Chapter

Chapter 6 Developments in the Main Industrial Countries

Author(s):
International Monetary Fund
Published Date:
September 1966
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IN the international financial markets there were fewer strains in 1965 than had been experienced in the preceding year. There were no problems comparable to those that found expression in the strong pressure on the lira and on sterling during 1964. In large part, the international financial scene was dominated by a more rapid expansion of activity in the United States than had appeared to be likely, and by the effects of the measures taken in several countries to lessen the balance of payments disequilibria or inflationary pressures which had been evident in 1963 and 1964. Several countries that at the end of 1964 were concerned with fighting inflationary pressures were able during the past year to curtail the excess demand and relax their policies of restraint. On the other hand, certain countries that hàd enjoyed relative stability during 1964 developed symptoms which suggested that strong pressures of demand began to face supply inelasticities.

The money stock and the volume of bank credit expanded in all the main industrial countries during 1965, at rates similar to those prevailing over the last few years. The demand for credit, however, appears to have risen fairly rapidly, concurrently with the rising pressures on available capacity in the more industrialized parts of the world, and there was apparently a tendency toward more restraining monetary policies in most of these countries.

The capital markets in the industrial countries were generally very active during 1965 and the first part of 1966. Continued prosperity in Europe and expanded activity in North America fostered the need for finance, while high incomes encouraged a keen demand for securities. Even so, interest rates rose sharply in several countries. The volume of international security issues increased more than in 1964, and the market for these securities tended to become more internationalized.

Production

In contrast to the experience of recent years, output in 1965 expanded more rapidly in North America than in continental Europe (Chart 7). This difference in rates of growth reflected a continuation of expansion in the United States and Canada at slightly higher rates than in 1964, while the advance in Europe slowed down. Japan experienced a marked slowing of its rate of expansion until late in the year, and in the United Kingdom measures to moderate the excess expansion in 1964 were partly effective.

Chart 7.Selected Areas and Countries: Industrial Production, Seasonally Adjusted, 1962-April 1966

(1958 = 100)

1 United States and Canada.

Economic activity in the United States expanded rapidly in the second half of the year, under the stimulus of buoyant consumption and investment demand and increasing military outlays (Table 19). For the year as a whole, the rise in the gross national product at constant prices was slightly greater than that in 1964 and than the average increase during the last five years. This continued growth is the longest uninterrupted advance in the United States since World War II. It has served to ease one of the important economic and social problems of the United States: by December the unemployment rate had fallen almost to 4 per cent (an interim target established by the Administration in 1961 when the rate was 7 per cent). In the early months of 1966, it fell below 4 per cent. However, the achievement of this social target served to create scarcities of some types of labor, thereby limiting the capacity for further expansion. Also, despite a large and steadily rising volume of capital spending, excess physical capacity seems to be declining. A number of industries—notably nonferrous metals, rubber, textiles, and machinery—have reported shortages. By the end of the Fund’s fiscal year, although price increases could not be said to have reached serious proportions, the problem of incipient inflation was receiving more attention, and the problem of overall unemployment was causing less concern.

Table 19.Gross National Product at Constant Prices, Quarterly, 1963–65(Percentage increases or decreases from preceding quarter, seasonally adjusted)
CanadaItaly1United

Kingdom 1
United

States
1963
I1.70.10.20.8
II1.22.33.70.9
III1.31.20.11.2
IV2.01.13.91.4
1964
I2.10.60.41.1
II1.7−0.50.51.0
III0.5−0.80.51.0
IV0.81.42.20.6
1965
I3.00.60.82.2
II1.31.9−0.91.0
III2.01.30.51.6
IV1.01.10.91.9

Gross domestic product.

Gross domestic product.

In the United Kingdom, the first quarter of 1965 marked the end of a two-year period of relatively rapid expansion. Output, seasonally adjusted, declined in the second quarter of 1965, and the recovery in the second half of the year did little more than make good this decline; unemployment, after a fall in the first quarter, remained more or less unchanged during the rest of the year. In the last quarter, 1.5 per cent of the labor force was unemployed. These movements were, in part, reactions to the restraining policies followed by the Government in order to correct the balance of payments maladjustments that had been largely induced by the expansion during 1963 and 1964. The balance of payments improved markedly during 1965, although it still provides inadequate leeway for any important relaxations of policy.

In the European Economic Community as a whole, there was little expansion of output early in the year but more rapid progress later. In France and Italy, the restraints on expansion resulting from the financial policies imposed in 1963 and 1964 were eased during the year. As external demand continued to be active, output in these countries recovered and showed a fairly strong advance. In Germany, demand and output continued to rise; however, labor shortages and a nearly full utilization of capacity limited the expansion of output to a lower rate than that achieved in earlier years.

In Japan, the trend of industrial production was, if anything, downward until the third quarter, when output began to expand gradually.

