THE PURPOSE OF THIS STUDY is to examine the techniques and effects of official forward operations in foreign exchange, with emphasis on their role as an instrument of money market policy. Since such operations have recently been undertaken in the Federal Republic of Germany on a scale larger than in other countries, the main body of the paper analyzes the experience of that country.1


THE PURPOSE OF THIS STUDY is to examine the techniques and effects of official forward operations in foreign exchange, with emphasis on their role as an instrument of money market policy. Since such operations have recently been undertaken in the Federal Republic of Germany on a scale larger than in other countries, the main body of the paper analyzes the experience of that country.1

THE PURPOSE OF THIS STUDY is to examine the techniques and effects of official forward operations in foreign exchange, with emphasis on their role as an instrument of money market policy. Since such operations have recently been undertaken in the Federal Republic of Germany on a scale larger than in other countries, the main body of the paper analyzes the experience of that country.1

I. Role of Forward Operations as a Policy Instrument

Forward operations in the foreign exchange market affect both the balance of payments and the domestic money market of a country. By varying the rate at which they sell or purchase forward exchange, the monetary authorities may influence the direction and magnitude of international movements of short-term capital in much the same way as they can do by varying interest rates in the domestic money market. Therefore, by using forward operations, the monetary authorities can, in principle, maintain domestic interest rates that are higher or lower than those prevailing in foreign money markets, and this can be done without inducing international movements of capital. Such operations add to the freedom of action of the monetary authorities, particularly in situations where the sole reliance on the more conventional policy instruments might create a conflict between internal and external objectives of policy.

While the short-run effects on the balance of payments of variations in the premiums or discounts at which official forward operations are conducted are essentially the same as those of equivalent variations in domestic interest rates, the long-run effects are different. For example, in a given situation, the authorities may induce the same outflow of capital either by offering to purchase foreign exchange for three months’ delivery at a premium of ½ per cent or by lowering the interest rates in the domestic money market by 2 per cent. However, a lowering of interest rates will stimulate an expansion of the domestic economy and, in the long run, will induce a reduction in the balance of payments on current account. Such an effect cannot be expected from forward operations.2 Therefore, as a method of adjusting the balance of payments, such operations are essentially of a short-term nature. They are especially well suited for offsetting the effects on both the balance of payments and domestic liquidity of sudden movements of speculative capital.

In recent years, the impact of international transactions on domestic money markets has been of particular concern to the authorities in several European countries—e.g., Germany, Switzerland, and, recently, France—where balance of payments surpluses have coincided with inflationary pressures. If disequilibria in the balances of payments persist for some time and the monetary authorities of the countries concerned do not initiate appropriate countermeasures, both the regular participants in the exchange markets and pure speculators may be tempted to engage in large-scale speculations on changes in the par value of currencies that may further aggravate the internal and external imbalances. (This is illustrated by the experience in Germany in 1957 and 1961.)3 Such one-sided speculation will increase the forward premium (discount) on the surplus (deficit) country’s currency beyond interest parity,4 thereby further stimulating disequilibrating interest arbitrage.

Interest rate differentials and the cost of forward cover are not, of course, the only factors determining the volume and direction of the international flow of private short-term funds. Frequently (especially in periods of fundamental imbalances in the exchange markets at fixed exchange rates), the incentives for immediate or future capital movements also stem from the profit expectations of speculators, who may base their operations on their own forecasts of the future behavior of the spot rate, compared with the current spot rate or forward rate. In addition, capital movements arise from the need for hedging outstanding foreign assets in the spot market against the risk of depreciation, from differences among the economies in the availability of credit, and from expectations of impending losses of, or restrictions on, capital investments abroad owing to political instability and other events.6

II. Main Conclusions from German Experience

The present study arrives at the conclusion that official forward market operations, if undertaken as a matter of monetary policy, need not necessarily be associated with external objectives. Instead, the objectives may be primarily domestic. Which of these predominates can be ascertained from a study of the operational technique chosen; and this, in turn, depends to a certain degree on the size of the national money market and the scope for official open market operations (or similar offsetting devices) in the country concerned. If official forward operations had not been undertaken in Germany, the large balance of payments surpluses would have had disturbing effects on the domestic money market, because that market is narrow, the Bundesbank’s holdings of open market paper are relatively limited, and the indebtedness of the commercial banks vis-à-vis the Bundesbank has been low since 1957. In these circumstances, forward market policy in Germany appears to have been designed largely to supplement official open market operations by neutralizing the impact of balance of payments surpluses on the money market; that is, forward market policy has been used primarily as a money market instrument.5

This conclusion is suggested also by the form of intervention chosen by the Bundesbank.7 When the scope for international movements of capital was considerably enlarged as a result of the steps taken by a number of European countries at the end of 1958 to make their currencies convertible, the Bundesbank established a “closed” market for forward dollars.8 Since then, the Bundesbank has dealt in this market exclusively with German commercial banks at forward rates that are autonomously fixed and varied by the Bank itself. The rates quoted in the “open” market for forward dollars (and these rates are among the major incentives for disequilibrating or equilibrating flows of short-term capital into and out of Germany) do not appear to have been greatly affected by the rates in the “closed” market. A forward market policy of this kind differs from that in countries (e.g., the United States) where the money markets are deep and broad and the scope for official open market operations is wide, so that the authorities are able through such operations to offset the effects on the money market of swings in the balance of payments. In such countries, forward market policy is designed primarily to influence the balance of payments in the short run rather than to supplement open market policy; that is, forward market policies in these countries are directed toward influencing the rates in the open market for forward exchange.

