FOMC Minutes
A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washington on Tuesday, January 12, 1965, at 9:30 a.m.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Chairman
Balderston
Daane
Hickman
Mitchell
Robertson
Shepardson
Shuford
Swan
Wayne
Messrs. Ellis, Bryan, Scanlon, and Deming,
Alternate Members of the Federal Open
Market Commit ee
Messrs. Bopp, Clay, and Irons, Presidents of the
Federal Reserve Banks of Philadelphia, Kansas
City, and Dallas, respectively
Mr. Young, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Noyes, Economis.
Messrs. Brill, Holland, Jones, Koch, Mann, and
Ratchford, Associate Economists
Mr. Stone, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open
Market Account
Mr. Molony, Assistant to the Board of Governors
Mr. Cardon, Legislative Counsel, Board of
Governors
Messrs. Partee and Williams, Advisers, Division
of Research and Statistics, Board of Governors
Mr. Hersey, Adviser, Division of International
Finance, Board of Governors
Mr. Axilrod, Chief, Government Finance Section,
Division of Research and Statistics, Board
of Governors
1/12/65
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Messrs. Will.s, Holmes, Eastburn, Taylor,
Baughman, Tow, and Green, Vice Presidents
of the Federal Reserve Banks of Boston,
New York, Philadelphia, Atlanta, Chicago,
Kansas City, and Dallas, respectively.
Mr. Lynn, Director of Research, Federal
Reserve Bank of San Francisco
Messrs. Fousek and Sternlight, Assistant Vice
Presidents of the Federal Reserve Bank of
New York
Mr. Kareken, Consultant, Federal Reserve Bank
of Minneapolis
Upon motion duly made and seconded,
and by unanimous vote, the minutes of the
meetings of the Federal Open Market Com
mittee held on December 1 and 15, 1964,
were approved.
Before this meeting there had been distributed to the members
of the Committee a report from the Special Manager of the System Open
Market Acccunt on foreign exchange market operations and on Open
Market Account and Treasury operations in foreign currencies for the
period December 15, 1964, through January 6, 1965, and a supplemental
report for January 7 through 11, 1965.
Copies of these reports have
been placed in the files of the Committee.
Supplementing the written reports, Mr. Coombs stated that
the gold stock would be reduced by $200 million this week as a
result of the French decision to step up their gold purchases.
On
the basis of other scheduled orders, the Stabilization Fund was
expected to end the month with a balance of approximately $35 million
-3
1/12/65
This would be inadequate to take care of other prospective orders
coming through in February and another sizable reduction in the gold
stock would have to be made, probably du:ing the first half of
February.
At the December 1 meeting, Mr. Coombs said, he had indicated
to the Committee that the outlook was for a net reduction in the
gold stock of at least $750 million in 1965.
This was a conservative
estimate; subsequent developments suggested that the prospective
decline might well be on the order of $1 to $1-1/4 billion, even
without taking account of the reduction that would be occasioned
by the increase in the International Monetary Fund quotas.
There had been a heavy burst of speculation on the London
gold market last week, owing to two major factors:
first, the exag
gerated discussion in the French press of the gold policy of the
French Government and, second, widespread misunderstanding and mis
interpretation of Mr. Roosa's reference in his final press conference
to a prospective alteration of the 25 per cent gold reserve require
ment.
Buying pressure built up steadily last week, reaching a
crescendo on Friday (January 8).
In accordance with a general understanding reached in 1961
among members of the Gold Pool, Mr. Coombs said, the Bank of England
allowed the price to rise as a tactical measure up to a level at the
fixing of $35.15 on Friday.
After the fixing there were scattered
1/12/65
-4
transactions in a thin market at prices ranging between $35.16 and
$35.19.
Total turnover on Friday reached $31 million and the cost
of intervention amounted to $28 million.
The statement put out by
the U.S. Treasury on Friday, reasserting the U.S. determination to
maintain the $35 gold price and to convert official holdings of
dollars at that price on demand, helped to restore confidence over
the weekend.
Yesterday, the Bank of England brought the price
down to $35.14 by forceful tactics, and today the price dropped
another cent to $35.13.
This tactical maneuver of letting the
price move up and then hitting the speculators had paid off, and
it would be used again if needed.
The heavy intervention made
last week not only exhausted the Gold Pool reserve, which
initially was $40 million, but put the Pcol into deficit to the
extent of $28 million.
Accordingly, the Gold Pool selling
arrangement was reactivated over the weekend at Basle, retroactive
to last Friday.
As the Committee would recall, the U.S. share of
the cost of intervention was 50 per cent.
Since the last meeting of the Committee, Mr. Coombs con
tinued, there had been a good deal of downward pressure on sterling
and upward pressure on continental currencies in foreign exchange
markets.
By now the British had drawn a total of $745 million on
the credits made available to them under the $3 billion credit
package.
Of this $745 million, $200 million had been used to
-5
1/12/65
repay prior debts and another $200 million already had been
committed during the hectic days just before Thanksgiving.
Thus,
the British had used in the market a total of $345 million, net,
of the package since its announcement.
1/
Yesterday and today, Mr. Coombs said, the sterling market
atmosphere was somewhat better, and the sterling rate was driven
up above $2.79 through sizable intervention yesterday.
Renewed
pressure on the pound might well appear over the coming weekend.
One question in the offing was what Britain's trade figures for
December, scheduled for publication on January 18, would show.
