A History of the Federal Reserve, Volume 2 (90 page)

TOWARD INTERNATIONAL REFORM, 1963–65

President Johnson showed less interest in, and less concern about, the balance of payments and the gold loss than did his predecessor. There were fewer meetings and less discussion, but basic policies were similar. Domestic expansion had precedence. The risk of slowing economic expansion to reduce prices, output, and imports did not appeal to either administration. Both relied mainly on swap lines to alleviate the immediate pressure on the gold stock and specific controls on lending or spending abroad to prevent a crisis. Table 3.9 (above) lists some of the principal controls.

At the Federal Reserve, Martin, Hayes, Balderston, Daane, and a few others expressed much more concern, but Mitchell and Robertson were closer to the administration’s position. Most of the time all agreed that the problem was primarily not a monetary problem. FOMC members could agree that the first line of attack should be an administration program to reduce its own overseas spending for defense and foreign aid.
³³²
Maisel (1973, 224) estimated that during his years on the Board of Governors, international concerns influenced the policy decision in only eight out of more than one hundred directives. In three of the eight, policy remained less restrictive because of concerns for the pound, French franc, and other currencies.

Controls and restrictions relieved pressures temporarily, often by relatively large amounts. The interest equalization tax in July 1963 contributed to a decline in United States purchases of foreign securities, but bank loans to foreigners, not subject to the tax, rose. In February 1965, so-called voluntary restrictions on bank lending and foreign investment by U.S. corporations helped to reduce the officials settlements deficit to $1.3 billion.
However, foreign direct investment rose to a record level. Evidence suggested these expenditures would increase again in 1966 (Council of Economic Advisers, 1966, 166). The administration imposed a new type of “voluntary” restriction in December. Corporations investing abroad were asked to hold foreign investment and earnings retained abroad in 1966 to 90 percent of their 1962–64 average. Financial institutions were asked to keep their dollar outflow to the 1965 level in 1966 (ibid., 167). Most government spending abroad for foreign aid was either in-kind transfers or tied to purchases in the United States. Military spending abroad increased, however.

331. Johnson (1971, 342) wrote, “If I had to do it over again, I would have made the same decision to recommend a guns-and-butter budget to the Congress.” He recognized that the guns-and-butter budget created pressure for inflation, but he blamed Congress for inflation because it delayed enactment of the tax surcharge that he requested in 1967 (ibid.).

332. In October 1965, Governor Robertson sent a memo to administration officials proposing extension of the Interest Equalization Tax to most forms of capital outflow and earnings retained abroad. Governor Maisel (1973, 207) wrote that the international payments problems during his term in Washington (1965–72) “was never really faced up to properly.” He criticized the Federal Reserve also for supporting “unsound policies” and limiting its activity to swap arrangements (ibid., 207–8). He estimated the cost of slowing the economy as a 10 to 20 percent decline in output to close a $3 billion payments deficit (ibid., 213). Estimates of this kind were misleading. Once the economy recovered, the deficit would return unless prices changed. Maisel (ibid., , 24) estimated that a 5 to 8 percent change in relative wholesale prices would have closed the deficit.

The Council’s report described the response to existing restrictions as excellent. Secretary Fowler told President Johnson that the voluntary program “is a good in terms of what it accomplishes” (Oval Office Conversations, Johnson Library, November 28, 1965). Johnson was not persuaded. He described the new restrictions as raising “the target a little bit on something that already kind of failed anyway” (ibid.). He blamed the administration’s use of guideposts, especially against the aluminum industry, for souring relations with businessmen. He did not expect their cooperation. The Board’s staff also doubted the value of the restrictions (Stockwell, 1989, 36).

