United States. This deal would result in some
changes in relative exchange rates (a good thing) but only at the cost of
changing the gold-dollar parity (a bad thing). For a much fuller analysis
of this type of deal, the Europeans' reasons for proposing it, and the
reasons why it would be undesirable for the United States, see Balance-
of-Payments and International Financial Policies for the United States:
A Review of the Choices (Strictly Confidential mimeographed book pre-
pared for the Board, June 30, 1969), PP. 114-131.
FORD & LIBRARY GERALD
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If the President Holds Out Against a Gold Price Increase and Insists
on a Better Policy
There is no doubt in our minds that the types of resolutions
to the crisis that ought to be preferred do not involve a change in the
dollar price of gold. The economic merits of the situation argue
against a revaluation of gold, almost regardless of which country's
perspective is taken. The political arguments against a revaluation
of gold, seen from the perspective of the United States, are also
decisive.
"Better" solutions to the crisis do exist. They would involve
a once-for-all realignment of exchange rates that was pretty thorough-
going, together with a commitment to have somewhat more flexibility in
exchange rates in the future. The dollar would be devalued relative to
the currencies of Japan and a number of European currencies, but there
would be no change in the dollar price of gold. The "better" package
would also contain commitments on the future creation of SDR. It might
need to contain U.S. commitments of a more formal kind to limit future
expansion in the reserve-currency role of the dollar (here is the area
in which the United States, on the economic merits of the case, might
FORD & LIBRARY GERALD
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have to yield to the Europeans). It could even contain some under-
standings about the consolidation of existing reserve assets into a
single reserve claim on the Fund.
A "better" package of this sort is the type of resolution of
the crisis which the verdict of history would regard favorably. This is
clearly the approach behind which the President ought to throw his own
political resources and prestige.
But, it is necessary to point out, the President would have to
fight an uphill battle to obtain this more rational resolution of the
crisis. It would certainly take longer to get international agreement
on a package of this sort. Meanwhile, the uncertainty in exchange
markets and financial markets would be continuing. The pressures on the
President noted above would probably be growing more intense. "Why
doesn't the President do something to end this crisis? Why are negotia-
tions taking so long?" Even with able Administration explanations of the
goals and tactics of a "better" approach, it is conceivable that the
pressures on the President for a speedier resolution (even if essentially
false for the longer run) would build up to a point where they seemed
politically intolerable.
FORD i LIBRARY GERALD
If the President Yields to Pressures for an Increased Gold Price
A substantial increase in the dollar price of gold might
temporarily calm things down. Exchange markets would move back towards
normalcy, with monetary authorities once more pegging rates within
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narrow bands. Financial markets would get back to a more even keel. If
some changes in relative exchange rates had accompanied the revaluation
of gold, the period of calm might even last for some time.
Yet ultimately, in our judgment, the world monetary system would
be seen to have become more unstable. The President would have followed
a seriously wrong policy on the economic merits of the case. He would
have bought a temporary easing of the crisis atmosphere at the high price
of prejudicing the rational future evolution of world monetary arrangements.
The deliberate multilateral creation and regulation of reserve assets via
the SDR scheme and the Fund would be seriously undermined. Progress on
improving the adjustment of international payments imbalances (e.g.,
through the introduction of greater flexibility of exchange rates) might
have been derailed. Confidence in existing reserve assets and their
values in terms of each other would have been dealt a severe blow, from
which some of them -- most notably dollar and sterling balances -- would
never recover. Not only would central banks be less willing, in the future,
to hold dollars; the private use of the dollar abroad might also dwindle,
and this would affect the role of New York as a financial center.
Apart from the economic costs, there would be some high
FORD & LIBRARY QERALD
political costs to agreeing to a gold price increase. These might come
increasingly home to roost as time went on, especially as it became
apparent that the problems that produced the crisis in the first place
were far from being resolved by the President's consent to a revaluation
of gold. As for political opinion at home, there might be a growing
undercurrent of resentment at the President "capitulating" to the gold
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lobby, the gnomes of Zurich, the South Africans, the Russians, and
others with a strong vested interest in gold revaluation. Congressional
bitterness might grow, in retrospect, that the President had failed to
provide better leadership in the crisis. Consent to a gold price in-
crease might, even at home, come to be seen as a symbol of weakness in
foreign policy.
It seems almost inevitable that, sooner or later, political
awareness will catch up with the economic merits of the President's
decisions. If the President does give in and consent to what is a bad
policy, he will ultimately get caught out by Congress and the electorate,
not to mention future historians. Unfortunately, political awareness
will probably catch up only after a significant lag. There is thus a
bitter irony in the situation, and great political danger for the
President. Congressional and public opinion might push the President
into a decision in the heat of the crisis for which, later on in calmer
times, they would want to pillory him.
Effects of the Crisis on U. S. Foreign-Policy Objectives
Assume first that the President does give in to pressures for
a revaluation of gold. The adverse consequences of this decision for
foreign policy, even in the short run, would be great.
An increase in the dollar gold price would inevitably be
interpreted as a defeat for the United States and a sharp blow to our
FORD & LIBRARY GERALD
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prestige. The United States would be seen to be the country initiating
the action that would (supposedly) end the crisis. Other governments
could thus more easily disassociate themselves from responsibility for
the crisis. "The United States was at fault," it would be argued, "and
acknowledged this fact publicly by taking draconian action. " More
seriously, the credibility of all U. S. foreign policies would be under-
mined. It has been a bipartisan policy of long standing that the U. S.
Government would maintain the $35 gold-dollar parity. Unlike the promises
of governments never to devalue their exchange rates (promises that are
not believable because circumstances can arise in which the only
practical thing to do is to change the exchange rate), this U. S.
promise is one that could be kept and which ought to be kept. (Changes
in the rates at which the dollar exchanges against other currencies,
which are necessary, need not and should not involve a change in the
dollar gold price.) Most seriously of all, yielding to pressure on the
issue of the gold price would almost surely be interpreted by foreign
governments -- on both sides of the iron and bamboo curtains -- as a sign
of weakness. On which of its other commitments would the United States
yield when the going got really rough? What about NATO and other treaties?