If they indicated a significant decline in imports the market
should behave much better.
But if they showed deterioration the
situation might become difficult again.
Mr. Coombs reported that at the weekend meeting in Basle
Governor Carli of the Bank of Italy had discussed with him the
problems arising from Italy's growing intake of dollars during
recent months.
The Governor thought it might be desirable to
follow the procedure that had been used in 1962, when the U.S.
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material related to certain
other operations by the Bank of England.
1/12/65
Treasury had taken over many of the Bank of Italy's forward lira
contracts.
Mr. Coombs indicated that he agreed, and planned to so
recommend tc the U.S. Treasury.
In addition, Governor Carli thought
it might be desirable for the System to draw on its swap arrangement
with the Bank of Italy, and Mr. Coombs considered this suggestion
also a useful one.
The atmosphere at the Basle meeting, Mr. Coombs continued,
was characterized by as much apprenhension [sic]
and uncertainty on the
part of the central bank governors as he had observed at any such
meeting in the last four years.
What the Europeans feared most was
periodic evidence of simultaneous weakness of sterling and the
dollar and the possibility of a joint speculative attack on the
two key currencies.
It was important to remember that the resources
of the Gold Pool were limited to $270 million, and it would not take
many days like last Friday to run through this amount in short order.
The central bank governors present at the meeting were
unanimous in recommending early removal of the Federal Reserve's
25 per cent gold cover, Mr. Coombs said.
They felt that uncertainty
on this issue had been a major factor behind the recent speculative
pressures, and they thought it would be preferable to remove the
U.S. gold reserve requirement in one stroke rather than in two
steps.
Moreover, they thought that in explaining removal of the
requirement major emphasis should be placed, if possible, on the
importance of freeing the gold stock for international purposes
-7
1/12/65
rather than on the need to allow for prospective increases in the
U.S. money supply.
Mr. Coombs remarked that the central bank governors expressed
strong feelings on the urgency of this countcy's acting to curtail the
volume of bank lending to foreigners, particularly term lending, and
if possible also acting to curtail somewhat the outflow of direct
investments.
This was the position not only of France but of nearly
all of the Common Market countries.
Unless the United States acted,
there was a clear risk of joint countermeasures by the Common Market
countries.
Finally, Mr. Coombs said, many of the central bank officials
were disturbe
by the decision of France to step up gold purchases
from the U.S.
They felt that the manner in which this matter had
been handled had seriously undermined their own positions with their
respective governments.
Mr. Ellis noted that Mr. Coombe had referred to the possi
bility of a "jcint speculative attack" on the pound and the dollar
and asked what he had meant to imply by that phrase.
Mr. Coombs
replied that the attack on sterling had been interpreted in many
quarters as also undermining the position of the dollar.
It was
widely accepted in the foreign exchange markets that if specula
tion against sterling led to devaluation of that currency--and to
competitive devaluations of other foreign currencies--the position
of the dollar might become untenable and there would be a major
1/12/65
-8
risk of its devaluation also.
There also was a risk that certain
central banks would decide to increase their gold ratios, as France
had done.
Spain had indicated that it would be buying gold, and
Austria was likely to do so also; and other countries might react
similarly, as they had in 1960.
Along with purchases from the U.S.
by foreign central banks, there easily could be a convergence over
a short period of speculative demands on the London gold market,
and thus on the Gold Pool, 50 per cent
of U.S. stocks.
of which would be met out
As he had indicated in his statement, the present
outlook was for a substantial reduction in the U.S. gold stock in
1965.
It
was quite possible that declines would have to be reported
every month, and this would intensify the prevailing uncertainties.
In his judment, the dollar now was in a situation of acute danger;
the progressive erosion of its position over the past five years
had made the dollar vulnerable.
Mr
Hayes asked if Mr. Coombs wculd express his own views
on the matters discussed at Basle of the U.S. gold cover and of
possible means of curtailing U.S. bank lending abroad.
Mr. Coombs
replied that he could not speak to the domestic aspects of the gold
reserve requirement, but from the point of view of the foreign
exchange markets he thought a complete removal of the requirement
would do much to restore confidence.
The more thorough-going the
action the more clearly it would be understood abroad and the
greater its effect would be.
1/12/65
With respect to curtailing foreign lending by U.S. banks,
Mr. Coombs continued, he personally thought that some reduction of
domestic credit availability would be useful.
But to add a cutting
edge, he would favor combining this with moral suasion designed to
reduce foreign lending on a selective basis.
In his judgment there
were a number of arguments against extending the interest equaliza
tion tax to term loans of banks for this purpose.
First, in many
cases the one per cent tax would not be much of a deterrent; pro
vision had already been made in many loan contracts to allow for
the tax if it should be extended to bank loans.
Secondly, the
tax was a blunt and inflexible instrument that did not deal with
the geographical nature of the problem.
As he saw it, the main
problem at present concerned U.S. bank lending to the Common
Market countries and to Austria and Spain.
These countries were
accumulating large amounts of dollars and were increasingly
inclined to use them as a bargaining instrument in dealing with
the United States.
But the tax would apply equally to countries
such as Britain and Japan where it would be undesirable now to
curtail U.S. oank lending.
In response to Mr. Mitchell's request for an amplification
of the suggestion that moral suasion be used, Mr. Coombs noted that
Second District banks presently reported all of their foreign term
loan commitments to the New York Reserve Bank.
