A History of the Federal Reserve, Volume 2 (42 page)

Governor Balderston asked why foreign depositors should be paid more than domestic savers. Why not let foreigners buy Treasury bills if they wanted open market rates? Robert Roosa of the New York Reserve bank replied that about two-thirds of the $700 million dollars withdrawn from time deposits at New York banks had gone into government securities. He thought it desirable that the New York banks be allowed to compete, since New York was now the world’s banking market.

The following week, the Board again discussed maximum deposit interest rates with the Federal Advisory Council. The Council now agreed unanimously that the 3 percent ceiling rate should remain. New York wanted higher rates for foreign deposits, and the rest of the Council supported the increase.
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California banks faced intense competition from thrift institutions that offered rates that were unregulated at the time. Its representative voted to maintain the 3 percent ceiling because he believed that non-bank institutions would match any increase by commercial banks to maintain their advantage.

Some large banks pressed the Board to raise ceiling rates. The Board considered a formula that adjusted the ceiling rate to a smoothed average of market rates, but it made no decision. The principal reasons were reluctance to adopt a rule and the divisions within the banking system. The average rate had increased slightly but remained less than 2.5 percent (Board Minutes, May 17, 1960, 1–18).
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271. Martin asked Hayes whether he would favor an end to regulation of time deposit rates. Hayes replied that he found the “basic idea of regulating interest rates . . . repugnant” (Board Minutes, February 9, 1960, 3). He added that his opinion differed from some of the New York staff. One of the latter responded that there was “a need to protect some of them [banks] against such excesses” of competition (ibid., 3–4).

272. New York banks with branches overseas could pay a higher rate abroad, and most did. Robertson was skeptical that the Board could authorize higher rates for foreign deposits, but the Board’s counsel ruled later that the Board could set different rates based on location if there were differences in conditions (Board Minutes, February 25, 1960, 12). A higher rate in New York would attract domestic deposits also to the disadvantage of other banks.

273. Some of the Federal Advisory Council favored removing the prohibition on payment
of interest on demand deposits, but none favored raising the ceiling on time deposit rates (Board Minutes, May 17, 1960, 17).

Aggregate time and saving deposits continued to increase. Most banks did not experience the intense competition for deposits found in California and a few western states. Time and savings deposits at member banks rose at a 7.6 percent average rate from 1955 to 1960. Growth declined to 3.4 percent in 1959, as market rates rose, but increased again in 1960, when market rates fell. By the late 1950s, time and saving deposits approached 50 percent of demand deposits, in dollar value more than $50 billion. A 0.5 percentage point increase in ceiling rates, if generally effective, would have cost member banks more than $250 million in the aggregate, about 17 percent of net income for the year.
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In early June 1960, market interest rates fell precipitately, ending any remaining pressure for higher ceiling rates. The Board considered whether it should raise the ceiling to anticipate future increases. Board members discussed many suggestions but did nothing.
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Governor Robertson reopened the discussion in August by proposing a 6 percent ceiling (or its home state’s usury ceiling). He argued that the increase would remove the problem the next time that rates rose. Banks could no longer blame the System for failure to raise rates. His only concern was whether “this would be a wise move in a political year” (Board Minutes, August 19, 1960, 15). Governor King objected that raising the ceiling rate well above market rates was unwise. “Big banks would get bigger and small banks would be eliminated” (ibid., 17). The Board took no action. King offered no evidence, but the discussion ended, and the Board missed the opportunity to establish a policy of allowing banks to respond to market forces.

GOLD AND INTERNATIONAL PAYMENTS

At the time of the Treasury–Federal Reserve Accord, the United States held $22 billion of gold in total, more than 60 percent of the non-Soviet stock. If anyone thought about the possible conflict that could arise from the decisions to ratify the Bretton Woods Agreement and approve the Employment Act, I have not found that their views reached the Truman or
Eisenhower administrations, Congress, or the Federal Reserve.
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The concerns of 1944–45 were opposite. The United States held a disproportionate share of the world’s gold. A widely held belief claimed that the international system collapsed in the 1930s because of the maldistribution of gold and would work best if the U.S. lost gold to other countries. A major concern at the time was that the U.S. would return to the deflationary monetary and protectionist trade policies of the 1920s.
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274. Banks began to circumvent ceiling rates by compounding interest quarterly but paying interest monthly. Banks in the south absorbed exchange charges for non-par banks as a means of increasing the interest rate (Board Minutes, August 4, 1960, 17–20). Earlier, the Board had ruled against this practice. Costly rules encourage circumvention.