If governments came to ask this question of themselves, as many would,
there could obviously be adverse consequences for nearly all aspects of
our foreign policy.
FORD & LIBRARY
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Some foreign governments and other observers would draw an
analogy with Britain's situation. Just as poor economic performance led
to a secular weakening of sterling and a concomitant erosion of Britain's
influence in world affairs, it might be argued, the United States was
headed down the same road. Just as the United States had taken over
leadership from the United Kingdom, Europe would now have to take over
world political and economic leadership from the United States.
It might seem inconsistent for foreign governments to urge
an increase in the gold price on the United States as part of a
compromise "deal" (see above) and yet, on the hypothesis that the United
States yielded to the urging, to think less of the U. S. authorities for
showing weakness and failing to honor past commitments. These attitudes
are not inconsistent for governments (e.g., France, Soviet bloc countries)
wishing to dilute the political power and prestige of the United States.
For many other countries these attitudes would be somewhat inconsistent.
Such attitudes, however inconsistent, might still be held. Schizophrenia
is a disease afflicting national policies as well as individual policymakers.
Countries that had held large proportions of their reserves
in dollars -- Japan, Canada, most of the less developed countries --
would feel resentful at a U.S. decision to raise the gold price. The
increases in reserves resulting from the gold revaluation would go mainly
to the European gold-holding countries. Countries whose arms we have
FORD & LIBRARY GERALD
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twisted not to purchase gold would feel particularly betrayed. Our
relations and bargaining power vis-a-vis these countries could be ex-
pected to deteriorate.
The big gain to South Africa from an increase in the price
of its major export would be resented by the many countries that feel
strongly about apartheid. Some countries would also resent the benefits
from gold revaluation that would be reaped by Russia.
Apart from its serious economic disadvantages in undermining
the SDR scheme, gold revaluation might also have political costs
stemming from its effects on the IMF and SDR creation. Many countries
in addition to the United States have invested great amounts of time
and prestige in the SDR arrangements. They would tag the United States
with the political onus for harmful effects of gold revaluation on these
arrangements.
Suppose that the President did not yield to pressures to raise
the gold price and held out for the "better" type of resolution of the
crisis. What consequences for foreign policy might result?
FORD is LIBRARY
Perhaps the main point to make is that, regardless of the
President's decisions, world monetary relationships would never again be
the same. The fall-out from the crisis would go on for several years.
Especially if the President were to consent to an increase in the gold
price, but even if he did not, foreign governments would press still
harder for some limitation on the future expansion of the dollar's role
as a reserve currency. The flexibility the United States is alleged to
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have to engage in foreign activities without worrying about the balance
of payments (we can "print" reserve liabilities instead of running down
reserve assets) has in any case been declining in the last decade.
However the crisis assumed here were resolved, it would clearly ac-
celerate this trend.
If a "better" resolution of the crisis were to be negotiated,
difficult multilateral compromises would have to be taken on par value
changes, on greater flexibility of exchange rates in the future, and
on the proper role of the dollar as a reserve currency. These
compromises would also have political costs. There would certainly be
some resentment at a strong U. S. position that was unyielding on the
gold price. To some extent, foreign governments would damn us if we
don't agree to a gold price increase ("Why is the United States trying to
dictate its own solution and force it down our throats?") and damn us
if we do ("A sign of political weakness").
The most unfavorable impacts on our foreign policies stemming
from a refusal of the President to consent to an increase in the price of
gold would come in the short run. At the time of the crisis and immedi-
ately after, relations with some governments (e.g., France) would be
strained. In the longer run, given the superiority of the "better"
FORD & LIBRARY 0ERALD
resolution of the crisis, these strains would gradually fade into the
background.
1/ The "better" solution would be superior in the long run both from
the point of view of the United States and all other countries except those
with vested interests in gold revaluation (South Africa) or those who be-
lieve they would benefit from a diminution in
U. S. prestige and
influence.
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The Probability of a Crisis Occurring
It seems appropriate after trying to peer into the witches'
cauldron to draw back and to ask how likely such a crisis is and how
the probability of a crisis depends on the current stance of economic
policy.
If foreign governments believe that U.S. economic policy has
been irresponsible prior to the crisis, as noted above, they will be
much more hostile than otherwise. The chances of getting them to agree
quickly to a "better" package for resolving the crisis would be markedly
smaller. For the Europeans, "irresponsible" demand management would
mean trying too blatantly to manipulate the economy for the purposes of
the 1972 elections. The Europeans and the Japanese would also probably
condemn us if we make no attempt at a serious incomes policy. A fur-
ther symptom of "irresponsible" behavior, as seen by our major trading
partners, would be any sign that the President and his advisers were
taking a blasé, let-it-rip attitude towards the U.S. balance of payments.
An aggresive relaxation of the capital controls would no doubt exacerbate
the situation.
Even if economic policy is as "responsible" as it can in
good faith be made to be, there is a significant possibility of a crisis
occurring. The short-run outlook for the balance of payments is for
continued weakness, even without a deliberate move to more expansionary
FORD is LIBRARY GERALD
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fiscal policies. This uncomfortable fact makes it still more
critical than usual to get demand-management policies right and
to keep in close, cordial touch with foreign governments who are on
the other end of our balance-of-payments deficit.
Whatever he does about a crisis, should one occur, the
President will be in an extremely hot situation. It is difficult,
if not impossible, to imagine him emerging from a crisis unaffected.
It follows from this judgment that the President, as he formulates
the new budget and charts the course of economic policy, should
do all he reasonably can to minimize the possibility of a crisis
occurring. Deflating the domestic economy significantly below the
growth path that would otherwise be warranted (if it were not for the
balance of payments) would be a mistake. That would not help our
relations with any foreign government and would only produce a domestic
economic crisis with all of its unfavorable political impacts. But
it would also be a great mistake to disregard the tenuous state of
the balance of payments and go for broke.
FORD & LIBRARY
FEDERAL RESERVE BANK OF NEW YORK
NEW YORK, N.Y. 10045
AREA CODE 212 RE2-5700
December 11, 1970
ALFRED HAYES
PRESIDENT
CONFIDENTIAL (F.R.)