What he had in mind
-10
1/12/65
was urging commercial banks in the national interest not to make
any loans of relatively large size--perhaps $5 million or more--to
designated countries.
The list of such countries might be modified
from time to time as circumstances changed.
The banks involved in
lending abroad were aware, of course, that their foreign loans
added to the nation's balance of payments deficit.
However, they
were faced with a competitive problem; unless they knew that their
competitors were also being asked to curtail foreign lending they
were likely to feel that a refusal to make a particular foreign
loan would mean foregoing a profitable opportunity with no gain to
the national interest, because some other oank would make the loan
in question.
On several occasions in the past the commercial banks
had demonstrated their willingness to follow such suggestions.
For
example, all banks had complied with requests not to participate
in the financing of certain Canadian wheat sales--to Russia on one
occasion, and to Japan on another.
Mr. Hickman observed that these earlier examples of the use
of moral suasion were one-shot affairs, and Mr. Coombs was now
proposing a continuing program of policing foreign lending by
banks.
He asked whether such a program, to be successful, would
not require some quid pro quo in the form of a willingness on the
part of the Federal Reserve to reduce domestic credit availability.
To his mind, it was the present level of credit availability that
-11
1/12/65
was the basic cause of the problem, although he was not necessarily
suggesting a reduction in credit availability at this time.
Mr. Coombs replied that he would not describe reduced credit avail
ability as a "quid pro quo", but he did agree that the administrative
problems of the program would be lessened if banks had a smaller
volume of funds to lend.
Mr. Hickman then noted that it might be difficult to imple
ment the program if the specific objectives were being continually
modified as the matrix of capital flows changed.
Under such circum
stances it might be hard for an individual banker to understand from
week to week which loans were acceptable and which not unless there
was some guiding group along the lines of a capital issues committee.
There also might be some problem in coordinating the program among
the several Federal Reserve Banks.
Mr. Coombs replied that he would not expect such problems
to be serious,
The program would not involve a great many details;
rather, it would amount to suggesting to commercial banks in
February, say, that they hold back on loans to certain countries,
and then perhaps indicating in September that they no longer need
hold back on loans to one or more of these countries.
Within the
System, the Reserve Banks readily could keep in touch with one
another on the objectives being sought.
-12
1/12/65
Mr. Mitchell observed that he thought it was difficult to
justify using moral suasion of the sort discussed in a democracy,
particularly if some quid pro quo was to be offered.
He noted that
a relatively small number of banks were important foreign lenders.
Mr. Hayes responded that he did not think that any question of a
quid pro quo was involved.
What was proposed was to draw on the
great patriotic instincts of bankers--instincts which as yet had
not been tapped.
In his judgment it clearly would be unreasonable
to expect an individual banker to curtail his foreign lending if
he did not know that his competitors also were doing so.
In reply to Mr. Hickman's question on the possible useful
ness of controls on direct foreign investments, Mr. Coombs observed
that these would be more difficult to administer than controls over
bank lending because of the larger number of businesses involved.
In any case, however, such controls would presumably lie in the
province of the Department of Commerce and not the System.
Mr. Mitchell asked whether it was correct that some
European governments were not prepared to take steps to curtail
1/
U.S. investment in their countries.
1/ Three sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted sentences, reporting the
first part of Mr. Coombs' reply, related to the interests of certain
countries, including the United States, in the matter under discussion.
1/12/65
-13-
The situation with respect to particular countries
changed from month to month.
When the Italians had been in diffi
culty last year, for example, a heavy flow of U.S. investment there
had helped to ease the situation.
excess dollars.
Now the Italians were accumulating
It was because circumstances were so changeable that
he favored a flexible approach to the problem.
In the course of the preceding discussion Messrs. Daane and
Young tempororily left the room.
Thereupon, upon motion duly made
and seconded, and by unaninous vote, the
System open market transactions in foreign
currencies during the period December 15,
1964, through January 11, 1965, were
approved, ratified, and confirmed.
Mr. Coombs then noted that two System swap arrangements
would reach the end of their terms on February 8:
the $100 million,
three-month facility with the Bank of France, and the $250 million.
six-month facility with the German Federal Bank.
He recommended
renewal of the French swap line for another three months and of the
German line for either six or twelve months, depending on the out
come of discussions to be conducted with the German Federal Bank.
Renewal of the swap arrangement
with the Bank of France for a further
period of three months, and of the swap
-14
1/12/65
arrangements with the Gernan Federal
Bank for either six or twelve months,
as recommended by Mr. Coonbs, was
approved.
Mr. Coombs reported that two System drawings of Dutch
guilders from the Netherlands Bank, which already had been renewed
once, woul
mature next month; one on February 4 for $20 million
equivalent, and another on February 10 for $10 million equivalet.
At the present moment he saw no possibility of repayment, and con
sequently he recommended their renewal for another three months.
Renewal of the two d:awings of
Dutch guilders from the Netherlands
Bank, as recommended by Mr. Coombs,
was noted without objection.
Mr. Coombs then noted that of the $200 million authorization
by the Committee to engage in forward transactions, a total of
$154 million was employed at present and another $15 million had
been committed, for a total commitment of $169 million.
These
forward operations had been extremely useful in reassuring the
markets and in preventing an undue concentration of gold losses.
