147. Memorandum From the President’s Special Assistant (Rostow) to President
Johnson1
Washington, October 19, 1967, 7:05
p.m.
SUBJECT
- Contingency Support For Sterling
At Tab A is Joe Fowler’s memo recommending an
increase of $100 million in the funds he has available for market
operations to support sterling.
What it comes down to is this.
Today’s increase in the discount rate is part of the last ditch British
effort to hold the sterling rate. As you know, they moved strongly last
year to support the pound: they deflated their economy, cut down foreign
commitments and borrowed heavily abroad.
The program worked well through the first quarter of this year. They were
able to pay off more than $1 billion in debt. Then they ran into bad
luck:
- —disappointing exports, largely because of the recession on
the continent;
- —the Middle East crisis and the closure of the Canal;
- —rising interest rates elsewhere while theirs were going
down.
They began to lose reserves and had to draw heavily on their line of
short term credits.
The increase in the bank rate is designed to draw funds back to London.
The market’s initial reaction was slightly disappointing because some
expected a higher increase in the rate. But sterling is holding steady
because of support operations.
Through selective and carefully timed actions, we have operated
successfully in the market in the past to keep the rate from worsening
on bad news or to strengthen it on good news. We do so at our own
discretion but in cooperation with the British.
We now have $160 million available for this purpose. Fowler recommends that you authorize
him to make $100 million more available out of the Exchange
Stabilization Fund. This would give the necessary leeway to have a
maximum impact on the market—either to continue defensive operations or
to take advantage of favorable opportunities.
These funds are guaranteed against loss from devaluation. There is no
balance of payments effect. If the funds are used, it would in effect
amount to an increase in our lending to the U.K.
This is a contingency investment that could be used very effectively to
support sterling. I believe Fowler’s proposal makes sense. Deming, Okun, Daane and
Fried who have gone into it
carefully concur in the recommendation.
Your decision is needed as soon as possible so that our people in the
exchange market will know how much ammunition they have and plan their
operations accordingly from tomorrow on.
[Page 421]
Attachment
Washington, October 19,
1967.
Memorandum From Secretary of the Treasury
Fowler to President
Johnson3
SUBJECT
- Additional Assistance to the U.
K. in Support of Sterling
- 1.
-
The austerity program imposed by the British last year
brought sterling out of its summer crisis and very
considerable gains were made in restoring British reserves
and repaying short-term credits. This favorable picture
prevailed through the fourth quarter of last year and into
April of 1967. The British predicted a sizable balance of
payments surplus for the year.
A sharp reversal took place in May, following poor April
trade figures, accentuated by the Mid-East crisis. The
British reserves suffered from some movement of Mid-East
funds accompanied by other speculative flight from sterling
and more fundamentally due to closure of the Suez canal and
related aspects of the Mid-East crisis. In addition, the
hoped for resurgence in U. K.
exports did not take place, due in large part to the
stagnation in Germany and slow downs elsewhere, including
the U.S. in the early part of the year. Finally, interest
arbitrage relationships were turned against the British as
interest rates in the United States rose.
As a result, the British again find themselves with reserves
depleted and large debts on their short-term lines of
credit.
Their reserves at the end of September stood at $2,733
million, down $425 million from a year earlier and
short-term credits drawn at $2,072 million, up $250 million
from a year earlier. This $2.1 billion of credits drawn is
out of established short-term lines totaling $2,690 million
leaving about $620 million remaining. Of the $2,690 million
in credit lines, $1,750 million have been extended by the
United States and the balance of $940 million by other,
largely European, countries. The worsening of the short-term
credit position has to a large extent been offset by
reestablishment of medium-term facilities with the
International Monetary Fund, but these latter are not as
readily available and publicity surrounding an IMF drawing could be
counterproductive.
At present the United States has two credit lines, one a swap
line by the Federal Reserve amounting to $1,350 million of
which $800 million is
[Page 422]
drawn and a $400 million agreement
shared $200 million by the Federal Reserve and $200 million
by the Treasury Exchange Stabilization Fund.4 Under this latter agreement the U.S.
extends support by purchasing sterling generally in the
market, subject to an exchange guarantee granted by the
British. There is no fixed maturity at which the sterling
will be resold to the Bank of England or the market. The
Exchange Stabilization Fund also extends, on occasion,
overnight assistance at month end.
- 2.
-
The drain on the British position in the past few months,
after the Mid-East crisis settled down, seems to be largely
related to the fact that interest rates elsewhere,
particularly in the Euro-dollar market, are more attractive
than rates on sterling investments when the cost of forward
cover is taken into account. In addition, their trade
figures have not been a cause of encouragement. Given the
other problems of sterling, this drain is unsustainable. The
increase today in the Bank of England rate of 1/2 percent is
designed to reestablish the interest relationship which
existed earlier. It may well prove to be not enough and
another 1/2 percent increase could be around the corner.
In response to an inquiry by the Chancellor of the Exchequer,
I have indicated the United States would not stand in the
way of or retaliate to such a move. We could not, of course,
make any promise as to the general trend of our own rates.
The Bank of England had moved its rate down by 1–1/2 percent
to 5–1/2 percent earlier this year (1/2 percent each in
January, March and May). The United States reduced its rate
by 1/2 percent in April.
- 3.
- We wish to take advantage of what may be a favorable
psychological moment to assist in a strengthening of the
exchange rate for the pound sterling or at the least to lend
sufficient support to avoid a worsening of the outlook. To this
end we would propose to engage in market operations by buying
guaranteed sterling under the aforementioned $400 million
agreement of September 1965.
- 4.
-
With your approval, we agreed to extend the further $400
million assistance in September 1965. At that time we
succeeded in obtaining additional pledges of assistance,
known as the Basle agreement, from the European central
banks. This is the present credit line of $690 million of
which the British have now used $540 million.
A further credit package in the amount of $300 million, of
which a group of foreign central banks would supply $275
million, is being currently discussed to assist the U.K. to make a repayment due to
the International Monetary Fund this December. It is not
sure as yet, however, whether this additional credit will
materialize. Therefore additional assistance by the United
States may not be matched by others.
- 5.
- In connection with any current market operations, it would be
helpful to have some more ammunition available now to reinforce
their position. At present the Exchange Stabilization Fund has
only $50 million left unused from its pledge of $200 million
under the September 1965 agreement. The Federal Reserve has $110
million left but, as noted, already has undertaken assistance of
$800 million under its swap line.
- 6.
-
Following the weekend developments, I convened a meeting
Tuesday morning5 of the ad hoc group we normally call on to
consider the U.K. problems
and our role in dealing with them. It included, in addition
to Treasury personnel, Mr. Fried of your staff, Chairman Martin and Governor
Daane of the
Federal Reserve Board, Mr. Okun of the Council of Economic Advisers,
Assistant Secretary Solomon of the State Department, and Mr.
Charles Coombs of the Federal
Reserve Bank of New York, who acts as our agent in the
market. We reviewed the overall U.
K. situation, the various alternatives open, the
risk of devaluation, and the situation in the gold market.
After pooling our information and views, this ad hoc group
referred a general proposal along the lines of this paper to
the Interagency Steering Group operating under the
Chairmanship of Under Secretary Deming of the Treasury. That group met on
Wednesday and considered the problem at some length.
In light of the above, I recommend that you authorize me to
increase the Exchange Stabilization portion of the September
1965 agreement by $100 million to $300 million. Sterling
purchased under this authority would, of course, have to be
subject to guarantee so that no exchange risk would be
incurred. There would be no adverse balance of payments
effect from the transaction.
