A History of the Federal Reserve, Volume 2 by Allan H. Meltzer Read Free Book Online Page B

Federal Reserve, the rest from the Treasury) in addition to the $1.35 billionswap line (ibid., 14).

    Uncertainty, indecision, and differences of opinion also arose among central bank governors. Hayes reported that the bankers could not reach agreement at the Basel meetings in early December. Several countries wanted to withdraw from the gold pool. They urged the United States to reduce capital investment in Europe and borrow from the IMF to support the gold price instead of relying on the gold pool (Maisel diary, December 12, 1967, 2). Discussions began to consider alternatives to the gold pool including a two-tier system with official sales restricted to other central banks and governments.
    During fourth quarter 1967 and first quarter 1968, the United States gold reserve fell $2.3 billion, more than 18 percent of its stock in September 1967. The federal funds rate rose from 4.02 percent in the week following the U.K. devaluation to 5.40 in the last week of March 1968. Bond yields, however, showed little net change, and stock price indexes rose until mid-January, then declined slightly. These markets showed no sign that participants thought a major event had occurred.
    President Johnson met with his advisers and some principal members of Congress on November 18. The president made another strong commitment to the tax surcharge and probed the congressional leadership about what it would take to get the surtax passed. He remained reluctant, but yielded on spending reductions. He told the participants, “If we don’t act soon, we will wreck the Republic.” And he issued a public statement again “unequivocally” reaffirming his commitment to the $35 gold price (Sterling Devaluation and the Need for a Tax Increase, Johnson Library, National Security File, November 18, 1967).
    Early on the first trading day following the British devaluation, Monday, November 20, the trading desk implemented the plan agreed to earlier by placing bids for long-term bonds slightly below the market. The System bought $121 million of one- to five-year issues, $65 million of longer-term issues, and $427 million of bills. Stock prices fell nearly fifteen points in the first half hour (Annual Report, 1967, 268). After those initial reactions, markets stabilized, and there was no crisis. By the close on the following day, bond prices were above the prices at which the System bought (FOMC Minutes, November 27, 1967, 63).
    Despite their failure to prevent devaluation, participants in the negotiations regarded the experience as “a strong reaffirmation of international financial cooperation” (FOMC Minutes, November 27, 1967, 29). Only France had gone its own way, acting in “an unfriendly and mischievous fashion” (FOMC Minutes, November 27, 1967, 31). But it had “little power to affect developments by means other than making press statements and leaking confidential information in an effort to embarrass the United States” (ibid.). These statements proved to be overly optimistic.

    One of the anomalies of the gold pool was that the U.S. government supplied gold to match the demands of foreign citizens, but it was illegal for U.S. citizens to buy or hold gold. Contrary to claims about international cooperation, Solomon explained that if the U.S. failed to supply gold to the pool, the market price of gold would rise above $35 an ounce. Foreign central banks could then sell on the market and buy at the $35 price from the Treasury. “In fact, some central banks might be tempted to buy gold from the United States for the purpose of reselling it at the higher market price” (ibid., 30–31). Within a little more than three months, the two-price system became official policy.
    To maintain fixed parities, the central banks agreed to sell their currencies for dollars in the forward market as required. This gave reassurance that they intended to maintain the exchange rate and moderated the effect of a dollar inflow on rates elsewhere. The amount of