Costs and Prices

In the United States, the pace of wage advances accelerated slightly in 1965 (Chart 8), yet labor costs per unit of output in manufacturing (Chart 9) remained virtually unchanged. Since the beginning of the current economic expansion, unit costs have declined by 3 per cent, as productivity has advanced somewhat faster than wage rates. However, a number of recent labor contracts have involved immediate increases in hourly labor costs (including the effects of benefits other than higher wages) somewhat in excess of the “guideposts” outlined in the 1962 Annual Report of the Council of Economic Advisers. Indeed, a few of these contracts have provided for increased payments over the next few years which are markedly above the limits outlined in these “guideposts.”

Chart 8.Selected Areas and Countries: Wage Rates, 1962-April 1966

(1958 = 100)

1 United States and Canada.

Chart 9.Selected Countries: Wage Cost per Unit of Output in Manufacturing, 1962-First Quarter 1966

(1958 = 100)

In the United Kingdom, wage increases were larger than in previous years and higher than the increases in productivity. As a result of these wage increases, combined with a decline in the rate of growth of productivity consequent on the less rapid expansion in total output, labor costs per unit of output rose sharply, particularly in the first part of the year. In Germany, wages increased fairly rapidly in 1965, leading to an increase of about 5 per cent in average labor costs for all output (including services as well as manufacturing), compared with 2.5 per cent in 1964 and 3 per cent in 1963. In Italy, the pace of wage increases moderated. Wage rates also continued to advance in Belgium and the Netherlands, even though output was increasing less rapidly. In Japan, the rate of wage increase declined during the year, but less markedly than output, so that the declining trend of Japanese wage costs that had prevailed since early in 1963 was reversed.

The pace of price increases in the United States and Canada accelerated, but the rise in prices there was still less than in Europe (Chart 10). The U.S. wholesale price index for industrial commodities—i.e., all except farm products and processed food—was 1.7 per cent higher at the end of 1965 than a year earlier. While this was not a very striking increase, it contrasted with the virtually flat trend of recent years. The movement of U.S. consumer prices during 1965 was substantially affected by the spurt in food prices, on the one hand, and by the reduction of federal excise taxes (some of which were raised again early in 1966), on the other. The consumer price index, which had risen by only about 1.2 per cent annually for the past several years, increased by 2.0 per cent during the year (Chart 11). In the United Kingdom, the increases in labor costs per unit of output have not exercised their full effect on prices; part of the increase in the cost of living during 1965 was due to higher indirect taxes. In continental Europe, the increases in wholesale prices were less sharp than those in the cost of living indices. In the United States, Canada, and Japan, export prices (Chart 12) trended slightly downward during 1965, in contrast to the increases in wholesale prices in these countries.

Chart 10.Selected Areas and Countries: Wholesale Prices, 1962-May 1966

(1958 = 100)

1 United States and Canada.

Chart 11.Selected Areas and Countries: Cost of Living, 1962-May 1966

(1958 = 100)

1 United States and Canada.

Chart 12.Selected Areas and Countries: Export Prices, 1962-March 1966

(1958 = 100)

1 United States and Canada.

Credit and Interest Rates

For some time, bank credit has been expanding in the United States and in Europe at roughly comparable rates (Charts 13 and 14). These nearly parallel trends continued during 1965 despite signs of a slight deceleration in continental Europe. In the United Kingdom, the pace of advance was sharply stemmed.

Chart 13.Monetary System Credit to the Private Sector, 1962-April 1966

(1958 = 100)

Chart 14.Money, Seasonally Adjusted, 1962-March 1966

(1958 = 100)

1 United States and Canada.

The strength of demand for credit, interacting with the monetary policies followed by most countries to restrain it, contributed to a continuance of the upward drift in interest rates that has been in progress over the last decade (Charts 15 and 16). These increases were sharpest in some of those countries where rates had been relatively low at the end of 1964. Rates in the United States, in particular, moved upward quite markedly. Since January 1966, the yield on Treasury bills has been at a height that was only touched briefly during the crisis late in 1929; that on medium-term government bonds has been higher than at any time since shortly after World War I. In Germany, the yield on government securities passed out of the 6 per cent and into the 7 per cent range during the year. By April 1966 the yield approached 8 per cent. In these circumstances it was agreed that the states and municipalities and the Federal Railways and Post Office would refrain temporarily from issuing securities. On the other hand, in Italy and Japan, a relative easing of monetary policies, as the difficulties of 1963 and 1964 were overcome, served to bring interest rates down from their very high levels in 1964. Rates in the United Kingdom also declined from those reached during the crisis at the end of 1964. As a consequence of the upward drift of some interest rates that had been low, and of declines in some that had been high, the international differentials of interest narrowed in 1965, in contrast to their tendency to widen during the previous year.

