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The Exchange Stabilization Fund: How It Works

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The Exchange Stabilization Fund: How It Works December 1999 Federal Reserve Bank of Cleveland The Exchange Stabilization Fund: How It Works By William P. Osterberg and James B. Thomson The increased turmoil in international ■ An Overview of the ESF financial markets, starting with the Asian The ESF began operations on April 27, crises of 1997, has led to calls for finan- 1934, with capital of $2 billion. Initially, Increasingly controversial, the cial assistance from the wealthier nations. $1.8 billion of the ESF’s reserves were Exchange Stabilization Fund is In December 1997, the United States an- maintained in the Treasury’s gold used to influence the international nounced a $5 billion commitment toward account. The remaining $200 million value of the U.S. dollar and to pro- an international package of financial as- was deposited in a special account at the vide aid to foreign countries. The sistance for South Korea. Two months Federal Reserve Bank of New York as debate surrounding the Fund will earlier the United States pledged $3 bil- the working balance for investing in become more informed, suggest the lion for assistance to Indonesia. In both gold and foreign exchange.2 The work- authors, when observers understand instances, the Exchange Stabilization ing fund of the ESF has expanded over how to calculate the total amount of Fund (ESF) was to be involved. time, reaching as high as $42 billion in mid-1995.3 As documented by Schwartz resources available to the Fund. This Established by Congress in 1934 to help (1997), most of the growth in ESF assets Economic Commentary explains how stabilize the international value of the has occurred since 1960 and has com- the ESF’s balance sheet figures must dollar, the ESF received little public prised increases in foreign exchange and be adjusted to produce an accurate attention until it was used in the provi- securities. As of June 30, 1998, almost account of those resources. sion of financial assistance to Mexico in 60 percent of the asset total had been the wake of the peso crisis of 1995. financed by cumulative net income, Indeed, greater scrutiny may have been mainly reflecting interest earnings and “… a loan or credit to a foreign entity or inevitable given the ESF’s expansion capital gains on foreign currencies. government of a foreign country may be beyond its original mandate.1 Despite the made for more than 6 months in a 12- recent attention, the full range of ESF The Gold Reserve Act of 1934 excluded month period only if the President gives activities and the actual amount of avail- the ESF from the congressional appro- Congress a written statement that unique able ESF resources are not well under- priations process and explicitly autho- or emergency circumstances require the stood. This impedes an informed public rized it to operate without congressional loan or credit be for more than 6 months discussion of ESF operations. oversight and accountability. In other (31 U.S.C. 5302(b)).” words, Congress gave exclusive control A major goal of this Economic Commen- of the ESF to the executive branch. All Finally, 1978 legislation requires the tary is to facilitate accurate assessments decisions regarding the ESF are made by Treasury to provide monthly statements of the amount of resources available to the Secretary of the Treasury, subject to of ESF activities to the House and Sen- the ESF. First, in order to understand the the approval of the President. uses of ESF resources, we provide an ate Banking Committees. Nevertheless, overview of ESF operations. Second, we Legislative changes in the late 1970s re- none of these legislative changes has examine the ESF balance sheet to show duced somewhat the secrecy under which reduced the discretion of the Treasury how “total assets” is a poor measure of the ESF operates and made it more ac- Secretary in operating the ESF. All of his the resources available to the ESF for one countable to the Congress. For instance, decisions are final and not subject to of its major activities, foreign-exchange since 1979 the administrative expenses of approval by the Congress. intervention. Third, we discuss how any the ESF have been subject to the budget ■ The Size of the ESF measure of ESF resources must take process. Moreover, a 1977 amendment to A common misperception about the ESF account of warehousing and swap lines. Section 10 of the Gold Reserve Act pro- is that its size is adequately measured by Finally, we suggest a better procedure for vides that: assessing the amount of resources avail- the “total assets” number reported on the able to the ESF. ESF balance sheet, published quarterly in ISSN 0428-1276 the Treasury Bulletin (see table 1).4 This TABLE 1 ESF BALANCE SHEET, JUNE 30, 1998 might seem to be a reasonable presump- tion since the ESF