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Swap Arrangements - General, 1970-75 (1)
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The original documents are located in Box B98, folder "Swap Arrangements - General,
1970-75 (1)" of the Arthur F. Burns Papers at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald R. Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
What are the swaps?
The Federal Reserve swap network is a system of reciprocal-
credit arrangements between the System and 15 other central banking
institutions (that is, the central banks of 14 industrialized countries
and the Bank for International Settlements). It was first established
in 1962.
Foreign central bank needs dollars. The foreign central bank
has typically requested a drawing to obtain dollar for intervention in
the foreign-exchange market. It would credit the System with X million
of dollars-equivalent of local currency on its books and receive, in
return, a credit of X million of dollars at the Federal Reserve Bank of
New York. The two credits are to be repaid within a specified period.
At that time, the foreign central bank pays X millions of dollars to
the Federal Reserve Bank of New York and, in return, the New York Reserve
Bank pays it X millions of dollars-equivalent of its own currency.
Federal Reserve System needs foreign currency. The Federal
Reserve typically makes a drawing when the foreign central bank asks it
to do so to cover excess dollar holdings in its hands. The System receives
a X millions of dollar-equivalent of foreign currency from the foreign
central bank and credits it, in return, with X millions of dollars at
the New York Federal Reserve Bank. The System immediately uses the
foreign currency to purchase X million of dollars from the foreign
central bank. The foreign central bank holds the dollars vit has received
from the System for the duration of the drawing in special Treasury
FORD & LIBRARY GERALD
- 2 -
Certificates of Indebtedness at an agreed interest rate. When the
time for repayment comes, the Federal Reserve is obligated to repay
the foreign central bank X millions of dollars-equivalent of the
foreign currency and, in return, receives from the foreign central
bank the X millions of dollars held at the Federal Reserve Bank of
New York.
Purposes of swap network. The Federal Reserve swap network
has had the objective of safeguarding the U.S. gold stock as one major
purpose. In practice, the Federal Reserve made a drawing of a foreign
currency primarily at the request of a foreign central bank which
wanted a short-term exchange-value guarantee on dollar receipts it
might otherwise have wished to convert into gold. In addition, the
network was used to mobilize international official resource to
stabilize private markets and, on occasion, even to support major
currencies during political or military emergencies. It was also
intended to function as a means of offsetting or financing temporary
and disturbing international capital flows, especially during specula-
tive crises.
QERALD FORD LIBRARY
CONSULTATIONS WITH CONGRESS ON
SWAP NETWORK
Extracts from Minutes of Federal Open Market Committee
Meeting of January 9, 1962
Mr. Mills seconded the proposal that Chairman Martin be
authorized to contact the Chairmen of the House and Senate Banking and
Currency Committees to acquaint them with the problem and with the
approach that the System might be making to operations in foreign
currencies, and to obtain their reaction. (p. 67) FOMC so agreed. FORD
(p. 68)
GERALD
LIBRARY
Meeting of January 23, 1962
Chairman Martin reported on his consultations about the
subject with the Chairmen of Senate and House Banking and Currency
Committees and commented briefly on the general problem of obtaining
legislation that would clarify the Committee's authority to conduct
foreign currency operations
In the light of the Chairman's report and the roundtable
comment, a majority of the Committee were favorably disposed towards
operations on an experimental basis. (p. 112)
Meeting of February 13, 1962
He (Chairman Martin) had been authorized to make reference
to the subject in his testimony before the Joint Economic Committee on
January 30 in connection with hearings on the President's Economic
Report. He presumed that the members of the Committee had seen the
testimony. Rather surprisingly, the Chairman said, there had been
little comment, either favorable or adverse, since that time. (p. 163)
- 2 -
Meeting of March 6, 1962
The Chairman also reported that in response to the request
made by members of the Congress at the time of hearings on H. R. 10162,
a bill to authorize U.S. contributions in connection with expansion of
the stand-by resources of the International Monetary Fund, he had sent
to the Chairman of the House Committee on Banking and Currency on
March 1, 1962 the following documents for inclusion in the record of
the hearings:
(1) A memorandum from the Open Market Committee's General
Counsel dated November 22, 1961, expressing the opinion that foreign
currency operations by the System were authorized by the Federal
Reserve Act;
(2) A summary opinion rendered by the Open Market Commit-
tee's General Counsel to the Congressional Joint Economic Committee,
upon request, under date of February 19, 1962;
(3) A copy of the letter from the General Counsel of the
Treasury dated January 8, 1962, expressing his concurrence and that
of the Attorney General in the opinion of the Committee's General
Counsel and enclosing a memorandum that he had submitted to the
Secretary of the Treasury to the same effect;
(4) A copy of the letter sent by Chairman Martin on February 16,
1962, to the Chairman of the National Advisory Council, along with a
copy of the enclosed authorization of the Federal Open Market Committee
for System foreign currency operations; and
(5) A copy of an action by the National Advisory Council
dated February 28, 1962, indicating that the Council was in accord
with the System's decision to undertake foreign currency operations.
Chairman Martin pointed out that this meant that the authoriza-
tion for foreign currency operations, approved February 13, 1962, was
now a public document. (pp. 286-87)
FORD & LIBRARY 9ERALD
Extracts from Congressional Committee Hearings, Jan-Feb 1962
I. JEC Hearings "January 1962 Economic Report on the President,"
January 30, 1962
Martin prepared statement
As one step in such cooperation, the System is now pre-
pared in principle and in accordance with its present statutory
authority to consider holding for its own account varying
amounts of foreign convertible currencies. Toward this end,
we are now exploring, in consultation with the Secretary of
the Treasury, methods of conducting foreign exchange operations
in convertible currencies with due and full regard for the
foreign financial policy of the United States.
These System operations, along with those conducted by
the stabilization fund, would have the primary purpose of
helping to safeguard the international position of the dollar
against speculative flows of funds. (p. 175)
Subsequent Martin statement
I want to make clear, Mr. Bolling, that the Federal
Reserve is not anxious to engage in this type of activity.
It is only. because we feel that we have a responsibility --
with convertible currencies as they are today, currency
values -- including that of the dollar -- are more subject
than for a long time to speculative movements. (p. 181)
The Committee questioning
GERALD FORD VIBRARY
Concern was with various economic matters other than
proposed operations in foreign currencies.
II. Hearings, "Bretton Woods Agreements Act Amendment, House Committee
on Banking and Currency, February 28, 1962.
Martin prepared statement
The contemplated Federal Reserve operations in convert-
ible foreign currencies would complement the proposed IMF
arrangements in two ways.
The Federal Reserve would help to deal with minor pres-
sures before they reach a scale commensurate with IMF action.
And it could take prompt action in more serious circumstances
while IMF arrangements are being worked out. (p. 91)
- 2 -
With this same object in view, the Federal Reserve has
recently decided to reenter the field of foreign-exchange
transactions. (p. 90)
...
While in time it may be desirable to recommend amendment
of the Federal Reserve Act to provide greater flexibility than
we now have under the act in carrying out these operations, it
would be impractical to request such legislation before operating
experience under existing authority has provided a clear guide
as to the need for it. (p. 92)
Some Committee members challenged authority of System
Reuss: Much of the operation that you are doing under this seems to
me to duplicate the foreign exchange stabilization that the
Secretary of the Treasury has very properly undertaken pursuant
to the Gold Reserve Act of 1934.
To me this is a tremendous power you have taken upon your-
self, and I must serve notice on you right now that I consider
this an usurpation of the powers of Congress. I don't think
you are authorized to do this at all
...
(p. 102).
Widnall: That (Federal Reserve decision) is for the purpose of the
stabilization of the dollar; isn't it? (p. 99)
Multer: On page 6 of your statement, Mr. Martin, you refer to the
possibility or desirability of recommending an amendment of
the Federal Reserve Act at some future time. We should not
draw the inference from that that what you have done thus far
in these operations are not authorized by the act?
Mr. Martin: They are, in our judgment, Mr. Multer. We studied
that very carefully. What I was trying to convey was the fact
that there are some things that we might want to do because
of changed circumstances, that we would not think we had
authority to do, and we would certainly be very careful to
hue to our authority. If we wanted to do those things we
would come up for legislation.
Mr. Multer: You don't think the time is ripe to ask for such amend-
ments at this time?
Mr. Martin: No, we think we ought to experiment with our existing
authority before coming up for more. (pp. 99-100)
GERALD FORD
- 3 -
Mr. Martin (in reply later to Mr. Barrett): I merely meant in the
paragraph that
...
I would see no way in which we could buy
foreign Treasury Bills as an investment. I wouldn't think we
would have the authority to do that, and we wouldn't do it.
But it might be of value to us to be able to buy foreign
Treasury bills at some time. I don't think we have authority
to do so at the present time, so we will certainly abide by
the letter of the law as it is now drawn. But if we felt that
it was desirable for us to do that, we would expect to come
up with legislation. (p. 101)
Mr. Patman: Tell me where in the Open Market Committee law you
have a right to do this? (Mr. Martin had cited Section 14 of
the Federal Reserve Act which specifies that any Federal
Reserve Bank can purchase or sell
cable transfers, bills
of exchange or foreign exchange.) Otherwise the Federal Open
Market Committee does not have the power to do it.
Mr. Martin: No, Mr. Patman. I don't think SO. We went into that
very carefully. This was reviewed carefully by our counsel,
by other counsel in the Federal Reserve System. They decided
we had this authority under the existing law. It was taken
up with the counsel of the Treasury of the United States, and
he concurred in that opinion.
It was taken up with the Attorney General of the United
States and he also concurred.
You can always get lawyers to disagree, but I don't know
how many more we should consult.
Mr. Reuss: I just want to state that I am a lawyer, qualified to
practice, and I disagree. I don't think the Fed has the power
to do the things that are in here, and I join with the request
of Mr. Patman that you file with this committee the opinions
not only of your own consel which I have seen, but of the
counsel of the Treasury and of the Attorney General.
Mr. Patman:
...
I think Mr. Reuss is correct
Remember,
the banks, when they were set up in 1913, your member banks,
were given authority, not collectively, but individually, as
Federal Reserve banks in 12 regions. They were given this
power.
Now you are assuming it for an entirely different agency --
the Open Market Committee. (pp. 127-28)
GERALD FORD
- 4 -
Resolution of Committee discussion:
Mr. Martin filed with Chairman Spence on March 1 five docu-
ments for inclusion in the permanent record of the hearings:
(1) A memorandum from the Open Market Committee's General
Counsel dated November 22, 1961, expressing the opinion that foreign
currency operations by the System were authorized by the Federal
Reserve Act;
(2) A summary opinion rendered by the Open Market Commit-
tee's General Counsel to the Congressional Joint Economic Committee,
upon request, under date of February 19, 1962;
(3) A copy of the letter from the General Counsel of the
Treasury dated January 8, 1962, expressing his concurrence and that
of the Attorney General in the opinion of the Committee's General
Counsel and enclosing a memorandum that he had submitted to the
Secretary of the Treasury to the same effect;
(4) A copy of the letter sent by Chairman Martin on February 16,
1962, to the Chairman of the National Advisory Council, along with a
copy of the enclosed authorization of the Federal Open Market Committee
for System foreign currency operations; and
(5) A copy of an action by the National Advisory Council
dated February 28, 1962, indicating that the Council was in accord
with the System's decision to undertake foreign currency operations.
GERALD FORD LIBRARY
System Sways Drawings, QIII, 1971
($ mellions equivalent)
amount Transactionate Value date
Bank of England
to 750
Aug.13 aug. 17
Swiss national Bank 350 aug. 6 aug. 10
400
aug. 12 aug, 17
(750)
national Rank of Belgium
4D
July 16
July 21
25
July 23
July 28
55 July 30 any 4
40
aug. 6
aug 10
70
aug. 9 aug 12
20
aug!!
aug 14
\
10
ang/3
aug 17
(260)
BIS
(Swise france)
600
aug. 10
aug, 12
(Belgian fance)
35
aug, 13
Charg, 18
FORD is LIBRARY GERALD
BOARD OF GOVERNORS
RESERVE THE to SYSTEM OF COMMISSIONER:
OF THE
fome
FEDERAL RESERVE SYSTEM
12/15
WASHINGTON, D.C. 20551
December 8, 1970
CONFIDENTIAL (FR)
TO:
Federal Open Market Committee
FROM: Mr. Broida
There is enclosed a copy of a memorandum to the Committee
from Mr. Bodner dated today and entitled "Proposed modification
of procedures to be employed in transactions under certain swap
lines." It is contemplated that this memorandum will be discussed
at the next meeting of the Committee.