III. Background and Characteristics of German operations

At the beginning of 1959, the Deutsche Bundesbank supplemented its policy instruments by undertaking, earlier than other central banks in the postwar period, regular operations in the forward exchange market. By such operations, it considerably enlarged its influence on the domestic money market. This step was brought about by the introduction, at the end of 1958, of external convertibility of the currencies of most member countries of the Organization for European economic Cooperation (OEEC), which greatly widened the scope for international movements of commercial bank funds and other private capital in reaction to financial incentives of any kind. The monetary problems created by these new conditions could not be solved readily by means of the policy instruments previously applied by the Bundesbank and most other central banks, since these instruments had not been designed either to exercise a major influence on ail the incentives (particularly forward market incentives) for international movements of private capital or to offset the extreme effects of such movements.9

Characteristics of forward market policy

The characteristics of the Bundesbank’s forward market policy may be summarized as follows:

1. The only trading partners in forward exchange dealings of the Bundesbank are German commercial banks, which are the only participants in the German money market. They conclude on their own account the forward contracts offered by the Bundesbank. By providing forward cover exclusively for short-term foreign investments of German banks,10 the forward market operations of the Bundesbank influence the proportion of the foreign money market assets of these banks to their total money market assets (as shown in Table 1) and, thereby, the condition of the German money market. Except for movements of funds of German commercial banks, all international capital transactions remain outside the sphere of direct influence of the Bundesbank’s forward market policy. This applies especially to speculative capital movements, which in 1960 and the first half of 1961 represented the major disequilibrating force in the German balance of payments (Table 2, items Ib 1, Ib 2, and Ic). This characteristic of forward market policy in Germany is a marked contrast to official forward market operations in other countries, e.g., the United States where, since early in 1961, the financial authorities have occasionally intervened in the open market in forward exchanges in order to reduce or even eliminate undesired forward market incentives for outflows of both commercial bank funds and nonmonetary sectors’ capital, rather than to offset the effects of these capital outflows on the domestic money market.

Table 1.

Federal Republic of Germany: Foreign and Domestic Money Market Assets of Commercial Banks, December and June, 1958–63

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Sources: Deutsche Bundesbank, Monthly Reports and Annual Report, 1962.

Short-term balances with foreign banks and foreign money market securities but excluding short-term credits to foreign banks (see footnote 3), which are not available separately.

Excluding forward commitments of the Bundesbank resulting from the temporary inclusion of the financing of German imports in the forward operations of the Bundesbank.

Domestic short-term interbank balances and loans, and domestic Treasury bills and noninterest-bearing Treasury bonds. Domestic money market assets are overstated by short-term loans to foreign banks and understated by interbank balances with maturities ranging from three to six months.

Table 2.

Federal Republic of Germant: Changes in Foreign Money Market Assets of Commercial Banks and Other Balance of Payments Transactions, 1959–63

(In millions of deutsche mark)

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Source: Deutsche Bundesbank, Monthly Reports.

Including changes in commercial bank capital, other than those shown under item II.

The amounts shown in this line may be regarded as a rough measure of the effect of international transactions on domestic bank liquidity.

For definition, see Table 1. The movement in each half year is influenced by repatriations for seasonal reasons, including window dressing in December, and their reversal. See Chart 1D (p. 405).

Excluding statistical change resulting from the inclusion of the banks in the Saar.

Approximate amounts.

Item III includes, and item IV excludes, International Monetary Fund accounts of the Federal Government and Bundesbank foreign assets of limited usability.

Of this amount, DM 900 million represents advance debt redemption of the Federal Government.

Of this amount, DM 3,125 million represents advance debt redemption of the Federal Government.

Excluding revaluation loss.

2. The Bundesbank has so far been prepared to provide at almost any time, on its own terms, forward cover for any amount desired by German commercial banks.11 That is, the amount of forward cover is a dependent policy variable of the Bundesbank, whereas in the United States and other countries the amounts used in official forward market operations are determined by the monetary authorities themselves. The ready availability of official forward cover in Germany greatly facilitates investments by German banks in foreign money markets. If there had not been such official cover, these investments would have been greatly hampered, since the open market for forward exchange does not always provide sufficient cover to German banks (and other German transactors) for their assets maintained abroad.12 The insufficient facilities for forward cover in the open forward market have stemmed from the persistent balance of payments surpluses of Germany. These surpluses have tended to resuit in an excess, further augmented by speculation, of commercial demand for, over commercial supply of, forward deutsche mark (i.e., an excess supply of forward foreign exchange).

