United States: Swaps to the Bank for International Settlements and Deutsche Bundesbank, 1967

Swap lines were the main tool that the Fed used to defend the dollar and maintain the gold standard during the 1960s. However, the Fed and other central banks also used swaps to promote liquidity in the eurodollar market. Eurodollar markets were typically stressed at year-end by seasonal supply shocks that resulted in elevated eurodollar rates. The devaluation of the pound sterling contributed to steep spikes in eurodollar rates in late 1967. Elevated eurodollar rates threatened spillover effects in foreign exchange markets and in domestic (US) money markets (McCauley and Schenk 2020).

This case study focuses on two swap lines: the Fed-BIS European swap line and the Fed-Bundesbank swap line, which the Fed used to promote liquidity in the eurodollar market in late 1967. Five other central banks participated in swaps with the Fed in late 1967, but the main purpose of most of these transactions was to defend the dollar (see Key Design Decision No. 2, Part of a Package). We focus on the activities of the BIS and the Bundesbank because of their size and because the Fed described their actions as being particularly impactful in lowering eurodollar rates, arguably for financial stability reasons (Bordo, Humpage, and Schwartz 2014; Coombs 1968a).

The Fed and BIS had established the Fed-BIS European swap line in 1965. It was a bilateral reciprocal line that permitted the BIS to borrow US dollars in exchange for deposits of any of eight European currencies as collateral (deutsche marks, Austrian schillings, Belgian francs, French francs, Italian lire, Netherlands guilders, Swedish kronor, and Swiss francs) as well as Canadian dollars, Japanese yen, and pounds sterling^FIn at least one instance, the BIS entered into swap arrangements with the Fed in more than one foreign currency; it was the Fed’s only swap counterparty to do so by December 1967 (Leimone 1967). (Fed 1968). During the 1967 operations that are the focus of this case, the BIS always provided marks to the Fed as collateral. The swap arrangement was reciprocal and also permitted the Fed to borrow any of the 11 currencies from the BIS in exchange for deposits of dollars as collateral, although in practice, the Fed and BIS swapped dollars and deutsche marks (Leimone 1967).

The Fed and the BIS established the swap line in 1965 for a period of six months, but it had been renewed by mutual consent (Fed 1968; Leimone 1967).

The Fed-Bundesbank swap line permitted the Bundesbank to borrow dollars in exchange for deposits of marks as collateral.  The arrangement was reciprocal and also permitted the Fed to borrow marks from the Bundesbank in exchange for deposits of dollars as collateral. The Fed and Bundesbank established the swap line in 1962 for a period of six months, but it was renewed by mutual consent (Fed 1968; Leimone 1967).

The Fed maintained 16 swap lines globally in 1967. The main purpose of these swap lines was to defend the dollar and the gold standard. The Fed used swaps at times to address unwanted holdings of short-term fluctuations in official dollar reserves at foreign central banks (cover operations—see discussion at Overview), and at times to fund spot market intervention (Bordo, Humpage, and Schwartz 2015). Going into the 1967 year-end crisis, the Fed maintained swap lines with 15 central bank (including the BIS) counterparties,^FThose counterparties were: Austria, Belgium, the BIS, Canada, Denmark, France, Holland, Italy, Japan, Mexico, Norway, Sweden, Switzerland, the UK, and West Germany (Coombs 1968b). the largest of which was with the Bank of England (Coombs 1968b). (For an illustration of aggregate swap facility usage by counterparty from 1962 to 1971, see Figure 9 at Appendix B.)

When the governors of the central banks of the United States, Germany, Switzerland, Belgium, Italy, the United Kingdom, and the Netherlands convened in Frankfurt on November 26, 1967, to collaborate in response to the sterling devaluation, they decided to coordinate central bank actions to intervene in the forward eurodollar market. Five central banks (the central banks of Italy, Germany, Switzerland, the Netherlands, and Belgium) in addition to the BIS intervened in the eurodollar forward market at year-end 1967, sometimes in coordination with the Fed. We focus on the action of West Germany’s central bank and BIS in this case because the Fed noted that their actions were particularly targeted and effective (Coombs 1968a).