The Honorable Arthur F. Burns
Chairman
Board of Governors of the
Federal Reserve System
Washington, D. C. 20551
Dear Arthur:
You may be interested in the enclosed memorandum written
by Charlie Coombs on the possible use by the Treasury of the BIS to
absorb Euro-dollars.
As you know, the substantial spread between Euro-dollar
rates and domestic rates has been a matter of concern to our banks as
they consider whether or not to maintain their Euro-dollar base. As
we look ahead to next year there is the disturbing possibility of a
massive flow of Euro-dollars into European central banks. Charlie's
memorandum is a timely proposal for dealing with what may possibly
become a very worrisome situation.
I am taking the liberty of sending copies of this letter to the
other members of the Board of Governors.
Sincerely,
al
Alfred Hayes
FORD i LIBRARY GERALD
Enc.
cc: Members of the Board of Governors
FEDERAL RESERVE BANK
OF NEW YORK
OFFICE CORRESPONDENCE
CONFIDENTIAL (F.R.)
DATE December 10, 1970
TO
Mr. Hayes
SUBJECT: Eurodollar Debt Problem.
C. A. Coombs
FROM
As you may recall, in a letter to Chairman Burns on
November 19, 1970, I hastily and briefly outlined one possible way of
dealing with the effects of continuing repayment of U. S. bank liabilities
to their European branches. Since then, I have given the question more
thought and have become persuaded that such an approach would be not
only technically feasible, but also useful in a number of ways.
The essence of the scheme, as you will recall, would be
to make an arrangement with the BIS which would undertake to absorb
in a more or less passive way part of the return flow of dollars to the
Eurodollar market as U. S. banks repay debt to their branches. The
dollars thus absorbed would probably fall primarily in the overnight to
30-day maturity range, reflecting the pronounced shortening of the
maturity range of Eurodollar debt on the books of the U. S. banks.
The BIS would then channel the dollars so acquired to the U. S. Treasury
against issuance of a special dollar certificate. In my letter to the Chairman,
I mentioned the technique already employed by the U. S. Treasury in
borrowing Swiss francs via the BIS, in which the BIS took relatively
short-term deposits from the Swiss banks and channeled them into a
FORD i LIBRARY 938870
U. S. Treasury certificate in the 15-month range. In this operation a
two-day call feature was introduced; first, in order to permit the BIS to
2
stay within its legal limitations regarding the liquidity of its assets, and
secondly, to permit renegotiation if a big change in market rates required
alteration of the interest rate applicable to the security. In effect, the
main purpose of the call feature was not to anticipate a possibly complete
liquidation of the operation before maturity, but rather to facilitate its
being rolled over on a different interest rate basis if events so required.
In actual fact, the call feature was never exercised.
Specifically I could conceive an arrangement whereby the
BIS would channel short-term Eurodollar money into a 15-month Treasury
security and would similarly require a two-day call option in order to
satisfy its statutes and permit renegotiation of the interest rate on the
certificate. By and large, however, I would think that the U. S. Treasury
could count on taking and holding on to whatever dollars it might have
acquired from the BIS, although it might from time to time have to put
a higher rate on the certificate. There is also, of course, the risk of
a sudden drying up of the Eurodollar money in the short-term range, or
an exorbitant rate jump over brief periods, but as I indicated in my
letter, such emergencies could readily be dealt with by a BIS drawing
on the $1 billion swap line with the Federal.
An alternative technique would be for the BIS to borrow
Eurodollar funds in the overnight up to 30-day range, and channel them
as it went along into new Treasury certificates (or into special deposits
at the Treasury) with matched maturities or an average of maturities
FORD is LIBRARY 938470
3
originally borrowed by the BIS. In effect, under this proposal the U. S.
Treasury would be paying the Eurodollar rate for short-term money.
I think that this procedure would provide a cleaner operation and one in
which occasional, if not frequent, payment of Eurodollar rates above
New York rates might be justified on the grounds that the U. S. Treasury
is not borrowing in that range in the U. S. market, although, of course,
maturing issues are constantly passing through the very short-term
maturity range. Such an operation, I think, could be designed in such
a way as to ensure the U. S. Treasury of a reliable and stable flow of
dollar financing from the Eurodollar market, safeguarded again by the
possibility, in an emergency, of a BIS drawing on the Federal Reserve
swap line.
You probably have seen Mr. Solomon's commentary on
my letter to Chairman Burns, which noted several advantages of the
proposal. On the other hand, Mr. Solomon apparently misunderstood
certain aspects of the proposal as indicated by his suggestion that the
BIS might require an exchange rate or gold guaranty. Since the BIS
would be borrowing Eurodollars against a dollar placement, exchange
rates or gold fall completely outside the picutre, and we can be confident
that no problem would arise on this score. Secondly, Mr. Solomon
suggested that the BIS might acquire "rather weighty leverage against
the United States" if such an operation were undertaken. This suggests
a misinterpretation of the role of the BIS as an operational bank as
FORD i LIBRARY DERALD
4
distinct from its role as a gathering place for central bank governors.
There is virtually no influence on policy matters which the BIS, as an
operational bank, can exert, and they have over the years been most
assiduous in avoiding using their operational facilities as a platform
for policy discussions. So far as the BIS governors are concerned,
their attitudes, I think, would be governed by their national responsibilities
and would, I should think, be sympathetic to any proposal designed to keep
additional dollars out of their markets and the reserves of their central
banks.
The basic issue involved, I think, in appraising this
proposal, is whether the Treasury would find it preferable to borrow
dollars from the Eurodollar market rather than subsequently having to
buy back the same dollars from European central banks through sales
of gold, SDRs or drawings on the International Monetary Fund. The
responsibility here in this area is primarily that of the Treasury and
they should assume an adequate share of the burden. If anyone is to
pay rates above U. S. rates for Eurodollars in order to keep them out
of the hands of foreign central banks, it would seem to me it should be
borne by the general public via the U. S. Treasury, rather than a small
group of banks who can go only so far in subordinating the interests of
their stockholders to those of the U. S. balance of payments.