3. The Bundesbank has confined its forward market operations to only one foreign currency—namely, the U.S. dollar. This limitation is related to the preference of the German commercial banks for U.S. dollars, which in turn is explained both by the fact that a large part of Germany’s commercial transactions with the rest of the world is settled in U.S. dollars and by the usability of that currency for international credit transactions, e.g., through the Euro-dollar market. Therefore, the need of the German commercial banks for forward cover of their U.S. dollar holdings for transaction purposes is likely to be greater than their need for forward cover of their other foreign currency holdings. The preference of the banks for U.S. dollars becomes evident when their “working balances” are analyzed; the volume and currency composition of these balances are determined mainly by international payments requirements rather than by interest considerations (Table 3). From 1959 to 1961, the U.S. dollar component of working balances maintained abroad ranged between 40 per cent and 52 per cent of the total of such balances. In the years after the revaluation of the deutsche mark, German banks increased substantially their deutsche mark balances with foreign banks, so that the U.S. dollar component of their total foreign working balances fell below 40 per cent. However, of their working balances in foreign exchange, the percentage of U.S. dollar holdings in the period 1962–63 was about as high as in 1959–61. A major consideration of the Bundesbank in confining its forward market operations to U.S. dollars has been the fact that, unlike continental European markets, the U.S. money market offers investment opportunities to German commercial banks at any time, so that even investments or disinvestments by German banks that are massive by German standards would not greatly affect interest rates in the U.S. market; if this were not true, the U.S. authorities might be forced to take corrective measures. In addition, the Bundesbank may have considered that such limitations contributed to the strength of the main reserve currency in the exchange markets and, hence, to international monetary cooperation.

Table 3.

Federal Republic of Germany: Foreign Money Market Assets of Commercial Banks by Major Currencies and Major Areas, June and December, 1959–63

(In millions of deutsche mark)

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Source: Based on data in Deutsche Bundesbank, Monthly Report, August 1963.

The data shown here are somewhat understated, except those for June 1962 and June 1963; see footnote 2.

All amounts held in countries other than the United States and Canada, European countries, and Japan are included in item III, “other currency components,” except those for June 1962 and June 1963, which are included here. The “rest of world” includes international organizations.

Approximate amounts.

Mainly sterling, Swiss francs, and Belgian francs.

Somewhat overstated; see footnote 2.

See Table 1, footnote 1.

This limitation of the Bundesbank’s forward operations does not prevent the German banks from using the cover facilities at the Bundesbank for investments in the Euro-dollar market, or from switching from U.S. dollar investments to more profitable investments in other currencies until their forward dollar contracts with the Bundesbank expire. Thus, the official forward market policy, although confined to the U.S. dollar, does not in practice discriminate against covered investments in other currencies. On the contrary, it facilitates investments in markets other than the U.S. dollar market or the Euro-dollar market, because in exchange markets abroad forward markets for U.S. dollars are, in general, established more frequently than forward markets for other currencies. That is, German banks, desiring to invest on a covered basis in markets other than the U.S. dollar market or the Euro-dollar market frequently may not find the suitable swap-partner unless they first acquire U.S. dollars and then shift from U.S. dollars to the covered investment in the desired foreign market. In fact, however, German commercial banks do not seem to have taken full advantage at all times of arbitrage facilities abroad by shifting funds either indirectly through the U.S. dollar market or directly from the domestic market to more profitable covered investments in other foreign money markets. This forgoing of higher profits can be explained mainly by the limits for money market investments in individual foreign countries which the banks have imposed on themselves. Usually, the banks limit their short-term investments abroad to a relatively small percentage of their freely usable liquid assets, even when arbitrage facilities for such investments exist. During the period under review (1959–63), foreign money market assets of the German commercial banks did not exceed 20 per cent of their total money market assets (Table 1). According to Lipfert, the limits that the individual banks set themselves for their investments in individual foreign markets stems from their desire to spread the risk of their foreign exchange holdings.13 This explanation is not exhaustive, however. As Einzig points out, the self-imposed limits for the banks’ arbitrage funds, which tend to vary somewhat with the widening of the profit margins on international arbitrage, need not necessarily be born of distrust of the foreign center concerned (e.g., because of expected exchange restrictions). Even without such a reason, there would be limits because bankers usually do not want to jeopardize their future business relations with their customers by a large-scale cutting of credits—a practice that the banks normally would have to follow in order to take full advantage of temporary high profits on international arbitrage.14

Since the limits that the German banks have set for their investments in individual foreign money markets appear to have been higher and more flexible for investments in U.S. dollars than in other foreign currency assets, the amounts invested in currencies other than the U.S. dollar remained small and varied little in most of the years under review (Table 3, item III). This was true despite the fact that in that period the net yields on some of these investments were at times higher than those on investments in U.S. dollars. In contrast, the U.S. dollar component of the German banks’ foreign assets generally fluctuated widely. Apart from 1960, when foreign investments were relatively low because of higher net yields on domestic money market assets, investments in U.S. dollars were more than 60 per cent of total money market assets denominated in foreign currencies (Table 4). During most of the time, at least half of the U.S. dollar investments of the German banks were made in the U.S. money market. To that extent, the Bundesbank’s forward market policy supported the U.S. dollar in exchange markets.

