A History of the Federal Reserve, Volume 2 (77 page)

During the two-year transition period, the United States would treble its swap lines to $2.5 billion to purchase dollars other than those frozen by a multilateral standstill agreement. It would also increase forward exchange market operations to reduce the stock of dollars that private holders offered to their central banks.

The Treasury strongly opposed the program. Secretary “Dillon and [Undersecretary] Roosa contended that the steps they had already taken . . . — swap arrangements, offset agreements, the gold pool operation—were adequate to protect the U.S. dollar and gold supply” (Kennedy, 2001b, 388). They added that the agreement was not needed because most of the support it proposed had already been done (swaps, etc.). The main new element was a commitment to increase the IMF quotas, and this step was under way.

Ball replied, praising Roosa’s measures, but told the president, “These are all operations of very short-term” (ibid., 399). He wanted some agreement that required restraint, a type of standstill that limited the claims that foreigners could make and that prevented a run. The Treasury responded that any agreement of this kind would reduce confidence and stimulate what it wanted to prevent.

The idea of a standstill that restricted gold loss appealed to Kennedy. “We are going to be able to get tough about NATO expenditures and all the rest. So that’s what we want to do is to prevent a really major run over the next two years. Isn’t there any way we can get these countries to agree to hold dollars for this two year period?” (Kennedy, Oval Office tape recordings, tape 11, August 10, 1962, 11). Ball reinforced the argument. “It is only the part of prudence to try to move now towards getting a net under this tightrope on which the Treasury has been performing with such admirable dexterity” (ibid., 13).

Dillon and Roosa continued to argue that a formal agreement was unnecessary and could possibly create alarm that would cause a run on the dollar. Dillon accused Ball and the State Department of “reluctance to squarely tackle the more difficult but necessary job of obtaining a more adequate sharing of the burden of defense (quoted in Gavin and Mahan, undated, 25). Their main argument was that they could expand the length and size of quiet arrangements that countries had agreed upon. The advocates of a formal agreement argued the opposite case. Countries “have the suspicion that we’re playing off one against the other. . . . [I]t’s not the same thing to have done it one by one as it would be to discuss it all together” (Kennedy, Oval Office tape recordings, tape 11, August 10, 1962, 17).

Carl Kaysen, a member of the National Security Council, urged the Ball proposal in order to reduce “the burdens of running the world’s reserve system” (ibid., 19). In contrast to the French complaint that the United States gained great advantage from the dollar’s position as reserve currency, Kaysen emphasized only the burden. He did not explain what the burden was or compare it to the benefits. The burden that others talked about was the defense burden, the disproportionate share of NATO costs paid by the United States. This burden did not depend on the exchange rate system.

Paul Samuelson redirected the discussion by asking the Treasury participants if they would accept the proposal urged by Ball and Tobin if the Europeans proposed it. That appealed to the president more than to the Treasury. It spared him from admitting the weakness in the present international arrangements and gave the Europeans the opportunity to appear to lead. The only decision made was to meet the following week.

Almost a week later, August 16, 1962, Kennedy met with Martin to discuss gold and dollar problems and solicit Martin’s opinion on the BallTobin proposal. Martin opposed any attempt to get an international agreement to limit gold purchases. He made two principal arguments. First, the negotiations would suggest that the United States could not maintain convertibility into gold. This would reduce confidence and possibly precipitate a run. Second, the United States had made progress, so it did not need the type of “standstill” agreement that Ball and Tobin proposed.
²¹⁸

Kennedy expressed his concern vividly: “If everyone wants gold we’re all going to be ruined because there is not enough gold to go around. . . . I don’t know . . . whether it is impossible to work out an arrangement quickly enough that would be more satisfactory than the one we now have. . . . I am convinced the British, either the government or important influences in Britain, are trying to force us to devalue . . . because they think the pound is going to be devalued or because of their own gold” (Kennedy, Oval Office tape recordings, The Gold and Dollar Crisis, August 16, 1962, 2).

Martin objected. “I think it [a standstill] would be interpreted . . . as receivership on the part of the United States. . . . I think that under the leadership of your administration that it is amazing how much progress we have made” (ibid., 2).
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Then he added that there was not enough time to negotiate an agreement before the October IMF meeting.

