The Exchange Stabilization Fund:
How It Works
William P. Osterberg and James
controversial, the Exchange Stabilization Fund is
used to influence the international value of the U.S. dollar
and to provide aid to foreign countries. The debate surrounding
the Fund will become more informed, suggest the authors, when
observers understand how to calculate the total amount of resources
available to the Fund. This Economic Commentary explains how the
ESFs balance sheet figures must be adjusted to produce
an accurate account of those resources.
increased turmoil in international financial markets, starting
with the Asian crises of 1997, has led to calls for financial
assistance from the wealthier nations. In December 1997, the
United States announced a $5 billion commitment toward an international
package of financial assistance for South Korea. Two months earlier
the United States pledged $3 billion for assistance to Indonesia.
In both instances, the Exchange Stabilization Fund (ESF) was
to be involved.
Established by Congress in 1934
to help stabilize the international value of the dollar, the
ESF received little public attention until it was used in the
provision of financial assistance to Mexico in the wake of the
peso crisis of 1995. Indeed, greater scrutiny may have been inevitable
given the ESFs expansion beyond its original mandate.1 Despite the recent attention, the full
range of ESF activities and the actual amount of available ESF
resources are not well understood. This impedes an informed public
discussion of ESF operations.
A major goal of this Economic
Commentary is to facilitate accurate assessments of the amount
of resources available to the ESF. First, in order to understand
the uses of ESF resources, we provide an overview of ESF operations.
Second, we examine the ESF balance sheet to show how total
assets is a poor measure of the resources available to
the ESF for one of its major activities, foreign-exchange intervention.
Third, we discuss how any measure of ESF resources must take
account of warehousing and swap lines. Finally, we suggest a
better procedure for assessing the amount of resources available
to the ESF.
The ESF began operations on April 27, 1934, with capital of $2
billion. Initially, $1.8 billion of the ESFs reserves were
maintained in the Treasurys gold account. The remaining
$200 million was deposited in a special account at the Federal
Reserve Bank of New York as the working balance for investing
in gold and foreign exchange.2
The working fund of the ESF has expanded over time, reaching
as high as $42 billion in mid-1995.3
As documented by Schwartz (1997), most of the growth in ESF assets
has occurred since 1960 and has comprised increases in foreign
exchange and securities. As of June 30, 1998, almost 60 percent
of the asset total had been financed by cumulative net income,
mainly reflecting interest earnings and capital gains on foreign
The Gold Reserve Act of 1934
excluded the ESF from the congressional appropriations process
and explicitly authorized it to operate without congressional
oversight and accountability. In other words, Congress gave exclusive
control of the ESF to the executive branch. All decisions regarding
the ESF are made by the Secretary of the Treasury, subject to
the approval of the President.
Legislative changes in the late
1970s reduced somewhat the secrecy under which the ESF operates
and made it more accountable to the Congress. For instance, since
1979 the administrative expenses of the ESF have been subject
to the budget process. Moreover, a 1977 amendment to Section
10 of the Gold Reserve Act provides that:
a loan or credit to a foreign entity or government of a foreign
country may be made for more than 6 months in a 12-month period
only if the President gives Congress a written statement that
unique or emergency circumstances require the loan or credit
be for more than 6 months (31 U.S.C. 5302(b)).
Finally, 1978 legislation requires
the Treasury to provide monthly statements of ESF activities
to the House and Senate Banking Committees. Nevertheless, none
of these legislative changes has reduced the discretion of the
Treasury Secretary in operating the ESF. All of his decisions
are final and not subject to approval by the Congress.
A common misperception about the ESF is that its size is adequately
measured by the total assets number reported on the
ESF balance sheet, published quarterly in the Treasury Bulletin
(see table 1).4
This might seem to be a reasonable presumption since the ESF
cannot unilaterally issue debt in financial markets. However,
several important aspects of ESF operations are not apparent
from its balance sheet. In particular, since many ESF operations
use dollar assets, any limitation on the conversion of nondollar
assets to dollar assets is relevant to an assessment of available
Intervention, the purchase or
sale of foreign currencies to influence the international value
of the dollar, is a major use of ESF resources (see box, opposite).