Table 4.

Federal Republic of Germany: Commercial Banks’ Holdings of U.S. Dollars in Relation to Various Totals, June and December, 1959–63

(In per cent)

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Source: Based on data in Table 3.

4. The Bundesbank acted only as a purchaser (and not as a seller) of forward dollars (i.e., as a supplier of forward deutsche mark) either on a “swap” basis (i.e., by purchasing forward dollars and selling an equivalent amount of spot dollars) or on an “outright” basis (i.e., by purchasing forward dollars without selling spot dollars). This behavior stemmed from the large surpluses in Germany’s balance of payments and the resulting tendency toward surpluses in the domestic money market. These surpluses prompted the Bundesbank to use, although with varying intensity, its forward market instrument to promote exports of short-term capital by German banks. However, the Bundesbank is by no means restricted to the demand side of the forward dollar market. Should it become appropriate, it might also act to supply forward foreign exchange (i.e., to demand forward deutsche mark), perhaps at rates more favorable than those existing in the open market for forward exchange. This behavior might become appropriate if, in the long run, the balance of payments position should deteriorate to the extent that it might become desirable to promote borrowings abroad by German banks (or nonbanks) in order to alleviate pressure on domestic liquidity or the balance of payments. Of course, as an alternative in that situation the Bundesbank could increase its discount on forward dollars and/or its selling rates for domestic money market paper in order to induce the commercial banks to repatriate foreign assets.

5. The Bundesbank has chosen to use two independent variables in its forward dollar operations: (a) limitation of the maturity of its forward contracts and (b) forward margins (= swap rates).

a. Since the beginning of its forward dealings, the Bundesbank has set lower and upper maturity limits and has occasionally varied these maturity spreads. By fixing and varying the minimum maturities, the Bundesbank attempts to ensure that bank liquidity is tied in foreign money markets for a shorter or a longer period. Since the Bundesbank has also set maximum maturities for its forward contracts, which do not exceed the traditional maturities of domestic and foreign money market investments, its forward market policy is carried out exclusively in the field of money market operations. This enables the Bundesbank to bring about a desired reversal of the commercial banks’ capital exports (through an appropriate change in its forward dollar rate and/or its selling rate for domestic money market securities) more quickly than would be possible in longer-term forward operations. Since the commercial banks may not prematurely terminate their forward contracts with the Bundesbank, but may resell at any time before maturity domestic “open market” securities to the Bundesbank,15 bank liquidity is neutralized more effectively through the forward market policy than through the open market policy of the Bundesbank. Until the end of 1959, the minimum maturity of the Bundesbank’s forward contracts had predominantly been one month ; thereafter, it was increased, by stages, to three months. In August 1960, the minimum maturity was markedly reduced to one half of a month and was maintained at this short period until August 1961, when it was increased to one month. The maximum maturity of the Bundesbank’s forward dollar contracts had been three months until October 1959, when it was increased to six months. In order to discourage the banks from using the forward cover for relatively short-term investments abroad, and to induce the banks simultaneously to cover relatively long-term investments abroad, the Bundesbank has maintained since March 1962 two maturity categories at different forward rates, and thereby two minimum and maximum maturities.16 In the shorter-term category (one-two months), forward dollars are offered at a discount, which is one fourth percentage point (per annum) higher than the discount on forward dollars available in the longer-term maturity range (more than two, but not more than six, months). Moreover, in the autumn of 1962 the Bundesbank refused to offer forward dollar contracts maturing in December, in order to discourage the German banks from a large-scale repatriation of their foreign balances for year-end window dressing purposes. All these changes in the Bundesbank’s forward policy were made in a period when balance of payments surpluses appeared to have ceased and the foreign investments of German banks therefore became more dependent on changes in bank liquidity caused by domestic factors than on the balance of payments. This situation tended to cause a greater volatility of the German banks’ foreign investments which, if not checked, could have easily created undesired unrest in the exchange markets.17

b. The Bundesbank autonomously fixes, and also varies, its forward dollar margins, so that they are not necessarily identical with those in the open market for forward dollars. In fixing its margins, the Bank takes into account developments in respect of domestic bank liquidity, forward exchange rates quoted in the open market, spot exchange rates,18 and the interest rate differentials between the domestic and foreign money markets. That is, the Bundesbank’s forward dollar rate represents an independent policy variable in the same way as its buying rate for domestic money market securities (Chart 1). This is in contrast to the policies in countries where official forward operations are carried out in the open market and the monetary authorities attempt to influence the forward rate through the amounts bought or sold. In Germany, the forward dollar rates of the open market cannot adjust themselves to the forward dollar rates of the Bundesbank as long as the Bank does not permit parties other than German commercial banks to participate in its forward exchange dealings. Therefore, the forward market established by the Bundesbank may be termed a closed market; it is linked to the open market for forward dollars only through the German commercial banks, which are permitted to participate in both markets for forward dollars. In the years under review (1959–63), this link was never sufficient to establish uniform margins over an extended period in the closed and open market for forward dollars.