Cuther L Bioida
Arthur L. Broida,
Deputy Secretary,
Federal Open Market Committee.
Enclosure
BERALD FORD LIBRARY
STRICTLY CONFIDENTIAL--F.R.
FORD & LIBRARY 076870
DATE: December 3, 1970
TO:
Federal Open Market Committee
SUBJECT: Proposed modifica-
tion of procedures to be
FROM: David E. Bodner
employed in transactions
under certain swap lines
At the time of the November meeting of the B. I. S., representatives
of some of the EEC central banks approached Mr. Coombs to discuss the way
in which operations under the swap lines have affected their profit and loss
positions. It was agreed that representatives of the two central banks most
concerned about this question would come to New York to review it in greater
detail. On November 18 and 19 Messrs. P. Timmerman of the Nederlandsche
Bank and F. Heyvaert of the Banque Nationale de Belgique met with Mr. Coombs
and other officers of the Foreign Department at the New York Bank. The two
representatives noted that, in the normal course of events, the debtor country
in the swap arrangements tendsto make a profit on operations. Thus, given
the usual cycle of market developments, a country would draw when its currency
was weak and repay when it was strong and insofar as it operated in the market
at current rates it would make a profit over the cycle. They pointed out, however
that given the small size of the Dutch and Belgian foreign exchange markets, in
general it has not proved possible for the System to reconstitute foreign exchange
balances it acquired and disbursed under the swap arrangements except through
direct transactions with the two central banks. Consequently, profits made by
the System on operations have come at the expense of foregone profits by the two
central banks. Moreover, in some cases in which System purchases or sales
of exchange with the central banks have not been exactly matched by offsetting
operations of those central banks with the market, the two central banks have,
in fact, suffered some losses. More generally, when it has not proved possible
to reverse the swaps through changes in market conditions and we have unwound
-2-
our debtor position through IMF drawings by the Treasury, the Treasury has
made substantial windfall profits. These arise because the Treasury draws the
foreign currency at par from the IMF, while we repay swap drawings made at
or close to the ceiling. In the first instance, these windfall profits come at
the expense of the foreign central bank through a reduction in its foreign
exchange position. The two representatives expressed the view that these costs
in foregone profit opportunities and, on occasion, in actual bookkeeping losses,
had raised more and more questions within their banks, especially in view of
the existence in the swap arrangement of the revaluation clause in a context
in which they felt under pressure from the U. S. Government to revalue their
currency.
R.FORD in LIBRARY 0ERALD
Messrs. Timmerman and Heyaert then proposed a new method
of operating under the swap arrangements. They suggested that all transactions
be handled at par, including not only drawings and repayments of the swaps
themselves, but also the secondary spot sale of the swap proceeds and final
reconstitutionof System balances to liquidate the swaps. It was explained to
them that such a solution would involve the System in extensive dealings in non-
market rates which, aside from certain legal problems which might be raised,
would constitute a fundamental change in policy on behalf of the Open Market
Committee. Mr. Timmerman then proposed that the same effect be achieved
by bringing the U. S. Treasury into the transactions: System swaps with the
central banks would be made as at present, but the System would then swap the
proceeds with the U. S. Treasury and the Treasury would sell the foreign
exchange balances to the central bank at par. At the time of liquidation, the
central bank would resell the currency to the Treasury at par and the swaps
between the Treasury and the System and the System and the central bank would
then be unwound. With all the swaps being reversed at the same rates at which
-3-
they were made there would be no profit or loss incurred by any party to the
swap transaction.
This proposal was put to the Treasury, which did not find it
acceptable. Moreover, it clearly had serious drawbacks from the view of
GERALD FORD LIBRARY
the Federal Reserve. An alternative proposal was then considered:
1) In any case in which the swap line has to be repaid through a
Treasury drawing on the IMF, the Treasury would resell the foreign currency
proceeds of its drawing to the central bank concerned at par, rather than, as
at present, selling them to the System at the current market rate. This sale
would reduce the central bank's dollar position correspondingly and make room
for a direct transaction with the System to unwind the swap. In this manner,
the Treasury would forego the windfall profits that now accrue to it on such
Fund drawings. This procedure would be exactly analogous to what now occurs
when the Treasury sells gold or transfers SDRs to enable the System to repay
a swap drawing. The Treasury has this proposal under consideration.
2) Recognizing that, because of the limitations imposed on operations
by the small size of the Dutch and Belgian markets, it has proved necessary for
us to acquire balances to liquidate the swap through direct transactions with the
central banks, and recognizing that when the conditions that gave rise to the swap
drawing are not reversed within the normal time span it is necessary to liquidate
the swaps through such direct transactions, we might consider fixing the rate for
such transactions at the time of the initial activation of the swap. This would be
accomplished by entering into a forward contract under which the System would
purchase the currency needed to liquidate the swap, the rate on that contract to be
the market rate then prevailing, i.e., the same rate used for the swap drawing
itself. Thus, no profit or loss would accrue to either party to the extent a swap
was unwound in this manner. The execution of such a contract at the time of the
initial swap drawing, however, would complete the circle of spot and forward
4.
transactions in such a way that the foreign central bank concerned would lose
the protection against a possible devaluation of the dollar that is in many
cases the essence of the swap drawing by the System. (That is, the protection is
afforded to the central bank by the fact that it has an outstanding contract to
sell dollars forward to the System at an established rate. If it then enters into
a forward purchase contract for the same value date at the same rate, it effec-
tively washes out its protection.) To deal with this problem it was proposed that
the new forward contract include a conditional clause indicating that in the remote
event of a devaluation of the dollar this new forward contract would be considered
to be
canceled. Furthermore, it was suggested that the System might agree
that a formal suspension of gold sales by the U. S. Treasury without an official
change in the price of gold would also result in a cancellation of the contract.
3) The new forward purchase by the System would be further qualified
to leave open the possibility that the System could acquire, at market rates,
currencies needed to prepay the swap to the extent that there was a reversal
in the market. That is, the new forward contract to buy currency at the rate
of the original swap drawing would cover only that portion of the outstanding
swap that it had proved impossible to liquidate through normal operations.
This proposal appears to be acceptable to the Europeans--although
1t does not meet all their desires--while offering certain distinct advantages
to the System. It would eliminate windfall profits made by the Treasury, and
to some extent by the System, at the expense of foreign central banks under present
arrangements and protect the foreign central bank against the risk of loss in
operations under the swap. At the same time, it would preserve the basic
structure of operations under the swap lines and guarantee the System against
FORD i LIBRARY GERALD
See sample cable attached.
-5-
any risk of loss. At present, the System is exposed to a potential loss any
time that it makes a drawing when the spot rate for the foreign currency is
below its ceiling. If in such a case no reversal occurs and the System has to
liquidate the transaction through direct dealings with the central bank (in
association with Treasury sales of reserve assets), there is the possibility
that the spot rate could then be higher than it was at the time of the drawing,
thereby making the foreign currency more expensive for the System to acquire.
Although unusual, there have been such occurrences. Under this proposal
such a situation could not arise because the new forward contract would guarantee
that the System could acquire the necessary currency at the same rate as the
original swap. This may prove to be particularly important in coming years
when the EEC countries move to narrow the margin of fluctuation among their
GERALD FORD
currencies within the present dollar band. Under those circumstances, it is
entirely possible that the System could be called upon to make a swap drawing in
a case in which the central bank was maintaining an interim "ceiling" at a level
below the official EMA ceiling. If at the time of liquidation of the drawing, the
EEC band had been moved upward so that the currency in question, even if below
its formal ceiling, was above the rate at which the System had drawn, a loss would
be incurred. Such occurrences may arise, moreover, with greater and greater
frequency as the EEC succeeds in narrowing its band. The proposed new arrange-
ment would effectively protect the System against these potentially significant
losses. In addition, the new arrangement would protect the System against the
risk of loss in the event that a country to which the System was indebted under the
swap was to widen the margins against the dollar while a swap drawing was
outstanding and the spot rate was then to move above the old ceiling. Although
from time to time informal understandings have been reached concerning the
activation of the revaluation clause in such an instance, this situation is not
-6-
covered in any formal way by the present revaluation clause. Thus, on
balance, the proposed change in procedures appears to offer significant
advantages to the System as well as eliminating a source of continuing
irritation among some of the System's swap partners.
GERALD P. LIBRARY FORD
DRAFT CABLE
DE NEDERLANDSCHE BANK
AMSTERDAM
I
FOR VALUE (Date - Three Months Forward) WE BUY FROM
YOU UP TO NG (AMOUNT of guilders drawn) AT RATE OF
(SPOT Rate, as per Swap Contract).
II IN THE REMOTE EVENT OF A DEVALUATION OF THE
U. S. DOLLAR PRIOR TO THE VALUE DATE ABOVE,
THIS CONTRACT WOULD BE CONSIDERED TO BE CANCELLED.
III PLEASE CONFIRM
FEDERAL RESERVE BANK OF NEW YORK
FORD LIBRARY
STRICTLY CONFIDENTIAL--F.R
FORD i LIBRARY DERALD
DATE: December 3, 1970
TO:
Federal Open Market Committee
SUBJECT: Proposed modifica-
tion of procedures to be
FROM: David E. Bodner
employed in transactions
Item 3
under certain swap lines
At the time of the November meeting of the B. I. S., representatives
of some of the EEC central banks approached Mr. Coombs to discuss the way
in which operations under the swap lines have affected their profit and loss
positions. It was agreed that representatives of the two central banks most
concerned about this question would come to New York to review it in greater
detail. On November 10 and 19 Messrs. P. Timmerman of the Nederlandsche
Bank and F. Heyvaert of the Banque Nationale de Belgique met with Mr. Coombs
and other officers of the Foreign Department at the New York Bank. The two
representatives noted that, in the normal course of events, the debtor country
in the swap arrangements tendsto make a profit on operations. Thus, given
the usual cycle of market developments, a country would draw when its currency
was weak and repay when it was strong and insofar as it operated in the market
at current rates it would make a profit over the cycle. They pointed out, however
that given the small size of the Dutch and Belgian foreign exchange markets, in
general it has not proved possible for the System to reconstitute foreign exchange
balances it acquired and disbursed under the swap arrangements except through
direct transactions with the two central banks. Consequently, profits made by
the System on operations have come at the expense of foregone profits by the two
central banks. Moreover, in some cases in which System purchases or sales
of exchange with the central banks have not been exactly matched by offsetting
operations of those central banks with the market, the two central banks have,
in fact, suffered some losses. More generally, when it has not proved possible
to reverse the swaps through changes in market conditions and we have unwound
-2-
our debtor position through IMF drawings by the Treasury, the Treasury has
made substantial windfall profits. These arise because the Treasury draws the
foreign currency at par from the IMF, while we repay swap drawings made at
or close to the ceiling. In the first instance, these windfall profits come at
the expense of the foreign central bank through a reduction in its foreign
exchange position. The two representatives expressed the view that these costs
in foregone profit opportunities and, on occasion, in actual bookkeeping losses,
had raised more and more questions within their banks, especially in view of
the existence in the swap arrangement of the revaluation clause in a context
in which they felt under pressure from the U. S. Government to revalue their
currency.
GERALD FORD LIBRARY
Messrs. Timmerman and Heyaert then proposed a new method
of operating under the swap arrangements. They suggested that all transactions
be handled at par, including not only drawings and repayments of the swaps
themselves, but also the secondary spot sale of the swap proceeds and final
C
reconstitutionof System balances to liquidate the swaps. It was explained to
them that such a solution would involve the System in extensive dealings in non-
market rates which, aside from certain legal problems which might be raised,
would constitute a fundamental change in policy on behalf of the Open Market
Committee. Mr. Timmerman then proposed that the same effect be achieved
by bringing the U. S. Treasury into the transactions: System swaps with the
central banks would be made as at present, but the System would then swap the
proceeds with the U. S. Treasury and the Treasury would sell the foreign
exchange balances to the central bank at par. At the time of liquidation, the
central bank would resell the currency to the Treasury at par and the swaps
between the Treasury and the System and the System and the central bank would
then be unwound. With all the swaps being reversed at the same rates at which
-3-
they were made there would be no profit or loss incurred by any party to the
swap transaction.