The Fed swapped USD 1.8 billion with European counterparties by late December to stabilize currency flows and to support the eurodollar market. The largest segment of this amount comprised Swiss franc swaps with the BIS and the SNB. (Coombs 1968a). Figure 6 shows the aggregate Fed swap draws outstanding and their associated counterparties.

While the primary goal of the swap operations with European central banks was to operate in forward markets to provide foreign exchange stability, a second-order goal was to induce reflow from continental European currencies back into the eurodollar market (FOMC 1968a). In practice, there were many reasons for the swap line activations. Scholars have noted that, “the distinctions between purposes can be hard to draw . . . pressures in offshore dollar markets may affect the dollar exchange rate; as a result, providing funding to these markets could be seen as part of or akin to [foreign exchange] intervention” (McCauley and Schenk 2020, 15). The FRBNY said that foreign exchange interventions and eurodollar market interventions were related: “sudden shifts of funds out of the [eurodollar] market . . . also had destabilizing effects on the exchange markets as well” (Coombs 1968a, 50). Leimone of the Federal Reserve Bank of Atlanta said, though, that “the drawings of the BIS probably should be distinguished from the others since these drawings were made to channel dollars into the [eurodollar] market” (Leimone 1967, 166).

While not directly related to the eurodollar market but to the extent that dollar fragility played a role in eurodollar market tightening, the US sold USD 1.5 billion of gold between November 18 and the end of December, defending the dollar’s gold peg and thus attempting to defend the currency; compared with recent previous activity, this was a huge quantity (Schenk 2010, 183). Between October 1, 1967, and January 1, 1968, the US lost 7.8% (USD 1 billion) of its monetary gold stock (NBER 2023).

While we found no evidence that the BIS did the same in 1967, the BIS in its eurodollar intervention at year-end in 1966 also sold USD 70 million–75 million in US Treasury bills and injected the dollar proceeds into the market (McCauley and Schenk 2020).

Section 14 of the Federal Reserve Act provides that the Fed may transact “in the open market, at home or abroad, either from or to domestic or foreign banks, firms, corporations, or individuals, cable transfers and bankers’ acceptances and bills of exchange . . . ,” a section that, since Federal Reserve Board of Governors’ general counsel Howard Hackley’s 1961 interpretation, was interpreted by the Fed to authorize foreign exchange transactions, including forward and swap transactions (Bordo, Humpage, and Schwartz 2015; US Congress 1913, sec. 14).

The FOMC’s Authorization for System Foreign Currency Operations (FX Authorization) authorized the FRBNY to carry out all spot and forward transactions in authorized currencies on behalf of the FOMC. Any agreements or understandings “concerning the administration of the accounts maintained at the [FRBNY] with foreign banks” were reviewed and approved by the FOMC(Fed 1968, 90-91). The FX Authorization permitted the investment of swap proceeds in accordance with Section 14(e) of the Federal Reserve Act (Fed 1968).

The Fed’s Foreign Currency Directive authorized System Open Market Account (SOMA) operations in foreign currencies to "aid in making the system of international payments more efficient . . . further monetary cooperation with central banks . . . and help insure that market movements in exchange rates . . . reflect the interaction of underlying economic forces” (Fed 1968, 92).

The BIS Statutes authorize the BIS to act as correspondent for any central bank, transact in foreign currencies with central banks, and open and maintain deposits with and for central banks (BIS 1930, art. 21).

The Bundesbank Act of 1957 gave the Bundesbank the authority to conduct foreign exchange transactions, while reserving authority over decisions about foreign exchange transactions for the Board of Directors of the Governing Board (Bundestag 1957, sec. 7[3], 19[8–9]).