Chart 1.
Chart 1.
Chart 1.

Federal Republic of Germany: Indicators of the Forward Market and Interest Rate Policy of the Deutsche Bundesbank, 1959–631

Citation: IMF Staff Papers 1964, 003; 10.5089/9781451969023.024.A003

Sources: Deutsche Bundesbank, Monthly Reports; [U.S.] Board of Governors of Federal Reserve System, Federal Reserve Bulletin; International Monetary Fund, International Financial Statistics.1 Data for 1959 are for end of quarter, with the exception of Bundesbank data in section B, which are for end of month; all data for 1960–63 are for end of month.2 Swap-rate for maturities of two-six months (which is one fourth of a percentage point below the swap-rate for one-two month contracts) since the end of March 1962, when the Bundesbank differentiated its swap rate; see text, page 402.3 These net yields reflect incentives for, or deterrents to, U.S. money market investments of German banks, but not those relevant to (1) nonresidents, who have been prohibited from purchasing German money market paper since June 1960 or (2) German bank customers, to whom neither the Bundesbank’s selling rate for money market paper nor its forward dollar margin apply. The positive (negative) net yields are understated (overstated), insofar as they do not allow for the effect on the interest earnings of the German banks as a result of the fact that, since May 1961, they have been permitted to deduct their foreign assets from their foreign liabilities when calculating minimum reserves, and thus maintain smaller minimum reserves (which do not yield any interest) than they would otherwise have had to do.4 Including those resulting from the inclusion of the financing of German imports in the Bundesbank’s forward operations between August and November 1960.

IV. Chronological Review of the Bundesbank’s Operations

Chart 1 indicates, though only roughly, the combined effect of the Bundesbank’s forward market policy and its interest rate policy since the beginning of 1959 in encouraging or discouraging foreign investments by the German banks. Until the beginning of 1960, the Bundesbank temporarily purchased forward dollars at the spot rate and temporarily at a discount less than the interest differential, so that the higher interest rates then prevailing in the United States and other foreign money markets remained more attractive to German banks than short-term rates in the domestic market. However, at most of the 1959 dates shown in Chart 1, the forward dollar margins quoted in the open market were more favorable than those quoted by the Bundesbank, so that only a small portion of the foreign short-term investments of the German banks was covered by the Bundesbank. In 1960, when inflationary pressure developed in Germany, the Bundesbank pursued a policy of high interest rates, while short-term interest rates in the United States and other foreign countries declined considerably. The resulting interest rate differentials favoring investments of German banks in the domestic money market were widened by forward premiums on the deutsche mark in the open market, which at that time were not reduced through the intervention of the U.S. authorities in the forward market. On the other hand, official forward market policy in Germany did not eliminate these interest differentials, since the Bundesbank purchased forward dollars at the spot rate until July 1960, and at a high but yet insufficient premium from August 1960 through January 1961.19 As a result, the German banks repatriated most of their foreign money market assets and thereby contributed greatly to the extreme overall balance of payments surplus of 1960 (Table 2). From May 1961 through June 1962, the Bundesbank promoted foreign investments of German banks most effectively. On the one hand, it gradually decreased domestic money market rates and finally maintained them at levels below those of rates in major foreign markets. On the other hand, it offered forward cover at terms more favorable than the open market rates for forward dollars, and thus ensured a considerable incentive for capital exports of German banks. Accordingly, the German banks increased their investments in foreign money markets by the largest amounts on record, and they resorted more than in any previous period to the forward cover facilities of the Bundesbank. At the beginning of 1962, the banks’ foreign money market assets reached more than DM 6 billion, two thirds of which was covered by the Bundesbank. These foreign investments greatly exceeded the masse de manæuvre, which the Bundesbank had available at that time for sales of money market paper in the domestic market; therefore, the diversion of liquid funds from the domestic market to foreign money markets through the combined influence of the forward market policy and the interest rate policy of the Bundesbank helped to prevent the open market instrument of the Bundesbank from becoming overburdened. As the balance of payments surpluses diminished, or temporarily disappeared, and domestic bank liquidity tightened in the course of 1962, the Bundesbank gradually removed its incentives for the banks to invest in money markets abroad. Thus, it narrowed the interest rate differentials vis-à-vis foreign countries by increasing domestic interest rates. At the same time, it increased its discount on forward dollars; toward the end of 1962, the Bank’s discount exceeded the discount on forward dollars quoted in the open market. This change in policy resulted in a substantial decrease during 1962 in the forward dollar commitments of the Bundesbank while the decrease in foreign assets of German banks was not quite so great (Chart 1). In the first half of 1963, the forward market policy and the interest rate policy of the Bundesbank remained unchanged, while short-term interest rates in the United States increased and the open market discount on forward dollars declined and finally changed into a premium. Therefore, the gap between the swap rates of the Bundesbank and the open market rates for forward dollars widened further. As a result, the German banks entirely dissolved their outstanding forward dollar contracts with the Bundesbank. Instead, they sought to cover in the open market a part of their new and existing foreign investments. To a great extent, the banks even avoided the need for forward cover by considerably increasing their foreign holdings of deutsche mark, partially at the expense of their U.S. dollar holdings in the United States (Table 3). During the second half of 1963, these general conditions in the forward market remained unchanged, and the Bundesbank did not enter that market.