Chart 15.Selected Countries: Long-Term Government Bond Yields, 1962-May 1966

(In per cent per annum)

Chart 16.Selected Countries: Short-Term Interest Rates, 1962-May 1966

(In per cent)

In 1964, all the changes in central bank discount rates had been increases (Chart 17), motivated to a large degree by desires to protect external positions. In 1965, Japan and the United Kingdom lowered their discount rates, as pressures on the balance of payments eased; most of the other changes during the year (Table 20) were directed to influencing domestic economic conditions.

Chart 17.Discount Rates, 1962-June 1966

(In per cent)
Table 20.Selected Countries: Changes in Discount Rates, 1965 and First Half 1966
DateIncrease or

Decrease (—)

Percentage Points
New

Rate
BelgiumJune 2, 19660.505.25
CanadaDec. 6, 19650.504.75
Mar. 14, 19660.505.25
FranceApr. 9, 1965−0.503.50
GermanyJan. 22, 19650.503.50
Aug. 13, 19650.504.00
May 27, 19661.005.00
JapanJan. 9, 1965−0.3656.205
Apr. 3, 1965−0.3655.840
June 26, 1965−0.3655.475
NetherlandsMay 2, 19660.505.00
SwedenApr. 9, 19650.505.50
June 10, 19660.506.00
United
KingdomJune 3, 1965−1.006.00
United StatesDec. 6, 19650.504.50

Money and Debt Management Policies

The increase in the money stock and outstanding bank credit in the United States occurred in the face of rather restrictive monetary policies. There was an accelerated shift in the composition of bank deposits from demand to time and savings deposits as a result of the increases in November 1964 in the maximum rates of interest payable on the latter. This somewhat reduced the need for more rapid reserve accumulation by the member banks. The increase in member bank reserves (somewhat larger than in 1964) that nevertheless took place was partly accounted for by an increase in borrowings from the Federal Reserve System. From March onward, the banks’ borrowings from the Federal Reserve were larger than their excess reserves. As a consequence of the high demand for credit and the restraining monetary policies, interest rates rose rather steadily throughout the year, so that, by October, the Treasury bill rate was above the discount rate.

With effect from December 6, the discount rates of the New York and Chicago Reserve Banks were raised from 4.0 per cent to 4.5 per cent (the highest rate for the New York bank since February 1930). The other Reserve Banks brought their rates into line within a few days. By early in January 1966, the Treasury bill rate was again higher than the discount rate. The Federal Reserve Board also increased the maximum interest rate payable on time deposits and certificates of deposit. The intention was to bring these rates into line with money market rates without putting such pressure on other personal savings institutions as would have led to a rise in construction mortgage rates. To maintain the desired growth of bank reserves in 1965, the Federal Reserve System purchased more government securities in open market operations than during 1964. These purchases were the main element in an expansion of $4 billion in Federal Reserve credit, which was more than sufficient to offset the effect on bank reserves of increased gold sales and the continued expansion of holdings of currency by the general public. The ratio of short-term issues to the total debt held by the Federal Reserve System increased, as its net purchases were concentrated on Treasury bills. While the yields on all government securities rose during the year, the increases were most marked at the short end of the market (Chart 18). In the early months of 1966 the authorities continued their restraining policies.

Chart 18.Term Structure of Interest Rates

(In per cent)

The Federal Reserve System sold a small amount of securities in the first quarter, the gold stock declined slightly, and, despite increased bank borrowing, the excess reserves of the member banks declined.

In Canada, as in the United States, the developing economic situation led to a need for greater monetary restraint. On December 6—simultaneously with the U.S. discount rate increase—the Bank of Canada raised its rate from 4.25 per cent to 4.75 per cent. The strong demand continued after the turn of the year, but the marked upward movement of U.S. interest rates made it possible for the Bank of Canada to impose further restraint by again raising its discount rate, to 5.25 per cent from March 14, 1966.

In the United Kingdom, the authorities were actively engaged during the year in further revising and strengthening the measures designed to restore domestic and external equilibrium. On April 29, 1965, the Bank of England called for special deposits of 1 per cent from the London clearing banks and ½ per cent from the Scottish banks. On May 5 the Bank of England advised the banks not to increase their advances to the private sector by more than an annual rate of 5 per cent in the year to March 1966. The banks were also asked to apply restraint to the granting of acceptance facilities and the purchase of commercial bills. On June 3, the bank rate was lowered to 6 per cent from the 7 per cent level that had been set in November 1964, on the understanding, expressed by the Chancellor of the Exchequer, that the reduction was not to be taken as representing a relaxation of credit restrictions. On July 27, the Bank requested the banks to scrutinize credit even more carefully than before where it appeared that the purpose might be to facilitate payment for imports. Largely as a consequence of these measures, the rate of increase in advances by the London clearing banks, seasonally adjusted, changed from an average of £22 million a month in January-April to nil for the rest of the year. Because of the pattern of interest rates, the authorities were able to sell only a moderate amount of government debt to the economy, apart from the banks. The latter, therefore, remained liquid throughout most of the year; the liquidity ratio of the London clearing banks was somewhat higher at the end of 1965 (32.1 per cent) than a year earlier (30.6 per cent).