This proposal was put to the Treasury, which did not find it
acceptable. Moreover, it clearly had serious drawbacks from the view of
the Federal Reserve. An alternative proposal was then considered:
FORD & LIBRARY 938870
1) In any case in which the swap line has to be repaid through a
Treasury drawing on the IMF, the Treasury would resell the foreign currency
proceeds of its drawing to the central bank concerned at par, rather than, as
at present, selling them to the System at the current market rate. This sale
would reduce the central bank's dollar position correspondingly and make room
for a direct transaction with the System to unwind the swap. In this manner,
the Treasury would forego the windfall profits that now accrue to it on such
Fund drawings. This procedure would be exactly analogous to what now occurs
when the Treasury sells gold or transfers SDRs to enable the System to repay
a swap drawing. The Treasury has this proposal under consideration.
2) Recognizing that, because of the limitations imposed on operations
by the small size of the Dutch and Belgian markets, it has proved necessary for
us to acquire balances to liquidate the swap through direct transactions with the
central banks, and recognizing that when the conditions that gave rise to the swap
drawing are not reversed within the normal time span it is necessary to liquidate
the swaps through such direct transactions, we might consider fixing the rate for
such transactions at the time of the initial activation of the swap. This would be
accomplished by entering into a forward contract under which the System would
purchase the currency needed to liquidate the swap, the rate on that contract to be
the market rate then prevailing, i.e., the same rate used for the swap drawing
itself. Thus, no profit or loss would accrue to either party to the extent a swap
was unwound in this manner. The execution of such a contract at the time of the
initial swap drawing, however, would complete the circle of spot and forward
41
transactions in such a way that the foreign central bank concerned would lose
the protection against a possible devaluation of the dollar that is in many
cases the essence of the swap drawing by the System. (That is, the protection is
afforded to the central bank by the fact that it has an outstanding contract to
sell dollars forward to the System at an established rate. If it then enters into
a forward purchase contract for the same value date at the same rate, it effec-
tively washes out its protection.) To deal with this problem it was proposed that
the new forward contract include a conditional clause indicating that in the remote
event of a devaluation of the dollar this new forward contract would be considered
to be canceled. Furthermore, it was suggested that the System might agree
that a formal suspension of gold sales by the U. S. Treasury without an official
change in the price of gold would also result in a cancellation of the contract.
3) The new forward purchase by the System would be further qualified
to leave open the possibility that the System could acquire, at market rates,
currencies needed to prepay the swap to the extent that there was a reversal
in the market. That is, the new forward contract to buy currency at the rate
of the original swap drawing would cover only that portion of the outstanding
swap that it had proved impossible to liquidate through normal operations.
This proposal appears to be acceptable to the Europeans--although
it does not meet all their desires--while offering certain distinct advantages
to the System. It would eliminate windfall profits made by the Treasury, and
to some extent by the System, at the expense of foreign central banks under present
arrangements and protect the foreign central bank against the risk of loss in
operations under the swap. At the same time, it would preserve the basic
structure of operations under the swap lines and guarantee the System against
BERALD FORD VIBRARY
1/ See sample cable attached.
:
FORD
-5-
any risk of loss. At present, the System is exposed to a potential loss any
GERALD
LIBRARY
time that it makes a drawing when the spot rate for the foreign currency is
below its ceiling. If in such a case no reversal occurs and the System has to
liquidate the transaction through direct dealings with the central bank (in
association with Treasury sales of reserve assets), there is the possibility
that the spot rate could then be higher than it was at the time of the drawing,
thereby making the foreign currency more expensive for the System to acquire.
Although unusual, there have been such occurrences. Under this proposal
such a situation could not arise because the new forward contract would guarantee
that the System could acquire the necessary currency at the same rate as the
original swap. This may prove to be particularly important in coming years
when the EEC countries move to narrow the margin of fluctuation among their
currencies within the present dollar band. Under those circumstances, it is
entirely possible that the System could be called upon to make a swap drawing in
a case in which the central bank was maintaining an interim "ceiling" at a level
below the official EMA ceiling. If at the time of liquidation of the drawing, the
EEC band had been moved upward so that the currency in question, even if below
its formal ceiling, was above the rate at which the System had drawn, a loss would
be incurred. Such occurrences may arise, moreover, with greater and greater
frequency as the EEC succeeds in narrowing its band. The proposed new arrange-
ment would effectively protect the System against these potentially significant
losses. In addition, the new arrangement would protect the System against the
risk of loss in the event that a country to which the System was indebted under the
swap was to widen the margins against the dollar while a swap drawing was
outstanding and the spot rate was then to move above the old ceiling. Although
from time to time informal understandings have been reached concerning the
activation of the revaluation clause in such an instance, this situation is not
-6-
covered in any formal way by the present revaluation clause. Thus, on
balance, the proposed change in procedures appears to offer significant
advantages to the System as well as eliminating a source of continuing
irritation among some of the System's swap partners.
FORD dr LIBRARY GERALD
DRAFT CABLE
DE NEDERLANDSCHE BANK
AMSTERDAM
I
FOR VALUE (Date - Three Months Forward) WE BUY FROM
YOU UP TO NG (AMOUNT of guilders drawn) AT RATE OF
(SPOT Rate, as per Swap Contract) .
II
IN THE REMOTE EVENT OF A DEVALUATION OF THE
U. S. DOLLAR PRIOR TO THE VALUE DATE ABOVE,
THIS CONTRACT WOULD BE CONSIDERED TO BE CANCELLED.
III
PLEASE CONFIRM
FEDERAL RESERVE BANK OF NEW YORK
GERALD FORD LIBRARY
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date December 15, 1970
To Mr. R. Solomon
Subject: Comment on Mr. Bodner's
From A. B. Hersey
December 8 Memorandum to FOMC
aBit
STRICTLY CONFIDENTIAL (FR)
The gist of Mr. Bodner's memorandum is that the foreign
departments of the Dutch and Belgian central banks are beginning to
doubt that the sacrifice of normal foreign exchange profits involved
in getting an exchange value guaranty on their dollar reserve gains
is worth it. On November 18 and 19 a discussion took place in New
York between their representatives and Mr. Coombs and other officers
of the New York Bank. Proposals were made by the visitors for changes
in methods of operating under the swap arrangement to give them
profits. The Federal Reserve could not agree to one of the proposals,
and the Treasury, which would have been involved in the other, found
it unacceptable. Mr. Coombs and his associates made a pair of
counter-proposals, complementary rather than alternatives, to achieve
the same end by other means. One of these proposals involves Treasury
actions and the Treasury has it under consideration. The other
"appears to be acceptable to the Europeans."
At the FOMC meeting on November 17, Mr. Coombs had mentioned
that some of the Common Market central banks might raise the question
of losses they suffered under the present procedure, and he then said
that if such questions were raised he would distribute a memorandum
to the Committee. Mr. Bodner's memorandum carries out that promise.
GERALD FORD LIBRARY
To: Mr. R. Solomon
-2-
STRICTLY CONFIDENTIAL (FR)
As I see it, the central question for the Treasury and the
Federal Reserve to consider in connection with these proposals is
whether the effects of our making exchange value guaranties available
to our swap partners are worth enough to the United States to justify
our amending long-established procedures in such a way as to provide
new financial incentives in order to encourage continued use of
exchange value guaranties. A second question -- if the first question
is answered, "Yes, but," as I think it should be -- is whether the
specific amendments now being negotiated are as satisfactory from the
point of view of the United States as this memorandum suggests they
are. I have some doubts, but I have nothing better to offer. In
this memorandum I shall discuss both these questions. In an appendix
I shall try to clarify the matter of how losses may be suffered and
profits forgone by our swap partners under present arrangements.
The central question
BERALD FORD LIBRARY
Others may think the central question is whether or not to
maintain the highest possible degree of cooperation with the Common
Market central banks in exchange market operations. From what
Mr. Coombs said at the last meeting, I take it that his view is that
if the Administration places a top priority on maintaining existing
exchange rates between the dollar and the European currencies, then
everything possible should be done "to defend the dollar on the
exchange markets" while domestic policies are producing the necessary
adjustments. In Mr. Coombs's view, "if the United States were to
drift into a political bargaining encounter over the issue of whether
one parity was to be revalued or the other devalued, the very rationale
of the central bank swap operations would be called in question.' "
To: Mr. R. Solomon
-3-
STRICTLY CONFIDENTIAL (FR)
The outlook for the balance of payments is not yet so
clearly favorable or unfavorable that decisions can be made on the
basis of a once-for-ever choice between the two alternative policies
Mr. Coombs describes. Therefore, while not completely dismissing
"the rationale of central bank swap operations," we are not compelled
to go all out "to defend the dollar on the exchange markets.' Inter-
national cooperation and discussion among economic and financial policy
makers must aim at more basic objectives like growth, stability, and
flexibility of adjustment, rather than just at exchange market
stability. "Political bargaining" that will disturb exchange markets
may be unavoidable. Still, on both sides there is an interest in
avoiding an exchange crisis if possible.
The rationale of central bank swap operations, as I under-
stand it, is to help maintain confidence in international markets
th t an existing parity will be defended as long as it is useful to
do so -- that is, the aim is to prevent a crisis or postpone a
crisis as long as possible. Specifically, when we initiate swap
drawings at the request of partner central banks it is to make it
easier for them to abstain from buying gold from us, so that markets
will not take fright at the dwindling of our gold stock. What helps
our partner central banks to abstain from buying gold is their ability,
when a swap has been made, and their excess uncovered dollars have
been "mopped up," to explain to their governments or their public that
the increase in their dollar reserves is just as good as an increase
in gold reserves -- so long as the swap is outstanding.
QERALD FORD LIBRARY
To: Mr. R. Solomon
-4-
STRICTLY CONFIDENTIAL (FR)
The reason the Dutch and Belgian central banks are beginning
to doubt the value of the exchange value guaranty the Federal Reserve
swap gives them is, as Mr. Bodner's memorandum suggests, that they feel
"under pressure from the U.S. Government to revalue their currency" --
in which case there would be no dollar devaluation to be protected
against. (The swap arrangement gives them no protection against the
writedown of the domestic-currency value of their dollar holdings
in the case of their revaluing their own currency upward.)
FORD is LIBRARY GENALD
I imagine the unspoken part of their argument to run as
follows. "Your Government gives us the impression it is determined
not to devalue the dollar in terms of gold. If we were to believe
this, and if we could convince our domestic critics of this, there
would be no point in our getting an exchange value guaraney from you
for our dollars in terms of gold. We see, however, that you fear an
e> hange crisis, and that you think that our abstaining from buying
gold helps prevent a crisis; you do not know whether or not we would
buy gold without the exchange value guaranty for our excess dollars,
but you know that we never do buy gold while a guaranty is outstanding.
We are therefore willing to go on with these swap arrangements, if
you really want us to, even though we are beginning to doubt their
value to us. But you must show us you really want us to go on with
them. The best way might be to put an end to all talk of our revaluing
our currencies, as well as to do what you need to do if you are to avoid
devaluing the dollar. To help kill all talk of our revaluing, it would
be useful to change the swap arrangements so as to give us your promise
To: Mr. R. Solomon
-5-
STRICTLY CONFIDENTIAL (FR)
that if we did have to revalue you would make good the book loss
we would suffer. We are not asking that now. Short of that, however,
you should act as cooperatively as possible in our inter-central-bank
relationships."
If this is a correct interpretation to put on the Dutch
and Belgian approach to Coombs, we have already "/drifted/ into a
political bargaining encounter" of sorts. What, then, would the
GERALD FORD LIBRARY
United States gain if the Dutch and Belgians were to be given a
friendly, cooperative reply? First, we would avoid putting them on
the spot to carry through with their implied threat to stop using
the swap arrangement -- before we have decided whether or n t we want
them to do SO. Second, continued use of the arrangement would
certainly prevent their buying gold so long as their excess dollars
were guaranteed. But would this be a net gain for the United States?
Wou' they buy gold if their excess dollars were not guaranteed?
They might. We cannot take seriously the implication in what they say,
that they are sure we will not devalue the dollar in terms of gold;
whatever our intentions may be, it is possible that their intentions --
whatever they may be -- will prove irreconcilable with ours. Therefore,
we must assume that they still trust gold more than dollars -- or at
least will act as if they did -- so that without Swap drawings we
might lose a good deal of gold, and a crisis in the markets might get
stirred up before we were ready.