The entering into swap lines, their governance, and any agreements or understandings “concerning the administration of the accounts maintained at the [FRBNY] with foreign banks” were reviewed and approved by the FOMC (Fed 1968, 90-91). Both the Fed (Board of Governors) and the FRBNY specifically disclosed the size of the BIS European and Bundesbank swap lines in their annual reports for 1967 (Fed 1968; FRBNY 1968).

The BIS disclosed the size of its swap lines in its annual report for fiscal year 1967 (BIS 1968). The BIS documented details about the use of its swap funds and activities in its Daily Banking Sheets, but did not disclose them to the public (they are housed in the BIS archives) (McCauley and Schenk 2020).

Fed officials worked closely with the Treasury. The Fed was required to advise the Secretary of the Treasury with respect to foreign currency operations; and FOMC staff officers were required to communicate foreign currency operations information to Treasury staff (Fed 1968).

If the Fed failed to pay down its obligations on a swap, the Treasury backstopped the Fed, providing the needed foreign currency by selling foreign-currency-denominated certificates or bonds. These actions shifted exposure from the Fed to the Treasury (albeit while extending maturity), which some scholars have said threatened the Fed’s independence (Bordo, Humpage, and Schwartz 2014).

The FX Authorization said that the FRBNY should, as a practice, coordinate foreign currency transactions with foreign central banks but could not agree to maintain any specific balance with a foreign central bank unless authorized by the FOMC. The FX Authorization permitted the investment of swap proceeds in accordance with Section 14(e) of the Federal Reserve Act (Fed 1968). This prohibited the investment of foreign currency proceeds in foreign government debt^FIn practice, this typically resulted in investment into commercial debt with a maturity of fewer than 90 days (Leimone 1967). (Leimone 1967). In the event that the FOMC was unavailable, a subcommittee consisting of the chairman and vice chairman of the FOMC and the vice chairman of the Board of Governors could authorize foreign currency operations; any and all subcommittee actions had to be reported promptly to the FOMC (Fed 1968). Draws on Fed swap lines could be arranged within “a few hours” via telephone consultation (Leimone 1967, 162).

The FOMC published a press release for its November 27, 1967, meeting with a Record of Policy Actions attached that announced the BIS swap line usage and size increases. In its announcement, the FOMC described the expansion of the lines as necessary to (1) discourage large accumulations of dollars in foreign central bank reserves and (2) to encourage reflows out of continental European currencies into the eurodollar market (FOMC 1968a). The FRBNY published a biannual report on “Treasury and Federal Reserve Foreign Exchange Operations” in its Monthly Review every March and September. In these reports in 1968, the head of foreign exchange operations discussed the BIS swap line and other central bank actions in the eurodollar market (Coombs 1968a).

BIS publications (other than its annual report) were archived and unavailable for review. The Fed and BIS communicated closely about swap draws generally, and the BIS generally alerted the Fed to any potential swap draw and planned downstream use of the resulting funds (Bordo, Humpage, and Schwartz 2015).

American media generally covered eurodollar market strains, the sterling devaluation, and Fed swaps, reporting increases in foreign central bank dollar holdings, eurodollar rates, and expansions of the Fed swap network (Heinemann 1967; Lee 1967; New York Times 1967).

The BIS was the only institution eligible for its specific swap facilities (comprising the CHF and European swap lines), and the Bundesbank was the only institution eligible for its specific swap line, although the Fed maintained many similar swap lines with other counterparties (see Key Design Decision No. 2, Part of a Package) (FOMC 1968a).