218. Martin praised especially the president’s televised press conference in July that was shown via satellite. Kennedy had committed to maintain the dollar price of gold, and he added. “The United States can balance its balance of payments any day it wants if it wishes to withdraw its support of our defense expenditures overseas and our foreign aid” (Kennedy, 2001b, 467 n. 42).

219. Martin added two statements that reveal his thinking: “When inflation gets ahead
of you, it leads to deflation. That’s the only reason to fight inflation” (Kennedy, Oval Office tape recordings, The Gold and Dollars Crisis, August 16, 1962, 5). Next he accepted Federal Reserve responsibility for the depth of the Great Depression. “I really believed that we could solve everything—all the problems were on the Federal Reserve. I read the records over here today, and I still think they made some grievous mistakes” (ibid., 8). Martin made three additional statements about his firm beliefs. First, referring to Triffin, he said he did not believe there was a gold shortage. Second, “[Congressman] Henry Reuss is always trying to pin me down to 3 percent [money growth] . . . but I think there ought to be steady growth in the money supply.” Third, he told the president, “I neither support nor oppose a tax cut” (Kennedy, Oval Office tape recordings, The Gold and Dollar Crisis, August 16, 1962, 8–10).

Martin urged Kennedy to remove the 25 percent gold reserve behind the monetary base to make the full gold stock available. The timing was not appropriate because of the pressures on the dollar and the reaction of the Europeans. Martin then described how the Europeans had responded to the proposed expansion of the International Monetary Fund. “We were over there [Vienna] negotiating for the first time in my experience where the other people had the cards. . . . [T]he French, and the Italians, and the Germans were more or less jumping up and down and saying well now you’re in the soup and we’ll go along with you . . . but we want to tell you under what terms we would let you draw if you have to draw” (Kennedy, 2001b, 467).
²²⁰

The president decided to try Ball’s plan, if it could be done as a European proposal to the United States. He sent two officials to sound out European opinion. The initiative failed. Soon after, the Cuban missile crisis diverted attention from the dollar and international payments.

The experience recalls French policy after it restored convertibility in 1927–29. Once again, France resented the rules of a monetary standard that asked them to hold dollars or pounds in place of gold but allowed the United States to hold only gold reserves. In both periods, the French government was willing to either destroy the system or force the United States to follow more deflationary policies. This time, they had a stronger case because, as the Kennedy conversations show, the United States did not
have a long-term strategy in the event that its policy of low inflation, and short-term palliatives did not succeed.

220. Martin mentioned specifically that Britain, Belgium, and Spain wanted to hold all their reserves in gold. The French had gone from 65 to 75 percent gold. Germany held dollars; its reserves were about 70 percent in dollars. Martin repeated that many in Britain wanted to force the United States to devalue (Kennedy, 2001b, 464). Martin added: “This is a tough, rough mean gang. And there is very little altruism” (ibid., 469). About a year earlier, Jacques Rueff, an adviser to President de Gaulle published a series of letters on monetary issues in
Le
Monde.
He urged de Gaulle to end the dollar’s role as a reserve currency by invoking emergency powers to bypass Parliament and take measures to force devaluation of the dollar. He considered the gold exchange system “a prodigious collective error that allowed the United States to avoid the consequences of its economic profligacy” (quoted in Gavin and Mahan, undated, 8). Gavin and Mahan cite other examples of the difficulties and suspicions on both sides of the U.S.-French relationship. De Gaulle did not believe Kennedy would remove the U.S. troops because Europe would be lost and the U.S. weakened
, (ibid., 12).

This time, a few other countries joined France in trading surplus dollars for gold. France did not repeat its earlier error of deflating. Instead, it devalued in 1958 and both before and after ran a higher rate of inflation than the United States.
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As in earlier periods, efforts to coordinate policy failed. A few countries with payments surpluses, at the time notably Germany and Japan, held dollars. But many countries, especially France, did not. They drained gold and pushed the adjustment problem onto the United States.

SILVER

In February 1962, the administration proposed repeal of laws requiring the Treasury to purchase silver at 90.5 cents an ounce.
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The legislation also authorized the Federal Reserve to issue $1 Federal Reserve notes, and authorized the Treasury to retire silver certificates gradually. Federal Reserve officials had discussed silver many times but had not taken a firm stand. This time was different.