Perhaps the time is approaching when the United States should
turn to other methods of safeguarding the U.S. gold stock. Drawing
foreign currencies from the IMF with which to buy back excess dollars
To: Mr. R. Solomon
-6-
STRICTLY CONFIDENTIAL (FR)
from countries in balance-of-payments surplus is such a method.
One disadvantage is that once our gold tranche position is exhausted
we will have to enter into negotiations with the Fund and accept
conditions that the Fund may lay down. (That disadvantage might
be an advantage if it meant keeping international negotiations about
currency parities and the future of gold in a broader forum than
either Basle or G-10, but as a practical matter discussion of these
matters will not be confined to any one forum.)
Certainly we may feel tempted to tell the Dutch and the
Belgians that it is they who should show a more cooperative spirit.
There is nothing new about the effects of swaps on their profits.
The arrangements have worked for over eight years; why should they
be changed now?
Since, however, the prospects for the U.S. balance of
pa ments are uncertain, and since policy positions of the United
States, the Europeans, and the Fund regarding future currency parities
are in a state of flux, the reaction the New York Bank has given to
the Dutch and Belgian approach is probably the right one: to take a
magnanimous view, and to see if some suitable way of relieving the
irritation that loss of exchange profits is causing them can be found.
The answer to the central question, for the present, should then be:
"Yes, but is there any suitable way to provide the profits our partners
want?"
GERALD R.FORD LIBRARY
To: Mr. R. Solomon
-7-
STRICTLY CONFIDENTIAL (FR)
The specific counter-proposals
The two counter-proposals now under consideration are com-
plementary: one would be used when an accumulation of reserves by
one of our partner central banks proved more than temporary and the
United States had to draw on the IMF to unwind the swap, while the
other could be used for reversible temporary gains of reserves.
The first needs Treasury action. Sales of a foreign currency by the
Treasury to the Federal Reserve would be made in a roundabout way,
via the central bank concerned, at rates that would give the foreign
central bank a profit. Mr. Bodner's memorandum asserts that the
result would be analogous to what happens when the Treasu / sells
gold or transfers SDRs to enable the System to repay a swap drawing.
(I shall try to explain in the appendix in what sense this is so.)
He told me this morning that the Treasury is agreeable to this change
of procedure.
The second proposal is a complex thing. Starting with
present procedures for (1) a "swap" at the current market rate
(i.e. a spot transaction, and a forward transaction to reverse it,
both at the present spot rate) and (2) a "mop-up" purchase of foreign-
held excess dollars also at the current market rate, the proposal
piles on top of this (3) another forward contract, at the same current
market rate¹/, to get us the foreign currency with which to meet the
first forward contract. Then, since all this has destroyed the
exchange value guaranty that the whole arrangement was meant to give,
GERALD
LIBRARY
1/
See further comment, page 10 below.
To: Mr. R. Solomon
-8-
STRICTLY CONFIDENTIAL (FR)
(4) another agreement is piled on top of the rest, namely to cancel
the second contract (and thereby give effect to the exchange value
guaranty) if some specified event occurs.
Apart from the obvious objection that this gadgetry would
be much harder to explain to citizens and legislators than the present
mechanism, the necessity of spelling out precisely what is being
insured against might be regarded as a fault in this proposal. At
present, our partner central banks holding dollars under swaps get
protection against any fall in the value of the dollar in terms of
their currency between the time of a swap drawing and the date the
swap matures, except one caused by their own action of revaluing
their currency. The proposal is that they be protected against two
specific contingencies, (a) a devaluation of the dollar (against
gold) -- which would of course mean depreciation of the dollar against
the other currency if the other currency were not devalued (against
gold) or were devalued less than the dollar -- and (b) market deprecia-
tion of the dollar in case of "a formal suspension of gold sales by
the U.S. Treasury without an official change in the price of gold,"
if the partner country did not formally revalue against gold but
allowed its rate against the dollar to float.
The present arrangements give our swap partners protection
against exactly these contingencies, without naming them. In this
respect and also with respect to the contingency of a revaluation
by a partner country, the proposal involves no. substantive change.
GERALD FORD LIBRARY
To: Mr. R. Solomon
-9-
STRICTLY CONFIDENTIAL (FR)
The existing provision for terminating the exchange value guaranty
prior to any revaluation by the creditor country would remain in
force, taking precedence over all other elements of the swap arrange-
ments. This was not mentioned in Mr. Bodner's memorandum, but this
morning he told me that it is so. Whatever the advantages or dis-
FORD LIBRARY
advantages of our promising to reimburse a partner central bank for
market depreciation of the dollar on condition that the swap is
wound up before -- but not after -- a formal revaluation of the other
currency, the proposal leaves these advantages or disadvantages just
as they are now -- and this is so whether or not a formal suspension
of U.S. Treasury gold sales were to occur.
Mr. Coombs and Mr. Bodner do not regard the necessity of
spelling out the contingencies in which the exchange value guaranty
is valid as a fault of their proposal. On the contrary, they see
reasons to regard this as a virtue. In particular, it would be
useful for avoiding losses in the operation of the System account in
the future "when the EEC countries move to narrow the margin of
fluctuation among their currencies within the present dollar band."
At the time of a Federal Reserve drawing the rate for the foreign
currency could be at the ceiling of the EEC band, but the whole EEC
band might be well below the ceiling of the dollar band; and then at
the time of liquidation the EEC band might have moved higher, always
within the dollar band. Thus the dollar would have depreciated
against the currency drawn. Under present arrangements this could
To: Mr. R. Solomon
-10-
STRICTLY CONFIDENTIAL (FR)
prove costly to the System account. Under the proposal, this would
not be one of the specified contingencies in which the exchange
value guaranty would hold. (The proposal would of course prevent
System profits as well as avoid losses, but no one argues that we
should be seeking profits in the swap operations.)
One further comment must be made on the third component
of the proposed arrangement. The point of the proposal is that the
second forward contract, in order to undo the basic swap, would
have to be made at the existing spot market rate, not at the existing
forward rate in the market. The forward side of the basic swap
drawing is of course contracted for at the same (spot market) rate
as is applied to the spot side of the drawing. While the FOMC's
Authorization for System Foreign Currency Operations and its Foreign
Currency Directive do not spell out this feature of the swaps, any
other forward exchange contract is governed -- or so it appears to
me -- by paragraph 3 of the Authorization, which says in effect that
transactions other than drawings "under the reciprocal currency
arrangements" "shall be at prevailing market rates, "unless other-
wise expressly authorized by the Committee." Presumably this would
mean, for a forward contract, the prevailing forward market rate.
Use of the spot market rate for a forward transaction would appear
to require express authorization.
GERALD FORD JBRARY
STRICT CONFIDENTIAL (FR)
BERALD FORD LIBRARY
Rates at which Netherlands Bank buys (B)
or sells (S) dollars, in terms of NG per $ as % of par
No
Swap; reversal
Fed.
with B/P swing,
Swap, no B/P swing
Res.
Fed. Res. Buys NG from:-
IMF drawing
Direct trans.
swap
Neth. Bk.
market
now
their
now
offer
now
offer
proposal
no. 1
no. 2
1
2
3
4
5
6
7
8
1. Buys $'s in market
B.994
B.994
B.994
B.994
B.994
B.994
B.994
B.994
2. Initiation of swap
...
B.994
B.994
B1.000
B.994
B.994
B.994
B.994
3. Mop-up sale of $'s
...
S.994
S.994
S1.000
S.994
S.994
S.994
S.994
4. Sells $'s in mkt.
S1.006
...
S1.006
S1.006
...
...
...
...
5.F.R. sells in mkt.
...
...
...
...
...
F.R. reconstitutes balances;
getting NG from:-
6. Mkt. (=preceding line)
...
...
...
...
7. Direct, Neth. Bk.
...
...
B1.006- B1.000
...
B1.000- B .9943/
...
8. IMF
...
...
...
...
*1.000
...
...
...
( *1.000
9. IMF via Neth. Bk.
...
...
...
...
... (S**1.000
...
...
(β***.994
10. Fwd. side of swap
...
S.994
S.994
S1.000
S..994
S.994
S.994
S.994
P&L result
profit
...
profit
...
profit
...
profit3/
*
Netherlands Bank acquires reserve position in IMF at par. This is the form the net
addition to its reserves takes.
** Treasury sells NG (Neth. Bk. buys NG) drawn from IMF; i.e., Neth. Bk. sells $'s to Trea
*** Fed. Res. buys NG to reconstitute balance and be able to unwind swap (i.e., Neth. Bk.
buys $'s). It is assumed that the NG is still at ceiling ($ at floor). If the rate
has fallen below the ceiling the Netherlands Bank's profit is less.
1/
If the direct purchase of Netherlands guilders by the Federal Reserve from the
Netherlands Bank is made at a time when the exchange rate for the dollar has fallen
off, there is a profit for the Netherlands Bank. On the other hand, if the market sales
(line 4) were made at a lower rate for the dollar than the exchange rate for the direct
purchase, the Netherlands Bank has a loss.
2/
In this case it is assumed that balance of payments has not reversed itself, but the
guilder has fallen from its ceiling (the dollar has risen from its floor) to par.
The Federal Reserve buys guilders at this market rate, par. The Netherlands Bank makes
a net addition to its reserves, in the form of dollars at par.
3/
The assumptions are the same as in the preceding case, but the price is the market
rate at the time of the initiation of the swap. This gives the Netherlands Bank a
potential profit, in the sense that it has acquired dollars at the floor price for dollars
and will realize a profit in the future when it sells these dollars.
STRICTLY CONFIDENTIAL (FR)
Appendix
GERALD R. FORD LIBREAT
How profits are forgone or losses suffered
by the Netherlands Bank
The reader of this appendix should start by looking at
column 1 of the accompanying table. When a central bank gains
dollar reserves and then later has to sell them off because of a
reversal in the balance of payments it normally earns a profit,
because it buys dollars cheap and sells them dear. Whenever a
central bank puts its dollars under a Federal Reserve swap it normally
forgoes this profit, and in fact transfers the profit to the Federal
Reserve.
Mr. Bodner's memorandum seems to say, on page 1, that a
foreign central bank forgoes its normal exchange market profits
from buying cheap and selling dear only when the System has to go
directly to the partner central bank to reconstitute its holdings
of the other currency preparatory to unwinding the swap. Actually,
as columns 2 and 3 of the appended table show, the normal profits
in absence of a swap are ordinarily forgone whenever there is a swap,
whether we reconstitute our balances in that way or in the market.
Forgoing profits is the price the other central bank pays for receiving
the exchange value guaranty. The underlying principle is that whatever
rate the partner pays in the market (line 1) is the rate at which the
mop-up sale of dollars to the Federal Reserve is made (line 3), and
that, if the partner sells us the foreign currency at the end to
A-2
STRICTLY CONFIDENTIAL (FR)
enable us to liquidate the swap, as in column 3, the sale (line 7)
is to be at the same rate as that at which the partner acquires its
currency (sells dollars) in the market (line 4). Whenever the
Federal Reserve reconstitutes its balances in the market, as in
column 2, the other central bank is not involved in the two trans
actions just mentioned (lines 4 and 7).
GERALO FORD LIBRARY
Federal Reserve profits
The Federal Reserve generally makes a profit when there
is a swap that is reversed after a swing in the balance of payments
of the partner country. This fact can be appreciated by a close
examination of columns 2 and 3 of the table. The four transactions
in column 2 and the six transactions in column 3 are transactions
of the Netherlands Bank. The Federal Reserve is not involved in
the initial market purchase of dollars (line 1). In column 2,
however, it has a sale of dollars to the market (a purchase of
guilders) on line 5 -- for which the rate is not shown in the table,
because the Netherlands Bank is not involved in that transaction.
In the remaining transactions that are between the Netherlands Bank
and the Federal Reserve, one buys and the other sells. From the
point of view of the Federal Reserve, the "B's" on line 2 (initia-
tion of swap) and line 7 (reconstitution of balance by direct trans-
action) become "S's" (meaning, sale of dollars) and the "S" on line 3
(the mop-up sale of uncovered dollars to us) becomes a "B" (a buying
of dollars). It is evident that whereas the Netherlands Bank had
pairs of B's and S's at cheap and dear rates for the dollar, we have
the following:
A-3
STRICTLY CONFIDENTIAL (FR)
Column 2
Column 3
Line 2
S cheap
S cheap
Line 3
B cheap
B cheap
Line 5
S dear
BERALD FORD LIBRARY
Line 7
S dear
Line 10
B cheap
B cheap
We have a pair of B and S at the cheap rate, and a profit from a
cheap B and dear S. Thus, the profit the Netherlands bank forgoes
as the price of an exchange value guaranty is passed over to the
Federal Reserve.
