comrummAL-^r.

IL )
U. S. Foreign Exchange Operations: Needs and Methods Introduction The current international position of the United States c l e a r l y demonstrates the advantages that would exist if the United States had at its disposal the r e s o u r c e s and techniques for undertaking foreign exchange operations a s a permanent feature of public policy. The present later*

. on c u r r e n c i e s , relatively free short-term capital markets, and the existence cti lle of large dollar holdings by foreigners (both public and private), has Co greatly enhanced the possibility of large recurring movements of capital Jr. , inof ety out of and into the Halted States. Such movements i short-term capital, art oc a s the Federal R e s e r v e System has learned from i t s experience of the y Ml S e a sn execution of aa appropriate dome stic past y e a r , eaa greatly complicate the e toric Ch His been faced by monetary authorimonetary policy. Similar problems have Mc ri u ties abroad, ia both m recent period aad ia e a r l i e r y e a r s . Solutions to liatheisso il to shifts ia capital flows aad their impact on national problems relating M eW th balances of payments, together with the relationship of each international romto domestic monetary p o l i c i e s are perhaps best approached through Fflows
national financial structure, characterised by convertibility of the major joint actioa by central banks. It i s no accident that individual European central banks have developed highly sophisticated techniques of operating in the foreign exchange market, aad have supplemented individual operations by joiat m e a s u r e s of both a formal aad aa informal, ad hoe, character. Monetary authorities ia the Plaited States, on the other hand, have not, aatU recently, operated ia the foreign exchange market, bat have

 2 -

maintained the stability (and primacy) of the dollar in the international currency structure by standing ready to buy gold from* and s e l l it to, foreign monetary authorities who either mm^4 or acquire dollars for exchange purposes. There can be little question that the intercon\ ertib lity of gold

and the dollar at a fixed price will have to remain the keystone of the international currency structure. At the s a m e time, foreign exchange

dealings by the United States monetary authorities, when judiciously

applied, can s e r v e to reduce capital flows, to dampen speculation, to

r. C J , be toymaintain confidence The basic purpose of such operations would rtinciet a in the dollar* Foreign exchange operationsM would,oof c o u r s e , not be a ey al S n substitute for other appropriate and basic ic es tor actions to maintain the integrity Ch His of the dollar* but would server as a highly useful and flexible addition to Mc ri m e a s u r e s . The continuation and expan* other monetary and fiscal policy m ou lia ia sshave recently bm&n executed respecting the s il sion of such operations W M he Germantmark could make the United States an important factor in the rom exchange market and thus help to enhance i t s bargaining position in any F
the United States gold stock. international approach to currency problems. Moreover, the holding of foreign currencies by the Waited States might strengthen confidence in such currencies and add to their usefulness in international trade and payments and hence contribute to an expansion of the movement of goods and s e r v i c e s among countries.

minimize potential rmm^T^m effects, and hence, to minimize the impact on

lec ol

. on ti

 3 I. Federal R e s e r v e Operations for Its Own Account

Previous Experience The Federal R e s e r v e Bask of Mew York has had a number of accounts abroad, of which three with nominal sum s remain at present. The three accounts are with the Bank of England, the Bank of France and the Bank of Canada. The r e a s o n s for opening the various accounts

differ somewhat but maintenance of the accounts over recent y e a r s has been largely a matter of courtesy.

Jr. in, Theyaccount at the t investments and the purchase and earmark of gold. art ocie Bank of France was opened in 1918 in order that we might establish a y Ml S e sn rica sight account for possible nee in transactions for the stabilization of e x he isto change rates. cC i H M r The BIS account was u m so opened in 1931 in the sum o f $ 1 0 million* In illia is to Chairman E c c l e s in September 1936 it was a letter from Mr. Harrison eW M stated th *The deposit was made for the s a m e purpose* essentially, that m o as Fr the c r e d i t s which the Federal R e s e r v e Banks extended to foreign
f

