A History of the Federal Reserve, Volume 2 (68 page)

136. Howard Hackley, the Board’s general counsel, wrote the opinion authorizing Federal Reserve participation in currency stabilization. Hackley’s opinion quoted Glass. “For a period of 6 years one of the Reserve banks has apparently given more attention to ‘stabilizing’ Europe and to making enormous loans to European institutions than it has given to stabilizing America. Accordingly, we have a provision in this bill asserting in somewhat plainer terms, the restraint the Federal Reserve supervisory authority here at Washington should exercise over the foreign and open market operations” (House Committee on Banking and Currency, 1962, 147). Glass’s reference was to the $200 million loan to the Bank of England in 1925, when Britain restored gold convertibility. The operation was very similar to the “swap” operations that the System undertook in the 1960s. Britain did not draw on the $200 million credit in the 1920s.

137. Hackley’s interpretation relied to a considerable extent on the interpretation of “wheresoever” in the text of section 14(e) of the Federal Reserve Act. The act authorized the Board of Governors “to open and maintain accounts in foreign countries, appoint correspondents, and establish agencies in such countries wheresoever it may be deemed best for the purpose of purchasing, selling, and collecting bills of exchange” (House Committee on Banking and Currency, 1962, 145). If the “wheresoever” clause limited the System to opening only for the purposes named in the clause that followed “wheresoever,” it would not permit the action Martin and the Treasury proposed. Note that the wording referred explicitly to bills of exchange reflecting the System’s “real bills” origins. Everyone agreed at the time that
the act did not permit purchases of foreign treasury bills. In 1980, Congress authorized the federal reserve banks to invest in foreign government securities.

Governor Robertson disagreed.
“Nowhere
in
the
Act
can
authority
be
found
for
the
stabilization
function
that
is
the
core
of
this
proposal”
(FOMC Minutes, December 5, 1961, 59; emphasis in the original). Further, Robertson insisted, Congress created the ESF for the express purpose of stabilizing the value of the dollar. If the Treasury needed additional funding, it should ask Congress to increase the size of the ESF.

Several members agreed to approve purchases, if Congress authorized the System to undertake these operations. Although Martin initially agreed, the Board did not ask Congress to legislate or to increase the size of the ESF. The Treasury did not want legislation.
¹³⁸
It feared opening public discussion at a time when the anticipated balance of payments report would show a large deficit. The Federal Reserve disliked opening broad questions of purpose and authority out of concern that Congress would include amendments that the System did not want (FOMC Minutes, January 9, 1962, 60–62). Martin discussed the Federal Reserve’s proposal with the chairmen of the two banking and commerce committees and after the decision to intervene, he included the following statement when he testified at the annual hearing on the Economic Report of the President:

The System is now prepared in principle and in accordance with its present statutory authority
[sic]
to consider holding for its own account varying amounts of foreign convertible currencies. Toward this end, we are now exploring 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. They would not, and could not, serve as substitutes for more basic action to correct the deficit in the country’s balance of payments. (Joint Economic Committee, 1962, 175)
¹³⁹

138. Congressional committees held hearings on Federal Reserve and Treasury operations without formally approving or disapproving. This is treated as evidence of implied consent, but that is mainly wishful thinking. No committee can bind Congress, and a failure to reject the operation is not the same as approval. Hackley’s memo remains as the legal basis of the Federal Reserve’s holding of foreign exchange by purchase or “warehousing,” i.e., a loan to the Treasury secured by foreign currency. To avoid conflict with provisions regarding loans to the Treasury, the Federal Reserve avoided the word “loan” when describing these operations, hence “warehousing.”

139. The only question asked about intervention at the hearing requested an explanation about how the operation would work (Joint Economic Committee, 1962, 181). By citing
“present statutory authority,” Martin was less than fully candid with the committee. Hayes mentioned the new program as a possibility in a speech to the New York Bankers Association on January 22, one day before Martin made his announcement to Congress. “We may need to consider, therefore, whether the problems in this area may not require that the Federal Reserve System also enter into foreign exchange operations” (Reprinted, House Committee on Banking and Currency, February 27, 1962, 85).