Later on we shall see what the profit situation is if no
swing in the balance of payments of the partner country takes place.
Exceptional losses and profits
In these cases in which the Netherlands Bank generally
gives up its normal profit to the Federal Reserve, it may conceivably
happen that the market rate at the time the mop-up sale (line 3)
occurs is no longer exactly the rate at which the Netherlands Bank
originally bought dollars in the market (line 1). Similarly, in
column 3, the rate at which the Netherlands Bank sells us guilders
to reconstitute our balances (line 7) may conceivably differ from
the rate at which it has been buying guilders (selling dollars) in
the market (line 4). Whenever there are such differences, the
Netherlands Bank may make small losses or profits, and the Federal
Reserve's profits may be correspondingly enlarged or diminished.
Apparently it is losses of this rather exceptional kind that the
Dutch and Belgians have mentioned in their discussions with Mr. Coombs.
A-4
STRICTLY CONFIDENTIAL (FR)
Their main concern appears to be not over such losses, but over the
forgoing of normal profits when they engage in a swap with the
Federal Reserve.
The first Dutch-Belgian proposal
Column 4 of the table illustrates how the plan the Dutch
and Belgians first proposed would have worked. Here, all trans-
actions between the partner central bank and the Federal Reserve
are at par, and the Netherlands Bank is left with the normal profit
(as in column 1) arising from the difference between buying and
selling rates on lines 1 and 4.
Net reserve gains of the foreign central bank
Columns 5-8 treat a few of the various cases that can
arise when there is no swing in the balance of payments and the
Netherlands Bank ends up with a net gain in its reserves, in the
form of an increase in its IMF position (columns 5 and 6) or in
the form of dollars, gold, or SDRs. Columns 7 and 8 relate explicitly
to the case of a net reserve gain taken in the form of dollars no
longer covered by a swap, but those dpllars can be converted at
par into gold or SDRs, leaving the profit and loss results shown
in columns 7 and 8 unchanged.
BERALD FORD LIBRARY
1/
Perhaps they are also concerned about losses that might occur
in the future with changes in EEC exchange rate behavior such
as those discussed on page 9 of the memorandum to which this
appendix is attached.
A-5
STRICTLY CONFIDENTIAL (FR)
In all these cases the Netherlands Bank has an odd number
of transactions. All but one form pairs (normally equal under present
practices -- as illustrated in columns 5 and 7 -- but exceptionally
giving rise to losses or profits as mentioned above), and the
unpaired transaction gives the book value of the reserves acquired.
If this transaction is at a rate below par, the Netherlands Bank
has a potential profit.
A minor point of interpretation of the table
GERALD FORD LIBRARY
Since the table is set up in terms of rates paid or
received by the Netherlands Bank for dollars bought or sold, the
calculation of realized or potential profits has to take account
of the number of dollars in the various transactions. In each case
the amounts in all transactions except those on lines 4 and 7, 8,
or 9 are equal to each other. Suppose 100 million of dollars have
been bought in the market. We then make a swap drawing of NG 99.4
million -- I am assuming, for convenience, that at par NG 1=$1 --
for which we give $100 million (line 2). The Netherlands Bank
sells us $100 million (line 3). At the end (line 10) we will buy
back the $100 million we gave when the swap drawing took place.
But in between, to reconstitute our guilder balances, we pay out
whatever amount of dollars is required to obtain, at some new rate,
the NG 99.4 million that was equivalent to $100 million at the original
rate. Thus, the amounts involved on line 7 are $98.8 million approxi-
mately in column 3, $100 million in column 4, $99.4 million in column
7, and $100 million in column 8. Similarly, in columns 5 and 6, the
A-6
STRICTLY CONFIDENTIAL (FR)
amounts of change in the Netherlands reserve position in the Fund
(lines 8 or 9) are in each case NG 99.4 million, equivalent to $99.4
million. As to line 4 (in columns 3 and 4) if we count market sales
of dollars exactly equal to the amount that is to be taken from the
Federal Reserve in the reconstitution transaction (line 7), at that
point the Netherlands Bank will have had exactly no net change in
its dollar reserves, and all profit (if any) will have been realized.
Comparison of IMF drawing with gold sale
When the Federal Reserve acquires guilders with which to
liquidate a swap drawing by buying from the Treasury guilders that
the Treasury has drawn from the IMF, the Netherlands Bank acquires,
at par, an addition to its gold tranche or super-gold tranche in
the IMF. (This is shown in columns 5 and 6 by the items with a
single asterisk. The symbol B is omitted because this is not a
purchase of dollars. The U.S. Treasury gives up some of its reserve
position in the Fund and gets guilders, the Netherlands Bank gives
guilders and gains an addition to its position in the Fund.)
BERALD FORD IBRARY
Column 5 represents present practice, and column 6
illustrates the effect of the first of the two counter-proposals
given to the Dutch and Belgians. After the U.S. drawing on the Fund
(which automatically gives the Netherlands Bank an increase in its
reserve position in the Fund), the Netherlands Bank sells the U.S.
Treasury dollars for its guilders at par (two asterisks), and then
lets the Federal Reserve buy guilders dear -- i.e. it buys dollars
A-7
STRICTLY CONFIDENTIAL (FR)
cheap (three asterisks). Thus the Netherlands Bank realizes a
profit, while acquiring a net addition to its reserves at par.
Mr. Bodner's memorandum asserts that this result is
analogous to what happens when the Treasury sells gold to enable
the System to repay a swap drawing. In the latter case the Nether-
lands Bank sells the U.S. Treasury dollars for gold, and then lets
the Federal Reserve buy guilders from it. This gold transaction
case is not shown in the table, but it can readily be constructed
from column 7 ("direct transaction, now") by adding an interchange
of dollars and gold at par. Also, column 7 needs to be modified
because it arbitrarily assumes that the Dutch balance of payments
has moved into equilibrium so that the exchange rate is now at par
(footnote 2 of the table); the Netherlands Bank has decided to hold
uncovered dollars rather than ask us to draw on the IMF or sell gold.
In that case there is no profit for the Netherlands Bank, either
realized or potential. But we now want to consider the gold sale
case. If a gold sale had to be made, the more realistic assumption
would be that the guilder is stilldear and the dollar cheap. When
column 7 is modified to conform with that assumption (changing the
rate on line 7 from 1.000 to .994), it will show that the Netherlands
Bank does have a potential profit. Evidently there is an analogy
between such a potential profit in the gold case and the realized
profit in column 6, but it is not an exact analogy.
BERALO FORD LIBRARY
A-8
STRICTLY CONFIDENTIAL (FR)
Analogy with other countries' conversions of IMF drawings
Mr. Bodner pointed out, in our conversation, an analogy
between the first counter-proposal (column 6) and the practices
followed when other countries draw currencies from the IMF. Again
this is not a perfect analogy.
France may draw German marks from the Fund. Needing dollars,
it asks the German central bank to convert its marks to dollars.
Exactly so, under the counter-proposal we would draw guilders and
ask the Netherlands Bank to convert them to dollars. But the
analogy is imperfect, because what the United States needs at this
point is not dollars but guilders, and the transaction just noted
has to be followed by another, in which the Federal Reserve finally
gets the guilders it needs.
The Treasury's windfall profits
Mr. Bodner's memorandum puts less emphasis on the profits
that would accrue to the Netherlands Bank if the column 6 procedure
were adopted than on the fact that the Treasury would be forgoing
windfall profits. How do these windfall profits arise?
Under present procedures, the partner central bank normally
makes no realized profits or losses in those cases (columns 5 and 7)
in which there has been no swing in the balance of payments that would
allow it to sell dollars in the market. It may or may not have a
potential profit, depending on the rate at which it acquires the
FORD is LIBRARY 074830
uncovered dollars, the addition to IMF position, or the gold that
constitute the addition to its reserves. If it has a maximum potential
profit, the United States has no profit; but if it has no potential
A-9
STRICTLY CONFIDENTIAL (FR)
profit, the United States does have a profit, and in fact a realized
profit. Thus, in column 5 or column 7, the U.S. purchases (B) of
dollars and sales (S) of dollars are as follows:
Line 2:
S cheap
Line 3:
B cheap
Line 7 or 8:
S at par
Line 10:
B cheap
This profit results from the fact that the mop-up transaction
(line 3), like the partner central bank's own purchases of dollars
from the market, is made at a rate for the dollar below par, whereas
we give up dollars for guilders (line 7 or 8) at par. (The latter
rate is always par when we draw m the IMF; the par rate in column 7,
however, is an arbitrary assumption; if we had assumed a rate below
par on line 7 in column 7 our profit would be smaller, or zero.)
The profit the United States makes (in those cases in
which it does have a profit) is realized by the Federal Reserve if
it is able to reconstitute its guilder balances at par (as arbitrarily
assumed in column 7). But if there is an IMF drawing at a time when
the market rate for the dollar is below par, the Federal Reserve
realizes no profit (having to buy guilders dear from the Treasury
according to our own rules) while the Treasury does make a profit
FORDO is LIBRARY GERALD
(since it gets guilders at par from the IMF).
The second counter-proposal
In column 8, which illustrates the second counter-proposal
made to the Dutch and Belgians, the Netherlands Bank is assured a
potential profit, because it buys dollars cheap (sells guilders dear)
on line 7 regardless of the market rate at the time of liquidation
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STRICTLY CONFIDENTIAL (FR)
of a swap drawing. This is the effect of the proposal to make a
second forward contract, undoing the exchange value guaranty, at
the spot rate prevailing at the time of the swap drawing. At the
time of a drawing, the dollar is invariably below par. (In column
8, the spot rate at the time of the drawing, appearing on lines 2,
3, 7, and 10, is assumed to be the same as the rate, on line 1, at
which the Netherlands Bank bought dollars in the market.)
FORD i LIBRARY 97V839
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date December 17, 1970
To
Chairman Burns
Subject:
From
Mr. Broida
Attached is some background material for the expected discussion
concerning swap arrangements with the Common Market countries. The
material includes extracts from Committee minutes in 1962 and certain
memoranda in 1968 relating to transactions with foreign central banks
at rates other than market rates.
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dollar rate against the Swiss franc and the Dutch guilder. Several factors
had contributed to a noticeable, although possibly temporary, improvement
in foreign confidence in the U. S. dollar. These included President
Kennedy's Telestar statement, the announcement of improved balance of pay-
ments figures for the second quarter of the year, and the forestalling of
potential gold losses through Treasury and System foreign exchange opera-
tions. The London gold market had been quieter recently.
Following a discussion of Treasury Stabilization Fund operations
during the past three-week period, Mr. Coombs noted that the Federal Re-
serve System also had been active during that period. On August 2 the
System liquidated its $50 million swap with the Bank of France and re-
placed it with a standby swap in the same amount. On the same day the
System entered into a $50 million standby swap arrangement with the German
Federal Bank. On August 7 the System used $10.5 million equivalent of
Belgian francs to purchase the equivalent amount of dollars from the Bel-
gain National Bank in order to forestall a potential Belgian demand for gold.
Also, on August 7 the System drew an additional $10 million equivalent of
Swiss francs from the Bank for International Settlements under its $100
million standby agreement and used the francs to mop up "excess" dollar
holdings of the Swiss National Bank and thus avoid a potential gold loss.
Further, a strengthening of the dollar rate against the Dutch
guilder and a decline in the gold holdings of the Netherlands Bank had
given the System an opportunity to accumulate Dutch guilders for the
purpose of paying off System drawings under the $50 million swap arrange-
ment with the Netherlands Bank. Arrangements had been made with the
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Netherlands Bank to purchase guilders for System Account at market rates
whenever such operations would not place downward pressure on the
dollar spot rate vis-a-vis the guilder. Orders executed by the Nether-
lands Bank under this agreement had totaled more than $10 million through
yesterday. The Account Management would expect to utilize the guilders
to pay off $10 million of the $50 million drawn under the swap, leaving
$40 million outstanding. It was hoped that the situation had now turned
in favor of the dollar and that in the next month or 80 enough guilders
could be bought back to liquidate the swap completely. If this worked out,
it would provide another illustration of how official swap operations
could be useful in offsetting or cushioning reversible flows of funds.