The other is the provision of financial assistance to foreign
countries. Whenever the ESF sells foreign currency, it produces
a crediting of the ESFs (nonmarketable) U.S. government
security account with the Treasury, which is equivalent to dollar
cash assets. When purchasing foreign currency, the ESF first
obtains dollar balancespossibly by selling some of its
Treasury securities to the Treasury (with the Federal Reserve
[hereafter, the Fed] acting as agent). The subsequent purchase
of foreign exchange with dollars leaves the ESF with a lower
level of Treasury securities but an offsetting increase in foreign
exchange and securities.
Thus the relevant measure of
resources available for ESF interventions depends on whether
foreign exchange is being bought or sold. Dollar assets are needed
to buy foreign-currency-denominated assets. On the other hand,
purchases of dollars are financed from international reserves,
which include official holdings of gold, foreign government securities
or deposits at foreign central banks, the reserve position in
the International Monetary Fund (IMF), and special drawing rights
ESF accounting for SDRs provides
another example of why total assets is a poor measure of available
resources. The SDR is an international reserve asset created
by the IMF (under the First Amendment to its Articles of Agreement)
to supplement existing reserve assets. The value of an SDR is
determined by reference to a basket of currencies of the five
largest industrial-economy member countries of the IMF. Pursuant
to the Special Drawing Rights Act of 1968, SDRs allocated to
the United States or otherwise acquired by the United States
are resources of the ESF.
There are three SDR entries on
the ESF balance sheet (see table 1). The SDR asset entry and
the SDR liability entry, SDR allocations, pertain
to ESF linkages to the IMF. The allocations represent the current
value of the provisions of SDRs by the IMF to the U.S. Treasury,
which were transferred to the account of the ESF.6
The SDR asset entry reflects the dollar value of SDR allocations
to the United States plus interest earnings, valuation changes,
and sales and acquisitions of SDRs from other IMF participants.
The third entry, SDR certificates,
equals the portion of the SDR assets which has already been used.
As noted earlier, all SDRs owned by the U.S. government must
be held by the ESF. In other words, the ESF cannot engage in
transactions with either the U.S. Treasury or the Fed that would
result in a reduction in the ESFs SDR holdings. Thus, in
order to convert SDRs to dollar-denominated assets, the ESF issues
a claim on its SDR assets to the FedSDR certificatesin
a process called monetization.7
While this does not decrease the SDR asset entry on the balance
sheet of the ESF, it does increase the certificate number by
the amount of the monetization. By law, the certificate entry
cannot exceed the SDR asset entry. However, up to the limit imposed
by the SDR asset total, monetization increases the size of the
balance sheet, since the certificate amount increases dollar
for dollar with the eventual purchase of assets (for example,
foreign-currency-denominated government securities).8
Since the monetization process
increases the total asset number while decreasing the amount
of SDRs available to be monetized, the certificate total must
be subtracted from total assets to arrive at an estimate of the
ESFs available resources. Thus, although total assets of
the ESF on June 30, 1998, were $39.7 billion dollars, a slightly
more accurate measure of available dollars would be $30.4 billion.
This is the sum of the nonmonetized portion of the SDR total
($10 billion SDRs minus $9.2 billion SDR certificates), the entry
for U.S. government securities with the Treasury ($15.7 billion),
and the dollar value of the German mark and Japanese yen items
Congress limited the ability of the ESF to issue liabilities
on its own and thus, perhaps intentionally, limited the ESF to
financing new interventions through the sale of assets, a practice
known as asset management. However, beyond the uses of SDRs and
securities as described above the ESF can obtain additional dollar
resources by moving foreign-denominated assets off-balance sheet
through an arrangement with the Federal Reserve System. Thus,
the $30.4 billion on-balance sheet asset number is still a flawed
measure of the dollar assets available to the ESF.
The first problem is that, once
the Treasury securities (dollars) are exhausted,
the ESF cannot use its German mark assets or Japanese yen assets
to purchase additional mark or yen items, respectively, without
first converting them into dollar-denominated assets. This conversion
of the ESFs foreign currency portfolio into dollar-denominated
assets requires an off-balance-sheet financing arrangement with
the Fed, referred to as warehousing.