In France, the discount rate was reduced from 4 per cent to 3½ per cent on April 9, and on June 24 the authorities took further steps to ease credit. The limitation of the increase in commercial bank loans to not more than 10 per cent a year, which had existed since September 1963, was lifted from July. Hire-purchase regulations were also relaxed: institutions specializing in financing installment sales were allowed to increase their credits, and the maximum duration for medium-term credits eligible for rediscounting at the Bank of France was raised from five years to seven years. (However, rediscounting facilities were available only for credits having at the most three years to run to maturity.) In the condition of relative ease which had developed by the end of the year, interest rates were tending to fall, after having risen slightly in earlier months. In December, the Minister of Finance announced that, owing to the improvement in the Treasury situation, the minimum proportion of their liabilities which the banks are required to cover by Treasury bonds would be reduced from 7.5 per cent to 5 per cent.

Italy adopted a combination of monetary and debt management policies intended to foster growth in output. To stimulate construction activity, credit facilities previously available for investment in agriculture and industry were extended to the building industry. Steps were also taken to reduce interest costs to purchasers of houses. A generally expansive monetary policy resulted in a 14 per cent increase in the stock of money during the year, compared with an 8 per cent rise in 1964. As a result of the measures taken by the authorities, long-term interest rates, which had risen sharply in 1964, declined in 1965. To take advantage of this decline and of the generally favorable conditions, the Government shifted its financing from heavy reliance on borrowing from the Bank of Italy to primary reliance on long-term bond issues. The result was that while in 1964 almost half the government deficit was covered by borrowing from the Bank, in 1965 the Government made small net repayments to the Bank and covered over half of its increased deficit in the long-term market.

Largely as a result of the external surplus, the credit institutions’ liquidity was eased in 1965. To prevent the monetary expansion from getting out of hand, and to keep Italian interest rates in line with those prevailing in other markets, the authorities encouraged the banks to make large investments in foreign short-term markets, particularly in Euro-dollars, by entering into repurchase arrangements with them for funds invested. The banks’ investments markedly eased the strain on these markets resulting from the withdrawal of U.S. and Canadian funds and the strong demand from German borrowers. Toward the end of the year the authorities’ policies were modified in the direction of lower interest rates. The repurchase arrangements were also intended to assist the commercial banks to reduce their net foreign indebtedness and were withdrawn for those banks having net foreign asset positions.

In Germany, faced with persistent demands for credit and continued upward pressure on wages and prices, the Bundesbank considered it necessary to increase its discount rate twice during the year: from 3 per cent to 3½ per cent on January 22, and from 3½ per cent to 4 per cent on August 13. On May 27, 1966, the discount rate was raised again, to 5 per cent. The rate for advances on securities was increased in 1965 by the same amounts as the discount rate, but in May 1966 it was raised by 1¼ per cent, to 6¼ per cent. Since the beginning of 1965, the Bundesbank’s selling rates for money market paper have been adjusted upward by amounts ranging from 2⅜ per cent to 2⅝ per cent. During the year, the demands made by public authorities on the capital market were exceptionally high. At the same time, the tight liquidity positions of the banks prevented them from participating in the market as actively as they had been accustomed to do. Long-term rates increased sharply. The granting of permits for new issues was suspended by the Government from July 28 until measures designed to reduce and coordinate public-sector borrowing had been introduced. These demands for finance and associated high rates induced an inflow from other countries of Euro-dollars, other short-term capital, and some long-term funds. The pressure on the capital market continued in the early part of 1966, with results discussed on page 73. However, the Federal Government has indicated that, under its budget for 1966, repayments on loans would exceed new borrowing.

In most of the other Western European countries financial policies continued to be directed toward a containment of demand. In the Netherlands the quantitative restrictions on bank lending were continued. Even so, the money supply increased by 11 per cent, compared with 8 per cent in 1964. For this there were two main causes: the improvement in the balance of payments, and the fact that the central government financed its rising requirements largely by sales of short-term Treasury bills. Interest rates, on balance, moved upward, and there were further rises early in 1966. Bank rate was raised by ½ per cent to 5 per cent on May 2, 1966. In Sweden, restrictive measures were tightened in April 1965, when the Riksbank increased its discount rate from 5 to 5½ per cent; such measures were continued into 1966, and the discount rate was raised by a further ½ per cent on June 10. In Switzerland, despite the general maintenance of restraining monetary policies, the National Bank reversed in July the swap of Sw F 473 million for dollars and sterling made with the commercial banks in January 1965 in order to foster lower interest rates and stem the inflow of foreign exchange. On the other hand, the National Bank of Belgium eased some monetary restrictions in mid-July 1965. It rescinded the 1 per cent cash reserve requirement introduced in August 1964 and suspended its recommendation to the banks that they limit to 20 per cent the increase in their credits to the private sector over the two years 1964-65. However, the banks were requested to maintain cautious lending policies.