At the time, the BIS was the only counterparty that was not a central bank. The decision to include the BIS among the Fed’s swap counterparties had to do with the BIS’s special role as a “bank for central banks” and its large dealings in the foreign exchange and eurodollar markets (Leimone 1967, 164). Per Coombs’s memorandum to the FOMC, the Fed viewed the BIS not only as a conduit to the SNB but, increasingly by 1965, as a supplementary provider of European liquidity more generally^FFor example, if the Fed wanted to intervene in the Italian lira-US dollar exchange rate and it had already drawn the maximum from its swap line with Italy, the BIS’s non-Swiss franc European currency swap line with the Fed allowed it to access lira, providing a supplementary facility through which to intervene in that foreign exchange market. (Coombs 1965). To the extent that the BIS held reserves of most European currencies and could lend directly to European banks (including European central banks), it acted similarly to the way the European Central Bank does today with respect to channeling US funds. In other words, the Fed could lend through the BIS in one transaction to multiple central and commercial banks in Europe.

The FRBNY-BIS European swap line stood at USD 300 million before the FOMC’s November 27, 1967, meeting at which FOMC members voted to double the cap to USD 600 million in order to provide a broader margin of safety for the international monetary system, an enlargement to which the BIS agreed (FOMC 1968a). From 1962 to 1971, the European swap line with the BIS was one of the largest the Fed maintained during this period, and BIS usage of this swap line was second only to usage under the Bank of England’s Fed swap line (McCauley and Schenk 2020). The parties agreed to expand the facility to USD 1 billion on March 18, 1968 (Coombs 1968b).

The Fed-Bundesbank swap line stood at USD 400 million before the FOMC’s November 27 meeting, at which FOMC members voted to increase the cap to USD 750 million in order to improve the safety of the international monetary system, an enlargement to which the BIS agreed (FOMC 1968a). The parties agreed to expand the facility to USD 1 billion on March 17, 1968 (Coombs 1968b).

When the BIS drew on the European swap line, it placed deutsche mark as collateral in the FRBNY’s correspondent account at the BIS (McCauley and Schenk 2020). Deutsche marks^FIn at least one instance, the BIS entered into swap arrangements with the Fed in more than one foreign currency; it was the Fed’s only swap counterparty to do so by December 1967 (Leimone 1967). served only as collateral—the FRBNY did not use them (McCauley and Schenk 2020). The invested amounts bear interest at a rate agreed to in advance (Leimone 1967).

The BIS then used the dollar proceeds to lend downstream to eurodollar market participants (McCauley and Schenk 2020). Draws on Fed swap lines could be arranged within hours via telephone consultation (Leimone 1967).

When the Fed borrowed deutsche marks, it credited the Bundesbank’s correspondent account at the Fed with dollars, which the Bundesbank could invest in non-transferable Treasury certificates. The invested amounts bore interest at a rate agreed to in advance. However, in the 1967 year-end operations, the Bundesbank swapped those dollars with German commercial banks, meaning that it withdrew the dollar collateral deposited by the Fed and moved those funds into West Germany; we have not been able to determine how this use was authorized, but it most likely required Fed consent (Leimone 1967) (see Key Design Decision No. 10, Downstream Use of Borrowed Funds). The FRBNY reported that the Bundesbank actions were part of a “coordinated central bank effort to calm the exchange markets” and that the Fed “participated in this operation by drawing $300 million equivalent of German marks on its [Bundesbank] swaps line” (Coombs 1968b, 51).

With its dollar swap proceeds, the BIS offered dollar deposits to eurodollar market participant commercial banks. In November and December 1967, the BIS deposited USD 346 million with at least eight banks^FMcCauley and Schenk (2020) count at least 30 distinct deposits. While some may have been related, the scholars estimate that there may have been between one dozen and two dozen different banks. for periods of one month or shorter. Not all deposit offers were accepted by commercial banks. All deposits made to eurodollar market participant banks earned 100 basis points more than the rate the BIS paid to the Fed (see Figure 3 at Overview) (McCauley and Schenk 2020).

