The third in a series of moves to prop up the ailing dollar was announced yesterday by the Federal Reserve Board, providing markets with a strong hint that the Fed plans to keep short-term interest rates high.
Yesterday's step was a technical one, designed to make it more attractive for member banks to borrow funds in the Eurodollar market. The board eliminated the 4 percent reserve requirement on borrowings that member banks make from their own foreign branches or other foreign banks.
The Fed said the intended effect "is to encourage member banks to substitute Eurodollar borrowings for domestic borrowings as a source of funds."
There are some $400 billion to $600 billion in dollar-denominated deposits in Europe. If this overhang were reduced by money returning to this country, in theory it would reduce some of the pressure on the dollar.
Market experts yesterday noted that large American banks in fact would borrow more abroad only if there is a real incentive to do so. They would have such an incentive only if the federal funds rate - at which they borrow money here - is maintained above the rate at which they borrow in the Eurodollar market.
Yesterday the Fed allowed the federal funds rate to edge up to a range of 8.25 per cent to 8.30 percent. "The implication of what they did is that they will keep the federal funds rate up there, over the Eurodollar rate," said one money market observer.
Even so, money market experts think that the withdrawal of the 4 percent reserve requirement will have only a marginal effect on the large amount of money circulating in the Eurodollar market. Only big-city banks, in any event, tend to be interested in Eurodollar borrowings.
The action was nonetheless welcomed as a further cumulative sign of the Carter administration's commitment to shore up the dollar. Earlier moves were an increase in the discount rate from 7.25 percent to 7.75 percent and a stepup in Treasury gold sales.
Possible future steps include a U.S. borrowing on its $4.5 billion reserve position in the International Monetary Fund, a sale from the U.S. holdings of special drawing rights (SDRs), a new export-promotion drive, and a toughened anti-inflation program.
Yesterday's Fed action also eliminated the one percent reserve ration on loans by member banks' foreign branches to U.S. borrowers. Reductions in reserve requirements are effective with borrowings during the four-week period beginning yesterday.
On a related front of potential importance to the dollar exchange rate, the Japanese-government is readying a new expansionary program designed to achieve a 7 percent real growth target.
[Reuters news service reported yesterday that Japan will spend $10.3 billion on various measures to stimulate its economy. Dow Jones news service reported that Japanese government officials said the money would be used for construction projects and to restructure some industries as well to create jobs.]