Noting that he might have occasion to engage in additional forward
operations of authorized types in the near future, Mr. Coombs re
quested the Committee to increase the dollar limit on forward
transactions specified in the continuing authority directive for
System foreign currency operations by $75 million, to a total of
$275 million.
-15-
1/12/65
Upon motion made and seconded,
and by unanimous vote, the second
paragraph of the continuing authority
directive for System foreign currency
operations was amended, effective
immediately, to read as follows:
The Federal Reserve Bank of New York is also authorized
and directed to operate in any or all of the foregoing cur
rencies in accordance with the Guidelines and up to a
combined total of $275 million equivalent, by means of:
(a)
purchases through forward transactions, for the
purpose of allowing greater flexibility in covering
commitments under reciprocal currency agreements;
(b)
purchases and sales through forward as well as
spot transactions, for the purpose of utilizing
its holdings of one currency for the settlement
of commitments denominated in other currencies;
(c)
purchases through spot transactions and concurrent
sales through forward transactions, for the
purpose of restraining short-term outflows of
funds induced by arbitrage considerations; and
(d)
sales through forward transactions, for the
purpose of influencing interest arbitrage flows
of funds and of minimizing speculative disturb
ances.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering open market operations in U.S. Government securi
ties and bankers' acceptances for the period December 15, 1964,
through January 6, 1965, and a supplemental report for January 7
through 11, 1965.
Copies of these reports have been placed in the
files of the Committee.
-16-
1/12/65
In supplementation of the writter. reports, Mr. Stone
commented as follows:
Looking back in the record, I note that at the first
meeting of the Committee in January of last year I com
mented that December of 1963 showed none of the turbulence
that often characterizes that month. This time, however,
we have been experiencing one of the more turbulent year
end periods in recent memory.
The Committee last met on December 15, the quarterly
tax date. The money market was quite comfortable at that
time, as it had been over the preceding few days (which
included the December 10 dividend date), largely because
banks in New York and in other major money centers across
the country had worked themselves into basic reserve posi
tions in which they would be able to meet without strain
the demands they knew would converge upon them around
mid-month. This situation was soon to change, however.
Deale credit demands picked up sharply as the month
progressed, and these demands have continued into the
new year as dealers acquired large holdings of rights
in the advance refunding.
At the same time, a significant redistribution of
reserves to country banks occurred. Over the past three
weeks excess reserves averaged abou, $100 million higher
than in the preceding three weeks.
A counterpart of the heavy and persisting credit
demands and the movement of reserves to country banks
has been a sharp deterioration of the basic reserve
positions of major city banks. The large New York banks,
for example, moved from a basic surplus position in the
week or two preceding the tax date to a basic deficiency
position averaging in the neighborhood of $500 million
over the last two weeks of December; and then to a defi
ciency in the neighborhood of $1 billion for a few days
last week. Large basic reserve deficiencies have also been
recorded in a number of other major cities around the
country. The 38 banks that report daily showed, as a
group, a basic reserve deficiency averaging $585 million
in the three full statement weeks since December 15.
Such a situation in money market banks has, of course,
meant heavy pressure on the Federal funds market as these
banks sought actively to acquire funds to cover their
deficiencies. The volume of funds moving through the
1/12/65
-17-
market has, if anything, been a little larger than usual,
but the demands have been so enormous that all trading
has been at 4 per cent, except for two or three hours on
one particularly difficult day when a major bank bought
funds at 4-1/8 per cent. Bank lending rates to dealers
moved up as the banks' reserve positions deteriorated.
From a general range of 4- 4-1/4 per cent at the time of
the last meeting, such rates rose to a range of 4-3/8
4-1/2 per cent by.the end of the year and have remained
around those levels.
Our efforts to deal with these heavy pressures were
complica:ed by unusually wide and unpredictable swings in
market factors affecting reserves. Indeed, the average
"miss" per day during the period was about $240 million,
and on two days the misses were on the order of $1 billion;
moreover, about three-fourths of the misses were in the
direction of a lesser availability of reserves than the
estimates,had suggested.
Und,r these circumstances, repurchase agreements
were a particularly useful device for moderating the
strong pressures that weighed upon the money market
during the period. And making those agreements at
3-7/8 per cent--until yesterday, when we made some at
4 per cent--helped both to keep the bill rate within the
range indicated by the Committee and to insure the success
of the Treasury financing. Indeed, I have little doubt that
in the absence of these repurchase agreements at a 3-7/8 per
cent rate the bill rate would have moved into the 3.90's
during the second half of December. This would not only
have been contrary to the Committee's wishes, but also
would have posed a serious threat to the Treasury's plans
for the advance refunding. For a rise in bill rates into
the 3.90's would have been accompanied by a decline of
some magnitude in prices of intermediate- and longer-term
issues, and even a small decline might well have precluded
Treasury financing within the 4-1/4 per cent interest rate
ceiling. As it was, the longest option in the refunding
had to be priced to yield a full 4-1/4 per cent, while the
1974 issue was priced to yield 4.24 per cent. In short,
there was little or no room left.
Turning to the advance refunding itself, the operation
was well receied by the market. After a day or two of
some nervousness over developments in gold, the refunding
closed out with what appears to have been real success in
achieving debt extension. Dealer holdings of the longer
1/12/65
-18
issue, however, total over $500 million, and the aggregate
exchange into that issue was very large. The success
achieved by the Treasury may be regarded, from a longer
run stancpoint, as a dramatic indication of investor con
fidence in the interest rate outlook. In the short run,
however, the market might well encounter some difficult
problems in the process of distributing its large holdings
to investors, particularly if we should experience again
the kind of unsettlement in intecnational financial condi
tions that occurred last week.