I. Types of Foreign Exchange Speculation Affecting the German Balance of Payments

In the postwar period, and especially when exchange restrictions have been widespread, the most favored form of speculation has been the so-called leads and lags. They arise from an acceleration (postponement) of payments on current account to countries whose currencies generally are considered to be undervalued (overvalued), as well as from excessive “hedging” against an expected depreciation of outstanding assets denominated in overvalued currencies. Although this form of speculation has taken place primarily outside the forward exchange market, it has affected demand and supply in that market.20

In the balances of payments, the leads and lags are reflected in a shift of the so-called terms of payments (i.e., the extension of, and the recourse to, trade credits) in favor (at the expense) of the country whose currency is considered to be undervalued (overvalued). Since trade credits frequently escape recording in the appropriate balance of payments items, changes in the entry for net errors and omissions or, where records of international transfers of money are maintained, differences between the trade balance on a payments basis and the trade balance on a transactions basis, may serve as rough indications of leads and lags.

On several occasions during the postwar period, the terms of payments shifted strongly in favor of the Federal Republic of Germany; this was particularly true in the autumn of 1957 and immediately before and after the revaluation of the deutsche mark in March 1961, when speculative flight to the deutsche mark was most pronounced. The shift in the terms of payments in favor of Germany resulted from prepayments in deutsche mark by foreign importers on future German exports, on the one hand, and the delay in payments on German imports invoiced in foreign currencies, on the other. When rumors of further revaluations continued after the revaluation in March 1961, the liquidity effects of shifts in the terms of payments were greatly augmented by “hedging” operations of German residents who were maintaining foreign assets or were expecting foreign exchange receipts. These individuals found it cheaper to obtain forward cover through the spot market rather than through the forward market, where the forward margins were extremely high. To hedge their foreign currency claims, they borrowed an equivalent amount of foreign currency, to be repaid out of their future foreign exchange receipts; sold the borrowed funds spot for deutsche mark; and either invested the proceeds or used them to repay domestic credits, thereby reducing the borrowing costs, which in this case represented the cost of forward cover.21

In addition to these forms of speculation in the spot market, speculation in the forward market has played a prominent role in the postwar period. During speculation on an appreciation of the deutsche mark, German exporters, importers of products from Germany, and “pure” speculators (i.e., “bulls” of deutsche mark) bought more deutsche mark in the forward market (i.e., sold more of the forward currency under pressure) than was usual, in the expectation that the future spot rate would be above the current rate of forward deutsche mark in terms of the currency under pressure. Conversely, German importers and exporters to Germany tended to delay their sales of forward deutsche mark (i.e., their purchases of the forward exchange under pressure).22 During the one-sided speculation on an appreciation of the deutsche mark in 1957, these market forces increased the premium on forward deutsche mark to 15 per cent per annum against sterling and 28 per cent per annum against the French franc—the highest premiums that had ever been attained. Einzig23 draws attention to the fact that at that time individual expectations of exchange profits were extremely high, so that speculation even assumed the simple form of “uncovered” spot purchases of deutsche mark, despite the big profit on the high premium on forward deutsche mark that could have been obtained without any exchange risk whatever.

II. Equilibrium in the Forward Exchange Market

In the normal course of events, the forward premium or discount on one currency against another is directly related to the interest rate differentials between the countries concerned. This normal relationship is such that the currency of the country with high (low) interest rates shows a discount (premium) against the currency of the country with low (high) interest rates. According to the modern theory of interest parity, the forward rate is at “interest parity” if the forward premium or discount (in per cent per annum) is equal to the interest rate differentials between the two countries concerned;24 that is, the interest parities form the equilibrium level for forward rates. However, as Einzig has shown,25 the forward rates can stabilize for long periods at a level above or below their interest parities. These déviations of the forward rates from their interest parities reflect an overvaluation or undervaluation of forward exchanges and are defined by Einzig as “intrinsic premiums” or “intrinsic discounts.” They mainly arise when, on the one hand, there are persistent imbalances in the balances of payments and one-sided speculative operations in the forward markets and when, on the other hand, the funds available for covered international interest arbitrage are insufficient to readjust the “exaggerated” (i.e., the overvalued or undervalued) forward rates to their interest parities. The persistent balance of payments surpluses of Germany resulted in premiums on forward deutsche mark in relation to most foreign currencies during most of the time following the resumption of foreign exchange dealings in Frankfurt am Main in May 1953. These premiums represented intrinsic premiums primarily, since capital controls, which were widely used before 1958, discouraged incoming interest arbitrage that otherwise would have reduced, or even eliminated, the intrinsic premiums on forward deutsche mark.

Opérations officielles de change à terme: l’expérience allemande


Les opérations officielles de change à terme élargissent la liberté d’action des autorités monétaires et conviennent particulièrement pour neutraliser les effets de mouvements soudains de capitaux spéculatifs sur la balance des paiements et le marché monétaire intérieur. L’objectif de ces operations peut être intérieur plutôt qu’extérieur.