The account with the Bank of England was opened in 191? and s u b -

sequently need for a number of transactions involving exchange operations,

lle Co

n tio c

central banks during 1931. It w a s made in lion of our having to respond to requests for a s s i s t a n c e on behalf of various smaller European central banks. w It w a s then msod for the purchases of prime c o m m e r c i a l bills for our account and finally c l o s e d in 1946. An account with the Bank of Canada was opened in 1943, almost entirely as a courtesy m e a s n r o . Other accounts included those with Iran,

. 4

gyp t

aad

India which were opened in our name in order that the Treasury These latter accounts

would not be identified with certain transactions. have been c l o s e d . Authority

Authorization for the opening of accounts abroad i t contained in Section 14(e) of the Federal R e s e r v e Act. Such accounts are subject to

Regulation N and to other rules prescribed by the Board of Governors a s contained im the
M

Statement of Procedure With Respect to Foreign

Jr. in, et granted im a subject to decision by the FOMC. Basic authority was y art oci November 13 1936, resolution which authorized each Federal R e s e r v e y Ml S e Bank to "purchase and s e l l at home and iabroad cable transfers and Mils sn r ca he isto of exchange and bankers cC acceptances payable in foreign currency to M ri H the extent that such purchases and s a l e s a r e deemed n e c e s s a r y or m u lia isso il advisable im connection with the establishment, maintenance, operation* W M e reduction or discontinuance of accounts of Federal R e s e r v e i n c r eth , ase rom in foreign c o u n t r i e s - Since at least 1944, the resolution has B nks
Federal R e s e r v e Act, the investment of funds im the accounts are a l s o
t n

Relationships of Federal R e s e r v e Banks. M Under Section 12A of the

lle Co

ion ct

been reviewed regularly by the FOMC and, in each instance, the basic authority has not been rescinded. Finally, it should be noted that n due

from" accounts with foreign banks may be participated among other Federal R e s e r v e Banks; in the event of such participation, the operating bank make weekly r&pmtt* to the participating banks. Previous operation of the accounts has been carefully c i r c u m scribed. Thus, in a tetter dated May 8, 1944* from Mr. Sproul to

- 5 ~

Mr. Peyton (President, Minneapolis R e s e r v e Bank), it was stated that "The balances of the Bank of England, the Bank of France, and the BIS w e r e approved by the Beard of Governors a* or near the figures shown; they could not be increased (except for minor adjustments) without the prior approval of the Board of Governors. I f In substance, operations

by the Federal R e s e r v e Bank of Mew York are possible with the approval of the Board of Governors, the FOMC, and after participation has been offered to the other Federal R e s e r v e Banks. A. Proposal

r. C ,J y to purchase foreign exchange, either in the market or from the Treasury rtinciet Ma So in connection with the repayment of foreign official debt or a drawing on ey al n the International Monetary Fund* s u r c h a c s of exchange in the market e P toris e h would, in view of current p rCs u r e is the dollar, be quite limited; es c i H on M favorable balance-of-payments developments, however, would make such m sour s illia in ithe future. operations possible M W h the tIne c a s e of transactions with the Treasury, the foreign exchange rom be acquired by the R e s e r v e Bank against the credit of dollars to Fcould
One approach would be for the Federal R e s e r v e Bank of New York the T r e a s u r e s account with the Federal R e s e r v e Bank in a manner similar to the current practice with regard to the acquisition of gold certificates. The r e s e r v e effects of such operations would be similar

lec ol

. on ti

to those involved in purchases of gold certificates and would require coordination with System open market operations a s d i s c u s s e d below. Arrangements for the conduct of operations would have to be worked out

~ 6~ among the FOMC, the Board of Governors, the Federal R e s e r v e Bank of Mew Tork # and other participating R e s e r v e Banks. Some mi thm technical

arrangements meed by the System i the twenties and thirties might well be adaptable to current needs. In the immediate instance, for example,

the proposed German debt repayment of some $700 million could be made partially in dollars and partially in Deutsche marks (DM). The portion

received by the Treasury in DM could be sold immediately to the Federal R e s e r v e Bank against dollar credit to the Treasury. This procedure