Mr. Ellis asked Mr. Stone to enlarge on his reasons for first
making repurchase agreements at a 3-7/8 per cent rate and then
shifting to a 4 per cent rate.
Mr. Stone replied that the 3-7/8 per cent rate had been
addressed to the special circumstances of unusually heavy seasonal
pressures which coincided with the Treasury's advance refunding
operation.
He had had no intention of retaining that rate any
longer than necessary for the purposes of meeting the Committee's
objectives and of avoiding impairment of the refunding.
Yesterday
(January 11), some relaxation finally became evident in the seasonal
pressures that had weighed so heavily on the market since the latter
part of December.
As a result, the 3 7/8 per cent rate no longer
appeared justified and repurchase agreements were made at 4 per cent.
Mr. Hickman asked Mr. Stone to comment on the usefulness of
the new program of reserve reports from a sample of country banks,
in light of the size of the recent misses in reserve estimates.
Mr. Stone said that the first results of the new country
bank sample had become available on December 10, 1964.
As with
-19-
1/12/65
any new survey, there were bugs that had to be worked out; and it
probably was more difficult to launch a survey of this kind in
December than at any other time of the year.
He had not felt suf
ficient confidence in the early results to rely heavily on them,
so the new survey as yet had not been particularly helpful.
How
ever, he would expect it to become increasingly useful as experience
was gained.
Mr. Holland said he felt much the same way.
Refinements in
methods were being made in this "shakedown" period, but the results
to date were encouraging with respect to the probable ultimate
usefulness of the new sample in reducing after-the-fact revisions
in weekly required reserve and vault cash estimates.
There was
still the problem of day-to-day misses in estimates of operating
factors such as float and currency.
There elements were the major
cause of the big misses Mr. Stone had mentioned earlier.
Thereupon, upor motion duly made
and seconded, and b unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
during the period December 15, 1964,
through January 11, 1965, were approved,
ratified, and confirmed.
Chairman Martin then called for the staff economic and
financial reports, supplementing the written reports that had been
distributed prior to the meeting, copies of which have been placed
in the files of the Committee.
1/12/65
-20
Mr. Brill made the following statement on economic conditions
I am afraid my remarks today are somewhat diffuse, since
there are many facets of the present situation worthy of
exploration. Out of the welter of words, I hope that three
points will emerge:
(a) the economy is still showing surpris
ing moderation in the face of an inventory bulge of apparently
very large proportions, (b) the present balance of forces
appears likely to persist for the next few months, and (c) so
long as this balance persists, the present stance of monetary
policy seems to me to be appropriate to domestic needs.
Now as to the evidence. Before the onset of work
stoppages last fall, the economy was growing at a rate of
close to 5 per cent in real terms. Industrial production
alone was increasing at over a 7 per cent annual rate. After
the interruption resulting from the GM and Ford strikes,
activity resumed with great vigor, a, auto manufacturers
pressed to make up for lost production and steel consumers
continued to lay in stocks as a hedge against the possibility
of a spring steel strike. The industrial production index in
December is estimated to have jumped about 1-1/2 points, to
a level some 7-1/2 per cent higher than that a year earlier.
Employment rose to record levels and the unemployment rate
edged down slightly.
A significant part of the December production rise was
for stockpiling; two-thirds of the point and a half increase
in the production index last month was accounted for by the
auto and steel industries. Rough staff guesses put November
December inventory accummulation in the vicinity of an
$8 billion annual rate.
Yet, even with this pace of activity and such concentra
lion in inventory demand, it is hard to discern substantial
evidence of inflation or inflationary psychology. Some up
ward price pressures persist, but they continue to be
confined to specific areas and continue to be offset, at
least in part, by decreases elsewhere. For example, pressures
seem to be abating in the nonferrous metals markets as more
supplies become available from private production and Govern
ment stocks, and building material prices continue to reflect
the leveling off of activity in the construction industry.
On the other side of the ledger, the steel price situa
tion remains touchy as the industry nibbles away at
Administration resistance. The steel increases to date--at
least the published ones--have had insignificant effect on
the broad indexes, but there is always the possibility that,
emboldened by the mild reaction so far, the industry may
1/12/65
-21-
essay more substantial advances. By and large, however,
there are few signs as yet in commodity markets that
recent price increases are spreading or becoming cumulative
or accelerating.
Neither do we see signs of inflationary psychology
in security markets. There has been relatively little net
advance in stock prices since early summer, and bond prices
at year-end were generally about the same or a little higher
than a year ago.
Many reasons can be attributed for this general market
stability, after another year of substantial economic gain,
a year in which a significant reduction was made in the
extent of unutilized resources. I still prefer as an
explanat:on the rolling readjustment theory. Last year
we had important shifts in demands, the principal one
being the shift from the Government to the private
sectors. Federal spending held about level, while tax
cuts permitted businesses and consumers to take priority
in claiming additional resources.. Within the private
sector there was a shift from residential construction to
industrial construction. More recently, there was a shift
in consumer spending from nondurables to durables, and
within durables from furniture and appliances to autos.