The most lasting effect on adjustment came through the relative price mechanism. Price stability in the United States and rising prices abroad were major factors reducing the U.S. current account deficit from slightly above zero in 1959 to $6 billion surplus in 1965. During the same years, the surplus of principal industrial countries other than the United States fell from $3.5 billion to $2.25 billion (Solomon, 1982, 51).
³³³

A report prepared for the Treasury by outside experts forecast a continued increase in the current account surplus. Based on p
rojections of (1) rising costs and prices in Europe relative to
the United States and (2) increased profitability of investment in the U.S. relative to Europe, the report concluded that the United States would go from a 1961 deficit of $850 million to a $2.7 billion surplus in 1968 in its “basic balance” (ibid., 57–58).
³³⁴
We cannot judge the projection’s accuracy because Vietnam War
spending and increased U.S. inflation reversed the rise in the current account surplus (see Chart 3.11 above). Many comments on the report expressed doubts about the optimistic projection. Few favored floating rates as a solution (Solomon, 1982, 66).
³³⁵

333. Politics had a major influence on discussions with the Europeans. They complained about imported inflation resulting from lower U.S. interest rates. The United States countered by complaining about underdeveloped European capital markets that induced them to borrow in the United States. The French, under President de Gaulle, disliked investment by U.S. corporations in Europe but could not get agreement on a policy to restrict it. Solomon (1982, 53–55) presents these positions.

334. The report defined the basic balance as the balance on goods and services and longterm capital both official and private. The report is usually called the “Brookings report.” The authors accepted the Triffin argument that world reserves would grow too slowly once the
United States achieved balance. Unlike Triffin, they considered greater exchange rate flexibility as an alternative solution.

The administration recognized that International Monetary Fund rules permitted devaluation of the dollar against gold in case of a structural deficit. Robert Roosa opposed this alternative. His successor on February 1, 1965, was Frederick W. Deming, president of the Minneapolis Federal Reserve Bank. Deming maintained most of Roosa’s policies, but he never developed a comprehensive policy. The 1964 Economic Report of the President (ibid., 139) explained that the devaluation option did not exist for the United States. “For a reserve currency country, this alternative is not available. For other major industrial countries, even occasional recourse to such adjustments would induce serious speculative capital movements, thereby accentuating imbalances.”
³³⁶
This ignored experience with devaluation of the pound, the other reserve currency.

Ruling exchange rate adjustment out of consideration shifted attention away from adjustment back toward a new multi-national reserve asset to replace the dollar and the pound and supplement gold for settling payments. Some of the French favored return to a full gold standard with any new reserve asset tied to gold. Eventually, they relented. In June 1965, Ackley reported the French finance minister, Valéry Giscard d’Estaing, as having said that “France does not support a return to the pure gold standard or any ‘appreciable’ rise in the price of gold.” He opposed any plan centered on the IMF (memo, Weekly Balance of Payments Report, June 19, 1965, Confidential Files, Box 49, LBJ Library).

The United States decided to press the issue. With Roosa retired, the president officially accepted the goal of establishing a multi-national cur
rency unit in June 1965 (Johnson, 1971, 315). Several European countries opposed the proposal, arguing correctly that the international system did not require “any further increase in the volume of unconditional or conditional liquidity” (Solomon, 1982, 83).
³³⁷

335. Ackley gave a different view. Sometime in the 1960s, he recognized that “the dollar was really overvalued and that sooner or later we were going to have to bite the bullet and devalue” (Hargrove and Morley, 1984, 264). He believed that it was a dangerous topic to broach because public awareness that government economists considered floating rates would bring a run on gold. He suggests that he discussed with President Johnson that devaluation “wasn’t really the end of the world” (ibid.). Most of the time, “we generally loyally supported the Treasury view about the various kinds of efforts that we made” (ibid., 265).

336. This statement overlooks earlier British devaluation of a reserve currency, devaluation of other European currencies, and revaluation by West Germany and the Netherlands. The argument is a restatement of Nurkse’s (1944) claim and ignores Friedman’s (1953) reconsideration and rejection of the role of speculation as a destabilizing element. Solomon (1982, 60) notes that few comments on the Brookings report advocated exchange rate adjustment.