In Japan, monetary policy during 1965 was directed toward the revival of economic activity. The Bank of Japan reduced its basic discount rate three times, from 6.57 per cent at the end of 1964 to 5.48 per cent on June 26, 1965. In mid-July reserve requirements for certain types and sizes of deposits were lowered. During the year, also, the Bank of Japan purchased securities and provided loan funds to semiofficial institutions. Although bank liquidity has been relatively ample, bank credit expanded at a slower pace during 1965 than in 1964.

Fiscal and Other Economic Policies

Fiscal policy was used, if anything, a little more widely to maintain balance between domestic demand and supply in 1965 than in earlier years. Quite appropriately, domestic considerations in this field have tended to be given more weight than those arising from balance of payments problems.

Through 1965, fiscal measures in the United States were, on the whole, motivated by a desire to foster longer-term growth rather than by short-term cyclical considerations. The first stages of a program of excise tax reductions became effective in June. Other legislation provided for hospital care for elderly citizens and an increase of at least 7 per cent in all social security payments. To help offset the increase in payments, social security taxes were increased in January 1966 and are to rise gradually until 1987. On August 10, 1965, the President signed into law a $7.5 billion housing bill with a rent subsidy provision for low-income families. The bill extended for four years urban renewal, public housing, and other measures. An anti-poverty program was also launched. The Federal Government’s cash deficit of $4.5 billion for the calendar year was slightly less than in the preceding year ($5.2 billion).

The budget presented in January 1966 involved a shift in the direction of fiscal policy, from encouraging economic growth to restraining the incipient inflationary pressures which appeared to be emerging, partly as a consequence of the Viet-Nam conflict. As a first fiscal step to restrain demand, some of the reductions in excise taxes that went into effect in January 1966 were rescinded, and the further reductions scheduled for the future were deferred. These changes, together with the effect of rising incomes on tax revenues and with economies in government operations, are expected to result in a federal government consolidated cash surplus of $0.5 billion in 1966/67. This compares with an expected deficit of $6.9 million for the fiscal year 1965/66, and an actual deficit of $2.7 billion for fiscal 1964/65.

The Canadian economic situation, and the fiscal policies adopted to meet it, also altered during the year. Early in 1965 the Government considered an expansionary policy to be appropriate, and personal income taxes were reduced. Later in the year, rather excessive demand pressures emerged, and the March 1966 budget rescinded most of the 1965 income tax reductions. It also required corporations to make compulsory loans to the Government—in effect, additions to the corporation tax, to be offset by effective tax reductions in later years.

In the United Kingdom, new fiscal measures were introduced during 1965 in the continuing effort to stabilize the economy. Hire-purchase controls were tightened early in June. On July 27, the Chancellor of the Exchequer announced a further series of economic measures. In the public sector, the rate of increase in expenditure on capital projects was reduced, and instructions were given for purchases of equipment and stores by government departments, local authorities, and nationalized industries to be deferred as far as possible. Economies in defense spending resulted in its reduction by about 5 per cent. Government legislation was introduced to license the starting dates of privately sponsored office buildings and similar construction projects valued at £100,000 or more.

The Budget for 1966/67 proposes to achieve a sharp reduction in the over-all deficit, despite an increase of about 10 per cent in government expenditure (including grants and loans to local authorities and public corporations). The reduction expected in the deficit is due mainly to the imposition of an employment tax on service industries, combined with a subsidy to manufacturing industries.

When the French Parliament was presented in September with budget proposals for 1966, they were based on an expected surplus of some F 3.91 billion in 1965. The new budget included features designed to stimulate saving. Beginning in 1966, investors may choose to pay a flat rate of 25 per cent on interest from bonds instead of paying income tax on it. The withholding tax on dividends has been abolished and shareholders now receive a tax credit amounting to 50 per cent of dividends. The schemes to encourage the public to maintain longer-term savings accounts have been made more comprehensive. In order not to distort the distribution of savings, interest earned on savings deposits (except the first F 15,000 deposited with savings banks) and other fixed-interest-bearing assets (e.g., Treasury bonds), hitherto exempt from taxes, has been subjected to the same taxation as industrial bonds.