GERALD FORD LIBRARY
U. S. TREASURY DEPARTMENT
Date
12/14
TO
Dr. Burns
FORD & LIBRARY GERALD
H. I. Liebling
Office of Financial Analysis
Room 4409
Ext. 5781
FOR OFFICIAL USE ONLY
REVIEW OF
ECONOMIC AND FINANCIAL DEVELOPMENTS
(December 11, 1970)
PRICES AND THE FULL EMPLOYMENT GAP
Addressing the National Association of Manufacturers, President Nixon
outlined a new economic policy to be directed towards crossing onto the road
of higher real economic growth in 1971, while continuing to reduce inflation.
As last week's Review on "The Price-Unemployment Dilemma"
indicated, important gains towards disinflation have been in progress,
as reflected in a decline in growth of the private GNP deflator to an
annual rate of 4.7% in the third quarter from the recent peak of
5.3% in the first quarter of this year. But -- this was accompanied
over this period by increases in the unemployment rate to 5.2% from
4.2% two quarters earlier. By the end of the year, the unemployment
rate, apart from strikes, had continued to ascend; whereas the plan
in early 1970 had contemplated it to have entered a descending phase
by this time.
With current rates of unemployment so much above expectations, the
President announced a new plan to move the economy as rapidly as possible
towards the "full potential of growth and employment while continuing to
reduce inflation." Still in the midst of this season of economic policy-
making, the exact time and rate of growth required to achieve these goals were
not stated but they surely will be specified subsequently in the
Economic Report.
These important parameters: (a) how much acceleration in real growth
and reduction in unemployment, and (b) the time period in which these goals
were to be accomplished, remain to be considered by policy-makers during the
weeks ahead.
It is these parameters which influence the degree of progress
towards disinflation. Unfortunately, there exist considerable
uncertainties in economic knowledge concerning the interrelationships
between them.
At least two -- there are many more -- of these uncertainties are illus-
trated in the chart on the following page. Therein two different theories
of price change are depicted. The numbers used in the chart are hypothetical.
GERALD FORD LIBRARY
- 2 -
TWO THEORIES OF PRICE BEHAVIOR
Bil. 1958 dols. (A.R.)
900
ACTUAL AND POTENTIAL GNP
Upward pressure on
800
prices
Actual value
700
Downward pressure on
prices
Potential level
600
1967
1968
1969
1970
1971
1972
1973
1974
0
In the lower panel, the
2
"speed of adjustment" of
5.0%*
prices to rates of economic
4.5%*
4.0%*
growth is shown. The dura-
High
tion of time in which the
employ-
"full employment gap" is
ment
closed is directly related
gap
to the rate of inflation. A
1970-III
seven-quarter sequence in
closing the "gap" -- which
requires a 7% economic
$34.9 bil.
growth - -- is associated at
the end of a sequence with
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
a 5% inflation rate; longer
Quarters from 1970-III
sequences are associated
* Hypothetical inflation rates at period
with lower rates of
of gap close.
inflation.
A contrasting theory of price behavior is portrayed in the upper panel.
Therein, the very existence of a "gap" is influential in restraining the
forces of inflation. The theory presupposes that the "gap" by its very
existence assumes that supply capabilities are not fully utilized; and that
the forces of increased demand on prices become neutralized by increased
supplies or other factors.
FORD & LIBRARY GERALD
- 3 -
Whether one or the other theories in fact will apply to the period
ahead will not be determined until the record for 1971-72 is made. The
record of other industrialized countries is not reassuring on this score.
Still, these theories of inflation, each in its turn, could be modified
by improved functioning of markets -- a matter noted by the President, and by
such students of inflation as Chairman Burns. Among these are the inflation-
prone structure of collective bargaining in the construction industry and
elsewhere, barriers to entry in the skilled trades, adequate job training and
job bank programs, etc.
These could have influential effects over the longer run. They appear to
bear the promise of fulfillment of lower inflation and higher rates of employ-
ment. At least, this appears to have been the experience of the 1960s, as
compared with the 1950s.
Change in Private Nonfarm GNP Price Deflator and Unemployment Rate for Males 25 and over, 1955-67
%
%
Change
Change
in Deflator*
in Deflator*
5.0
1955I-1962I
5.0
%
Log Y=5.392-1.351X+.141X²
(R² =.662)
/962 II - 1967-IV
'57
4.0
181'56
Log Y= 4.685-.753X+.084X
(R²=.840)
4.0
056
III
570
ONS
360
N 66.67
ONI
3.0
3.0
'57
IV
'66
III
59
2.0
59
0.55
039
20
II
'59
38
'64
35
500
'650
OII
'64
OII
50
38
58
or 60
80
'660
65
53M
53
'67
'64
o
1.0
840
62M
I
329
'62
1.0
X
055
6/1/O
OH
0
2
3
4
O
5
6
7
Unemployment rate (males 25 and over)?
* Percent change from one year earlier.
+ Four quarter moving overage, ending in current quarter.
FORD & LIBRARY 07V839
This is illustrated in the above chart, which shows two so-called
Phillips curves for these periods of time.
- 4 -
The leftward shift in this curve in the 1960s reflected a structural
change in the economy, such that for a given level of unemployment the rate of
price increase was less than that expressed in earlier years. Hopefully, a
further leftward shift in the Phillips curve would be in prospect for the
1970s under the proposals noted earlier.
FINANCIAL MARKETS
Following two months of relatively slow growth, the money supply (M₁)
rose $800 million in November. This advance was four times as much as that
in October and may have developed to average up the slow rates of September
and October to conform more closely with the recent rate of 5% or more
established by the FOMC as a target.
Through the four-week average ending December 2, the annual
growth rate from December 1969 was 5.7%.
ANNUAL RATES OF GROWTH IN M1 DURING QUARTER
(Percent)
FORG i LIBRARY 928470
I
II
III
IV
1969
5.6
4.7
0.8
1.6
1970
6.0
5.9
6.2
n.a.