Warehousing is a swap transaction
in which the Fed buys foreign exchange from the ESF in a spot
transaction and sells it back with a forward transaction that
is, the ESF agrees to exchange dollar assets for foreign exchange
on the date the forward transaction comes due. The ESF balance
sheet would thus record a decline in foreign exchange and
securities but an increase in the U.S. government
securities total, which could be used to purchase foreign
currency or implement dollar loans to foreign countries (the
forward transaction would not appear). In other words, the Fed
warehousing arrangement allows the ESF to take a leveraged position
in foreign assets that is not reflected on the ESFs balance
Two factors complicate the ESFs
ability to use the Fed warehouse. First, the size of the warehouse
is determined by FOMC deliberations. Although the size of the
warehouse was increased to $20 billion to help finance the Mexican
financial assistance package in 1995, it is currently limited
to $5 billion with no balances currently outstanding. Second,
although the currencies currently eligible for the warehouse
are indicated in the Authorization for Foreign Currency Operations,
they are not necessarily the same as the currencies that the
ESF needs to exchange.9
Since about 1978, warehousing
has been controversial. Goodfriend (1994) argues currency-warehousing
agreements between the ESF and the Fed provide the ESF with additional
funding that circumvents the congressional appropriations process
and statutory limits on Federal borrowing.10
The second problem with the on-balance-sheet
asset measure of ESF resources is that it ignores swap lines.
Swap lines, formally called reciprocal currency arrangements,
are credit lines between governments (or central banks) stipulating
terms which, usually for a short period of time, allow either
country to borrow the others currency.11
The mechanics of drawing down a swap line are similar to that
of warehousingoffsetting spot market and forward market
transactionsexcept that our swap lines do not provide us
with dollar assets directly but rather provide dollar assets
for the other country. As in the warehousing arrangement, the
forward market transaction does not appear on the balance sheet
until the expiration of the swap line.12
Drawings might be renewed once routinely, but statutes require
that the executive branch report subsequent renewals to Congress.
Both the Fed and the ESF maintain swap lines the sizes of which
are indicated in the quarterly summary of ESF and Fed foreign
exchange operations published in the Federal Reserve Bulletin.
As of March 31, 1999, the only authorized ESF swap line was with
the Bank of Mexico for $3 billion.13
Finally, any measure of ESF resources
available for intervention needs to take account of any stated
commitments by the U.S. Treasury to provide financial assistance
to foreign governments via the ESF. For instance, the commitments
that had been made to Korea and Indonesia would have reduced
the total resources available for intervention as reflected on
the June 30 balance sheet by $8 billion.14
The Exchange Stabilization Fund, under the U.S. Treasury, is
now routinely involved in efforts to stabilize currencies and
to provide financial support to foreign countries. However, the
amount of resources available to the ESF and its range of activities
are perhaps not well understood by many observers. In this Economic
Commentary we correct the misperception that total assets
is a good measure of available ESF resources.
First, total assets
ignores the fact that the monetization of SDRs does not decrease
the SDR asset entry even though the total amount of monetization
is limited by the SDR asset number. Consequently, total assets
must be reduced by the outstanding amount of monetization, measured
by the SDR certificate number. Second, estimates of resources
available to the ESF for intervention must take into account
the warehousing arrangement with the Fed. The current limit on
the size of the warehouse is relevant to whether the foreign-currency-denominated
assets could be converted into dollars for use in purchasing
foreign assets. Third, outstanding swaps and any existing commitments
of ESF funds should be reflected in estimated ESF resources.
An understanding of these points is a prerequisite to an informed
debate regarding any change in ESF funding.
The Fed and the ESF in Foreign-Exchange
Since the ESFs inception,
the Federal Reserve Bank of New York has been the officially
designated agent for the ESF in intervention operations. In 1962,
the Federal Reserve Systems Federal Open Market Committee
(FOMC) authorized open-market transactions in foreign currencies
for the account of the Fed, and since then, the Federal Reserve
Bank of New York has acted as agent for both the Fed and the
ESF in such transactions. Starting in 1978, the ESF and the Fed
have almost always intervened jointly.
Although the decision to intervene
is usually made jointly by the Treasury and the Fed, it falls
primarily under the Treasurys purview. While the two entities
routinely intervene in the same direction and amounts for their
individual accounts, formal independence is maintained. In other
words, the Treasury can instruct the Fed to intervene on behalf
of the ESF but it cannot force the Fed to intervene for the Feds
exception to this would be a declared national emergency.
See also Owen F. Humpage, Institutional Aspects of U.S.
Intervention, Economic Review, Federal Reserve Bank
of Cleveland, vol. 20, no. 1 (Quarter 1 1994), pp. 219.
Table 1 ESF Balance Sheet, June 30,
Liabilities and capital
Held with U.S. Treasury: U.S.