The Joint Economic Committee did not endorse the Federal Reserve’s decision. Its report took note of the Federal Reserve’s announcement and said: “We have doubts that the Federal Reserve should be entering into this field of activity. Responsibility for international incomes and financial policies resides with the President and the Secretary of the Treasury. . . . It would seem undesirable to have two competing and possibly conflicting agencies in this vital area.”

Rouse, Trieber, and Hayes stressed the need for prompt action. Martin too called the matter urgent and pressed the case by reminding the FOMC that the System was often accused of being obstructive. It had an opportunity to be constructive. Trieber argued that foreign central banks and governments engaged in these operations. He assumed that these operations were effective and ignored the distinction between sterilized and unsterilized intervention. If the System did not intervene also, the exchange value of the dollar would be “determined exclusively by the exchange authorities of foreign countries” (FOMC Minutes, September 12, 1961, 45). The main advantage of a stabilization policy was that the System could “defend the dollar . . . reduce the drain on gold and . . . promote confidence in the dollar” (ibid., 45).
¹⁴⁰
Authorization to undertake operations used similar language, “to help safeguard the value of the dollar in the foreign exchange markets.”

At a Board meeting on December 4, Martin expanded the role for foreign exchange intervention that he envisaged. “The System must be prepared to do something, and perhaps this would be more than just facing up to a speculative crisis. Perhaps the operation should be on a reasonably continuous basis” (Board Minutes, December 4, 1961, 11). In effect, the System had found a way to offset the provision in the Banking Act of 1933
that removed federal reserve banks, particularly New York, from a major role in currency operations. The System would soon authorize currency stabilization agreements between central banks.

140. At the time, the Treasury’s ESF account had $200 million in capital and $136 million in net earnings over its life (Schwartz 1997, 141). It acquired some gold after President Kennedy approved purchases at a flat $35 price (not $35.20 as before). Also in 1961, the Treasury proposed, and principal countries agreed, to expand the IMF’s ability to lend. The General Agreements to Borrow provided $6 billion as lines of credit to assist countries with balance of payments deficits (see text below). At the time, the IMF held only $1.5 billion in convertible currencies other than dollars, (ibid., 141) Also, the Treasury began issuing bonds denominated in foreign currencies and sold to foreign official institutions to reduce their dollar holdings. Austria, Belgium, Germany, Italy, Netherlands, and Switzerland purchased these “Roosa bonds.” The total issue between 1962 and 1974 was $4.67 billion (ibid., 143–44). Roosa bonds removed excess supplies of dollars by shifting
claims to a future date.

Governor Mills expressed immediate concern about Martin’s statement. “The operations would constitute a counter-speculation with all of the attendant risks. If the operations were not going to be held down to crisis situations, the temptation toward continuous operation would be endless and the plausible reasons for them would be equally endless . . . [W]hether the System would lose position vis-à-vis the Treasury, which he [Mills] thought quite probable, would have to be seen from experience” (ibid., 12). Governor Robertson was willing to intervene in a crisis, but not otherwise, and Governor Shephardson wondered whether intervention would delay much-needed reforms. Balderston and Mitchell supported Martin at least in part.

Robertson was not satisfied with the legal opinion. He challenged the rationale. The cause of the gold outflow was the excess stock of dollars held by foreigners. The proposal added additional dollars that would be used to buy foreign currencies. “They would merely camouflage the problem” (FOMC Minutes, December 5, 1961, 60). The proper course was to deal with the “cause rather than the effect” (ibid., 62).
¹⁴¹

Martin showed his usual patience. Although there was little doubt about the outcome, or his own preference, he did not cut off discussion or call for a vote until he wanted to tell Congress that the proposal had been approved. The vote came on January 23, 1962. Governor Balderston proposed that the operation should be an “experiment” that would be evaluated based on their experience. No one suggested evaluating the ten months of Treasury experience or the longer record of intervention by foreign central banks.
¹⁴²
Balderston’s motion also authorized conversations with the Treasury to coordinate operations with the Exchange Stabilization Fund and to establish guidelines for operations.