This expansion in the money supply (M₁) during 1970 has developed
coincidentally with a relative weakness in the demand for money.
As a result, interest rates have been declining in 1970, especially
in short maturities. Though temporarily stiffening during the week
ending December 2, 3-month Treasury Bill rates for the week ending
December 9 eased again, reaching 4.94%, which compares with 7.81% a
year earlier, and the lowest since 4.92% in the week ending
December 6, 1967.
Long-term rates also have begun to decline somewhat. Yesterday, an
Aa-rated utility bond was offered at 7.75%, 10 basis points lower than on a
similar offering a week earlier, and the lowest in 1½ years.
The slack demand for short-term funds, which had been accounting for
lower short-term yields, is shown in the table below:
CHANGES IN SHORT-TERM CORPORATE DEBT
(Bils. of dols.)
Commercial
and
Commercial
Industrial
Period
Paper
Loans
Total
1969: June 30 - Sept. 30
2.3
1.2
3.5
Sept. 30 - Nov. 30
2.4
1.0
3.4
1970: June 30 - Sept. 30
-0.9
-1.3
-2.2
Sept. 30 - Nov. 30
1.9
-2.4
-0.5
- 5 -
As the table indicates, during the past five months ending November 30,
commercial paper outstanding rose by only $1 billion, which compares with a
rise of $4.7 billion during the comparable period of last year. Commercial
and industrial loans declined by $3.7 billion since June 1970, as contrasted
with a rise of $2.2 billion in this period of last year.
Initiators: Droitsch
Reviewer: Liebling
Liebling
OFFICE OF THE SECRETARY OF THE TREASURY
OFFICE OF FINANCIAL ANALYSIS
FORD is LIBRARY GERALD
MARKET YIELDS ON U.S. GOVERNMENT SECURITIES*
(Fully Taxable Issues)
1967
1968
1969
1970
JFMAMJJASOND
PERCENT
PERCENT
Monthly
Weekly
3 to 5 Years
3 to 5 Years
7.0
8.0
6 Month Bills
Long-Term
6.0
7.0
3 Month Bills
Long-Term
5.0
(10 years and over)
6.0
3 Month Bills
4.0
5.0
Latest average through
December 11. 1970
6 Month Bills
0
0
1067
1968
1969
1970
J F M A M J J A S 0 N D
1970
*Averages computed from daily closing bid prices.
FORD & 0ERALO LIBRARY
ECONOMIC AND FINANCIAL REFERENCE DATA
GERRALO FORD LIBRARY
Previous
Year
1. Seasonally adjusted
Latest Period
Period
Ago
Production,
Gross national product ($b1l.)
3rd Q.
985.5r
971.1
942.6
income, and
Personal income ($bil.)
Oct.
809.5p
811.9r
766.7
sales
Wage and salary payments ($b11.)
Oct.
541.3p
546.6r
522.7
Corporate profits before taxes ($b11.)
3rd Q.
85.0p
82.0r
89.9
Industrial production, FRB
Oct.
162.3₱
166.1
173.1
New orders, durable goods mfrs. ($bil.)
Oct.
28.7₽
29.9r
31.2
Shipments, durable goods mfrs. ($b11.)
Oct.
29.4p
30.7r
30.9
Retail sales, total ($bil.)
Nov.
30.3u
30.5r
29.8
Employment
Civilian employment (mil.)
Nov.
78.6
78.7
78.5
Unemployment rate (%)
Nov.
5.8
5.6
3.5
Construction
Total new construction ($b11.)
Oct.
93.1
93.3
90.7
Private housing starts, total (thous.)
Oct.
1,550p
1,504r
1,390
International
Exports ($mil.)
Oct.
3,707
3,535
3,365
transactions
General imports ($mil.)
Oct.
3,528
3,398
3,212
Merchandise trade balance ($mil.)
Oct.
+179
+137
+154
"Overall" payments balance ($mil.)
3rd Q.
-680p9/
-1,204r9/-2,279
"Official" settlements balance ($mil.)
3rd Q.
-1,847p9/
-1,761r9/
-582
Commercial
Loans and investments ($bil.)
Oct.
424.0
423.7
397.6
bank
Loans ($bil.)
Oct.
286.9
287.3
273.8
statistics
Money supply ($bil.)
Nov.
213.8
213.0
203.5
Time deposits ($b1l.)
Nov.
225.0
222.2
194.0
Latest Week
Previous
Year
2. Not seasonally adjusted
or Month
Period
Ago
Production
Raw steel production (thous. tons)
12/5
2,379
2,289
2,777
Auto production excl. trucks (thous.)
12/12
171.9
143.2
183.6
Electric power, seasonally adjusted
12/5
228
243
227
Price indexes
BLS raw industrials
12/8
107.7
108.4
116.4
Wholesale prices
Nov.
117.7
117.8
114.7
Banking
Loans, large reporting banks ($mil.)
12/2
174,475
173,309
169,048
Fed. Res. govt. sec. holdings (mil.)
12/9
59,937
62,499
57,153
"Free" reserves ($mil.)
12/9
-153
-41
-983
Treasury gold stock ($mil.)
12/9
11,117
11,117
10,367
Securities,
Treasury 13-week new bill rate (%)
12/7
4.882
5.094
7.803
average
Treasury long-term bond (%)
12/11
5.89
5.93
6.73
yields
Moody's seasoned Aa corporates (%)
12/11
8.23
8.27
7.85
New Aa corporates, Treasury est. (%)
12/11
8.15
8.39
9.12
Moody's seasoned Aaa municipals (%)
12/11
5.15
5.15
6.48
Bond Buyer's new munic. bond index (%) 12/11
5.33
5.41
6.88
1 Seasonally adjusted annual rate. 1957-59=100. Excluding military aid shipments.
Last Wednesday of month. 5/ Daily average. 6/ Demand deposits adjusted and currency
outside banks. 7/ Excludes gold in Exchange Stabilization Fund. 8/ 20-bond index.
Including allocations of Special Drawing Rights.
u - unofficial adv. estimate.
P - preliminary.
r - revised.