Jr. time, furnishing foreign exchange r e s o u r c e s for tmarketty in, e operations and ar oci adding leverage to the conduct of United States international financial y Ml S e policy* The holdings of foreign money coulda sn ric then be need to operate in o he istwarranted, to "buy out s o m e p o r the exchange market, or, a s C occasion Mc wmmmt^m or to m e e t other objectives. ri H tion of the Bundesbank dollaru m o liaw eirsesto be conducted by the Federal R e s e r v e Bank il If operations e W M provision would have to be made for protection on its own account, some th against changes in the value of the c u r r e n c i e s held, at l e a s t bntil such rom F
dollars in connection with the payment of foreign debt while, at the same
? 9

might s e r v e to m e e t any requirement that the United States r e c e i v e

lle Co

ion ct

time a s rmmmrvmm had been accumulated.

This could be provided by an

agreement under which the United States would hold the Federal R e s e r v e Bank h a r m l e s s against l o s s arising out of devaluation of the foreign currency; appropriate legislation might be required in this connection. Federal R e s e r v e Coordination of Open Market Operations Federal WLm&mwvm operations in foreign exchange would require the c l o s e s t coordination with open market operations. Indeed, they might

- ? -

become an integral part of such operations and could, in some c i r c u m stances* add desirable flexibility to System policy. On other o c c a s i o n s ,

the r e s e r v e effects of foreign exchange transactions might have to be offset by other open market operations in order to implement the Federal Open Market Committee's policy. Such offsetting operations would not

reprmmmmt an undue complication of System open market operations since

. on for exchange operations by foreign monetary authorities, the timingi and t ec opera* l size of which have recently complicated the conduct of open ol market r. C c l o s e r tions. System operations in foreign exchange, by permitting ,J y coordination a s to timing and amounts, could have beneficial effects on rtinciet Ma So market. o v e r - a l l System operations in relation to the money y neev eiscaals s u m e , for example, a To illustrate the effect on r e s r r , es to Ch His equivalent to the Treasury. The German payment of $30 million in DM Mc ri m sale of these Deutsche m a r ku by the Treasury to the Federal fteserve lia isso s il the T r e a s u r y ' s balance at the R e s e r v e Bank and Bank would increase eW M th perhaps reduce the need for calls upon tax and loam accounts, or n e c e s s i rom Ftate redeposits in C banks* Expenditures (or redeposits) by the
H n

in most e a s e s the foreign exchange operations a r e likely to be alternatives

Treasury would, of course* add r^mmr^m dollars to m e m b e r bank accounts. Sales by the Federal R e s e r v e Bank of DM in the market for dollars would directly reduce member bank r e s e r v e balances* Even in a strictly interThus, if

central bank transaction important effects would be evident.

the f e d e r a l R e s e r v e Bank need DM 100 million to buy $25 million from the Deutsche Bundesbank, simply by utilizing book e n t r i e s for the transaction, the account of the Deutsche Bundesbank on the books of the R e s e r v e

~ 8 -

Bank would be reduced by $25 million; the Deutsche Bundesbank might have to e e l ! T r e a s u r y Mile from it* investment account in order to replen~ ish its deposit account with the R e s e r v e Bank. A sale of Treasury b i l l s

in the market would immediately affect bank xmmmxvBB* Clearly, all operations would require c l o s e and continuing coordination. Meeting Requirements of S e c r e c y and Anonymity It i s of fundamental importance that foreign exchange transactions generally be subject to public analysis only with some delay.