Special drawing rights (SDRs)
Total current liabilities
Total other liabilities
Net income gain
(+) or loss ()
column sum does not equal this number because of rounding error.
SOURCE: U.S. Department of the Treasury, Treasury
Bulletin, December 1998, p. 108.
1. See Anna J.
Schwartz, From Obscurity to Notoriety: A Biography of the
Exchange Stabilization Fund, Journal of Money, Credit,
and Banking, vol. 29, no. 2 (May 1997), pp. 13553;
Walker F. Todd, Disorderly Markets: The Law, History, and
Economics of the Exchange Stabilization Fund and U.S. Foreign
Exchange Market Intervention, Research in Financial
Services Public and Private Policy, vol. 4 (1992), pp. 11179;
and C. Randall Henning, The Exchange Stabilization Fund:
Slush Money or War Chest? Institute for International Economics,
Washington, D.C., 1999.
originally authorized to deal in both gold and foreign exchange,
the ESF has tended to deal primarily in foreign exchange and,
to some extent, in the securities of sovereign nations (including
U.S. government securities).
3. See Schwartz
(footnote 1), pp. 1367.
4. For example,
a December 4, 1997, article discussing the proposed rescue plan
for South Korea states that the U.S. money, if needed,
would come from the Exchange Stabilization Fund
. The fund
contained $40 billion as of the end of March
South Korea, IMF Finalize $55 Billion Bailout Plan,
Los Angeles Times, p. D1.
5. The U.S.
drew on its IMF quota in
1964 66, 1968, 197072, and 1978 for amounts totaling
$6.5 billion. Treasury securities denominated in foreign currencies
were issued in 196274 (Roosa bonds ) and in
197879 (Carter bonds) for $11.1 billion. See
Schwartz (footnote 1), pp.1434.
6. These IMF
provisions of SDRs to the U.S. Treasury occurred in four separate
actions between 1970 and 1981.
7. The last
big cash-in, or conversion of, SDRs was in the third quarter
of 1995 to fund part of the financial assistance offered to Mexico.
8. The conversion
of SDRs first augments the asset-side entry for U.S. government
securities. This entry, plus foreign exchange and (foreign
government) securities more directly permits the funding
of ESF activities such as the purchase and sale of foreign currencies.
For example, U.S. government securities can be used to purchase
foreign currency as part of an effort to depress the international
value of the dollar. This would then add to the foreign exchange
total, which is largely held in the form of foreign currency
government securities, rather than cash.
9. The authorization
is published annually in Annual Report of the Board of Governors
of the Federal Reserve System. See also Owen F. Humpage, Institutional
Aspects of U.S. Intervention, Economic Review, Federal
Reserve Bank of Cleveland, vol. 30, no. 1 (Quarter 1 1994), p.
10. See Marvin
Goodfriend, Why We Need an Accord for Federal
Reserve Credit Policy: A Note, Journal of Money, Credit
and Banking, vol. 26 (August 1994, Pt. 2), pp. 57280.
Humpage (footnote 9), pp.78, for further details on the
accounting associated with swap lines.
a forward transaction commits the ESF to exchange foreign currency
for dollars at a fixed price in the future, the true exposure
of the ESF to foreign-exchange risk is not reflected on its balance
the last quarter of 1998, Federal Reserve System swap lines were
reduced from $32.4 billion to $5 billion ($2 billion with the
Bank of Canada and $3 billion with the Bank of Mexico), and the
ESF eliminated its swap line with the German Bundesbank. There
are no outstanding swaps for either agency. Reasons stated for
the reductions included history of disuse, formation of the European
Central Bank, and the existence of other arrangements for monetary
commitments to Korea and Indonesia and also to Thailand have
since been rendered inoperative. However, as of June 1999, the
ESF still provides backstop to the Bank of International Settlements
$7.5 billion dollar support package for Brazil.
William P. Osterberg
is a senior economist at the Federal Reserve Bank of Cleveland,
and James B. Thomson is a vice president and economist at the
Bank. The authors are grateful to Tim Dulaney, Owen Humpage,
Dino Kos, and Walker Todd for numerous helpful comments and suggestions.
The views stated herein are those of the authors and not necessarily
those of the Federal Reserve Bank of Cleveland or of the Board
of Governors of the Federal Reserve System.
Economic Commentary is published by the Research Department
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