As one type of final demand leveled off, another surged
forward, keeping aggregate activity rising at a moderate
but evidently sustainable pace. Industrial capacity
utilization increased, thus maintaining incentives for
continued investment, but not creating enough production
bottlenecks to incur widespread price instability.
Most analysts seem to agree that for the next few
months expansion will continue strong, reflecting a high
rate of inventory accumulation, rising expenditures for
fixed capital, and strong car sales. Other demands
taken together are expected to rise only moderately
further. Barring new serious work stoppages on the
docks or the rails, aggregate activity will probably
make up for the strike losses last fall. It looks as
though the economy could continue on this path until it
reaches the next set of hurdles, the first of which comes
in early April when consumers have to face the bite resulting
from underwithholdings on last year's income taxes. The
second hurdle comes on May 1, the deadline for the new steel
contract. Beyond that, increasing weaknesses loom, but this
is not the focus of any remarks this morning.
1/12/65
-22-
Assuming such a somewhat unbalanced expansion can
be sustained over the next two to three months without
developing significant departures f:om price stability,
it appears to me that the present posture of monetary
policy would remain appropriate. Along with a large
flow of savings, this policy has produced a structure
of interest rates admirably sited to domestic require
ments, Stable-to-declining long-term rates continue
to encourage investment by businesses and State and local
governments, while not subjecting already reduced housing
activity to financial pressures. I. relatively high short
rates are having any domestic effect, it must be in the
desirable direction of inhibiting some financing of
inventories, although probably this impact is minimal.
The critical question is what specific policy
objectives would contribute to maintenance of the present
set of rate relationships. What volume of reserve addi
tions would produce the appropriate banking system
contribution to credit flows? Here we have to look to
all the sources of funds banks can muster. Savings
deposits, which spurted in November when consumers
awaited the availability of new autos, apparently
declined a bit from this peak but stayed relatively
high in December, and may continue to expand rapidly
as the new higher rates offered by banks exert a tug
on furds which might otherwise flow to nonbank finan
cial intermediaries.
However, faster gains in savings accounts may be
offset in part by smaller rates of increase in CDs.
The high cost to banks of CD money since the November
rise in short-term rates appears to have discouraged
aggressive issuance by many prime banks, and other
important issuers had already curbed their CD activity
starting last spring. Also, corporations seem to be
displaying less interest in the CD market, perhaps
reflecting a developing squeeze on the availability
of liquid funds.
Thus, while banks may be, on balance, the
recipients of a somewhat larger net inflow of time and
savings accounts, some of this rising inflow will have
been bought away from other lenders and will not repre
sent a net contribution to the over-all supply of
loanable funds. To balance fund supplies against
prospective demands at current costs of credit, and
to meet apparent cash balance preferences at current
-23-
1/12/65
rates of return, would appear to require at least as
large an expansion in private demand deposits over the
next few months as occurred last quarter. It should be
recalled that this fourth-quarter rate of expansion was
well below that for the year as a whole. Possibly a
more rapid pace will be in order for a while, if dis
tribution of the present Treasury financing operation
requires extensive and extended bank underwriting.
But we should be able to read promptly from financial
market performance if such reserve objectives are wide
of the mark.
Mr. Holland then made the following statement concerning
financial developments:
I should like to concentrate my remarks on just
one or two issues this morning, taking advantage of
the enhanced flow of information to the Committee in
the form of the green book 1/ and the draft staff
answers to the agenda questions.2/ Before turning
to the main thrust of my remarks, however, I should say
that reports from outlying banks have made us revise
do n our estimate of December commercial bank credit
growth to $1.1 billion from the $1.5 - $2.0 billion
estimate in the green book, This reflected loan ex
pansion about in line with the 11 per cent rate for
the year as a whole, and some decline in securities
holdings. Indeed, commercial bank additions to
securities holdings over the fourth quarter as a whole
averaged only about $200 million a month, well below
the $800 million-a-month spurt in the third quarter.
Such a characterization of bank credit expansion is
somewhat less vigorous than one might have been led
to make on the basis of weekly reporting member bank
data alone, and reflects the fact that country bank
credit expansion has lagged behind city bank expansion
in parts of this period, most recently in December.
1/
2/
The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff,
The staff's prepared comments on certain questions considered
by the Committee at this meeting, given at a later point in
these minutes.
1/12/65
-24-
The large Treasury advance refunding clearly calls
for an "even keel" policy, as the staff answer to
Question 6 points out, probably until the next meeting
of the Committee. But in the current circumstances, I
think "even keel" can be construed to extend over a
substantially wider range of events than in some previous
financings. Let me explain what I mean. I think most
discussions of the definition of "even keel" have boiled
down its essential meaning to, "no change in money market
or reserve conditions (or in any other arena of System
action) that would be construed by the market as signalling
a change in monetary policy."
Given the recent large oscillations in free reserves,
the market obviously is now paying less attention to any
change of, say, $50 million than it did earlier this year,
and so we have acquired a correspondingly greater degree of
freedom here to use if we wish. Similarly, short-term
interest rate fluctuations seem to have been greater since
the discount rate increase, and not always in the same
direction. Thus, the three-month bill rate moved up rela
tively high in the cluster of short-term rates under
seasonal and expectational influences earlier in December;
and thereafter it has dropped relatively low in the money
market rate structure as these earlier special forces were
reversed, and additional downward pressure developed from
"rights" sales in the advance refunding and also from less
aggressive competition from bank sales of CDs. In the
circumstances, I think further bill rate changes of
several basis points either up or down would not upset
the market, so long as the changes evolved from under
standable changes in supplies and demands for bills and
were not linked to actions in the monetary authorities.