The Italian authorities introduced several measures during the year to help to stimulate activity in lagging sectors. The budget estimates for 1966 provide for an increase in the deficit over that of 1965, which in turn was higher than in 1964. In September, a long-term credit program for low-rent housing was inaugurated, and subsidies were provided for house purchases. In October, restrictions on the hire purchase of many consumer durables were abolished.

The German authorities, after curtailing or postponing some requests for increased expenditure and increasing fiscal revenue by raising the tax on spirits and sparkling wines, and by raising railroad charges, expect to achieve a better balance on the budget for the next fiscal year.

Ordinary budget expenditure in Belgium is expected to be 10 per cent higher in 1966 than in 1965. New tax measures are proposed to narrow the gap between revenue and expenditure. The 1966 extraordinary budget proposals included help to depressed areas and increased credits for infrastructural projects.

The Swiss budget for 1966 is on the whole less contractionary than that for 1965; it is expected to produce an over-all surplus of Sw F 35 million, compared with one of Sw F 488 million in 1965. The anti-inflationary measures adopted in 1964 have remained in force with only slight modifications.

Fiscal policy was used fairly actively to assist the recovery of the Japanese economy, the deficit being larger in 1965 than in 1964. In July, the Government expanded its program to stimulate the economy. The measures introduced included (1) the release for public works expenditure of the 10 per cent reserve in the original budget for the fiscal year ended March 1966; (2) further expenditures amounting to about ¥ 210 billion in the current fiscal year on the projects in the Treasury investment and loan program; (3) the reduction of interest rates on loans for medium-sized and small businesses by government financial institutions. In August, various measures for expanding exports were announced. In December, a supplementary budget was approved which provided for financing the shortfall in tax revenues by the issue of domestic government bonds for the first time since World War II.

Money and Securities Markets

Conditions in domestic money markets in 1965 were dominated by the forces discussed in previous sections of this chapter. They reflected the high level of economic activity, and also the monetary, credit, and interest rate policies applied to meet national problems. The balances of payments on capital account described in Chapter 5 involved large transfers of short-term funds on the Euro-dollar and similar international money markets. Data on commercial banks’ operations in foreign currencies vis-à-vis nonresidents—i.e., the Euro-currency market—are available only for ten countries which report to the Bank for International Settlements; these data are presented in Table 21. This table throws into relief the important change in the position of the Italian banks during the year, particularly the expansion in their Euro-currency assets in the second half of 1965. This more than compensated for the decline in Canadian participation in the market caused by the fact that the Canadian commercial banks were importantly affected by the Canadian and U.S. guidelines, particularly during the first nine months of 1965 (see below, Chapter 8, p. 96). The Canadian commercial banks reduced their foreign currency assets vis-à-vis nonresidents (particularly those in Europe) by $820 million between the end of December 1964 and March 1966, and reduced their foreign currency liabilities (largely to the United States) by $540 million over the same period; the banks’ net position vis-à-vis nonresidents thus deteriorated by nearly $300 million. The deterioration in net positions—i.e., the increase in effective borrowing in the market—of the reporting banks was greatest for Belgium, Canada, and the Netherlands.

Table 21.Selected Countries: Commercial Banks’ Foreign Currency Liabilities to, and Claims on, Nonresidents, at End of Period, September 1963-March 19661(In millions of U.S. dollars)
1963196419651966
Sept.Mar.Dec.Mar.Dec.Mar.
Liabilities
Belgium6407509409701,1601,330
Canada2,6102,4002,4002,070
France 21,2801,2001,3701,2801,6001,520
Germany370330520290440330
Italy2,2901,8201,8901,7902,1501,720
Japan2,1902,4402,7302,8702,9102,910
Netherlands360360510510740860
Sweden120130160200220240
Switzerland 31,9201,7902,0601,850
United Kingdom3,6103,5404,9005,1105,8006,060
Total12,210412,090417,55017,21019,48018,890
Assets
Belgium4905206807308501,010
Canada3,3802,9602,7802,560
France 21,3301,2701,5201,4801,8601,900
Germany740850760820790720
Italy1,3501,0801,1901,0602,0401,840
Japan1,8902,0802,6102,6903,0002,940
Netherlands710550680720820860
Sweden250320340290420380
Switzerland 32,7402,7803,2103,080
United Kingdom3,4603,3404,3304,1305,3405,730
Total12,380412,470418,23017,66021,11021,020
Net positions
Belgium−150−230−260−240−310−320
Canada770560380490
France 25070150200260380
Germany370520240530350390
Italy−940−740−700−730−110120
Japan−300−360−120−1809030
Netherlands350190170210800
Sweden13019018090200140
Switzerland 38209901,1501,230
United Kingdom−150−200−570−980−460−330
Total−640−5606804501,6302,130
Source: Bank for International Settlements, Annual Reports.

Deutsche mark, French francs, Italian lire, Netherlands guilders, pounds sterling, and U.S. dollars.