The FOMC approved the motion ten to two, with Robertson and Mitchell opposed.
¹⁴³
Six of the seven non-voting reserve bank presidents said
they supported the motion. President Bryan did not oppose the principle; he wanted to wait until the balance of payments had a surplus. Mitchell and Robertson wanted congressional authorization. Despite the Banking Act of 1933, which transferred foreign exchange decisions to the Board and away from New York, New York had regained a prominent role. Subject to Board approval, it could again negotiate with its counterparts abroad, as in the 1920s.

141. The Annual Report (1962, 56–57) described Mitchell’s objection as based on a desire for more analysis by outside experts, public discussion, and clarification of statutory authority. Robertson’s dissent “regarded the legality of the proposed operations . . . as questionable, inasmuch as the Federal Reserve Act provided no general and positive authorization” (ibid., 56). He favored increased appropriation for the ESF in the event of “dangerously disorderly foreign exchange markets, and undergirded by sound policies designed to eliminate unsustainable deficits in the U.S. balance of payments” (ibid., 57).

142. Later, the Treasury made its records available to the FOMC.

143. Coombs (1976, 74–75) gives main credit for designing the swap arrangement to Julien-Pierre Koszul of the Bank of France. He described a typical operation. The Federal Re
serve would credit the Bank of France’s deposit account for $50 million, advising the amount, the spot exchange rate, time to maturity, and other terms. At maturity, the Federal Reserve cancelled the deposit at the same exchange rate. This was an exchange rate guarantee. At the start, the Bank of France placed the dollar balance in a nontransferable three-month U.S. Treasury certificate of deposit. The Bank could redeem the certificate on two days notice. The Bank of France issued the franc equivalent of a $50 million deposit for the Federal Reserve and entered into a forward contract to reverse the deposit in 90 days. The United States could use the francs to purchase dollars that the Bank of France might otherwise have used to buy gold. Anna Schwartz points out that Coombs should have credited the Treasury staff which designed “swaps” with Mexico in 1936 that were used with other countries later.

The arrangements ended formally in 1998, after fifteen years of disuse. After consultation with foreign banks, the FOMC voted to allow the arrangements to lapse (FOMC Minutes, November 17, 1998).

Who
intervenes?
FOMC approval suggests the Board regarded the FOMC as the proper agency for approving purchases and sales of foreign exchange. They were a type of open market operation. In fact, several Board members argued that the FOMC members did not have much knowledge of international finance and that decisions would often have to be made without time for a meeting. They preferred to leave decisions to a small knowledgeable group.

The Board’s general counsel (Hackley) noted that the operations would be like open market operations, mainly purchases and sales of cable transfers, hence under FOMC jurisdiction. Section 14e of the Federal Reserve Act gave the Board the right to open accounts with and for foreign central banks, and section 14g authorized the Board to supervise all transactions (Board Minutes, February 8, 1962, 6–7, memo, Hackley to Board).

Three facts settled the issue. First, the New York bank managed Treasury operations as fiscal agent of the Treasury.
¹⁴⁴
It would be odd to establish a separate operation. Second, the FOMC determined open market operations in securities. Although several governors remained reluctant,
the Board decided after much discussion to authorize the FOMC to supervise transactions with foreign accounts and amended regulation N to that effect. Only Governor Robertson voted against the authorization because he opposed foreign exchange transactions (Annual Report, 1962, 56–57). Third, once the Board accepted that foreign exchange transactions were a type of open market operation, members recalled that they had opposed an Executive Committee arrangement for government securities operations and did not wish to revert to the former arrangement for foreign exchange operations.

144. Chairman Martin referred to this arrangement as a long-standing problem because the Board did not supervise the operations. This is a peculiar argument. New York had served since World War I as fiscal agent for the Treasury without Board supervision. Martin was consistent. He described New York’s role as fiscal agent for the Treasury as “a defect and a matter of concern” (FOMC Minutes, February 13, 1962, 65). It set New York apart from the rest of the System; “it was part of a broad problem, involving difficult questions of relationships within the Syst
em” (ibid., 65).