In November and December 1967, the Bundesbank entered into dollar swaps totaling USD 860 million (USD 300 million of which came from the Fed; see Overview) with German commercial banks at “favourable rates” (Bundesbank 1968, 38). This was an unusual arrangement because the Fed was the drawing party. The Fed drew deutsche marks and deposited dollars as collateral at the Bundesbank’s correspondent account at the FRBNY, which the Bundesbank then had to repatriate to lend downstream. In other words, the Bundesbank was using collateral for downstream lending, whereas usually collateral currency is held by the lending central bank and typically, the use of dollar collateral under Fed swaps was limited to investment in US Treasury certificates of indebtedness due on the maturity of the swap (Leimone 1967). It is likely that the Bundesbank’s eurodollar market interventions at year-end 1967 required special approval and agreement with the FOMC because of those collateral restrictions.

Swap draws were limited to a period of three months, but were renewable up to three times. Swap transaction periods ranged between one month and three months but were mostly one month (McCauley and Schenk 2020). Our research did not uncover information on the duration of swap draws on the Fed-Bundesbank swap line in the 1967 year-end operations.

The BIS paid an interest rate of the eurodollar rate minus 100 basis points, which resulted in year-end operations interest rates ranging between 475 and 575 basis points (see Figure 3 at Overview). Scholars have said that the rate spread (what the BIS earned in the market less what it paid to the Fed) resulted from the BIS taking on uncollateralized bank credit risk (McCauley and Schenk 2020). Our research did not uncover information on the interest rate or fees paid by the Federal Reserve to the Bundesbank when it drew on its swap line in the 1967 year-end operations, but it was likely benchmarked similarly to the rate the BIS paid the Fed.

When the Fed borrowed deutsche marks, it credited the Bundesbank’s correspondent account at the Fed with dollars, which the Bundesbank could invest in non-transferable Treasury certificates. The invested amounts bear interest at a rate agreed to in advance. However, in the 1967 year-end operations, the Bundesbank lent those dollars to German commercial banks; we have not been able to determine how this use was authorized, but it most likely required Fed consent (Leimone 1967). While we were unable to view the specific swap agreements with the BIS and Bundesbank, Fed swaps in the 1960s generally had “revaluation clauses,” which protected the lending central bank in the event that the borrowing central bank revalued its currency against gold during the draw period (Bordo, Humpage, and Schwartz 2015, 150-151). While not explicitly balance sheet-related, the Fed frequently sterilized swap draws (Bordo, Humpage, and Schwartz 2015).

Our research uncovered no further restrictions on the use of the BIS line and the Bundesbank line.

Our research did not uncover any other options considered by the Fed to provide liquidity to the eurodollar market that we haven’t already covered (for other Fed operations in the eurodollar market, see Key Design Decision No. 2).

By January 1968, the BIS had fully repaid the total USD 346 million obligation outstanding under the swap lines as a result of the year-end operations (Coombs 1968a). That same month, the United States imposed restrictions on US lending in Western Europe via the eurodollar market, among a package of measures that aimed to strengthen the US balance of payments. BIS scholars later argued that those restrictions contradicted the Fed-BIS swap goals to the extent that the lending restrictions curtailed dollar liquidity in the eurodollar market, whereas swap operations had aimed to increase dollar liquidity in the eurodollar market (McCauley and Schenk 2020).

On March 17, 1968, before the United States’ ability to maintain the official gold peg collapsed, the FOMC authorized an increase in the BIS’s European swap facility to a size of USD 1 billion from USD 700 million (FOMC 1968b; McCauley and Schenk 2020). The BIS continued to draw on the European swap line into 1976, after a pause in sizable activity in 1971–1972 (see Figure 10 at Appendix B). The FOMC voted to allow the line to lapse in its November 17, 1998 meeting (FOMC 1998).

On March 17, 1968, before the United States’ ability to maintain the official gold peg collapsed, the FOMC authorized an increase in the Fed-Bundesbank swap facility to a size of USD 1 billion from USD 750 million (FOMC 1968b; McCauley and Schenk 2020). By March 1968, the United States had repaid 69% of its swaps-derived foreign obligations and 100% of its Bundesbank-associated swap obligations (Coombs 1968a). The FOMC voted to allow the line to lapse in its November 17, 1998 meeting (FOMC 1998).