Perhaps the least elbow room for maneuver in an
even keel context attaches to such day-to-day financing
rates as those on dealer loans and Federal funds. These
have moved up to new highs since the turn of the year,
under the twin impetus of the strong shift of reserves
away from money market centers and the need for dealers
to finance their large operations in connection with
the Treasury refunding. Relatively sizable borrowings
by city banks have also been a consequence of these
events. Such developments have been fairly well under
stood by the market as natural sources of temporary
pressure, and so produced no flurry of talk of changed
Federal Reserve policy. Nonetheless, if such pressures
1/12/65
-25-
are not relaxed a bit over time, particularly as dealers
manage to work down their need for bank financing and if,
as is expected, reserves do drift back to the money centers
from out in the country, then market participants are likely
to become increasingly of the view that it is monetary
policy and not natural forces that are behind the persisting
tightness, and this revision in attitudes and expectations
could give rise to liquidating pressures in the short-term,
and especially in the long-term, markets. I think, the:e
fore, that the most practical operational constraints for
even keel in this period might be to allow day-to-day
financing conditions to slip back a shade toward pre
refunding levels. The degree of such decline could be
either slight or more appreciable within an even keel
context. and perhaps a middle-of-the-road view would be
to allow day-to-day financing rates to go no higher than
at present, and gradually to allow Federal funds rates to
slip occasionally below 4 per cent and dealer lending rates
to slide back toward 4-1/8 - 4-1/4 per cent and sometimes
lower as January proceeds. This may seem to be focusing
attention very narrowly, but I see no assured alternative
to such a procedure, given the size of undigested new
bond holdings that have been inj cted into the market by
the unexpectedly appealing Treasury refunding. In particu
lar, so large an addition to long bonds in dealer hands,
financed by increased demands for day-to-day money, has
served to tighten up very much the sometimes quite loose
linkages between the money market and the long bond markets.
For a time at least, for better or worse, any further
instalment of "Operation Twist"--that is, any further
upward push in money market rates without an increase
in long rates--seems out of the question.
In so concentrating operational attention upon day
to-day market rates rather than on the 3-month bill rate,
I recognize I am suggesting a departure of sorts. But
I think there are reasons for believing that the bill
rate currently is a less pertinent measure to both the
Committee's international and domestic objectives than
are day-to-day money market and bank reserve conditions.
The statistics for this past year show a considerable
willingness on the part of private foreigners to hold,
in one form or another, the dollars that reached their
hands as a consequence of our balance of payments
deficit. Thus the interest rate and other attractions
to them to hold dollar balances did not appear seriously
1/12/65
-26-
inadequate. If policy is thus still reasonably free to
concentrate on dealing with the causes of the deficit,
rather than simply trying to keep it financed, then
among the sources causing the deficit, the one most
amenable to further influence by monetary policy--either
general or selective--seems to me to be bank lending
abroad. Bank lending policies can be :hanged over time,
and money market and reserve conditions can contribute to
such changes. We already have evidence, in the September
and December surveys of bank lending practices, that
both customer standards and costs of credit for some
business borrowers are being tightened somewhat by a
substantial portion of big banks.
It is moot, however,
whether such tightened lending p:actices affect foreign
or domestic customers more. And the financing of orderly
domestic expansion continues to depend upon the avail
ability cf both bank loans and also longer-term credit.
The yields and terms in longer term markets are
currently very much tied to day-to-day money market
conditions because of the large dealer positions
arising cut of the advance refunding.
I conclude that both the international and domestic
concerns of the Committee at the momen: are more tightly
related to the cost and availability of day-to-day financ
ing in th market than to any other operational variables.
Whether the Committee should choose to have such financing
conditions tightened, eased, or left the same when the need
for an "even keel" fades has to depend upon a balancing of
international and domestic considerations. Whatever way
that choice may be resolved, I think a case can be made
that the safest way to communicate with the Manager in
these weeks is in terms of desired day- to-day money
market conditions.
Mr. Ellis referred to the question that Mr. Holland had
described as "moot," and asked if he had any evidence as to whether
the effects of a general reduction in the availability of funds
would impinge primarily on foreign lending by banks.
Mr. Holland
responded that he knew of no reliable evidence on this question
despite efforts such as he was sure everyone around the table had
made to obtain it from the available statistics.
At the moment,
1/12/65
-27
perhaps talking with bankers was the best method of getting clues
as to how they would react to a reduction in the availability of
funds.
From discussions he had had with some bankers he suspected
that both domestic and foreign loans of banks involved marginal and
inframarginal cases.
He emphasized that this judgment was based on
hearsay and not on any firm evidence.
Mr. Hayes agreed with Mr. Holland that the most useful way
of getting at the subject of bankers' probable reactions was to talk
with them.
He had talked about this with various New York bankers
many times, and he had obtained the impression that their foreign
lending was considered to be a more marginal activity than their
domestic lending and would be more susceptible to curtailment by
a reduction in the availability of funds,
Mr. Ellis remarked that there was another aspect to the
problem--some banks outside of New York appeared eager to get into
the foreign lending field.
