December 1963

FOREIGN DEPOSITS a n d BANK RESERVES

The build-up of foreign deposits in American the form of demand deposits than otherwise. On the banks affects domestic money and credit in various other hand, if banks in this country are offering rel­ ways. As frequently noted in the press, such deposits atively high rates on time deposits, larger amounts are closely linked with the nation's gold stock and are likely to be held in that form. can be the medium through which gold flows out of Shifts between alternative forms of investments the country. Gold losses, in turn, affect bank reserves may cause complications for member bank reserves. and, unless offset by Federal Reserve action, can For example, a shift from demand to time deposits have important restrictive effects on bank credit and reduces required reserves and— unless offset— enables the money supply. Apart from their potential effects the banks affected to expand loans or investments. on the gold stock, foreign deposits also can influence Similarly, a shift of deposits between banks subject to both the distribution and volume of bank reserves. different reserve requirements increases or decreases Accordingly, they present a problem, albeit a rela­ required reserves and with them the volume of bank tively minor one, for monetary policy. credit. Such effects can easily be offset, however, by day-to-day open market operations and present no Origin of Foreign Deposits Foreigners hold de­ problem for monetary authorities. posits with banks in this country chiefly to facilitate their international transactions. Changes in the vol­ Official Foreign Holders In addition to their ume of foreign deposits depend on the net balance choices among investments in the United States, of transactions between foreigners and Americans. foreign holders of dollar credits have yet an­ If, for example, foreigners receive more dollars from other alternative. They may convert their dollars Americans than they spend here, their deposits in­ into their own or any other national currency by crease. If the reverse is true, they decline. Thus “ selling” their dollar deposits, often to their central foreign deposits are linked with the nation's balance banks. Such sales involve a transfer of deposits at of payments. The build-up of these deposits since United States banks from foreign private holders to 1950 has been largely a by-product of the sizable foreign central banks. Since central banks frequently deficits in our balance of payments over this period. hold a part of their dollar deposits at the Federal Reserve rather than at commercial banks, this may Reserve Availability and Distribution W h en result in a shift of deposits and reserves from the there is a net transfer of deposits from Americans to commercial banking system to the Federal Reserve. foreigners, the total of bank reserves is not neces­ In the process, commercial banks experience a net sarily affected. Normally, foreigners hold their new reduction in total reserves. Conversely, a purchase of deposits, at least temporarily, with commercial banks United States dollars by private holders from their and the total of bank reserves remains unchanged. central banks usually results in a transfer of deposits The transfer, however, may involve a shift of deposits from the Federal Reserve to commercial banks and and reserves between groups of banks that use re­ an increase in commercial bank reserves. Such shifts serves with varying intensity. Hence excess re­ are among the mechanisms through which foreign serves and the volume of bank credit and money may deposits exert an immediate impact on bank reserves. be affected. Foreign central banks and other official institutions Foreigners acquiring new dollars do not usually — like private individuals— often use some of their hold all of such funds in demand deposit balances. A deposits to purchase United States investments. part may be invested in time deposits or in a variety of United States securities or in private obligations. When they do so, reserve losses resulting from Many choose such alternatives in order to earn in­ the shift of deposits from foreign private hold­ terest while at the same time remaining liquid. The ers to foreign official holders are offset since such rate of return on alternative investments in relation purchases shift deposits and reserves back to com­ to the degree of liquidity they provide is the deter­ mercial banks. This is not the case, however, when mining factor in choosing among appropriate forms foreign official institutions buy gold, an option not in which to hold dollar credits. If short-term rates are open to private foreign holders. Gold purchases in­ relatively high foreigners are likely to hold less in volve a transfer of deposit credit at the Federal

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Reserve from foreign holders to the U. S. Treasury posits (d) decline on the books of the member bank. and bank reserves are not restored. Thus a shift of foreign deposits from commercial The net effects of foreign deposit shifts to and banks to the Federal Reserve, taken by itself, will re­ from foreign central banks may be reflected in the duce the level of bank reserves. volume of deposits held by these banks with the Fed­ Suppose, as shown in panel II, a foreign central eral Reserve System. An increase in these deposits bank buys Treasury gold with funds transferred to usually implies a reduction in bank reserves and vice the Federal Reserve from a commercial bank. Foreign versa. It is for this reason that “Foreign Deposits demand deposits (a) and reserves (b) decrease on the at the Federal Reserve" are watched by the money books of the member bank; and foreign deposits (c) increase while member bank reserves (d) decline at managers as one of several factors affecting reserves. the Federal Reserve. When the foreign central bank Some Illustrations T h e m anner in w hich foreign draws down its balance at the Federal Reserve to pay deposit shifts affect bank reserves can be explained the Treasury for the gold, foreign deposits (e) then more clearly with the use of the hypothetical decline and Treasury deposits (f) rise. The Treas­ balance sheet entries on page 10. Suppose, for ury then draws down its account at the Federal R e­ example, as illustrated in panel I, that a foreign serve (g) to retire gold certificates (h) from the individual sells dollar deposits held at a member bank Federal Reserve. The net effect is a decline in Fed­ eral Reserve gold certificate holdings and a reduction to his central bank, which in turn deposits the funds in member bank reserves. with a Federal Reserve Bank. The individual draws Finally, the purchase or sale of government securi­ a check payable to the foreign central bank. The for­ ties in the open market by foreign official holders can eign central bank then deposits the check in a Federal affect the level of member bank reserves. Suppose, Reserve Bank, increasing foreign deposits there (a). for example, as in panel III, that a foreign central When the check clears, member bank reserves at the bank purchases a U. S. Treasury bill from a govern­ Federal Reserve decline by a like amount (b), and ment security dealer by drawing down its deposit at member bank reserves (c) and foreign demand de­ the Federal Reserve. The dealer deposits the check in his demand deposit at a member bank (a), and when the check clears this bank’s reserves increase, (b ) and (c), while foreign deposits at the Federal li. S. BALANCE OF PAYMENTS Reserve (d ) fall. $ Billion Foreign Deposit Build-up Accompanying the $27 billion deficit in the United States balance of pay­ + 25 - ments since 1950 has been an $18.5 billion build-up in short-term liabilities to foreigners and net sales of

