48. Memorandum From Henry C. Wallich of the Council of Economic Advisers to the Council0

Upon returning from the OEEC Conference which took place in Paris May 25–26, I had occasion to give a brief report of my impressions to Secretary Anderson and Chairman Martin.1 In the course of these conversations, I mentioned the apparently growing concern about the U.S. dollar that some European representatives had voiced privately. This concern had to do not so much with devaluation, but with a possible wave of speculation against the dollar and with the repercussions of a further gold outflow on American economic policy. I should add that I tried to avoid conversation on this subject and, where that was not possible, dealt with it as a balance of payments problem rather than a gold problem.

These impressions, fragmentary as they are, raise an obvious question: what can we do to discourage speculation against the dollar in the face of further gold losses? Our basic reply we have already given by our show of firm determination to pursue sound monetary and fiscal policies. Further proof of our determination to defend the dollar could be given by removing the 25 percent gold reserve requirement to which the Federal Reserve’s liabilities are subject. I mentioned this possibility to Secretary Anderson and Chairman Martin. Chairman Martin said that at the present time he would not be in favor of such action; consequently I shall not press the matter further. It seems worthwhile, however, to summarize briefly the pro’s and con’s of the case, which in part appeared in these conversations.

1. Positive Effects

By removing the 25 percent requirement, we would be unfreezing approximately $11.6 billion of gold tied up in domestic reserves as of June 10. We would then have $20 billion to meet any future gold drain, instead of $8.3, as at present.

This should demonstrate quite clearly that we are determined to use our reserves, not to protect them by devaluation. We would be scotching reports such as that attributed to Franz Pick, who seems to claim close contact with top men in Washington, that the Administration has set $18 billion as the minimum level that reserves would be allowed to reach before we devalue.
A change in the 25 percent reserve ratio may eventually become necessary for another reason: the prospect of a continuing growth in the Fed’s liabilities subject to reserve requirements. This growth can and has been held down by reductions in member bank reserve requirements. But over the long pull, the Fed’s liabilities subject to reserve requirements are apt to grow. If they were to expand proportionately to the money supply, i.e., at 3–4 percent per year, we would be adding close to half a billion cash a year to required gold reserves. Our present free reserves of $8.3 billion would disappear in 15–20 years. While to acquire more gold in such amounts does not seem practicable, since that would mean to absorb close to two-thirds of the world’s gold production available for monetary purposes, for reasons of international liquidity as well as of domestic expansion, therefore, something eventually may have to be done about the 25 percent requirement.
These considerations may not appear particularly pressing with a $20 billion level of total reserves. But if by the end of the year reserves should be in the 17–18 billion area the urgency would increase.

2. The Removal of Discipline

The basic purpose of the 25 percent requirement is to impose a certain discipline upon our policies. Removal of the requirement would also remove the discipline. How does this discipline operate today?

The sound monetary and fiscal policies of the Administration are being pursued primarily because of their intrinsic merit and not because of any pressure resulting from an anticipated short fall of central bank reserves. The large gold loss last year no doubt has added some urgency to these policies. I would not undertake to judge whether, with a similar gold loss, that sense of urgency would have been any less had the 25 percent requirement not been in existence.
The discipline may also take the form of a growing pressure to restrict imports, capital exports, and foreign aid. These are undesirable effects, except in the eyes of those who are skeptical of the present level of our foreign aid. These perverse discipline effects are likely to increase as our free gold reserves diminish. They would be reduced, though scarcely eliminated altogether, by a removal of the 25 percent requirement.
Nevertheless, the discipline exercised by falling reserves would serve a useful purpose in the event that the passive state of our balance of payments should prove to be permanent. In that case, it is clear that we shall have to do more to correct it than we have done. We ought to try to do this as much as possible by expanding our exports and other international receipts, and only secondarily by bringing down our outpayments. If that should be the underlying truth of our situation, it would be better to face it now with 8.3 billion of free and 12 billion of frozen reserves, than to unfreeze the 12 billion, use them up, and then face the same issue again a few years from now.
The present situation also imposes a certain discipline upon foreign countries: it makes them see the need to remove discrimination against the dollar and to take over part of the burden of financing underdeveloped countries, if they want to avoid restrictive measures on our part. This discipline, for what it is worth, would be weakened by a removal of the 25 percent requirement.

3. Timing

Even if a good case can be made for removal of the 25 percent requirement, it is uncertain whether the present would be a good time for such a step.

An action of this kind is best taken at a time when there appears to be no pressing need for it. To act now might make us look scared. However, international concern about the situation can reach a point where not much is to be gained for us by pretending that we have not noticed or that we are not concerned. In that case, bold action to demonstrate that the dollar will be defended would probably on balance have a favorable psychological effect.
While action without pressure is better than action under pressure, it is also less likely, because then the urgency is lacking.
The present political situation suggests that there might be a long wrangle in Congress that quite likely would have harmful repercussions abroad. Moreover, the proposal might offend some of the sound money advocates in the Congress on whose support the Administration ordinarily relies.

4. The Long Run Balance of Payments Outlook

If we had strong convictions one way or the other about the long run balance of payments outlook, these certainly would weigh more heavily than any desire to deal with maneuvers of speculators. Some people undoubtedly do have strong convictions of an optimistic or pessimistic nature. But the facts at hand do not seem to support clearly either conclusion. More tentative considerations therefore gain weight.

It is possible that the monetary and fiscal policies of the Administration will do the trick. It can be argued that they should be given a chance before other action is taken.
Some observers think that the dollar problem, originally underrated may now be in danger of becoming over-rated.
The gold movement during the first half of 1959 has been less than during the first half of 1958. This suggests at least the possibility that the worst may have been seen. Since we sat it out last year, it may be well not to be precipitous now.

5. Alternative Approach

The 25 percent reserve requirement can be suspended under Section 11 (C) of the Federal Reserve Act. This section gives the Board the power to suspend the requirements for a period of 30 days with successive extensions of 15 days each. For a reserve deficiency of up to 5 percent against Federal Reserve notes, i.e., down to a reserve level of 20 percent, a penalty of only 1 percent per annum is imposed. For each [Page 115] additional deficiency of 2½ percent against Federal Reserve notes, a penalty of 1½ percent per annum is imposed. In the case of member bank reserve balances the Board can set whatever penalty it wants.

This provision allows some flexibility. For the long run, it would probably not be adequate, because of the very short extension periods, which would make the situation embarrassing, and perhaps also because of the burden imposed by the penalties.

  1. Source: National Archives and Records Administration, RG 56, Records of the Office of the Secretary of the Treasury, Robert B. Anderson, Subject Files, Council of Economic Advisers. Filed with a covering note of June 24 from Wallich to Anderson.
  2. William McC. Martin, Chairman of the Board of Governors of the Federal Reserve System.