MISC. 3B
FEDERAL RESERVE BANK
Misc. 3B.2-30M-3-64
OF NEW YORK
OFFICE CORRESPONDENCE
admin
My CONFIDENTIAL (F.R.)
inarking
DATE December 14, 1970
Mr. Hayes
SUBJECT:
Euro-dollar policies of
TO
A. R. Holmes
New York banks
FROM
In response to Chairman Burns' request the following
summarizes briefly the results of a survey conducted late last
week of the Euro-dollar plans of the major New York banks.
Generally speaking the Board's December 1 amendment
to Regulation M is viewed by the banks as sending out a
clear message to them not to repay Euro-dollar borrowings.
This message, rather than the technical details of the amend-
ment, has been influential in inducing them to stand pat on
their current holdings for the time being. There seems to
be little evidence that banks which in the current period
are running below their most recently established base are
trying to rebuild that base before the current period expires
on December 23. All the banks are very much concerned about
the costs involved in maintaining Euro-dollar positions, with
varying degrees of resentment over the fact that the Federal
Reserve apparently expects them to shoulder these costs. The
banks generally feel caught in a dilemma between acting in
what they believe the Federal Reserve thinks is the public
interest, and the economics of the rate spread between
Euro-dollar and domestic interest rates. They are keeping
their Euro-dollar policies under close review, and unless
the spread between Euro-dollar and domestic rates narrows
will be under great pressure to reduce their takings because
of the impact of the extra costs on profits. Banks generally
believe that there should be some incentive for them to hold
on to Euro-dollars, and have come up with virtually all the
suggestions that the Board has under consideration that would
reduce the costs to the banks. One added starter is the
suggestion that the Treasury should make additional deposits
in Tax and Loan Accounts in those banks who agree to hold on
to their Euro-dollar positions.
A brief review of comments by individual banks
follows. It should be recognized that there are differences
of opinion within individual banks, and that the situation
is being kept under constant review by top management in all
the banks.
ARH:fm
Att.
FORD & 038470 LIBRARY
2
Irving Trust Company
Had been repaying Euro-dollars but now willing to
take on a spread of a point to a point and a half in order
to avoid going lower. Banks cannot be expected, however, to
incur such extra costs for any length of time. Some means
of reducing costs necessary to avoid further repayments,
such as special Treasury deposits in Tax and Loan Accounts
for cooperating banks or reduction in reserve requirements
linked to banks' willingness to hold Euro-dollars and to
rate spread. Also believes greater flexibility should be
introduced in base by permitting banks to go to, say,
75 per cent of base, without losing the original base.
Manufacturers Hanover Trust
Have been maintaining base but in view of cost may
have to decide to cut back. Believes Board is asking too
much of banks in terms of cost.
Morgan Guaranty
Took Board regulations as asking the banks to
hold on to Euro-dollars for awhile. Have decided to hold
base for another month and will review position after
year-end in light of spread between Euro-dollar and
dome stic rates. Maintaining base now provides opportunity
to see if some sort of inducement to hold Euro-dollars will
be forthcoming from the Board. Greatly concerned about cost
of maintaining position and effect on bank earnings. Would
be content to hold base if spread were only 1/4 per cent
but current 1 1/2 per cent entirely too high to hold on
very long.
FORD & GERALD LIBRARY
Bankers Trust Company
Board should provide incentive to retain Euro-dollars
rather than ask banks to shoulder cost of rate spread. Not
much influenced by increase of reserve requirements on above
base borrowings from 10 to 20 per cent. Sense of patriotism
only factor causing them to hold line at current levels, and in
light of earnings outlook for 1971, there are limits beyond
which economics must win out over patriotism. Some inducement
through lower reserve requiements--or other means--would be
more effective.
Chase Manhattan Bank
Believes Board's message very clear that it wants
banks--in public interest--to maintain Euro-dollar base.
Raising reserve requirements on over-base borrowing raises
some questions about Board's intent with respect to Regula-
tion Q. Are maintaining base but keeping under close review
in view of the heavy cost. Hard to make case for maintaining
base on purely economic grounds, believes some incentive should
be given banks but not enamored of most suggestions for relief.
The real problem is the unusual spread between Euro-dollar rates
and domestic rates and failure of Euro-dollar rates to decline
in recent weeks.
Chemical Bank
Have stopped running down base and will review after
year-end in light of what happens to Euro-dollar rates. View
Board action as very costly to banks, but as temporarily
effective in restraining Euro-dollar outflow. Expressed
concern over shift of base on foreign branch loans to U. S.
residents from May 1969 to November 1969, particularly since
this was not made clear in Board press release.
First National City Bank
Feels that they were singled out as "bad boys"
because went below base. Had made public announcement of
their position and had not been put on notice by Federal
Reserve that it did not want paydowns. Are currently
standing pat about $200-$300 million below their latest
established base. Had considered restoring earlier base
but rejected as too costly. Much concerned about cost to
bank of maintaining current position and will keep position
under review. Would like to see some sort of inducement to
banks to keep Euro-dollars, such as issue of special Treasury
notes to their foreign branches at concession rates.
FORD is LIBRARY GERALD
BOARD OF GOVERNORS OF THE FEDERAL reserve SYSTEM
12/16
DATE
Mr. Robert C. Holland
TO
FROM ROBERT SOLOMON
Any reaction?
FORD is LIBRARY 076870
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date December 10, 1970
To
Mr. Robert Solomon
Subject:
Reserve requirements and
From
Robert F. Gemmill
Euro-dollar borrowings
One of the principal objections to the proposed special reduced
rate of reserve requirement on demand deposits as a technique for dis-
couraging reductions in Euro-dollar borrowings is the fact that much and
perhaps all of the release of reserves would accrue to the largest banks
that have been the major borrowers of Euro-dollars. The proposal might
well be open to political criticism on this ground.
As noted in the Division's memorandum of November 28 to the
Board, one way to counter some part of this criticism might be to increase
reserve requirements on reserve city banks by an amount that would offset
the potential release of reserves expected to result from the special re-
duced reserve requirement applicable to Euro-dollar borrowings.