Comme les opérations officielles à terme ont été entreprises depuis 1959 sur une plus grande échelle dans la République fédérale d’Allemagne qu’ailleurs, l’auteur analyse principalement l’expérience de ce pays. Le marché monétaire y est étroit, et les moyens plus traditionnels de combattre les effets de forts excédents de la balance des paiements sur ce marché sont limités. Dans ces conditions, la politique du marché à terme semble avoir été utilisée dans une grande mesure pour apporter un appoint aux operations officielles du marché ouvert, et a donc servi surtout d’instrument du marché monétaire. Depuis 1959, la Bundesbank a traité en dollars à terme sur un marché “fermé” exclusivement avec les banques commerciales allemandes à des taux à terme qui sont fixés independamment par la Bundesbank elle-même. Les taux du dollar à terme cotés sur le marché “ouvert” (qui sont parmi les principaux stimulants des flux déséquilibrants ou équilibrants de capitaux à court terme vers l’Allemagne ou en provenant) n’ont guère été influencés par les taux sur le marché fermé. Une politique du marché à terme de ce genre diffère d’une façon marquée de celle des pays (comme les Etats-Unis) où les marchés monétaires sont larges et profonds et où le champ qui s’offre aux operations officielles du marché ouvert est vaste. Dans ces pays, la politique du marché à terme a pour but principal d’influer sur les taux des devises à terme sur le marché ouvert, et donc sur la balance des paiements à court terme. A part ces differences, l’auteur explique pourquoi la Bundesbank n’est intervenue que comme acheteur de dollars à terme, et expose les conséquences de cette restriction sur les investissements des banques allemandes en diverses monnaies à l’étranger.

Operaciones oficiales de cambio a término: la experiencia alemana


Las operaciones oficiales de cambio a término aumentan la libertad de acciôn de las autoridades monetarias y son particularmente adecuadas para contrarrestar los efectos que sobre la balanza de pagos y el mercado monetario local ejercen los súbitos movimientos de capital especulativo. El objetivo de tales operaciones puede ser màs bien interno que externo.

Dado que a partir de 1959 las operaciones oficiales de cambio a término se han efectuado màs intensamente en la República Federal de Alemania que en cualquier otro lugar, el autor analiza principal-mente la experiencia de ese pais. En éste el mercado monetario es limitado y son pocas las facilidades de ïndole mas tradicional para contrarrestar los efectos que sobre este mercado producen los grandes superávit de la balanza de pagos. En estas circunstancias, la politica de mercado a término parece haber sido usada en gran medida para complementar las operaciones oficiales de mercado abierto, y, por ende, primordialmente como un instrumento del mercado monetario. Desde 1959 el Bundesbank ha comerciado en un mercado “cerrado” de dôlares a término exclusivamente con bancos comerciales alemanes a base de tipos de cambio a término fijados de modo autônomo por el propio Bundesbank. Los tipos cotizados en el mercado “abierto” para los dôlares a término (los cuales figuran entre los principales incentivos que motivan la corriente equilibradora o desequilibradora del capital a corto plazo que afluye hacia Alemania o sale de ella), no han sido mayormente afectados por los tipos del mercado “cerrado.” Una politica de mercado a término de este género difiere ostensiblemente de aquella que rige en paises (por ejemplo, Estados Unidos) en que los mercados monetarios son de gran amplitud y la esfera para las operaciones oficiales de mercado abierto es extensa. En estos paises, la politica de mercado a término tiene como objeto principal influir sobre los tipos que rigen en el mercado abierto para las divisas a término y, de esa manera, sobre la balanza de pagos en brève plazo. Aparte de estas diferencias, el autor explica el porqué el Bundesbank ha actuado sólo como comprador de dôlares a término, asi como las consecuencias que ha tenido esta limitada actuaciôn en cuanto a las inversiones de los bancos alemanes en diferentes monedas en el exterior.


Mr. Brehmer, formerly economist in the Research and Statistics Department and now in the European Department, is a graduate of Kiel University. He was formerly assistant at the Wirtschaftswissenschaftliches Seminar of that university and a member of the staff of the Deutsche Bundesbank. He is the author of Struktur und Funktionsweise des Geldmarktes der Bundesrepublik Deutschland seit 1948 (Tubingen, 1956 and 1964).


This paper represents a modified and enlarged version of the discussion of this subject in E. Brehmer, Struktur und Funktionsweise des Geldmarktes der Bundesrepublik Deutschland seit 1948 (second edition, Tübingen, 1964), pp. 180–90. The views expressed here do not necessarily reflect those of the International Monetary Fund.


On the contrary, if the current account balance should be affected by the slight depreciation of the domestic currency that is implied in the lowering of the forward rate, the result would be an increase (likely to be negligible) in the balance.


See Appendix I (pp. 408–10).


See Appendix II (pp. 410–11).


For a discussion of the various types of foreign exchange speculation, see Appendix I.


At times, however, the objective undoubtedly has been to influence the balance of payments.


