The Fed’s Novel Idea

As chairman of the Fed, William McChesney Martin believed that his institution was the ideal candidate to act in international currency markets to address the threats to the dollar. As he put it, it was the only actor that could "undertake the task without new legislation and the inevitable horse-trading that went with it.”[1] Due to its political independence, the Fed was more nimble, more flexible in this realm than any other US institution. Martin proposed a novel solution to the threats posed by the gold drain and a potential speculative attack: the central bank currency swap. These deals would enable the Fed to "swap” dollars for the currency of a foreign partner for a prearranged period of time. Thus, they would give the United States access to foreign exchange much more swiftly than the IMF, and without conditionality. They could be used to "counter speculative attacks on the dollar” and "to avoid unnecessary U.S. Treasury gold losses resulting from rapid accumulation of excess dollar balances by foreign monetary authorities.”[2] In other words, the foreign exchange the United States would acquire via swap activation could be used in two ways. First, it could intervene in foreign exchange markets by buying dollars being sold by private holders, thereby warding off a speculative attack on the currency. Second, and most important, it could sop up dollars being held by foreign central banks in excess of what they were willing to hold, thereby preventing conversions at the gold window.

The United States negotiated the first swap with the French central bank on March 1, 1962—a full eight months before Congress approved the GAB. The first agreement was essentially a pilot program. It was quite small at only $50 million, and the agreement expired in a short three months. Nonetheless, the sheer monetary magic of the agreement was not lost on Charles Coombs, then the vice president of the Federal

Reserve Bank of New York, who negotiated the swap line with the Bank of France. As he put it, "As central banks endowed with the privilege of creating money, the Federal Reserve and the Bank of France thus produced out of thin air ... an increase of $100 million of international reserves.”[3] The ease with which the United States and France reached a deal encouraged Martin that the agreement with France could be duplicated with any number of partner central banks, thereby knitting together an informal lending network that would give the United States access to short-term financing denominated in the important currencies of Europe as well as Canada and Japan. Although Martin did not have to seek the approval of Congress to implement the swap deals, he did have to convince his fellow members of the Federal Reserve Board of Governors that the program should be expanded.[4] Some members were skeptical that the swap lines would be effective at protecting the dollar and advocated for a more classical approach to adjustment. Governor Robertson, speaking on behalf of a number of other governors and Fed staff, argued, "There are no gimmicks by which the position of the dollar can be maintained in the world. It would be unwise to resort to devices designed to hide the real problems. The United States must practice what it has long preached about the need for monetary and fiscal discipline.”[5] Moreover, many skeptical members of the board felt that the Treasury, not the central bank, should manage the swap program.

At this time, Treasury was using its own special cache of foreign currencies that it held in the Exchange Stabilization Fund (ESF) to make forward purchases of dollars in exchange markets. These transactions had a similar structure to the Fed’s swap arrangements. However, the limited resources of the ESF constrained the Treasury. The Fed had the ability to quickly increase the size and number of its swap arrangements almost at will—a distinct institutional advantage that the central bank had over the Treasury. Consequently, the Treasury’s Undersecretary for Monetary Affairs Robert Roosa wrote to the Federal Reserve Board informing the governors that, in the face of a crisis, "only the central bank can make the prompt, smooth

Table 3.2 FEDERAL RESERVE RECIPROCAL CURRENCY SWAP ARRANGEMENTS, 1962-1969 (US DOLLARS, MILLIONS)

Partner

1962

1963

1964

1965

1966

1967

1968

1969

Austria

50

50

50

50

100

100

100

200

Belgium

50

50

100

100

150

225

225

500

Canada

250

250

250

250

500

750

1,000

1,000

UK

50

500

750

750

1,350

1,500

2,000

2,000

France

50

100

100

100

100

100

1,000

1,000

Germany

50

250

250

250

400

750

1,000

1,000

Italy

50

250

250

450

600

750

1,000

1,000

Netherlands

50

100

100

100

150

225

400

300

Switzerland

100

100

50

50

150

350

550

550

BIS

100

150

300

300

400

1,000

1,600

1,600

Japan

150

150

250

450

750

1,000

1,000

Sweden

50

50

50

100

200

250

250

Denmark

100

100

200

Mexico

130

130

130

Norway

100

100

200

Total

900

2,050

2,350

2,800

4,500

7,080

10,505

10,980

adjustments that are called for.”40 In light of Roosa’s letter, the board quickly reversed its position and unanimously supported the program. Martin did not waste any time expanding the program. By the end of 1962, the Fed had negotiated a total often swap lines totaling $900 million—and that was just the beginning. Over the course of the decade, the Fed’s swap program grew to include 13 partner central banks as well as the Bank for International Settlements (BIS) and had expanded to a sizable total of $11 billion. Table 3.2 presents the growth of the swap program from its inception through 1969.41 The totals represent the size of each swap agreement at the end of each year. Totals in bold represent new arrangements; totals in italics represent a change in the size of the swap from the previous year.

  • [1] Bremner 2004, p. 167.
  • [2] Rainoni 1973, pp. 551-552.
  • [3] Coombs 1976, p. 76. Coombs cites an increase of $100 million in reserves because bothparties in the swap gain an increase in their reserves of $50 million.
  • [4] That is not to say the Fed did not face criticism from Congress. Indeed, some members felt the central bank had overreached with this move. For instance, one representativeexpressed his dissatisfaction with Martin, saying, "To me this is a tremendous power youhave taken upon yourself, and I must serve notice on you right now that I consider this anusurpation of the power of Congress. I don’t think you are authorized to do this at all, andyou give us only the vaguest generalities about what kind of arrangements you are going tomake with foreign Central Banks” (US House 1962, p. 91).
  • [5] FOMC 1961a, p. 71.
 
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