+ 20 ~ gold of $8.5 billion. Foreign owned deposits at Ameri­ can banks alone have more than doubled since 1950, rising from $5 billion at the beginning of 1950 to + 15 $11.5 billion at mid-1963. About $7 billion of the total represented demand deposits, and about $4.5 billion time deposits. + 10 - Most of the $11.5 billion of foreign deposits is owned by foreign commercial banks, central banks, governments, and international organizations. At

BALANCE OF PAYMENTS mid-year they held $9.3 billion of the total, while the Surplus ■■ Deficits remainder was held by other foreign interests. Although there is no readily available breakdown between demand and time deposits owned by foreign­ ers prior to M ay 1963, it is probable that in recent - 5 _____ I_____i_____ |_____ i_____I_____ I_____ I_____I_____ I_____I_____ I_____ I_____I---- '50 '52 '54 '56 '58 '60 '62 months the time deposit component has grown more Source: U. S. Department of Commerce rapidly than the demand deposit component. Increas­ U. S. Treasury, Federal Reserve System es in time deposit interest rates since January 1962 Note: Balance of Payment figures for 1963 cover the first six months. provide foreigners with greater incentive than form-

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I Federal Reserve Member Bank

Assets Liabilities Assets Liabilities

(b) Member bank (c) Reserves - 1 0 0 (d) Foreign dem and reserves —100 deposits —100 (a) Foreign deposits -(-100

II Federal Reserve Member Bank

Assets Liabilities Assets Liabilities

(h) Gold Certifi­ (c) Foreign (b) Reserves -100 (a) Foreign demand cates — 100 deposits +100 deposits — 100 (d) Member bank reserves — 100 (e) Foreign deposits — 100 (f) Treasury deposits +100 (g) Treasury deposits — 100

III Federa Reserve Member Bank

Assets Liabilities Assets Liabilities

(d) Foreign (b) Reserves + 100 (a) Domestic demand deposits —100 deposits +100 (c) Member bank reserves +100

erly to hold dollar credits in the form of time de­ a larger proportion of dollar accruals into their posits. The increases in interest rates have also re­ own currencies. This shifted large amounts of dol­ duced the incentive for foreign governments to pur­ lars to foreign central banks, which, in turn, began chase gold with their dollar credits. converting some to gold after accumulating needed The chart 011 page 9 points up the relationship dollar reserves. between the balance of payments deficit, the growth Other Factors Affecting Reserves Foreign de­ of foreign deposits and other forms of short-term posits are only one of several factors affecting liabilities, and sales of gold by the U. S. Treasury. bank reserves in this country. Others include Between 1950 and 1957 the country’s balance of currency in circulation, Federal Reserve float— payments deficits were relatively small, averaging the credit given to member banks at the Federal Re­ about $1.3 billion a year. During this period total serve for checks not yet collected— member bank short-term liabilities to foreigners doubled while vault cash holdings, Treasury balances at the Federal foreign deposits increased about 50%. At the same time gold outflows totaled less than $2 billion. In this Reserve, the gold stock, and miscellaneous other fac­ period the so-called “dollar shortage” was being tors. In addition, member bank reserves are deliber­ eliminated as foreigners built up stocks of dollars. ately influenced by the Federal Reserve through its Since 1957 the deficits have increased, averaging policy actions. Generally speaking, the Federal Re­ more than $3 billion a year. Foreigners have contin­ serve keeps abreast of the effects on reserves of the ued to build up their deposits and other short-term various factors which are beyond its control and dollar holdings but the rate of accumulation has slack­ tailors its reserve-creating or reserve-destroying ac­ ened. Total short-term liabilities to foreigners in­ tivities accordingly. creased about two-thirds between 1958 and 1962, When foreign deposits are considered in the broad while the deposit component rose less than 50%. In context of all the various factors affecting reserves, the same period, sales of gold by the Treasury it can be seen that they are of relatively minor im­ to foreign governments increased substantially, portance. Nevertheless, they must be considered amounting to $6.8 billion. Foreigners by this time along with other factors in day-to-day open market had built up their reserves of short-term dollar operations in order to achieve desired policy assets to a comfortable level and felt freer to convert objectives.

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