275. In June 1960, the Board agreed to permit the Bank for International Settlements in Switzerland (BIS) to set its interest rates without reference to regulation Q. The Bank remained “in conformity with the monetary policy of the central banks of the countries concerned.” The BIS regarded the New York Reserve bank as representative of the U.S. central bank, and New York had asked it in 1951 to follow regulation Q.

This concern soon vanished, replaced by early postwar concerns that growth of dollar balances would be positive but insufficient to finance growth of trade and payments. Higher U.S. productivity and more attractive goods were among the reasons given for expecting a “dollar shortage.” Marshall Plan assistance, Korean War expenditures abroad, and currency devaluation by Britain and France ended these issues. Symptomatic of the attitudes during this period was the official reference to the U.S. payments deficit as “net transfers of gold and dollars to the rest of the world” (Solomon, 1977, 19). The U.S. permitted countries to discriminate against U.S. exports and encouraged domestic businesses to invest abroad.

A political agenda guided these policy choices. The United States wanted to restore growth and economic stability in Western Europe and Japan. The cold war strengthened support for these objectives. Also important was the belief, supported by early postwar experience, that European countries would have difficulty competing against the United States for many years.

In the four years ending August 1949, the U.S. gold stock rose more than $4 billion, 20 percent of the August 1945 value, to reach its all-time peak. Table 2.7 shows the local peaks and troughs through the 1950s.

The U.S. gold stock declined slowly at first, but each peak and trough is below the preceding peak or trough. The table shows the major decline during the 1957–58 recession, when interest rates fell. The heavy gold outflow continued after interes
t rates rose. The proximate reason is that the balance on goods and services declined at the end of the 1950s, whilst U.S. overseas investment increased. The 1958 Report of the President’s Council of Economic Advisers expressed little concern about the U.S. international
payments position at the end of 1957. It mentions the French devaluation, Germany’s strong external position and its prepayment of long-term debt. Two years later, the report showed heightened concern but not alarm. “[C]ost and price disparities may now have developed to the advantage of these other countries” (Council of Economic Advisers, 1960, 31). Then, introducing a subject that would be revisited for many years, “[S]erious contractions [of exports] have been concentrated in a few items. Among these, automobiles and steel stand out, as they do in the rise in imports” (ibid., 31). Federal Reserve analysts also viewed the payments imbalance and gold outflow as arising mainly from loss of competitive position in selected industries. This is a partial view. The U.S. permitted foreigners to discriminate against the U.S. in trade, and it provided $33 billion in gifts and loans from 1946 through 1953, an amount equal to one-fourth of all U.S. exports (Solomon, 1977, 19–20).
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276. Robert Triffin was the principal exception. Although not directly concerned with the conflict in the text, Triffin was aware of some problems of sustaining the international system. I consider his arguments below.

277. Evidence of this concern is the time and energy that negotiators of the Bretton Woods Agreement spent on the “scarce currency clause” that applied penalties to the U.S. if it followed deflationary policies. The problem did not end there. As late as 1952, Sproul’s discussions with German officials showed continued concern about the “dollar shortage” and the importance of the United States moving toward freer trade (European trip, Folder 2, Sproul papers, October 9, 1952, 17).