For a detailed examination of the techniques employed, see Section III below.


It is relevant to recall that the favorable developments in Germany’s balance of payments and the resulting strength in that country’s foreign exchange position enabled the authorities to withdraw exchange restrictions, to a large extent, even before the end of 1958; in particular, nearly all controls on capital exports were removed in the autumn of 1957. Immediately following the declaration of external convertibility in December 1958, Germany withdrew its remaining restrictions on residents’ and nonresidents’ transactions on current and capital account. On the other hand, in May 1959, it abolished, though only temporarily, all its defenses against capital inflows (e.g., the prohibition of interest payments on nonresidents’ deposits with, and loans to, German commercial banks and the prohibition of the sale of German money market paper to nonresidents). Thus, Germany established complete freedom in its payments relations with foreign countries, while most of the other European countries initially undertook only to introduce by the end of 1958 external convertibility in their current account transactions. The more rapid progress in Germany toward complete freedom in external payments relations first tended to make the country’s external position less stable than that of several other European countries, although the difference between Germany and the other countries in these respects has subsequently been reduced somewhat.


Incidentally, the monetary problems created by the new conditions may arise not only when a current surplus or deficit in the balance of payments is reinforced by a net movement of capital in the same direction, but also when current and capital transactions together leave a large over-all surplus or deficit. Such imbalances are necessarily felt in those economies where the domestic money markets are relatively narrow and the existing offsetting facilities are limited in scope, as in Germany and other continental European countries.


Except from August 24 to November 11, 1960; between these dates the German banks, when lending foreign exchange to German importers, were expected to pass on the benefit of the Bundesbank’s swap premium to the importers in order to induce them to finance their requirements in the domestic financial markets rather than abroad. This was one of the policies adopted by the Bundesbank to ward off undesired inflows of funds during the period of high interest rates in Germany.


The Bank withdrew entirely from its forward exchange dealings only once—for a short interval at the end of October 1959.


Even in the New York forward exchange market, which is one of the most active in the world, deutsche mark transactions play a relatively minor role. It has been pointed out that “sterling is by far the most important currency traded in the New York forward market. There has in recent years been a growing forward market in Canadian dollars in New York, and from time to time there are forward transactions in other currencies, such as the Swiss franc, the French franc, the Dutch guilder, and the deutsche mark. For currencies other than the pound sterling and the Canadian dollar, no broad forward market can be said to exist in New York at the time of this writing [1959].” See Alan R. Holmes, The New York Foreign Exchange Market (New York, 1959), p. 37.


H. Lipfert, Der deutsche Privatdiskontmarkt (Frankfurt am Main, 1959), p. 62.


P. Einzig, A Dynamic Theory of Forward Exchange (London, 1961), pp. 166 and 180. Einzig also points out (p. 182) that in some countries, e.g., the United Kingdom, bankers have to observe officially fixed maximum limits for the funds they can employ for interest arbitrage.


Strictly speaking, this applies to securities maturing within less than one year.


In November 1959, the Bundesbank had established two maturity categories, but thereafter it reintroduced one maturity spread.


See Deutsche Bundesbank, Annual Report, 1962, pp. 16–17.


The actual spot exchange rates and the market expectations of their developments are important factors determining the commercial banks’ decision about seeking forward cover for their investments in foreign currencies. Usually, the commercial banks abstain from seeking forward cover if the following conditions exist simultaneously: (1) the spot rate of the currency concerned is quoted at the lower intervention point of the Bundesbank, (2) the market does not expect a devaluation of the currency concerned, and (3) the forward exchange rate quoted by the Bundesbank or in the open market is not at a premium. When the banks do not expect a change in par value, they may also avoid the cost of forward cover if the difference between the spot rate and the lower support point of the Bundesbank is less than the positive interest rate differential vis-à-vis the foreign center and if, at the same time, the forward discount of the Bundesbank or in the open market would cancel the positive interest rate differential (see P. Einzig, op. cit., p. 73).


To defend its policy of high interest rates, the Bundesbank reintroduced the defenses against capital inflows, which had been abolished in May 1959, and took certain other steps to stem the inflow. See G. S. Dorrance and E. Brehmer, “Controls on Capital Inflow: Recent Experience of Germany and Switzerland,” Staff Papers, Vol. VIII (1960–61), pp. 427–38.


See P. Einzig, op. cit., pp. 94–96 and 219–21.


See Deutsche Bundesbank, Monatsberichte, April 1961, p. 41, and Federal Reserve Bank of New York, Annual Report, 1961, p. 32.


For a thorough discussion of forward exchange speculation, see P. Einzig, op. cit., p. 41 f, and H. Lipfert, Devisenhandel: Devisengeschäfte der Banken, Exporteure und Importeure (Frankfurt am Main, 1958), p. 159 f.


P. Einzig, op. cit., pp. 75 and 355.


See, e.g., P. Einzig, op. cit., p. 144 f, and A. R. Holmes, op. cit., p. 44.


P. Einzig, op. cit., pp. 176–86.

IMF Staff papers: Volume 11 No. 3
Author: International Monetary Fund. Research Dept.