LEGISLATION AND REGULATION, 1963–65

The System had several continuing regulatory issues during these years. Banks looked for new ways to bypass ceiling rates on deposits. The 1956 Bank Holding Company Act did not apply to one-bank holding companies. The Board tried several times to extend its authority over these companies. The Board had never found the rules for setting reserve requirement ratios satisfactory. It had considered revisions several times in the past without reaching agreement. Requiring non-member banks to meet he System’s reserve requirements was a perennial issue. With Congressman Patman as chairman of the House Banking Committee, hearings on legislation changing the System’s structure occurred more frequently. Other issues arose periodically.

In response to criticisms at the 1964 Patman hearings, the Board began quarterly meetings with academic economists. The participants varied with the choice of subject matter. Also in 1964, to commemorate its fiftieth anniversary, the Board sent the minutes of FOMC meetings from 1936 to 1960 and supporting documents to the National Archives, where they would be available for research.
³³⁸

Deposit
Insurance

In 1963 deposit insurance had a limit of $10,000 per account. The Board opposed a congressional proposal to raise the ceiling to $25,000 at its April 7, 1963, meeting and an administration proposal, as part of a banking bill, raising the limit to $15,000. In May, the Board agreed to support an increase to $12,500 (Board Minutes, May 15, 1963, 9), but it soon reversed its position and accepted the $15,000 limit. Congress did not approve the higher limit (as part of a comprehensive bill). When the issue arose again, the Board approved of the increase with little discussion.

337. International Monetary Fund (IMF) resources increased from $16 to $21 billion, but the G-10 governments did not permit the IMF to have a major role in the liquidity discussions (Solomon, 1982, 83).

338. In March 1964, President Johnson sent Secretary Dillon a note directing him to get the banking agencies to act in concert. Dillon sent the letter to the Comptroller, the FDIC, and the Federal Reserve, asking them to give the other agencies and the Treasury ten days advance notice of any rule change. Martin replied that the Federal Reserve had adopted that policy earlier (Board Records, March 2–5, 1964).

Reverse
Repurchase
Agreements

The open market desk used repurchase agreements to smooth the money market. The desk provided reserves by purchasing Treasury securities, mainly bills, under an agreement that permitted the member bank to repurchase the securities at the end of a specified, usually short, period. Sale and purchase prices were set at the start. The difference between them was the interest payment. In April 1963, the desk proposed reversing these transactions to absorb bank reserves when temporarily excessive.

The memo from the New York bank proposing reverse repurchase agreements talked about “sloppy” money markets and intra-month changes. Emphasis was much more on the federal funds rate, and less on free reserves, showing the evolution in operating procedures that occurred in the early 1960s.
³³⁹

The Board’s staff opposed on grounds that the transaction constituted a loan to the Federal Reserve from dealers that might be illegal and would be embarrassing. The interest rate might be considered a way of paying interest on the dealer’s demand deposit (memo, Peter Keir to Robert Holland, Board Records, December 13, 1963, 2). To circumvent these obstacles, the desk proposed to make two simultaneous but separate transactions—a cash sale to absorb reserves and a deferred purchase to reverse the transaction. These transactions did not differ from an open market sale and a deferred open market purchase. The FOMC subsequently permitted reverse repurchase agreements.

Banking
Legislation

Pressed by Comptroller of the Currency James Saxon, the administration proposed to liberalize several of the regulations and prohibitions adopted in the 1930s. The existing rules sought to restrict bank competition for deposits, reduce competition between types of institutions, for example banks and thrift institutions, or commercial and investment banks. Lawyers and bureaucrats make rules; markets learn to circumvent costly rules.
Comptroller Saxon supported and encouraged the national banks efforts at circumvention. The Federal Reserve generally opposed the changes.

339. The problem as seen by the desk occurred during and after a weekend. Weekend dates counted for reserve calculations, so excessive reserve positions on Friday counted for three of the seven days. The desk had difficulty absorbing the excess during the week to make the weekly average target. Reverse repurchase agreements would temporarily absorb reserves on Friday, smoothing the adjustment of reserves with lower variability of the funds rate. The desk claimed that both transactions had to be done simultaneously with the same bank or dealer. Otherwise, they claimed, interest rates would change noticeably (memo, Peter Keir to Robert Holland, Board Records, December 13, 1963, 5). The memo expressed skepticism about the argument and did not endorse the proposal.