Such a general increase in reserve requirements for reserve city
banks (e.g. from 17-1/2 per cent to 18-1/2 per cent) would create inequities
of two sorts:
(1) Banks that have not borrowed Euro-dollars would have
increased reserve requirements, but would not readily (if at all) be
able to offset these increased requirements by Euro-dollar borrowings
which would entitle them to a reduced rate of reserve requirement on
an equal amount of demand deposits. (Most reserve city banks would have
much smaller reserve-free bases for Euro-dollar borrowings than do the
largest banks.) Roughly half of any general increase in reserve require-
ment on reserve city banks would fall on banks that have not borrowed
significant amounts of Euro-dollars.
(2) Among banks that are major borrowers of Euro-dollars, the
distribution of benefits (reduced rate of requirement equal to amount of
Euro-dollar borrowings) and burdens (increased requirement on demand de-
posits) would be inequitable. Euro-dollar borrowings of a number of
major banks exceed 20 per cent of deposits (subject to reserve require-
ments) and range as high as 30 per cent; on the other hand, borrowings
are equal to only about 5 per cent of deposits for one bank, and are
less than 10 per cent of deposits for a few others.
The Board could largely avoid the first sort of inequity, and
limit the increased reserve requirement to large Euro-dollar borrowers,
if the requirement were a graduated one, applied only to the amount of
BERALD FORD LIBRARY
Mr. Robert Solomon
-2-
a bank's net demand deposits in excess of $1 billion. As shown in
the attached table, a cut-off at this deposit level includes virtually
all the major Euro-dollar borrowers, and only a very few banks that
are (or were) not major borrowers. However, a graduated reserve re-
quirement, based on deposit size, cannot avoid creating inequities
among major Euro-dollar borrowers, since borrowings represent widely
differing proportions of deposits.
The table attached to this memorandum includes all banks
with net demand deposits of $1 billion or more (week of October 21,
1970). It excludes only three banks using historical bases for Euro-
dollar borrowings, with aggregate borrowings of $450 million. The
table is calculated on the assumption that the special reduced rate
of reserve requirement applicable to an amount of deposits equal to
Euro-dollar borrowings is set at 7-1/2 per cent -- providing the banks
with a reserve saving of 10 cents on each dollar of Euro-dollar borrow-
ing (equivalent at present interest rates to about 50 basis points
saving on the cost of borrowings.) This reduced rate of requirement
would involve a release of reserves for 17 banks of about $930 million,
based on recent levels of Euro-dollar borrowing; if banks that are not
making full use of their 3 per cent minimum bases were to do so, the
reserve release would be close to $1 billion for these billion dollar
banks (based on net demand deposits.)
A rate of reserve requirement of 21-1/2 per cent on a bank's
net demand deposits in excess of $1 billion would yield a total reserve
absorption of almost $1 billion (based on daily average data for the
week ended October 21.) As noted in the table, eight banks would obtain
a reserve release larger than the reserve absorption, and nine would
obtain a reserve release less than the absorption. Use of several
steps of graduated requirement to obtain the same total reserve ab-
sorption would increase the burden on the largest banks -- notably
Bank of America (which would have relatively low benefits from the
special reduced rate of requirement because of a low historical base)
and First National City (which would have relatively low benefits
because of repayments of Euro-dollars.)
The net reserve absorption would be reduced if lower graduated
requirements were imposed. A supplementary table indicates the way in
which the positions of individual banks would be affected by rates of re-
quirement of 19-1/2 per cent and 20-1/2 per cent on net demand deposits
in excess of $1 billion. As noted in the supplementary table, a require-
ment of 19-1/2 per cent on deposits in excess of $1 billion would produce
FORD is LIBRARY 07V830
-3-
a net reserve release for all banks of about $433 million, and only a
few banks (notably Security Pacific) would experience a significant
reserve absorption. A requirement of 20-1/2 per cent would result in
a net reserve release for all banks of about $188 million; seven banks
would experience reserve absorption, including net increases of more
than $20 million for Bank of America, Security Pacific and First
National City.
Apart from the inevitable differential impact among Euro-
dollar banks, use of a graduated reserve requirement in conjunction
with a special reduced requirement on Euro-dollar borrowing poses
several policy issues:
1. Is the Board prepared to adopt graduated requirements
as a relatively permanent feature of the banking structure?
2. Is this the time to introduce graduated requirements?
3. Is the rate structure appropriate for use in connection
with Euro-dollar borrowing consistent with longer-term Board objectives
regarding a graduated requirement.
GERALD FORD LIBRARY
Banks with Net Demand Deposits in Excess of $1 billion
Column 1
Column 2
Column 3
Reserve release (with special
Reserve absorption (with
reduced requirement of 7-1/2
reserve requirement of
per cent on net DD equal
21-1/2 per cent on net
Bank
to Euro-dollar borrowings)
DD in excess of $1 billion
Column 1 - Column 2
(millions of dollars)
(millions of dollars)
First Nat'l. Boston
40
5
+35
Bankers
71
56
+15
Chase
225
181
+44
Irving
45
13
+32
Morgan
125
62
+63
Mellon
12
4
+8
Cont. Illinois
62
41
+21
First Nat'1. Chicago
35
28
+7
Subtotal
615
390
+225
Chemical
82
91
-9
First Nat'1. City
90
153
-63
Manufacturers
59
96
-37
Nat'1. Bank of Detroit*
--
12
-12
Bank of America
76
162
-86
United California*
--
17
-17
Crocker Citizens*
3
13
-10
Wells Fargo*
5
16
-11
Security Pacific*
--
'42
-42
Subtotal
315
602
-287
Total
930
992
*
Note: The reserve release would be about $60 million greater, and the differences in Column 3
$60 million less, if the banks marked with an asterisk borrowed Euro-dollars in amounts
equal to their minimum (3 per cent) bases.
