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RESIDUAL ITEM

The balance of international payments for 1939 shows a "balancing" item of $1,037,000,000, recorded as "other transactions and residual," which comprises a substantial volume of unidentified capital transactions, as well as the net result of possible errors and omissions in the other estimates. Direct investigation has established the exist ence of various types of international capital transactions which, because of the conditions under which they were made, were not properly reflected in the reported data on capital movements. In certain instances transactions reported as international capital transfers are, in effect, not part of the international capital movement and, therefore, require an offsetting adjustment elsewhere in the balance of payments.

Since 1934 a relatively large "credit" residual has appeared every year in the balance-of-payments statement. Its appearance in this form during a period of abnormally large gold imports, which were influenced in general more by international capital movements than by trade and service transactions, suggests that the item during this period has been, in effect, an unreported counterpart of the heavy and almost continuous net gold inflow. This thesis is given strong support by developments during 1939, when the unprecedented net gold inflow of $3,040,000,000 was accompanied by unidentified items aggregating more than a billion dollars.

An important type of capital transaction included in this item in 1939 is a "corrective" offset to reported withdrawals of dollar balances which in reality are not outward movements of capital. In many cases the reporting institutions are unable to detect the foreign interest in accounts which appear to be "domestic." The transactions in question arise largely from the migration to the United States of foreign refugees or other persons who had previously expatriated funds to their accounts in this country, but who, upon arriving in this country, changed their accounts from foreign to domestic addresses. This withdrawal of funds from a "foreign" account in the United States results in a corresponding decline in reported foreign-owned dollar balances, thus indicating an outward movement of funds. Since this "outward" capital movement resulted from the owner's expatriation of himself to this country rather than from the repatriation of his funds, a "corrective" entry must be made in the balance of payments if proper itemization is to result. On the basis of a special study made by the Finance Division, it is estimated that the total of such transactions-together with corresponding changes from "foreign" to "domestic" accounts by corporations-included in the reported data on outward short-term capital movements in 1939, and therefore necessitating an offset in the residual item, is between $200,000,000 and $300,000,000.

Another type of transaction which undoubtedly was a factor in the residual item for 1939, but for which no actual estimate has been

undertaken, resulted during the closing months of the year from certain types of foreign expenditures for war materials in this country. The nature of these transactions was outlined by the Federal Reserve Bank of New York in its Monthly Review for March 1, 1940 (p. 1): While some transfers of funds to this country for the account of nonresidents of the countries at war have been reported, it seems fair to assume that a large part of the proceeds of the gold imports and the reduction in foreign central bank balances in this country was actually spent in this country by foreigners, including foreign governments. The figures for the past month, together with similar figures for other recent months, suggest a rate of foreign spending in the United States well above that indicated by the reported excess of merchandise exports over imports. In the past 4 months foreign spending here appears to have averaged at least $200,000,000 a month. The disparity between this figure and the average excess of reported valuations of merchandise exports over imports during these months may be attributable in part to the requirements of the Neutrality Act that foreign purchasers of war materials must make full payment for, and acquire title to such materials in advance of their shipment from the United States, partly in advance payments against the cost of production of such materials, and partly to payments made, in some cases, for the expansion of productive facilities required to expedite deliveries.

It must be noted, moreover, that such transactions are not confined to those just discussed. Presumably various individuals as well as corporations have shifted funds from abroad to the United States under conditions which associate the ownership of resulting balances with entities of nominal ownership under addresses in this country. Also, the conversion of such balances into currency, securities, or other forms of property may result in the accumulation of foreign-owned assets in this country without having the international movement of funds pass at any point through reporting channels. Such transactions merely reflect the extremely disturbed international situation at a time when security and property are threatened and when fears dominate the action of individuals acting under the full impact of dynamic and disruptive international forces.

Fear of invasion undoubtedly provided a powerful incentive during 1939 to persons in many European areas to seek means of protecting evidences of property ownership abroad from any unfriendly government whose hand could ultimately reach out for whatever assets might embody the potentialities of useful foreign exchange. It is probable that even prior to 1939 the unidentified items in the balance of payments resulted in part from efforts at "concealment" of beneficial ownership for the purpose of escaping or minimizing the risks of heavy taxation or direct levy by governments engaged in ever-growing armament expenditures.

The substantial excess of reported United States currency exports over reported receipts from abroad and the very large movements of such currency during recent years suggest that the flight of capital from abroad has at times taken the form of currency hoarding. Since currency returns to the United States in appreciable degree through nonbanking channels, this excess cannot be viewed as an accurate measure of such hoarding. Moreover, movements of paper currency through banking channels are virtually all included in a separate item under capital movements and need no further consideration here. On the other hand, the possibility of substantial hoarding of American currency in safety deposit boxes in this country and the export, through nonbanking channels, of bills for hoarding abroad cannot be dismissed as negligible factors in the unreported capital transactions during 1939.

Although various cases of such currency holdings for foreign account have come to the attention of the Finance Division, no satisfactory basis exists for an actual estimate. Special risks attach to any attempt at such an estimate because of the sensitiveness of dollar currency hoarding by foreigners to short-run changes in political conditions. The flight of capital from Europe to the United States since 1935 (when financial difficulties in several of the "gold bloc" countriesand, late in the year, the Italian venture in Ethiopia-inaugurated sharp flights to the dollar) has moved with barometric regularity as the vicissitudes of financial and political crises intensified or mitigated popular fears.