Mr. Coombs then commented that the Netherlands Bank had shown
resistance to making direct deals with the Federal Reserve on a wholesale
basis at market rates. As an alternative, it had offered to give the
System a special and more or less arbitrary rate under the market. While
the System would still make money on the deal if it accepted such an offer
this would represent a deviation from the rules set forth in the Committee
Authorization and Guidelines pertaining to System foreign currency opera-
tions, which called for operating at market rates in the absence of some
special circumstances that would cause the Committee to decide to do other-
wise. Mr. Coombs had indicated to the Netherlands Bank that he thought
the Committee would have serious doubts about deals at a rate other than
the market rate. He thought that the System could manage, in any event,
to accumulate enough Dutch guilders to pay off the swap before maturity.
LIBRARY GERALD FORD
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the Netherlands Bank might request a shift in the interest rate basis
from an arbitrary 2 per cent rate to one based on the U. S. Treasury
bill rate.
/
Thereupon, upon recommendation of
Mr. Coombs, the Committee authorized a
renewal for three months of the $50
million swap arrangement with the
Netherlands Bank.
In the case of the $50 million swap with the National Bank of
Belgium, Mr. Coombs noted that this arrangement would not mature until
December 20, 1962. The possibility of a standby facility had been sug-
gested by him to the National Bank of Belgium, but the National Bank
had preferred to have the original swap agreement executed on an out-
right basis.
Mr. Coombs next referred to the problem he had mentioned at
the August 21 Committee meeting relative to acquiring guilders through
direct transactions with the Netherlands Bank. He had recommended,
and the Open Market Committee had concurred, that guilders should
continue to be acquired at the market rate rather than to accept a
proposal from the Netherlands Bank that System purchases be arranged
at a special arbitrary rate at such times as the System wished to
purchase guilders in substantial quantity. The problem was that on
some days guilders were available in the market in only limited amounts.
In the circumstances, he had endeavored to think of some compromise
solution that would enable the purchase of larger quantities of guilders
GERALD FORD LIBRARY
9/11/62
-54
while continuing the market rate principle. It had occurred to him
that the System mi ht pay a stipulated commission or fee to the
Netherlands Bank for the convenience ofobtaining sizable lots of
guilders through irect transactions with the Netherlands Bank. He
had mentioned this possibility to the Netherlands Bank, and yesterday
he had received word that the Bank would be agreeable in principle to
such an arrangemo it. The Bank had suggested that the commission might
be fixed at the rate of 1/8 per cent. Such a rate, Mr. Coombs pointed
out, would result in roughly an equal sharing between the Federal
Reserve and the Netherlands Bank of the profits accruing from System
drawings of guilders when the dollar was weak and purchases of guilders
after tl dollar had strengthened. The Treasury also was involved
because It had $20 million of guilder drawings outstanding that it
was anx Jus to liquidate quickly. Accordingly, he had inquired whether
such an arrangement would be acceptable to the Treasury, and had found
that the Treasury would be agreeable. If the Open Market Committee
concurred in such an arrangement, it should be possible to clean up
the guilder operation completely in the course of the next week through
purchases of $15 million of guilders for System account and $20 million
for Treasury account. If the arrangement was not favored, he feared
that the guilder operation would drag on, with relatively meager
possibilities of acquiring guilders through the market.
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In reply to questions, Mr. Coombs confirmed that the Federal Reserve
Bank of New York made no charge when it executed foreign exchange transac-
tions on behalf of foreign central banks. The commission would be unusual
in interbank relationships, but the use of an arbitrary rate that deviated
from the market rate concerned him even more. He felt that the System
would be on better ground if it continued to adhere to the concept of
executing foreign exchange transactions only at the market rate, but
paid a fee to the Netherlands Bank for the convenience to the Federal
Reserve of the execution of wholesale transactions direct with the
Netherlands Bank.
Mr. Coombs recalled that the current swap arrangement was initiated
with a view to mopping up dollar holdings of the Netherlands Bank in excess
of the traditional $200 million limit of that Bank. The Netherlands had
subsequently experienced an outflow of funds. At present its total hold-
ings of dollars were down to around $135 million, and another prospective
out-payment appeared likely to reduce the holdings close to the $100
million level. Thus, repayment of the System's drawings would build up
the dollar holdings of the Netherlands Bank only to a point well below
the traditional dollar conversion point.
In reply to additional questions, Mr. Coombs reiterated that the
effect of the payment of the proposed commission would be to reduce a
windfall profit to the Federal Reserve from its guilder operations. While
no parallel question had arisen under swap arrangements with other foreign
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central banks, conceivably a question of the same nature might arise else-
where; the System was just getting into this field. A similar problem,
incidentally, had arisen in connection with the repayment of drawings from
the International Monetary Fund.
Mr. Coombs further pointed out that the question whether commissions
or fees should be paid on other occasions remained at the initiative of the
Federal Reserve. In markets the size of the Swiss franc, German mark, or
pound sterling markets, there should not be too much difficulty in buying
in sufficient quantity at market rates. Hence the question of the size
and depth of the various currency markets was involved. He had not been
able to think of any absolutely satisfactory solution to the guilder
problem, but he had a feeling that the commission plan was the least dis-
advantageous.
In reply to a question regarding the possibility of waiting until
the terminal date of the drawings, Mr. Coombs commented that this would
focus the present point of difficulty more sharply. He would prefer to
pay off the drawings in advance.
In reply to another question, Mr. Coombs repeated that he saw a
substantial advantage in liquidating the swap with the Netherlands Bank
as fast as possible in order to demonstrate that the System's operations
were designed to deal with reversible flows of funds and that the opera-
tions were effective. One never knew when the tide might move the other
way, and he would like to have this credit facility completely restored
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LISBARY
9/11/62
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if possible. The System had to feel its way on this sort of thing. He
did not think that the arrangement he proposed would necessarily create
a precedent, even in the case of guilders.
Mr. Hayes agreed, noting that the System could always say, even
to the Dutch, that it would not be able to operate the same way again.
In view of factors such as the differences in the size of the various
foreign exchange markets, the System could distinguish among its arrange-
ments more or less on an ad hoc basis.
After further discussion, Chairman Martin commented that the Federal
Reserve was engaged in experimental operations. The Committee might want
later to establish some principles that would apply to swap arrangements
generally. However, if it seemed desirable for the Federal Reserve to
liquidate the current guilder drawings and the arrangement proposed by
Mr. Coombs seemed to provide the best available mechanism, agreement on
a small fee probably was not too much of a price to pay.
Mr. Mitchell commented that in his view the payment of the fee was
not too important in itself. The important thing was the principle of
parallel treatment. So far as he could see, the payment of a fee had no
basis from the standpoint of principles that the System ought to be
following.
Mr. Deming inquired whether there might not be more justification
for paying a. premium if the swap arrangement was being unwound at the last
minute then if this were done in advance. Mr. Coombs replied that the
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United States would be saving interest. Also, by waiting it might forego
the opportunity to make a sizable profit. Mr. Deming then commented that
he was not too concerned about the making of a profit or the sharing there-
of. It was the principle of paying a fee that was of more concern to him.
Mr. Furth noted that. if the System endeavored to buy 15 million
dollars of guilders through the market, the market price probably would go
up by an amount at least equal to the 1/8 per cent commission. It was quite
customary, in the case of Fund drawings, to pay a rate close to the market,
taking into consideration the effect of a market transaction on the rate.
Therefore, he was not particularly apprehensive about the establishment of
a precedent. On a market broader than the guilder market, this simply
would not happen. Further, if it became known that a swap operation
always was to be reversed on the last day, it would be relatively simple
for a central bank to have the market on that day less favorable to the
System than the rate involved in the payment of a small commission.
Question was raised of Mr. Coombs whether payment of a commission
was actually more desirable than departing from the market rate. If some
kind of agreement was in effect whereby the market rate was made subject to
a certain adjustment, would this not be better than paying a commission?
Mr. Coombs replied that a rather nebulous area was involved when
one tried to ascertain the effect of a large transaction on the market
rate. The effect of such a transaction on the market rate might be more
or less than 1/8 per cent. As he had indicated previously, the payment
GERALD
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829
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of a commission of 1/8 per cent would come close to splitting between
the Netherlands Bank and the Federal Reserve the benefit of this
particular operation. This seemed to him better than getting into
the question of what would happen to the market rate i/f an attempt
was made to execute a large transaction in the market.
Chairman Martin then suggested that the Open Market Committee
approve the plan proposed in this instance by Mr. Coombs, with the
understanding that this was clearly not to be regarded as establish-
ing a precedent.
Thereupon, the plan proposed by
Mr. Coombs was approved on the basis
stated by the Chairman.
Mr. Coombs then commented that over the next few months, a
period of the year when there was usually some pressure on the pound
sterling, there might be opportunities to pick up sterling at rates of
par or below. He thought it might be well, as and when such opportu-
nities arose, to acquire sterling up to a total of not more than
$25 million equivalent. Such. holdings might be useful in pilot opera-
tions after the turn of the year, when the seasonal flow of funds to
London might be expected to begin.
Without objection, purchases of
sterling along the lines recommended by
Mr. Coombs were authorized.
Mr. Coombs also- noted that last week in London he had mentioned
to British officials that the Federal Reserve System might be prepared to
R.FORD
GERALD
TELEGRAM
REC'D IN RECORDS SECTION
LEASED WIRE SERVICE
BOARD OF GOVERNORS OF WASHINGTON THE FEDERAL RESERVE SYSTEM 51966
70mc: Foreign
CONFIDENTIAL (FR)
Currency oferations
December 27, 1965
ELLIS BOSTON
HAYES NEW YORK
Nederlands he Bank
PATTERSON - ATL NTA
(hey
SCANLON CHICA )
GALUSHA MINNEAPOLIS
Following request received from Committee's Special Manager
concerning liqu dation of System's guilder indebtedness.
"An opportunity has unexpectedly arisen to liquidate completely
the System's guilder commitments before year-end. During the past few days
there has been a sizable commercial demand for dollars in the Netherlands
apparently attributable to a rush for imports prior to the imposition of
new do estic taxes at the first of the year. The Netherlands Bank has
been sulling dollars in its market as the guilder eased, and now is in a
position to purchase from the United States $50 million against guilders,
the go lder proceeds to be used half to repay the System's August 1965
drawir* of $25 million equivalent under the swap arrangement and half to
liquicate the remaining guilder/mark swaps with the BIS, $12.5 million
equivatent each for System and for Treasury, that have been on the books
since che fall of 196.4.
9/28/62
"The Notherlands Bank has requested that we agree to pay a
commission of 1/8-per cent on the transactions as was done once before in
September 1962. / See FOMC minutes for the meeting of the September 11,
1962, pages 48-54 for a discussion of the earlier proposal. / I believe
it is in the interests of the System to agree to the commission in this
case, as was done in 1962, in order to liquidate on a wholesale basis
GERALD FORD VIBRARY
commitments that otherwise could be met through market acquisitions only
in small amounts over a protracted period. A transaction of this size
could not in any case be effected in the guilder market in a short period
of time without moving the rate against us. Some of these guilder commit-
ments under the third-currency swaps have been outstanding for more than a
year, and in the case of the drawing under the System swap arrangement
we now have an opportunity to repay our obligations well before the second
renewal. While the payment of a commission will somewhat reduce System
profits by passing on part of the potential profit to the Netherlands Bank,
it will not involve the System in losses.
"This transaction would again be considered an exception to the
rule that the System deal at market rates; the payment of the commission
Copy filed
70mc: foreign Currene
form
general
COPY
TELEGRAM
LEASED WIRE SERVICE
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
CONFIDENTIAL (FR)
WASHINGTON -2-
December 27, 1965
in 1962 did not become a precedent for subsequent transactions, as
indicated by the fact that since October 1962 we have liquidated some
$260 million in System drawings under the arrangement with the
Netherlands Bank without payment of commission. The Treasury has
already agreed to payment of a commission of 1/8 per cent on this
transaction. I request the Committee's approval to do likewise for
the System's portion."
Please wire whether you would approve this transaction}, if
EST
possible before 11:00 a.m./Tuesday.