GERALD R. FORD
Supplementary Table
Graduated Requirement of 19-1/2 per cent
Column (2)
Graduated Requirement
Column (1)
reserve
of 20-1/2 per cent
Bank
reserve release
absorption
(2) - (1)
Column (2)
(2) - (1)
First National Boston
40
2
+38
3
+37
Bankers Trust
71
28
+43
42
+29
Chase Manhattan
225
90
+135
135
+90
Chemical
82
46
+36
68
+14
Irving Trust
45
7
+38
10
+35
Morgan Guaranty
125
31
+94
46
+79
Mellon
12
2
+10
3
+9
Continental Illinois
62
21
+41
31
+31
First National Chicago
35
14
+21
21
+14
Subtotal
359
+338
First National City
90
77
+13
115
-25
Manufacturers Hanover
59
48
+11
72
-13
Subtotal
366
+480
Crocker Citizens*
3
6
-3
9
-6
National Bank of Detroit*
--
6
-6
9
-9
Bank of America
76
81
-5
122
-46
United California*
--
9
-9
13
-13
Wells Fargo*
5
8
-3
12
-7
Security Pacific*
:
21
-21
31
-31
Subtotal
131
-47
383
-150
TOTAL
930
497
+433
742
+188
&
FORD
Note:
If banks marked with an asterisk borrowed Euro-dollars in amounts equal to their minimum
(3 per cent) bases, the aggregate reserve release would be about $60 million greater.
GERALD
LIBRARY
BOARD OF GOVERNORS OF THE FEDERAL reserve SYSTEM
12/31/70
DATE
Chairman Burns
TO
FROM ROBERT SOLOMON
Phil Coldwell comes out just about
where your staff does: give the banks
an incentive- -via reduced reserve re-
quirements-- to retain their Eurodollar
liabilities.
RS
Attachment.
FORD is LIBRARY 9ERALD
From the desk of
ARTHUR F. BURNS
12/19/
Mr. R. Solomon
&
GERALD
Coldwell
12-15-70
BRIEF ON OVERHANG OF EURODOLLAR LIABILITIES
Basic Position
Since we permitted the banks to enlarge their Eurodollar
holdings and accepted the benefit therefrom, theoretically we should
accept the repayment and the detriment therefrom. One must recognize,
however, that there is an element of face-saving in trying to slow the
outflow as well as a real risk that the foreign central banks may decide
that enough is enough and begin trading their dollars for gold. We are
in no position to stand such a gold run nor is the international finan-
cial mechanism.
Secondary Position
Given the practicality of the problem and the need to slow the
outflow of Eurodollars, it seems to me that disincentives and negative
incentives of the type tried by the Board in its recent increase of re-
serve requirements are not the answer. Instead, it seems to me that we
must try some positive incentive in the form of cost improvement to en-
courage the banks to hold their base amounts of Eurodollars. This could
be done by either of the following methods:
1. Redefine "deposits" so as to give a positive credit of a
given percentage (perhaps 2 percent) of reserve require-
ments in an amount equal to the Eurodollar base of the
particular bank. Alternatively in the same vein, a certain
proportion of Eurodollar base (perhaps 10 to 25 percent)
might be counted the same way as cash items in the process
GERALD FORD LIBRARY
2
of collection. Either of these two methods would provide
a positive cost advantage of holding Eurodollars. The
percentages or dollar credits would have to be worked out
so that the advantage is not overwhelming but marginal
enough to make up for the cost differential.
2. Another alternative might be to differentiate the reserve
requirement on certificates of deposit by the amount
of Eurodollar deposits. Under this arrangement a bank
with its base amount of Eurodollars fully drawn would
get a credit on its reserve requirement against certifi-
cates of deposit. Again, the percentages would have to be
worked out with sufficient care that there would not be
too great a margin of advantage.
These proposals are based on the idea that there must be some
slowing of the Eurodollar outflow, at least for a temporary period of
time until, hopefully, we make more fundamental corrections in both our
foreign policy, which is causing the large outflow, or our balance of
trade, which presently provides too little offset against the other
forms of outflow.
P. E. Coldwell
December 11, 1970
GERALD R. FORD LIBRARY
1970
CONFIDENTIAL (FR)
Gross Liabilities of U.S. Banks to Their Foreign Branches
and Branch Participations in Head Office Domestic Loans
(billions of dollars)
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
7
14
21
28
4
11
/8
25
4
11
18
25
/
8
15
22
29
6
13
20
27
3
10
17
24
/
8
15
22
29
5
12
19
26
2
9
16
23
30
7
14
21
28
4
11
18
25
2
9
16
23
30
16.0
16.0
15.0
15.0
14.0
14.0
13.0
13.0
*
12.0
12.0
v]
Trj
NOV, 4
11.0
(-269)
11.0
10.0
10.0
9.0
9.0
8.0
FORD & LIBRARY 936870
8.0
-v
/ revised
Figures for Wednesdays
SELECTED EURO-DOLLAR AND U.S. MONEY MARKET RATES
Average for
(1)
(2)
(3) =
(4)
(5)
(6) =
month or
Call
(1)-(2)
3-month
60-89 day
(4)-(5)
week ending
Euro-$
Federal
Differ-
Euro-$
CD Rate
Differ-
Wednesday
Deposit1
Funds2
/
ential
Deposit1
/
(Adj.) 3/
ential
August
7.26
6.61
0.65
8.19
8.17
0.02
September
7.68
6.29
1.39
8.03
7.64
0.39
Oct. 7
7.73
6.36
1.37
8.35
7.24
1.11
14
7.13
6.21
0.92
8.18
6.97
1.21
21
6.08
6.18
-0.10
7.76
6.84
0.92
28
6.00
6.07
-0.07
7.66
6.84
0.82
Nov. 4
6.10
6.07
0.03
7.58
6.65
0.93
Daily
Nov. 5
6.13
6.13
0.00
7.56
6.72
0.84
6
6.25
6.00
0.25
7.56
6.72
0.84
9
6.63
n.a.
n.a.
7.50
n.a.
n.a.
1/
Noon bid rates in the London market.
2/
Effective rate.
3/ Offering rates (median, as of Wednesdays) on large denomination
certificates of deposit by prime banks in New York City; adjusted for
reserve requirements. Daily rates from New York Times.
FORD i LIBRARY GERALD