The new elements were the growing difference between Treasury silver purchases and sales and world production and demand for silver. World consumption had reached 300 million ounces, of which the United States used half for industrial use, jewelry, and coinage. Estimated world production remained below consumption by about 65 million ounces at the time, but the gap continued to rise (memo, Dillon to the president, Dillon papers, Box 33, November 27, 1961). Treasury sales from existing stocks filled the gap. From a peak of 174 million ounces in 1959, the Treasury’s stock of free silver had fallen to 22 million ounces. The rest of the Treasury’s stock, 1.7 billion ounces, served as the reserve behind silver certificates. Replacing the latter with Federal Reserve notes freed the silver reserve for coinage but obligated the Federal Reserve to use more of its shrinking gold stock as backing for the new Federal Reserve notes.

Secretary Dillon proposed to gradually replace $1 and $2 silver certificates and to suspend open market purchases and sales of silver.
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The
Board accepted the legislation as appropriate but, following objection by Governor Mills, did not request repeal of silver purchase laws. Mills’s main concerns were that the legislation required use of gold reserves and, by removing silver backing, reduced the backing for currency (Board Minutes, November 1, 1961, 7). The following year, Congress again considered the legislation. The Federal Reserve supported the change. At the time, the market price of silver had increased to a level that was above the government’s purchase price.

221. Rates of change of consumer prices for France are: 1955:1–1958:4, 5.37 percent; and 1958:4–1967:4, 3.54 percent. U.S. consumer prices rose on average 2.04 and 1.73 percent for the same periods. Among other countries—Canada, Italy, West Germany, Japan, and the U.K.—Canada, Italy, and Japan have modestly lower inflation rates in the first period. The United States has the lowest inflation in the second period.

222. See volume 1, chapter 6. Some of the silver purchase laws went back to the nineteenth century, but the government extended these laws in the 1930s. The proposed repeal affected only the silver purchase legislation enacted in 1934, 1939, and 1946. Silver certificates denominated $1, $2, $5, and $10 were outstanding in 1962.

223. The proposed legislation did not replace $2 silver certificates with Federal Reserve
notes because the law required the Treasury to maintain a certain level of notes. The $2 bills filled th
e requirement (Board Minutes, February 5, 1962, 4). The minutes do not explain why the Treasury did not seek to repeal the requirement.

Legislation
1962

Most of the legislation in 1962 of specific interest to the Federal Reserve concerned attempts by Congress or the administration to avoid expenditure increases by using credit subsidies in place of expenditures. The Board resisted or opposed legislation to establish a new government corporation to provide a secondary market for industrial mortgages, to permit the Department of Commerce to buy mortgages on industrial property in redevelopment areas, and to liberalize restrictions on financing multiple dwelling units by savings and loan associations.

Of greater moment was the proposal to permit national banks to underwrite revenue bonds. This was one of many steps taken in the early 1960s by the new Comptroller of the Currency, James Saxon, to expand national banks’ powers and remove Depression-era restrictions. Publicly, the Board questioned the advisability of the legislation (Board Minutes, August 28, 1962, 7). In fact, the Board divided on the issue. Mills strongly opposed. Martin recalled “the troubles of the 20s and early 30s” (ibid., 11). Mitchell, a former state finance official, favored use of revenue bonds and supported bank underwriting. Other governors were not enthusiastically pro or con.

In September, Congress transferred regulatory authority over trust departments of national banks from the Federal Reserve to the Office of the Comptroller. The Federal Reserve repealed regulation F relating to trusts on October 3 (Annual Report, 1962, 118).

A PLEASANT INTERLUDE

The two and one half years ending in mid-1965 are probably the best years under the Federal Reserve Act to that time and for many years to follow. Unlike the years 1922 to 1929, there were no intervening recessions. Although the period in the 1960s was much shorter, it was part of a long,
sustained expansion. And, unlike the 1920s, the expansion ended with an inflation, not a depression. Of special concern to the administration, the unemployment rate fell from 5.5 to 4.6 percent, the lowest rate since October 1957. The balance of payments deficit (official settlements) declined to a more sustainable level and became a short-lived surplus early in 1966.