Positions vis-à-vis banks only.

Including Euro-currency assets of the Bank for International Settlements.

Over-all estimates by the Bank for International Settlements.

Source: Bank for International Settlements, Annual Reports.

Deutsche mark, French francs, Italian lire, Netherlands guilders, pounds sterling, and U.S. dollars.

Positions vis-à-vis banks only.

Including Euro-currency assets of the Bank for International Settlements.

Over-all estimates by the Bank for International Settlements.

Long-term security markets were also very active during 1965. Record amounts were raised by the issue of company securities in Canada, the United Kingdom, and the United States, although, in all three, equity issues were lower in 1965 than in 1964. New issues were also high, if not at record levels, in the other industrial countries.

Not only did the international securities market expand during the year (Table 22) but its structure changed. A part of this change is not reflected in statistics of international capital movements.1 Prior to the effective date of the U.S. Interest Equalization Tax (August 1963), New York was the prime market for the issuance of securities by borrowers wishing to raise funds outside their national capital markets.2 By 1965, European subsidiaries of U.S. companies were the largest national group making new issues on the European markets (Table 23), and this financing had become an integral part of the total operations of these companies. Mainly in compliance with the U.S. voluntary balance of payments program, transfers of direct investment funds to Europe sharply decelerated during the year, although for 1965 as a whole they aggregated slightly more even than the large total for 1964. Complete data on the transactions by U.S. direct investment enterprises in Europe are not available. It is possible, however, to make some rough estimates from the available data, on the basis of past experience and of the plans of these companies made by the end of 1965. These estimates, presented in Table 24, suggest that investment by U.S.-controlled enterprises in Europe was more than 15 per cent larger in 1965 than in 1964, the necessary additional funds having been obtained primarily from bond issues on European markets. Transfers to Europe rose in the last quarter of 1965, as subsidiaries were accumulating liquid funds for the financing of still further enlarged investments in 1966 3 and in response to pressures on foreign direct investment companies in the United Kingdom and other European countries to finance part of their total expenditure from nonresident sources. The tightening of credit in the United States also encouraged corporations to seek financing in Europe, so as to release part of their available domestic funds for domestic investment. This made them willing to turn to the European security markets, even though the interest rates and other features of new issues abroad were considerably more costly than those of issues in the United States. At the same time, issues by European borrowers themselves outside their national markets continued to grow. Up to 1963, European issues ranked after those of Canada on the New York foreign issue market (Table 25). However, the reduced accessibility of the U.S. market to such issues, as a consequence of the Interest Equalization Tax and official discouragement, has caused European borrowers to turn to other markets. In 1965, international issues by these borrowers on European markets alone were more than twice as large as in 1963.

Table 22.New Foreign Issues by Markets of Issue, 1963-First Quarter 1966(In millions of U.S. dollars)
19651966
1963196419651st

quarter
2nd

quarter
3rd

quarter
4th

quarter
1st

quarter
United States1,4431,1551,451341419363328519
Canada232319
Europe
National markets319333210963825699
Belgium1412210
Germany140132
France12312525
Italy24242468
Luxembourg651
Netherlands31529227
Switzerland1428277927192231
United
Kingdom657337928
Other19
Euro-issue
markets11696291,116274179139523450
Total Europe4889621,326283243221579549
Grand Total1,9312,1172,8006476625849071,087
Sources: IMF and OECD staff estimates, and U.S. Department of Commerce.

“Euro-issues” are defined as those denominated in currencies other than that of the market of flotation, including dollar issues floated in New York for sale to nonresidents only. For 1964, foreign deutsche mark issues yielding less than 6 per cent per annum are treated as Euro-issues; from 1965, all foreign deutsche mark issues are treated as Euro-issues.

Sources: IMF and OECD staff estimates, and U.S. Department of Commerce.

“Euro-issues” are defined as those denominated in currencies other than that of the market of flotation, including dollar issues floated in New York for sale to nonresidents only. For 1964, foreign deutsche mark issues yielding less than 6 per cent per annum are treated as Euro-issues; from 1965, all foreign deutsche mark issues are treated as Euro-issues.

Table 23.Europe: New Foreign Issues, 1963-First Quarter 1966(In millions of U.S. dollars)
19651966
1963196419651st

quarter
2nd

quarter
3rd

quarter
4th

quarter
1st

quarter
European countries
and institutions348643696186166114230263
Scandinavian
countries833342379061157142
EEC countries1478922838317089157
Other European
countries4270104203993620
European
institutions761501273835203444
Japan591993535
U.S. companies3722844299222
Other countries819814834486640
Sterling area565512034483840
Other25432828
International
institutions2376621424
Total4889631,326283243206594549
Sources: IMF and OECD staff estimates.
Sources: IMF and OECD staff estimates.
Table 24.European Affiliates of U.S. Companies: Uses and Sources of Funds, 1962–65(In millions of U.S. dollars)
1962196319641965
Expenditures on plant
and equipment1,6741,9032,1422,520
Increase in other assets 18851,7092,2602,583
Total2,5993,6124,4025,103
Funds from United States8679241,3421,378 2
Undistributed earnings292513410325
Depreciation and
depletion7508751,0501,250
Borrowing abroad6501,3001,6002,150
Bond issues372
Other 36501,3001,6001,778
Sources: IMF staff estimates based on Table 23, and U.S. Department of Commerce, Survey of Current Business, August 1964, October 1964, September 1965, November 1965, and March 1966.