The factors which account for the unprecedented total of unidentified items in 1939 are thus the result in part of conditions brought about by the actual outbreak of war; but to an important degree they represent merely an intensification of a situation which since 1934, or even before, has made it impossible to secure, through the usual reporting agencies, complete data on international capital movements. In previous issues of this bulletin attention has been directed to transactions not reflected in the reported movements. These include the repatriation of foreign dollar bonds-particularly issues in defaultthrough nonreporting agencies located in this country acting in behalf of the foreign debtor. Only a detailed check of foreign-exchange operations whereby the American agent is placed in dollar funds would make identification possible.

Two other factors which have in certain recent years accounted for part of the unidentified transactions are stabilization-fund operations not reflected in the reported figures (for example, in 1937) and reported gold and silver movements which were theoretically subject to adjustment for balance-of-payments purposes. For example, in 1934 the reported gold inflow included gold placed under earmark abroad during the preceding year and therefore already included in the balance-ofpayments statement for 1933.

The exceptionally heavy gold imports of 1939 were clearly the result, first, of the imminence of war and, later, of the actual outbreak of hostilities. The exceptionally large item of unidentified capital and other transactions simply reflects the abnormal means whereby the capital transfers, giving rise to the major part of this gold inflow, were actually consummated. In various instances agencies in this country have acted for foreign financial houses under sealed instructions relative to steps which are to be taken by such agencies should certain developments eventuate abroad. This report is not concerned with the motives underlying such arrangements. It is perhaps sufficient to say that individuals tend to seek security of property by whatever methods the dangers, real or assumed, of a threatening situation can be most effectively met.

Real estate in the United States has at times been an important type of foreign-held investment. It is certain that during recent years, particularly in 1939, foreigners have shifted investment funds to this country for the purchase of land, apartment houses, and other forms of real property. Previous studies of the Finance Division have indicated that such foreign ownership is generally held through domestic holding companies or other entities. The foreign purchase of an equity interest in such holding company is generally made

directly through individuals or domestic agencies not included in the list of reporting institutions. As in other instances, evidence of actual transactions is sufficient to indicate that such transactions were not a negligible element in 1939 in the unreported capital movements; but no satisfactory data are available to warrant an actual computation or estimate.

Since, with the exception of the range estimate covering the transfer of originally foreign-owned deposits to domestic addresses, no estimates of individual types of transactions are ventured by the Finance Division in this report, no attempt is made to identify in detail the various methods of capital transfer which may possibly be reflected. in this special billion-dollar item. For certain purposes it is perhaps satisfactory to consider this item in 1939, as well as in other recent years, a special capital item. The Finance Division has refrained from using this convenient statistical device in its presentation of the annual data, since to do so implies that all other estimates in the statement are correct. The same conditions which have given rise to the type of transactions covered by this special item have accentuated the difficulties of developing sound statistical techniques in estimating certain other items.

Although various cases of such currency holdings for foreign account have come to the attention of the Finance Division, no satisfactory basis exists for an actual estimate. Special risks attach to any attempt at such an estimate because of the sensitiveness of dollar currency hoarding by foreigners to short-run changes in political conditions. The flight of capital from Europe to the United States since 1935 (when financial difficulties in several of the "gold bloc" countriesand, late in the year, the Italian venture in Ethiopia-inaugurated sharp flights to the dollar) has moved with barometric regularity as the vicissitudes of financial and political crises intensified or mitigated popular fears.

The factors which account for the unprecedented total of unidentified items in 1939 are thus the result in part of conditions brought about by the actual outbreak of war; but to an important degree they represent merely an intensification of a situation which since 1934, or even before, has made it impossible to secure, through the usual reporting agencies, complete data on international capital movements. In previous issues of this bulletin attention has been directed to transactions not reflected in the reported movements. These include the repatriation of foreign dollar bonds-particularly issues in defaultthrough nonreporting agencies located in this country acting in behalf of the foreign debtor. Only a detailed check of foreign-exchange operations whereby the American agent is placed in dollar funds would make identification possible.

Two other factors which have in certain recent years accounted for part of the unidentified transactions are stabilization-fund operations not reflected in the reported figures (for example, in 1937) and reported gold and silver movements which were theoretically subject to adjustment for balance-of-payments purposes. For example, in 1934 the reported gold inflow included gold placed under earmark abroad during the preceding year and therefore already included in the balance-ofpayments statement for 1933.

The exceptionally heavy gold imports of 1939 were clearly the result, first, of the imminence of war and, later, of the actual outbreak of hostilities. The exceptionally large item of unidentified capital and other transactions simply reflects the abnormal means whereby the capital transfers, giving rise to the major part of this gold inflow, were actually consummated. In various instances agencies in this country have acted for foreign financial houses under sealed instructions relative to steps which are to be taken by such agencies should certain developments eventuate abroad. This report is not concerned with the motives underlying such arrangements. It is perhaps sufficient to say that individuals tend to seek security of property by whatever methods the dangers, real or assumed, of a threatening situation can be most effectively met.

Real estate in the United States has at times been an important type of foreign-held investment. It is certain that during recent years, particularly in 1939, foreigners have shifted investment funds to this country for the purchase of land, apartment houses, and other forms of real property. Previous studies of the Finance Division have indicated that such foreign ownership is generally held through domestic holding companies or other entities. The foreign purchase of an equity interest in such holding company is generally made

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