cannot unilaterally Assets ($ millions) Liabilities and capital ($ millions) issue debt in financial markets. However, Held with U.S. Treasury: Current liabilities: U.S. government securities 15,691 Accounts payable 223 several important aspects of ESF opera- Total current liabilities 223 tions are not apparent from its balance Special drawing rights (SDRs) 10,001 Other liabilities: sheet. In particular, since many ESF Foreign exchange and securities: SDR certificates 9,200 operations use dollar assets, any limita- German marks 5,898 SDR allocations 6,524 tion on the conversion of nondollar assets Japanese yen 8,018 Total other liabilities 15,724 to dollar assets is relevant to an assess- Accounts receivable 119 Capital: ment of available ESF resources. Capital account 200 Net income gain (+) or loss (–) 23,581 Intervention, the purchase or sale of for- Total capital 23,781 eign currencies to influence the interna- Total Assets 39,727 Total liabilities and capital 39,727a tional value of the dollar, is a major use of ESF resources (see box, opposite). a. The column sum does not equal this number because of rounding error. SOURCE: U.S. Department of the Treasury, Treasury Bulletin, December 1998, p. 108. The other is the provision of financial assistance to foreign countries. When- ever the ESF sells foreign currency, it produces a crediting of the ESF’s (non- There are three SDR entries on the ESF an estimate of the ESF’s available re- marketable) U.S. government security balance sheet (see table 1). The SDR sources. Thus, although total assets of account with the Treasury, which is asset entry and the SDR liability entry, the ESF on June 30, 1998, were $39.7 equivalent to “dollar” cash assets. When “SDR allocations,” pertain to ESF link- billion dollars, a slightly more accurate purchasing foreign currency, the ESF ages to the IMF. The allocations repre- measure of available dollars would be first obtains dollar balances—possibly sent the current value of the provisions of $30.4 billion. This is the sum of the non- by selling some of its Treasury securities SDRs by the IMF to the U.S. Treasury, monetized portion of the SDR total to the Treasury (with the Federal Reserve which were transferred to the account of ($10 billion SDRs minus $9.2 billion [hereafter, the Fed] acting as agent). The the ESF.6 The SDR asset entry reflects SDR certificates), the entry for U.S. subsequent purchase of foreign exchange the dollar value of SDR allocations to the government securities with the Treasury with dollars leaves the ESF with a lower United States plus interest earnings, valu- ($15.7 billion), and the dollar value of level of Treasury securities but an off- ation changes, and sales and acquisitions the German mark and Japanese yen setting increase in “foreign exchange of SDRs from other IMF participants. items ($13.9 billion). and securities.” The third entry, “SDR certificates,” ■ Off-Balance-Sheet Financing Thus the relevant measure of resources equals the portion of the SDR assets Congress limited the ability of the ESF available for ESF interventions depends which has already been “used.” As noted to issue liabilities on its own and thus, on whether foreign exchange is being earlier, all SDRs owned by the U.S. gov- perhaps intentionally, limited the ESF bought or sold. Dollar assets are needed ernment must be held by the ESF. In to financing new interventions through to buy foreign-currency-denominated other words, the ESF cannot engage in the sale of assets, a practice known as assets. On the other hand, purchases of transactions with either the U.S. Trea- asset management. However, beyond dollars are financed from international sury or the Fed that would result in a the uses of SDRs and securities as de- reserves, which include official holdings reduction in the ESF’s SDR holdings. scribed above the ESF can obtain addi- of gold, foreign government securities or Thus, in order to convert SDRs to dollar- tional dollar resources by moving for- deposits at foreign central banks, the denominated assets, the ESF issues a eign-denominated assets off-balance reserve position in the International claim on its SDR assets to the Fed— sheet through an arrangement with the Monetary Fund (IMF), and special SDR certificates—in a process called Federal Reserve System. Thus, the drawing rights (SDRs).5 monetization.7 While this does not $30.4 billion on-balance sheet asset decrease the SDR asset entry on the bal- number is still a flawed measure of the ESF accounting for SDRs provides ance sheet of the ESF, it does increase dollar assets available to the ESF. another example of why total assets is a the certificate number by the amount of poor measure of available resources. The the monetization. By law, the certificate The first problem is that, once the Treas- SDR is an international reserve asset cre- entry cannot exceed the SDR asset entry.
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