r. C J , in connection with of immediate publicity if foreign funds a r e acquired rtinciety Ma So official debt repayment. In all probability, the paying country a s well ey al the payment. Perhaps, n a s the United States will immediately announce es toric Ch H s however, no mention would need to ibe made of the fact that some part or Mc rtake the form of dollars. On the other i all of such repayments did not m sou illia is hand, if circumstances warranted, it might be useful to let it be known W M e currency repayment was made and that such funds w e r e availthat a local th able for use in the exchange market. rom F
devised. Some thoughts should first be given, however, to the question The immediate problem of publication involves the weekly s t a t e ment of the Federal Wimmmr^m Bank of New York. At present, foreign exchange holdings are included in "Other A s s e t s , " a category which includes in addition to such * due from1* accounts, loans and s e c u r i t i e s past due three months; a s s e t s acquired account (industrial loan and c l o s e d banks); reimbursable expenses and other items; accrued interest; premium on securities; overdrafts; deferred c h a r g e s ; currency and coin

therefore, n e c e s s a r y that published statements and data be appropriately

lec ol

It i s ,

. on ti

- 9 ~

exhibits, e t c .

Generally, on the weekly statement of the Mew York

WLnmmrvm Bank, "Other A s s e t s " i s a relatively email item ranging between $30 million and $100 million. (On the consolidated statement for the

System, the item generally ranges between $125 million and $400 million. > Substantial fluctuations in the item (say, $40 million or m e r e ) might lead to rather immediate questioning and c l o s e analysis would probably reflect

. osnt s " should be some way to avoid title adverse result. P o s s i b l y Other tA s e ci lle might be grouped into a broader category so that the net impact of foreign Co . exchange dealings would not he so readily evident. Jr ithe, statements of condiNet operations would a l s o be reflected in rt nciety MaRSsor v e Bulletin with a tion published a s of month*end in the Federal e e ey al n month delay and in the statement s earnings and expenses (under the e on toric Ch His i t e m s "other income" and "other expenses") reported in the February Mc ri u Bulletin covering the previous year* T h e s e data* however, a r e published iamisso l iland pose no problem. with some delay eW M h tWith respect to forward operations, d i s c l o s u r e could be avoided rom commitments w e r e c a r r i e d simply a s memorandum accounts and Fif such
foreign exchange dealings with perhaps embarrassing promptness.
l,

There

thus not be made available in any published data; before adopting such a method, it would be n e c e s s a r y to consider to what extent a contingent liability should be shown. Evaluation o l Fed Operations For Its Own Account A major advantage to be gained by Federal R e s e r v e operations on i t s own account i s the foreign exchange market a r i s e s from the fact that

the Federal R e s e r v e Bank cam create dollars while the Treasury i s r e stricted to the use of fuads held by it. This does not mean that there There

a r e no l i m i t s on what the Federal R e s e r v e could or should do.

a r e very practical limitations upon such operations, the m o r e important revolving about the need to m e e t other objectives of open market policy, current p r e s s u r e s in the exchange market, and/or the willing-

. on dollars {or "rice v e r s a ) . l a substance, the creation and destruction iof t ecexchange Federal R e s e r v e credit would provide vast r e s o u r c e s for foreign oll r. C operations and defense of the dollar. ,J y r inciet If the decision should 1M made to conductt Federal R e s e r v e operaMalor o tions of this kind, there would be a vitalyneed S sufficient latitude s o ne ical that operations could be conducted effectively and promptly under such es tor Ch His Governors and the FOMC deemed rules m&4 regulations a s the Board of Mc ri m u appropriate. Finally, there la a subsidiary problem of arranging our lia isso il weekly statements so a s to avoid or delay publication of thm details of our eW M th foreign exchange operations. rom F
n e s s of central banks to deal directly by providing local currency against

- 11 -

Be

Operations a s F i s c a l Agent for the T r e a s u r y

Federal R e s e r v e Sank of New York operations a s fiscal agent of the Treasury operating through the Stabilisation Fund involve am a r e a in which considerable experience has already been gained. G r o s e r e s o u r c e s of the Stabilization Fund amount to about $336 million. The composition of these r e s o u r c e s ami the amount that in

practice would be available a r e approximately a s follows: (In Millions of Dollars)

" "

New York 17. 94.7 26.5 18.0

% % ^ ^ ^ ^ / t.S 0 25. 0

Jr. in, ety art5 oci 3 2 M26*S ey 335. ? Total R e s o u r c e s n ical L e a s Argentine p e s o s currently held s 18. he istor 31?.? cC i H L e s s Stabilization Commitments (Argentina, Mexico, M Chile) 122. ^ m sour L e s s Working Balance foris 25. illia Fund Met Available R W u r c eM eso s 170. 7 the A? A sm January 31, 1961--little change since that date* ro of F
Dollar* Gold Securities Foreign Exefcaage B/ C/ ~

lle Co 171. 5

ion ct 'Total

94. 7 SI. 5 ' I f . <&>

31Se ?