YOUNG
ALB:me
OLB
Couse
for and valed for
DAD
LIBRARY
FILE COPY
A RECORDS SECTION
TELEGRAM
LEASED WIRE SERVICE
JAN 51966
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
WASHINGTON
Jone Forcern
CONFIDENTIAL (FR)
Netherlands
Rook
HAYES - NEW YORK
December 28, 1965 NV(de)
Re Special Manager's request for approval of transaction
involving liquidation of System's guilder indebtedness, as described
12/27/65
in my wire of yesterday, available members of Committee haveadvised
that they approve.
YOUNG
ALB:me
20g
GERI
LISTARY
Cane
FILE COPY
THE SYSTEM OF COVER 10-BOARDO D
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, D.C. 20551
MEDICAL
RESERVE
CONFIDENTIAL (FR)
March 27, 1968
To: Federal Open Market Committee
From: Mr. Holland
Attached is a memorandum from the Special Manager,
dated today and entitled "Recent purchase of Swiss francs at
rate other than market rate." This is the memorandum referred
to i der item 4 of the agenda for the Committee meeting to be
held on April 2, 1968.
Ce i' Heard
Robert C. Holland, Secretary,
Federal Open Market Committee.
Attachment
DER
LIBRARY
CONFIDENTIAL (FR)
March 27, 1968
TO: Federal Open Market Committee Subject: Recent purchase of
Swiss francs at rate other
FROM: Charles A. Coombs
than market rate
On March 6, under paragraph 3 of the authorization for
System foreign currency operations, I secured the approval of the
Subcommittee of the FOMC provided for in paragraph 6 of the authoriza-
tion to purchase from the Swiss National Bank (BNS) $50 million
equivalent of Swiss francs at a rate other than the prevailing
market rate. This memorandum sets forth the reasons for this
operation.
The System's Swiss franc swap lines with the BNS and the
BIS have been in continuous use since June 1967. The System drew
heavily on these lines in June - July 1967 in order to compensate
for large flows to Switzerland following the Middle-East hostilities,
and again in December in order to offset flows resulting from the
sterling devaluation and year-end window dressing. By year-end,
combined commitments to the BNS and the BIS amounted to $650
million equivalent. Beginning in mid-January, the Swiss franc
came on offer as a result of a better market atmosphere surrounding
the dollar and the pound, reversal of year-end flows, and intermittent
foreign exchange requirements of the Swiss Confederation. Under
the circumstances, the Swiss National Bank began selling dollars
on January 6, replenishing its losses by purchasing from the
System a total of $288 million against Swiss francs. By March 4,
R.
GERALD
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the System had used these francs, together with francs acquired
from other sources, to reduce its swap commitments in that
currency by $333 million equivalent to $317 million.
In early March, the U. S. Treasury agreed to make a
drawing on the IMF and also to enter into a funding operation
with the Swiss National Bank to help reduce System swap debt.
In discussions with the Swiss authorities, a figure of $175
million was agreed upon as a reasonable target for a Swiss-franc
funding package. One hundred-twenty-five million dollars equivalent
was to be repaid to the BIS with francs made available by the
Swiss National Bank against issuance of a Swiss franc-denominated
U. S. Treasury note ($100 million equivalent) and a $25 million
Treasury sale of gold. The remaining $50 million equivalent
repayment was to be made through a System sale of dollars against
Swiss francs to the Swiss National Bank which undertook to hold
such dollars on an outright basis, pending eventual sale for
Swiss Confederation requirements.
On March 6, Mr. MacLaury called Dr. Ikle of the Swiss
National Bank to settle the final terms of the package. Dr. Ikle,
while still ready to take $50 million into his position, pointed
out that if he bought dollars from the Federal Reserve at that
day's market rate of SF 4.3450 per dollar, the Swiss National
Bank would incur a loss of SF 1,500,000 (somewhat more than
$345,000) since the swap contract obligated the Swiss National
GEBALO FORD
-3-
Bank to sell a llars against Swiss francs at 4.1350, the rate
of the drawing (i.e., the transaction would involve a purchase
of $50 million at 4.3450 at a cost to the Swiss National Bank
of SF 217,250,000; the Swiss National Bank would receive on the
swap repaymer : only SF 215,750,000). Moreover, the loss to the
BNS would be exactly matched by a profit accruing to the Federal
Reserve.
Ordinarily, the System would expect to make a profit
on repayments of drawings since it draws and sells a foreign
currency when the currency is expensive in terms of dollars
(i.e., at its ceiling) and reacquires the currency and pays off
the drawing when the currency is inexpensive in terms of the
/
dollar.
However, System profits are normally at the expense of
the market", not the foreign central bank. The System usually
buy the needed currency in the market or, if the foreign central
bank is selling dollars in the market, directly from it at the
same rate. The problem in this case stemmed from the fact that
the System was buying the needed foreign currency directly from
the foreign central bank, not from the market, at a time when the
central bank was not selling dollars to the market.
1/ Between January 19 and March 4, System repayments of Swiss
franc drawings had resulted in profits of nearly $2.6 million.
GERALD FORD LIBRARY
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In my judgment, it seemed inappropriate that the Swiss
National Bank should incur a loss on a transaction involving a
temporary (and possibly permanent) increase in its holdings of
uncovered dollars. On March 6, 1968, I therefore recommended to
the Subcommittee of the FOMC that I be authorized to purchase
$50 million equivalent of Swiss francs at 4.3150, the rate on
the swap drawing, rather than at 4.3450, the market rate at the
time. The Subcommittee gave its unanimous approval for this
transaction.
LIBRAST GERALD ? FORD
CONFIDENTIAL (F.R.)
GERALD
LIBRARY
April 25, 1968
TO: Federal Open Market Committee
SUBJECT: Recent purchase of
Dutch guilders from the Netherlands
FROM: Charles A. Coombs
Bank at market rate plus commission
On April 11, I secured from the Subcommittee of the FOMC
approval to purchase from the Netherlands Bank some 46 million Dutch
guilders at the prevailing spot rate in Amsterdam plus a commission of
1/8 per cent. This memorandum sets forth the reason for this operation.
When conditions in the gold market were reaching crisis
proportions in March, it was deemed desirable that the impact of large
dollar flows across the exchanges be moderated, whenever appropriate,
through official U. S. sales of foreign exchange in the forward markets.
Accordingly, on March 11, the Federal Reserve Bank of New York, acting
for System and Treasury accounts combined, authorized the Netherlands Bank
to sell forward up to $50 million of Dutch guilders for delivery up to
three months; commitments were immediately incurred for April, May and
June deliveries (a total of $20.855 million each for System and Treasury
accounts).
As I pointed out to the Committee in my memorandum of March 27
on "Recent Purchase of Swiss francs at Rate other than Market Rate", the
System usually makes a profit on repayments of its foreign exchange
obligations inasmuch as it tends to incur such obligations when foreign
currencies are expensive in terms of the dollar and to acquire the
currencies needed to discharge its obligations after such currencies have
become relatively inexpensive in terms of the dollar. This profit is
realized at the expense of the market even when the exchange is being
purchased from the central bank, provided, of course, that the central
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bank sells dollars to the market at the same rate at which it sells
its currency to the System and in the same amounts.
On April 11, Mr. Sillem of the Netherlands Bank called
Mr. Bodner to say that the Netherlands Bank was ready to sell to us the
46 million guilders needed to liquidate official U. S. commitments
falling due April 17, 1968 ($12.84 million equivalent for System account
and an identical sum for Treasury account). However, in proposing to
accommodate the System (and Treasury) the Netherlands Bank found itself
in a position similar to that of the Swiss National Bank last month. In
effect, the Netherlands Bank had bought guilders forward from the System
and was now selling guilders spot to the System to enable the System to
meet the iginal sale contract. The original forward sale was done at
3.596975. The market spot rate that would have been applicable to the
System hase to cover the sale was 3.619375. To the extent that both
the forward purchase and spot sale were matched by transactions between
the Netherlands Bank and the market, the latter would suffer the "loss"--
i.e., the cost of forward cover. But to the extent that the Netherlands
Bank had to sell the spot dollars at rates lower than that at which it
bought dollars from the System, it had to take a loss.
In fact, the Netherlands Bank had been selling dollars gradually
in the market in the preceding few weeks to make room in its dollar
position to absorb these dollars from the System; those sales had been
made at rates for the dollar lower than that prevailing on the 11th and,
consequently, the purchase from the System would result in a loss to the
Netherlands Bank (which would not normally buy dollars at the then
prevailing rate). In order to offset this loss the Netherlands Bank
felt it necessary to charge a commission of 1/8% over the prevailing
3
spot rate, i.e., $32,000 on the full amount.
It seemed inappropriate that the Netherlands Bank should suffer
a loss in an operation undertaken in cooperation with the System--
especially since under the terms proposed by that bank the System and
Treasury would still be left with a net profit of some $63,000 each.
On April 11, I therefore recommended to the Subcommittee of the FOMC
that I be authorized to pay a commission of 1/8 per cent to the
Netherlands Bank to purchase for System account the Dutch guilders
necessary to pay off System forward commitments to the market maturing
April 17. The Subcommittee gave its unanimous approval for this
transaction.
December 10, 1968
To:
Federal Open Market Committee
Subject: Legality of special
arrangement with German
From: Mr. Hackley
Federal Bank.
At the November 26, 1968, meeting of the Federal Open Market
Committee, Mr. Coombs reported regarding a proposed arrangement between
the New York Reserve Bank and the German Federal Bank. The Committee
raised no objection to the proposed arrangement, but Counsel was asked
to consider its legality.
That afternoon, Mr. Robert Crowley of the New York Bank
informed me by telephone of the general nature of the proposed arrange-
ment and indicated that, since the arrangement was to be executed the
following morning, he hoped the requested legal opinion could be given
that afternoon or at least by 8 a.m. the following morning. He stated
that Mr. Guy and Mr. Sloane, General Counsel and Assistant General
Counsel of the Reserve Bank, had been consulted and that they saw no
legal problems. At my request, Mr. Crowley wired the following descrip-
tion of the proposed arrangement:
"We are selling marks on an outright basis to the market
for delivery in 3 months at a premium of 3 per cent per annum
based on the spot rate. We obtain the marks to meet our for-
ward commitment by drawing now on our swap line with the
Federal Bank at the spot rate. In order to give the Federal
Bank 50 per cent of the profit arising out of our sales at a
premium from the spot rate, we propose to sell the marks back
to the Federal Bank in 3 months at a differential rate. To
state this in actual terms: Yesterday we sold 252,900,000
marks forward at a rate of 25.31 for a dollar amount of
approximately $64 million. We will draw value tomorrow on
our SWED line the marks to cover the sale at 25.125, a dollar
amount of approximately $63 million 600 thousand. This leaves
a profit of approximately $400,000 which we would split with
the Federal Bank by selling them 3 months forward the same
amount of marks we had drawn, but at a rate of about 25.045
for a dollar value of $63 million 400 thousand. This results
in the System and the Federal Bank each getting a profit of
$200,000."
Following receipt of the above wire, I discussed the matter
with Mr. O'Connell, Deputy General Counsel to the Board, who had been
present at the Open Market Committee meeting. At 8 a.m. on November 27,
1968, Mr. O'Connell talked by telephone with Messrs. Arnold and Bodner
of the New York Bank and advised them that he and I concurred in the
opinion expressed by Messrs. Guy and Sloane that there appeared to be
no legal impediment to the proposed arrangement. However, he also
advised that we felt it possible that some question might be raised
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as to the justification for seeming to "give up" a $200,000 profit on
the transaction involved. In this connection, Mr. O'Connell suggested
that a "background" memorandum would be helpful.
It is understood that transactions with the German Federal
Bank were executed on November 27 and on following days in general
accordance with the description set forth above in Mr. Crowley's wire.
My understanding of the transaction is as follows: Apparently
with the purpose of implementing the decisions reached at Bonn during
the latter part of the week of November 18, the New York Reserve Bank
in New York and the German Federal Bank in Frankfurt sold marks to the
market in order to stimulate an outflow of funds from Germany. The
New York Bank on November 25 sold such marks in New York forward for
delivery in three months at a premium of 3 per cent per annum based
on the spot rate, i.e., at a forward exchange rate of 25.31 cents as
compared with the then market spot rate of 25.125 cents. The New York
Bank will receive at maturity approximately $64 million for the marks
thus sold. In order to be in a position to deliver the marks, the New
York Bank on November 27 drew the same amount of marks under its swap
line with the German Federal Bank at the spot rate of 25.125 cents,
paying therefor about $63.6 million. At this point, therefore, the
New York Bank had a potential profit of about $400,000. However, the
New York Bank agreed with the German Federal Bank to sell the same
amount of marks back to the latter after three months at a rate of
25.045 cents for approximately $63.4 million. Thus, the transaction
would result in a profit of about $200,000 for the German Federal Bank
and a reduction in the New York Bank's potential profit from $400,000
to $200,000.