The decline in the U.S. gold stock, the increase in dollar balances of foreign central banks and governments, and some exchange rate adjustments permitted Western European countries to restore current account convertibility for non-residents at the end of 1958.
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By that time, productivity abroad had improved, and a Common Market attracted investment; Europe and Japan began to close the gap in per capita income with the United States, a trend that ended in the 1990s.
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278. Discrimination took different forms including quotas on imports from the U.S. Intended to be temporary, they ended for developed countries in 1961. Total foreign aid from 1946 to 1952 came to $41.66 billion, $31 billion economic aid and $10.5 billion military aid. $13 billion was postwar relief (1946–48), the rest was Marshall Plan assistance (1949–52). Total exports averaged $16 billion at the time. An interesting sidelight is Sproul’s discussion in 1952 of combining current account convertibility and floating exchange rates. After discussions with European leaders, he called this “a practical near term possibility” (European trip, Folder 2, Sproul papers, October 9, 1952, 3).

279. Only Germany removed controls on capital transactions in 1959. In 1964, the Japanese yen became convertible for current account transactions. Earlier in the 1950s, Western European countries cleared bilateral balances through the European Payments Union.

280. German and Japanese export growth reached 40 percent and 35 percent per year
for 1950–52, then 18.6 percent and 10.8 percent in 1952–56. French and British exports rose more slowly.

Federal
Reserve
Actions,
1951–60

The policy of the U.S. government and the International Monetary Fund (IMF) was to maintain the gold price at $35 an ounce and, if possible, keep gold in central banks and official institutions and away from private owners. In June 1947, the IMF urged member countries to prevent gold sales at premium prices. It saw these sales as a threat to exchange rate stability. South Africa did not follow the IMF’s recommendations and sold gold at premium prices. By 1951, the IMF did not think itself able to prevent such sales, so it left the decision to member countries. Prodded by the IMF, U.S. policy from 1947 on discouraged participation by individuals, banks, and businesses in gold transactions (Board Minutes, November 15, 1956, 6).

The International Monetary Fund was “considered to be largely immobile” in dealing with European payments and postwar adjustment (European trip, folder 2, Sproul papers, October 9, 1952, 4). Slowly prewar institutions returned. In 1954, the London gold market reopened. South Africa agreed to sell all newly mined gold in that market (Board Minutes, April 23, 1954, 12). In 1954, the Treasury allowed U.S. banks and others to sell in the London market (ibid., December 8, 1954, 17), and the Board was willing to let gold mining companies sell gold at the world market price. Also, the Randall Commission proposed that the Federal Reserve resume its 1920s practice of lending dollars to foreign governments or central banks that desired to restore currency convertibility.
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At the time, Chairman Martin took “a dim view of the proposal” (Board Minutes, May 18, 1954, 3). The Board believed that loans to restore convertibility should be the responsibility of the IMF or the Treasury. It agreed to make short-term loans to meet seasonal or temporary demands of foreign central banks (Board Minutes, December 6,1955,7, Policy on Gold Loans). The term would not generally exceed three months, but the Board could renew the loan. The Federal Reserve used its prevailing discount rate as the interest rate.

The Bank for International Settlements (BIS) received its charter in February 1930. Its main role was to serve as a place for exchange of views
over reparations between the Federal Reserve and European central banks. Congress d
id not permit the New York Reserve bank to become a member, and the State Department ruled that New York officers could not serve on the board of directors. But New York participated as an observer and remained actively involved.
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From time to time, the Federal Reserve considered asking Congress to authorize membership, but it never did. Finally, in April 1955, the New York Reserve bank asked whether it could join the BIS. The Board referred the issue to the Treasury department. After almost four months, the Treasury replied that the Federal Reserve should maintain “informal contact” but should not become a member. The Board accepted the Treasury’s view (Board Minutes, August 11, 1955, 3).
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281. The New York bank made loans to central banks in the 1920s to help countries return to the gold standard. Governments borrowed in the market. At the time the loans were a contentious issue. In 1933, New York lost its exclusive role as agent for the System in international transactions. In the 1950s, the New York bank continued to lend gold and offer participations to the other reserve banks. The loans could not be made without the Board’s approval (Board Minutes, September 15, 1955, 8). To prevent New York from proceeding with discussion to a point that would make it difficult for the Board to differ from New York’s position, New York agreed to inform the Board about negotiations as they proceeded.