An additional support order of $4$ million i s on hand--advance refunding.

Argentina can draw am additional $32 million, thus making total drawings $50 million. Mexico and Chile cam draw $75 million mmA $15 million, respectively. The above r e s o u r c e s provide s o m e latitude for operation, although

exchange purchases in the market face at present the obstacle of current p r e s s u r e on the dollar. Stabilisation Fund operations a r e provided for

* 12 under Section 10 of the Gold R e s e r v e Act which grants wide-ranging authority to the Secretary of the Treasury, with the approval of the President. Use

of the Stabilisation Fund, however, would ha limited to current rmmmutcm* since it appears that permanent additions to f or reductions in, a s s e t s of the Fund would require Congressional approval and appropriation. There

would, for example* s e e m to ha considerable obstacles toward enlarging the Stabilisation Fund by turning over to it, directly, official debt repayments from abroad. If, however, prepayments--particularly in local c u r r e n c i e s - -

r. C J Within the r e s o u r c e s , the holdings of (and n, operations ia> foreign rti ciety c u r r e n c i e s could he readily handled. Operations could be either in the spot Ma So ey al or forward market, although there would ha some real advantage in favor sn ric eoperations tend to afford maximum u s e o of forward transactions since Ch such ist Mecs o urri cH. Insofar a s forward contracts involved of the Stabilisation Fund's r m sou e s parallel operationsl with iforeign central banks it would be sufficient for the il ia s eW M Fund to hold a partial r e s e r v e adequate to c o v e r any possible l o s s in the event th of default. Thus, for example, if the Bundesbank w e r e to fail to honor its rom F
v

are contemplated, such prepayments might ha sufficiently attractive s o that

Congress would approve allocation of those xmm&mxmmmtothe Stabilisation Fund.

lec ol

. on ti

contracts with an under present arrangements* it would ha n e c e s s a r y far the

Fund actually to buy spot marks far delivery to meet the contract at maturity. The Fund would have to have dollars to pay for tike spot m a r k s hat it would immediately r e c e i v e dollars when it delivered the spot m a r k s to the purchaser under its forward contract. The possibility of l o s s would l i e in the difference

between the original contract price and the spot rata on the day the purchase would have to ha made. If the foreign central bank ware not under a parallel

 13 * commitment t then a partial reserve would need to be held to cover possible lotaes in buying apot currencies for shorter forward currencies) to meet contractual obligations. If parallel contracts were held, a reserve equal to 19 per cent of total obligations would seem desirable, subject to the proriso that the reserve would be adequate to cover total obligations undertaken lor any given day. If no parallel contract was involved, a rmwmrvm somewhat larger than 1 per cent would probably lie needed. Use of Fund

resources would then actually be expounded by ome multiple of the amount

r. C ,J y $1 billion* rtinciet Ma So Spot operations would undoubtedly be necessary on occasion. l ey ******* by the dollar equivalent. n Obviously such purchases would deplete the ica es tor Ch His Operations accordingly wouldcbe restricted to Hie amounts actually available M i in the Fund no noted above. m sour illia is Fund Resources Supplementing Stabilisation eW M Added foreign exchange resources might bo made available from a th drawing on the International Monetary Fund or foreign debt repayments if such rom F
aa available in the table above might cover forward contracts of up to, say, receipts were deposited in a special account of the Treasury which might be called the "Special Foreign Exchange Account, H with transactions being channeled through the Stabilisation Fund and with the Federal Reserve Bank of New York acting an agent. Such a procedure might be feasible ifas seems likely--the resources of the Stabilisation Fund could not readily bo supplemented by direct allocation*

