A History of the Federal Reserve, Volume 2 (69 page)

Martin reopened the issue with the FOMC using a memo that Hackley prepared. The memo did not make a recommendation, but it leaned toward giving responsibility for foreign exchange operations to the Board. The Board “governing these operations would be more defensible from a legal standpoint” (FOMC Minutes, February 13, 1962, 63–64). President Wayne (Richmond) asked whether the law was so ambiguous that either could be responsible. Hackley replied that the Board and the FOMC would have separate roles; the Board would open accounts at foreign banks; the FOMC would execute transactions (ibid., 64). In Hayes’s absence, Trieber (New York) argued forcefully for FOMC control on the very reasonable grounds that: (1) the planned operations were open market operations, and (2) section 14 of the Federal Reserve Act explicitly mentioned open market operations in cable transfers, one of the proposed activities. The Board’s case rested on its authorized responsibility to open accounts with foreign central banks. The purpose of the accounts was to facilitate open market transactions.

The members divided into three groups. Most presidents favored resting responsibility in the FOMC. Several governors argued for the Board. Robertson, partly supported by Mitchell, argued forcefully that the only reason for Federal Reserve involvement was to augment the funds in the stabilization fund. The Treasury, he said, should ask Congress for the additional funds or for permission to involve the Federal Reserve.
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Martin supported Balderston’s position and decided the issue in favor of the FOMC. Balderston argued that domestic and international goals
are closely related. It would be a mistake to separate them. Martin agreed and added a statement that belied the alleged experimental nature of the proposal. “Ten years from now, foreign exchange operations will likely be as much a part of the System as are open market operations” (FOMC Minutes, February 13, 1962, 78).
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145. In 1934 the Exchange Stabilization Fund had $2 billion. It contributed $1.8 billion to subscribe to the IMF leaving $336 million in 1961. The Treasury’s analysis of its resources reported $222 million in ESF agreements with Latin American countries and spot holdings of foreign exchange of about $100 million used as “ backing for outstanding forward exchange contracts” of about $340 million (Treasury Memo of February 6, 1962, quoted in Hetzel, 1996, 27).

At the FOMC meeting Fulton (Cleveland) reopened a dormant issue by arguing that the Board was a public body, implying that the reserve banks were not. He favored letting the Board manage foreign exchange operations (FOMC Minutes, February 13, 1962, 75).

The Board provided for crisis response by authorizing the chairman and vice chairman of the Board and the vice chairman of the FOMC to instruct the special manager of foreign exchange operations (FOMC Minutes, February 13, 1962, 85). These operations were to remain consistent with the FOMC’s guidelines.

The February 13 FOMC meeting approved the operating rules and rules for coordinating with the Treasury and starting operations.
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To start operations, the Exchange Stabilization Fund sold the Federal Reserve an initial stock of currencies, mainly $7 million German marks and $1 million each of French and Swiss francs, Italian lire, British pounds, and Netherland guilders (ibid., 93). The initial limit on the account was $500 million, but that limit increased soon after. Within a decade the limit was $20 billion. The Treasury intended to continue its operations, but it now could expand using the Federal Reserve as a funding source without getting approval of its spending from Congress.
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The two agencies decided that they would make no division between Federal Reserve and Treasury operations while the operations remained “experimental.” The Federal Reserve did not
distinguish between sterilized and unsterilized intervention in its discussions, and only a few members mentioned a possible limit on Federal Reserve independence if the Treasury requested intervention.
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The Federal Reserve could initiate operations in currencies in which the Treasury had not dealt (FOMC Minutes, February 13, 1962, 56). The Treasury could veto any Federal Reserve operation, and the Federal Reserve could refuse to participate in any Treasury operation if it disapproved (Coombs, 1976, 72).

146. The forecast proved incorrect. The Board amended regulation N to recognize the changes. The FOMC approved Charles Coombs as special manager and decided not to publish its actions. Mitchell recorded reservations about the haziness of the relation to the Treasury.