Including purchases of equity in existing businesses.

Excluding $80 million borrowed in Europe by U.S. companies for transfer to their European subsidiaries.

To some extent a residual.

Sources: IMF staff estimates based on Table 23, and U.S. Department of Commerce, Survey of Current Business, August 1964, October 1964, September 1965, November 1965, and March 1966.

Including purchases of equity in existing businesses.

Excluding $80 million borrowed in Europe by U.S. companies for transfer to their European subsidiaries.

To some extent a residual.

Table 25.United States: New Foreign Issues, 1963-First Quarter 1966(In millions of U.S. dollars)
19651966
196319641965First

quarter
Second

quarter
Third

quarter
Fourth

quarter
First

quarter
Canada734725738100240214184465
Western Europe3515118020458827
Latin America562585951863015
Japan202634320
International institutions520018119
Other1001172113573366739
Total1,4431,1551,451341419363328519
Sources: U.S. Department of Commerce, and IMF staff estimates. These data refer to the total issues (including those regarded as Euro-dollar issues in Table 22) and not to those amounts of the issues sold to U.S. residents as recorded in U.S. balance of payments statistics.
Sources: U.S. Department of Commerce, and IMF staff estimates. These data refer to the total issues (including those regarded as Euro-dollar issues in Table 22) and not to those amounts of the issues sold to U.S. residents as recorded in U.S. balance of payments statistics.

In one respect, the market for these issues tended to become more internationalized in 1965. Almost all the increase in international issues was accounted for by the rise of so-called Euro-issues (Table 26). As late as 1963, the international securities market was dominated by issues denominated in the currency of the market in which they were floated. By 1965, two fifths of the total issues were denominated in a currency other than that of the market in which bonds were sold, and frequently this currency differed from that of the borrower. These issues were at first arranged by European financial institutions.

Table 26.New Foreign Issues by Currency, 1963-First Quarter, 1966(In millions of U.S. dollars)
1966
First
196319641965quarter
Issues in
Currency of market issue1,7621,4881,684637
Other currency1216191,116401
Of which
U.S. dollars1075801,043381
Swiss francs14
Sterling and deutsche mark397320
Units of account481049
Total1,9312,1172,8001,087
Sources: IMF and OECD staff estimates.
Sources: IMF and OECD staff estimates.

However, the market has now become dominated by U.S. dollar issues, frequently handled by institutions based in New York. In some respects, the U.S. dollar has become an international capital currency, as well as a reserve currency. From the nineteenth century on, many international issues have been denominated in reserve currencies and other currencies different from those of the borrowers, but in practically every case the currency involved was that of the market on which the issues were sold. In 1965, by contrast, the dollar issues and the Euro-mark issues were sold elsewhere than in the United States or Germany. It might be noted that an earlier attempt to internationalize this market by the issue of securities denominated in “units of account” seems to have had little success.

This increase in international transactions has taken place despite restrictions on, and informal discouragement of, foreign security issues in the United States, and despite further restrictions on the outflow of capital from the United Kingdom, with little offsetting liberalization in other countries. National markets have adjusted with remarkable flexibility to the new situation, although some European countries—among them the Nordic countries like Finland—that had been borrowing regularly on European markets found increasing difficulty in raising funds in 1965, partly as a result of competition from U.S. borrowers. Another consequence of these developments has been further upward pressure on interest rates. While the Euro-currency markets are still largely insulated from national currency markets, the growing ability and willingness of lenders to acquire foreign issues, albeit frequently denominated in U.S. dollars, has provided alternative opportunities for borrowers, and has thereby served to bring the various national capital markets into closer contact. This has provided a somewhat informal integration of the international capital market over a period when there have been disappointingly few steps taken toward a more formal integration of European capital markets.

When a foreign-owned subsidiary (but not the parent company) raises money for investment in the subsidiary’s country of domicile, neither the borrowing nor the lending appears in the balance of payments accounts.

See Annual Report, 1965, page 51.

Plans for plant and equipment outlays in Europe look to an expenditure of over $3,500 million in 1966 (U.S. Department of Commerce, Survey of Current Business, Washington, D.C., March 1966, p. 7).

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