currently available. Thus, under parallel contracts, the $179 million noted

lec ol

. on ti

 14 ~ Meeting Requirementsof Secrecy and Anonymity Insofar as Treasury statements are concerned, details of tike Stabilisation Fund are published {uarterly with a delay of five months or so. Published figures are fe* cnd-of-quartcr. Operations during the

period are also shown on a net basis in the detailed statements of income and expense contained la the Treasury Bulletin* Thus, there Mem* to be sufficient publication delay from the Treasury aide to meet requirements. With respect

to Stabilisation Fund assets in the form of securities or foreign exchange, information in available only from the above sources with the noted delay; these assets do not appear in data published by tibia Bank or the Board.

r. C ,J y Cur rest statements by this Bank and the Board, however, do r e t rtincDollar assets are a o ie flect Stabilisation Fund holdings of dollars and gold. M S y statement and tike System s cone included in "Other Deposits" on our weekly al sn ric he isto solidated statement. The over-all category includes a range o other items cC i H M each as nonmember bank clearing accounts, Regulation K reserves, deposit m sour accounts of the IADB, IBRJD IDA, XFC IMF, Q N No. 1, etc. There i some H illia is eW M nominal variation in tibia amount over weekly periods, but if net transactions th in foreign exchange were of a substantial nature (eay, $ million or more), rom F
f f #

lec ol

. on ti

fairly clone analysis of foreign exchange operations could be gained from

these figures. Again, some regrouping of categories or use of special accounts would be necessary. Hold holding s of the Stabilisation Fund may he obtained with about a one-month delay from the Federal Reserve Bulletin, which shows tike total gold stock and so-called Treasury stock. Moreover, a gold sale or purchase

~ 15 ~ would be reflected in earmarked gold, bat again with about a month to a eixweek delay (the February Federal Reserve Bulletin shews data for January 31, 1941). Published data may be illustrated as follows, bearing in mind that figures would be net, and hence any individual transaction might be offset. For illustration, assume that the Stabilisation Fund purchases DM SO million in the market with dollars currently in the account.

1. Effect on Fund's foreign exchange account: would not appear 1st

r. C , J y on our weekly 2. Fund's dollar account: the item Other deposits" rtinciet statement would show a decline, and the transaction also would be reflected Ma So l ey delay. in the Treasury's quarterly report, sn with a but e toric 3. Reserve accounts: would show an increase In member bank Ch His Mc ri Bank weekly statement. reserves on the Federal Reserve m sou lia thesonly real problem related to the foreign exchange il i Essentially, M e W would tie in our weekly statement which would show a position ththe Fund ol direct Impact on the Fund*s dollar holdings, a s reflected in the item 'Other rom F
data of the Treasury, with a six to eight-month delay.
M

Federal Reserve Bank or System data but would be reflected in the quarterly

lec ol

. on ti

Deposits* H In order to minimise immediate analysis ol operations over the short-run, it would be desirable to include a wider range of items in these

categories. However, operations could under present conditions be masked to some extent by careful supervision of the account and a selective nee of "swaps."

* 16 * III. Conclusion The approaches discussed above to foreign exchange dealings are suggested possibilities. Whatever the technique used, the United States will run some risk of changes in currency values. To have effective protection of the dollar, such risks--minimised by careful management-would seem a relatively small price to pay* Once a basic choice is made as between operations lor the account of the Federal Reserve Banks and

operations by the Reserve Bank for the Treasury a s fiscal agent* detailed investigation of coordinating techniques and the requirements of secrecy

Jr. in, ety in the way of speed and simplicity. However, Aero are distinct benefits art oci to be gained from Federal Reserve operations for its own account. Foreign y Ml S e exchange operations by central banks n considered a normal part of their s are rica hesaidtfor utilising resources that are not C H o activities* and there is much to bo is Mc cash position. i directly limited by a required ur m so illia is eW M th rom April 5, 1941 F

can be made. It may bo that fiscal agency operations offer some advantages

lle Co

ion ct