Three weeks later, the staff discovered a memo dated November 20, 1936, dealing with the overlapping responsibilities of the Board and the FOMC in transactions with foreign banks. President Harrison (New York) had proposed that the FOMC “grant blanket authority to the Federal Reserve Banks to purchase and sell cable transfers, and bills of exchange, and bankers’ acceptances, payable in foreign currencies in connection with accounts of Federal Reserve Banks established in foreign countries with the approval of the Board of Governors” (FOMC Minutes, March 6, 1962, 15). The March 1962 meeting repealed the 1936 directive.

147. A four-person group from the Board and the Treasury worked out the draft. The Board sent Ralph Young and Charles A. Coombs, a vice president of the New York bank. The Treasury chose Robert H. Knight, Treasury general counsel, and Alan R. Holmes from Undersecretary Roosa’s staff and later manager of the System Open Market Account.

148. The Federal Reserve “would stand prepared to purchase currencies of these [the named] countries from the Treasury, either outright or under mutually satisfactory resale agreement, in the event that exchange market developments obliged the Fund to exhaust available resources” (FOMC Minutes, February 13, 1962, 93). The Treasury and the Federal Reserve agreed to get the approval of the National Advisory Council on International Monetary and Financial Policy. This was pro forma. The Council’s members included the Secretary of the Treasury, chairman of the Board of Governors, and several cabinet secretaries. It was established under Bretton Woods legislation.

Martin summarized the FOMC’s role. Its actions could serve as a “lubricating device . . . [O]perations should not be so large as to aim to correct a basic deficit, but they should be sufficient to give some assistance until fundamental problems could be corrected” (FOMC Minutes, February 13, 1962, 58). Coombs added that the operations would “buy time.”
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Governor King urged that they agree with the Treasury on risks that would limit the System’s obligation. Young responded that the Federal Reserve only had to buy from the ESF if it chose to do so. Robertson asked why, aside from the Federal Reserve’s “unlimited pocketbook,” two agencies were involved instead of one (ibid., 62). Coombs replied that there was no other reason. King urged again that they clarify how responsibilities would be divided. Martin ended the discussion by repeating that the rules would develop based on experience.

Two weeks later, on February 28, the FOMC approved by telephone vote a three-month $50 million swap operation with the Bank of France. The vote was nine to two, with King and Robertson voting against. Mitchell abstained because the members did not get enough information on the French economic and political situation.
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King and Robertson opposed because the operation was done so quickly they did not have time to decide.

Coombs used the March 6 meeting to get approval of swap operations with Switzerland and Britain. He said that these operations gave the market confidence that central banks would maintain their exchange rates. In effect the swap operations gave a foreign government a short-term guarantee against devaluation. This substituted for gold and temporarily removed dollars, thereby reducing foreign requests to exchange surplus dollars for gold. Martin recognized that the United States would continue to lose gold
for a year or more, but he believed swaps slowed the process and made it more orderly. Balderston added that the gold stock would fall to $15 billion from the current $16.7 billion (FOMC Minutes, March 6, 1962).

149. The members asked Coombs why the ESF engaged in forward market operations instead of spot. He replied that the Treasury did not have the funds to buy foreign currencies in the spot market and forward markets were thin, so small forward purchases would reduce the implied discount (FOMC Minutes, February 13, 1962, 55).

150. Coombs explained that the main risk of loss arose in case of revaluation. The ESF reduced this risk by getting agreements that countries would give two days notice of revaluations. Two days gave enough time to cover positions. Charles Coombs managed international intervention at the New York bank.

151. Young promised to supply such memos in advance of future transactions.

Coombs also asked for authority to purchase $25 million in marks from the ESF. Several members expressed concern about direct dealings with the Treasury. The law restricted direct purchase of Treasury securities, but Congress had approved limited purchases. Would Congress have to authorize direct foreign currency purchases from the ESF? Hackley said that purchases of foreign exchange were different. In this case, Treasury was not the issuer of the security. It was part of the market, so the purchase was an open market purchase. FOMC approved the $25 million purchase from the Treasury’s ESF.