It should be noted here that at some time in the future the
New York Bank will have to buy the necessary marks in the market in
order to pay back the marks drawn by it under its swap line with the
German Federal Bank. If the price it will have to pay should be less
than the spot rate on November 27, when it drew under its swap line,
its profit from the transaction will be increased; if the price it
will have to pay should be higher, its profit will be reduced. This
is why the preceding paragraph refers to the "potential" profit of the
New York Bank. It is understood that in either event the German Federal
Bank's profit of $200,000 would not be affected.
It should be noted also that, if the mark should be revalued
upward in the next three months, the New York Bank would be protected
against loss by a standard clause in its swap agreement with the German
Federal Bank. This was the primary reason for the form of the arrange-
ment in question.
Turning now to the legality of the arrangement, it appears
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that in essence the question is whether the New York Bank may properly
agree to sell forward to the German Federal Bank the amount of marks
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drawn under the swap line at an exchange rate that will have the effect
of reducing the profit that would otherwise inure to the New York Bank.
Since 1961, it has been settled (with the concurrence of the
U. S. Attorney General) that the New York Reserve Bank, under provisions
of the first paragraph of section 14 of the Federal Reserve Act, may buy
and sell foreign currencies in the open market, and that it may enter
into reciprocal deposit agreements with foreign banks under section 14(e)
of the Act. There is nothing in the law that restricts the exchange
rate at which foreign currencies may be bought and sold or that limits
the terms of agreements with foreign banks for reciprocal deposits or
drawings thereunder. Consequently, the law in no way limits the rate
at which the New York Bank may agree to sell marks forward to the German
Federal Bank.
The FOMC's Authorization for Foreign Currency Operations con-
tains the following provision:
"3. Unless otherwise expressly authorized by the
Committee, all transactions in foreign currencies under-
taken under paragraph 1(A) above shall be at prevailing
market rates and no attempt shall be made to establish
rates that appear to be out of line with underlying mar-
ket forces."
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Since this provision is applicable only to open market transactions
under paragraph 1(A), it does not apply to the rates at which trans-
actions are made under swap agreements. Thus, it appears that, at
least as far as the Committee's Authorization is concerned, there is
no inhibition against the setting of exchange rates on transactions
under swap agreements that may be different from prevailing market
rates.
Obviously, the making of profit is not the objective of any
Reserve Bank operations. Any profit that may result from the System's
foreign currency operations is only incidental. In the present instance,
it is assumed that any loss of potential profit to the System is regarded
as offset by the protection afforded the System under the swap agreement
with the German Federal Bank against possible revaluation of the mark
and particularly by the importance, in the interests of the United
States, of achieving the objectives of foreign currency operations as
set forth in the Foreign Currency Directive of the FOMC. Especially
relevant to the transactions in question is the objective stated in
paragraph 2.C of "avoiding disorderly conditions in exchange markets"
that may result from "responses to short-run increases in international
political tension" or from "market rumors of a character likely to
stimulate speculative transactions". Also relevant are the objectives
set forth in paragraph 4 of preventing "forward premiums or discounts
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from giving rise to disequilibrating movements of short-term funds" and
of minimizing "speculative disturbances".
To summarize, it is my opinion, as previously indicated, that
there is nothing in the law that prohibits the New York Reserve Bank
from agreeing to exchange rates on transactions under a swap agreement
that may have the effect of reducing potential profits that would other-
wise inure to the New York Bank. The major consideration is one of
policy, i.e., achieving the objectives of foreign currency operations
as described in the Committee's Foreign Currency Directive.
LIBRARY BERALD R. FOOM
December 17, 1970.
Chairman Burns:
The attached draft of memorandum
reflects my present views regarding the
legal implications of the proposed change
in swap procedures discussed in Mr. Bodner's
memorandum of December 8.
Howard H. Hackley
Attachment
FORD LIBRARY is GERALD
DRAFT
HHH:vcd
12/17/70
To:
Federal Open Market Committee
Subject: Legal implications of
Mr. Bodner's proposed modification
From: Mr. Hackley
of procedures under certain swap
arrangements.
In his memorandum to the Federal Open Market Committee of
December 8, 1970, Mr. David E. Bodner indicated that, in the course
of recent discussions with representatives of the Nederlandsche Bank
and the Banque Nationale de Belgique, they in effect complained of the
fact that the Federal Reserve has made profits on operations under their
swap arrangements at the expense of foregone profits on the part of their
central banks. As one means of meeting these complaints, Mr. Bodner's
memorandum proposes that, when it is necessary to liquidate swaps with
those banks through direct transactions with those banks, the System
might fix the rates of such transactions at the time of the initial
activation of the swap drawing. This would be accomplished "by entering
into a forward contract under which the System would purchase the currency
needed to liquidate the swap, the rate on that contract to be the market
rate then prevailing, i.e., the same rate used for the swap drawing itself."
The foreign currency operations of the Federal Reserve System
have been premised upon the authority of the Reserve Banks to "purchase
and sell in the open market, at home or abroad,
cable transfers"
(§ 14, qr 1) and, with the consent of the Board, to establish accounts
for and with foreign banks (§ 14(e)). A legal question that might be
raised with respect to Mr. Bodner's proposal is whether the proposed
forward purchase of foreign currencies from the central banks involved
at a rate other than the prevailing forward market rate would constitute
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a bona fide "open market" operation. The law itself does not expressly
limit the rates at which foreign currencies may be bought and sold; but
an "open market" transaction ordinarily means one in which commodities
are purchased and sold at a price determined by a free and competitive
market.
It might be argued that, even if the proposed forward purchase
of foreign currencies at a non-market rate may not be regarded as an
open market transaction, it may be legally supported on the ground that
it is an incidental step in the reconstitution of the System's foreign
currency balance with a foreign central bank and is therefore implicitly
embraced within the Reserve Banks' authority to establish accounts with
foreign banks. This argument, however, is not persuasive, since the
proposed forward purchase of the foreign currency directly from the
foreign bank obviously is intended only to enable the Reserve Bank to
acquire the amount of such foreign currency needed to fulfill its
commitment under another forward contract to sell the currency to the
foreign bank at the maturity of the drawing.
It appears that, since the inauguration of the System's
foreign currency operations in 1962, sales of foreign currency to
foreign banks on a forward basis have consistently been made at non-
market rates and that purchases of foreign currencies on a spot basis
have occasionally been made from foreign banks at non-market rates.
Moreover, the Committee's Authorization for System Foreign Currency
Operations has always recognized that "open market" purchases and
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sales of foreign currencies need not always be at prevailing market
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rates. Paragraph 3 of the Authorization provides:
"Unless otherwise expressly authorized by the Committee,
all. transactions in foreign currencies undertaken under para-
graph 1 (A) above shall be at prevailing market rates and no
attempt shall be made to establish rates that appear to be
out of line with underlying market forces."
It is understood that, since inauguration of Federal Reserve
foreign currency operations, it has been the practice, when the New York
Reserve Bank draws on a foreign central bank under a swap arrangement,
to sell at that time to the foreign bank for forward delivery on the
maturity date of the drawing such amount of the foreign currency as
will be needed to reconstitute the Reserve Bank's balance with that
bank at the maturity of the drawing. Such forward sales of foreign
currency are made at the same rate as the market spot rate at the
time of the drawing rather than the prevailing market forward rate
at that time. In addition, it is understood that, when a foreign
central bank draws on the New York Reserve Bank under an outstanding
swap arrangement, the foreign bank similarly enters into a forward
contract to sell to the Reserve Bank at a non-market rate the amount
of dollars necessary to liquidate the swap drawing at maturity. Thus,
in such instances the Reserve Bank has followed the practice of pur-
chasing dollars on a forward basis at a rate other than the prevailing
market forward rate.
In 1968, question was specifically raised as to the legality
of an arrangement with the German Federal Bank under which the Reserve
Bank would sell marks forward to that Bank at a rate that would result
in an even sharing with the German Bank of the profits made by the
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Reserve Bank through the forward sale of marks in the market at a premium
over the spot rate. In a memorandum of December 10, 1968, I expressed
the opinion that, since the law does not restrict the exchange rate at
which foreign currencies may be bought and sold or limit the terms of
reciprocal deposit agreements with foreign banks, there was no legal
impediment to the proposal for a forward sale of marks to the German
Bank at a non-market rate.
In 1962, it appears that, because Dutch guilders were available
in the market in only limited amounts, the New York Reserve Bank, with
the Committee's approval, in order to repay a swap drawing bought guilders
on a spot basis directly from the Netherlands Bank and paid that Bank a
fee or commission at a rate of one-eighth per cent, the result being a
sharing of Federal Reserve profits with the Netherlands Bank. Although
this transaction was approved by the Committee with the understanding
that it was not to be regarded as a precedent, it appears that in Decem-
ber 1965 the Committee approved a similar transaction with the Netherlands
Bank, recognizing that it was an exception to the rule that the System
deals at market rates. In April 1968, another such transaction with the
Netherlands Bank was approved by the Subcommittee of the FOMC. In March
1968, the Subcommittee of the FOMC approved a spot purchase of Swiss francs
from the Swiss National Bank at a rate other than the prevailing market
rate.
Obviously the present proposal for the forward purchase of a
foreign currency from a foreign central bank at a non-market rate would
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constitute an innovation in procedures and presumably involves policy
considerations. As a legal matter, however, it appears to be no different
in principle from transactions in which the System has engaged since 1962
under which forward contracts, as well as spot purchases, have been entered
into at non-market rates. The practices followed in the past have not
been subjected to legal attack; and, even though question might be raised
as to whether such transactions are true "open market" transactions, it
seems doubtful, in view of the history of the matter, that the proposal
now under consideration would be subject to such attack, particularly if,
as Mr. Bodner states, one of the consequences would be to guarantee the
System against "any risk of loss".
There is a question whether forward purchases of foreign currency
at non-market rates as proposed by Mr. Bodner would require the authoriza-
tion of the Committee. As previously indicated, paragraph 3 of the Foreign
Currency Authorization clearly states that any transaction in foreign
currencies undertaken under paragraph 1A of the Authorization must be at
prevailing market rates unless "expressly" authorized by the Committee.
Paragraph 1A authorizes the New York Reserve Bank to purchase and sell
foreign currencies "through spot or forward transactions on the open
market at home and abroad, including transactions
...
with foreign
monetary authorities
11
Paragraph 1D of the Authorization authorizes the Reserve Bank
to draw foreign currencies and to permit foreign banks to draw dollars
under reciprocal currency arrangements, without mention of rates of
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exchange; and it might be argued that purchase and sale transactions with
a foreign bank in connection with a drawing and repayment of a drawing by
the System under a swap arrangement are not subject to paragraph 3 of the
Authorization. In my memorandum of December 10, 1968, with respect to
the proposed forward sale of marks to the German Federal Bank at a non-
market rate, I expressed the view that paragraph 1A, and therefore 1D,
does not apply to transactions made under swap agreements. At the present
time, I am not so clear that this is the case. A better view might be that
paragraph 1D merely authorizes reciprocal deposit arrangements with foreign
banks and is not intended to exempt transactions under such arrangements
from paragraph 3. As has been noted, it appears that the Committee itself
in 1962 and 1965 felt that direct purchases of Dutch guilders from the
Netherlands Bank at a non-market rate required the authorization of the
Committee; and in 1968 the Subcommittee of the Committee approved purchases
of foreign currencies at non-market rates.
Even if a forward sale of a foreign currency to a foreign bank
in repayment of a swap drawing, made at a non-market rate, might be re-
garded as an incident to the reciprocal swap of deposits and as not
subject to paragraph 3 of the Authorization, such an immediate relation-
ship to the foreign currency deposit does not exist where the System
purchases the foreign currency directly from the foreign bank in order
to be in a position to liquidate the drawing.
For the reasons here indicated, it is my opinion that a forward
purchase of foreign currency at a non-market rate, as contemplated by
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Mr. Bodner's proposal, should be expressly authorized by the Committee.
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