The early swap agreements established the practice but were used only to gain experience. The first use of the swap arrangement to support the dollar came in June 1962. The Federal Reserve used $60 million in Belgian francs and Dutch guilders to buy excess dollar holdings at the two central banks. Soon after, the Federal Reserve used a $200 million swap with the Swiss National Bank to purchase dollars that accumulated following the stock market decline in June and the sharp fall in the Canadian dollar at about that time. Coombs (1976, 80–84) described his operations during these and several subsequent periods of market turbulence.
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The
General
Agreements
to
Borrow.
The Treasury negotiated an agreement with major industrial countries to supplement the IMF’s resources by permitting the IMF to borrow currencies and relend them to member countries. The agreement increased available resources by up to $6 billion in the event of a run against the dollar.
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At the time, deposits of foreign official institutions and commercial banks reached $5.6 billion (House Banking and Currency Committee, 1962, 96). Congress had to approve the new arrangement, submitted as an amendment to the Bretton Woods Agreement Act. The U.S. share was $2 billion.

152. Swaps assisted countries to adjust to disturbances. Coombs explained to Allan Sproul that countries used the dollar to make payments and settle balances. “If money moves from Italy to Switzerland, the Bank of England and the Bank of France wouldn’t care less, but we become automatically involved in a problem about what to do about the Swiss dollar surplus and the Italian dollar deficit . . . [T]he adjustment is often effected through debits and credits under our swap network” (Coombs to Sproul, Sproul papers, Correspondence, September 16, 1964).

153. At the time, the United States’ quota in the IMF was $4.1 billion. This gave the right to draw $1.7 billion automatically (one quarter of its quota plus an amount equal to the dollars drawn by other countries from the IMF, $600 million at the time). Total drawings could reach $6 billion, but that would require approval by the managing board. The managing director of the IMF would decide whether to use the General Agreements to Borrow before lending most of the IMF’s gold and convertible currencies other than dollars to the United States.

Martin used the opportunity to tell the Congress again about the decision to intervene and related that decision to the General Agreements to Borrow. The General Agreements permitted the United States and other countries to borrow for three to five years. Exchange rate intervention would have much shorter duration. He expected in time to ask for congressional legislation once “operating experience under existing authority has provided a clear guide as to the need for it” (ibid.,, 92). Thus, Martin acknowledged congressional authority but dismissed any current need for approval. And he insisted that the new arrangements gave the United States time to adjust its payments imbalance, but he recognized “they will not be substitutes for a basic cure” (ibid., 92).
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The Federal Reserve never asked for legislation.

Congressman Henry Reuss (Wisconsin) questioned Martin about his claim to have authority to engage in foreign exchange transactions. “You apparently assert the right to do this independently of the President or the Secretary of the Treasury, though you say something about consulting him occasionally. Much of the operation that you are doing under this seems to me to duplicate the foreign exchange stabilization operation that the Secretary of the Treasury has very properly undertaken pursuant to the Gold Reserve Act of 1934. . . . I consider this an usurpation of the powers of Congress. I don’t think you are authorized to do this at all, and you give us only the vaguest generalities about what kind of arrangements you are going to make” (ibid., 102). Martin replied that he would be willing to discuss the transactions in executive session at any time and that he proposed to summarize them in the Federal Reserve Bulletin and elsewhere (ibid., 102–3). Reuss later added: “I don’t think the Fed has the power to do the things that are in here” (ibid., 128).
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The
gold
pool.
Under the Bretton Woods Agreement, gold was the intended nominal anchor of the exchange rate system. Governments and central banks could obtain gold by redeeming currencies. U.S. citizens
could not hold gold legally or in the United States, or buy it at the Treasury, but, at the time, the law did not prohibit purchases abroad.

154. In the hearings Congressman Abraham Multer of New York asked Martin why he did not ask for repeal of the gold reserve requirements on the monetary base. That would make the entire gold stock available. Martin dodged diplomatically by saying that foreign central bankers had no doubts about the exchange rate after President Kennedy’s February 6 speech.

155. Congressman Reuss, joined by Congressmen Multer and Patman, continued to question Martin about the legal basis for the operation. Also, Reuss was very critical of the loose statement of purposes and procedures. “You propose to go off on . . . a frolic of your own involving unspecified sums without the slightest statutory guidance as to how you are going to make these, as you call them ‘cooperative arrangements’. . . . [Y]ou say . . . you are going to tell us what you think we ought to know, and no more” (House Committee on Banking and Currency, 1962, 140). He did not pursue the subject or insist on greater accountability.