If New York banks cut back their foreign
loans they might find the gap was being filled by other banks unless
something was done to minimize the spread of this activity.
Mr. Hersey presented the following statement on the balance
of payments:
Looking back at 1964, one of the most striking
features of our balance of payments was the unusually
large build-up in U.S. short-term liabilities to com
mercial banks abroad, which last year was of the order
of magnitude of $1-1/2 billion. This represents an
increase in interbank balances, including liabilities
1/12/65
-28-
of American banks to their branches abroad and liabilities
of foreign agencies and branches operating here to their
head offices, plus any increase there may have been in
holdings of short-term money market paper in this
country for the account of commercial banks abroad.
The countries concerned in this increase were primarily
Britain, Canada, Japan, Switzerland, and Germany.
Because of this inflow of private banking funds,
we had in 1964, at one and the same time, a deficit on
"regular transactions" (the concept we have ordinarly
focused on) of the order of magnitude of $2-1/2 billion,
and a deficit on the "official settlements" basis of the
order of magnitude of $1 billion. There was a striking
contrast also in the trends within the year. The annual
rate of deficit on regular transactions rose from under
$2 billion in the first half of the year to over $3 bil
lion in the second half. On the other hand, the annual
rate of "official settlements," adjusted for seasonal
variation as well as we can, dropped from somewhere near
$1-1/2 billion in the first half to $1 billion and per
haps less in the second half. This difference in trends
within the year reflects the fact that the large build
up of commercial bank balances was heavily concentrated
in the second half of 1964, starting in fact in July and
continuing in every month but September and December.
A seasonal run-down is normal in December.
I have had to state all these figures in very
approximate terms because we do not yet have compre
hensive figures for the month of December, but only
incomplete figures for the weeks ending on Wednesday.
I should also point out that the difference between
the two kinds of deficit is not due solely to the
behavior of commercial bank balances. In addition,
there was a much smaller normal growth of short-term
balances belonging to private foreigners other than
banks, but this was pretty well offset last year by
a decline in the liquid assets held in this country
by the World Bank and other international agencies.
Why did commercial banks help us out so greatly in
the financing of the deficit on regular transactions in
the second half of 1964? What does this development
portend for 1965? If we could get a good answer to the
first question, it would help in answering the second.
Previous large build-ups in commercial bank balances
occurred in 1959, 1961, and 1963. The first was of the
order of magnitude of $1 billion, but the other two were
1/12/65
-29-
only of the order of magnitude of about $1/2 billion.
A large decline occurred in the second half of 1960,
after a very wide spread had opened up between U.S. and
British short-term interest rates; that was also the
time of the first flare-up in the gold market. I mention
those earlier movements to emphasize that last year's
build-up was relatively very large. Also, in contrast
to the earlier movements, last year's build-up does not
appear to have been stimulated in large degree by special
inducements that foreign central banks, particularly the
Bundesbank, gave their commercial banks to acquire and
hold dollar balances in the United States or in the Euro
dollar market.
The plausible available answers to our first
question are of three kinds. First, one might associate
increases in foreign commercial bank balances here more
or less directly with borrowing cperat.'ons in the United
States by those banks or their customers, in so far as
the proceeds were not needed immediately for trade
financing or other purposes. Canadian issues in our
market were very large in the fourth quarter, and term
lending by U.S. banks was heavy all through the second
half. But when one pursues this explanation in terms
of the countries involved or in terms of comparisons
with earlier periods, it seems to be at best only a
very partial explanation.
Seccnd, one might be tempted to look for an explana
tion in terms of the placement of funds in New York by
Canadian banks obtaining deposits denominated in U.S.
dollars from U.S. corporations. Certainly for some of the
monthly mvements this explanation is valid. By half-years,
however, it breaks down. The net outflow of U.S. corporate
liquid funds into dollar deposits abroad was fairly large
last year, but it was probably not significantly larger
after midyear than before.
Third--and this may turn out to have been a fairly
important factor--banks operating in the Euro-dollar
market in London and elsewhere may have found the volume
of U.S. dollar funds coming to them from all sources
larger than they wished to employ in Euro-dollar lending
abroad. In the case of American bank branches abroad,
the relatively low rates they could pay on very short
term Euro-dollar deposits may have allowed them to
obtain funds abroad for their head offices in this
country at a cost below that of borrowing on 90-day
1/12/65
-30
CDs here.
An important element in this third explanation
is the thought that the aggregate volume of Euro-dollar
deposit, was rising strongly after midyear, and British
statistics do support this assumption.
Underneath all these complexities we are warranted,
it seems to me, in seeing at the least an undiminished
willingness of private foreignens to hold dollar balances,
at least on into December. Possibly we can infer even more,
that the uneasiness about sterling which began to develop
last autumn contributed to the increase in foreigners'
dollar holdings in the form of Euro-dollar deposits and
so to the increase in commercial banks' balances in this
country.
The implication of this line of thought is that in
1965, as and when confidence in sterling is restored, we
may see some unwinding of the 1964 developments. In any
case, it seems very unlikely that the build-up of commercial
bank balances would again be as large as it was last year.
The aftermath of the sterling crisis may also affect
other elements of the balance of payments in 1965.
As
British imports are cut back we will have one definitely
unfavorable factor thrown into the pot of uncertainties
about the outlook for the U.S. trade balance. While the
outlook does seem favorable for a further general expan
sion of world trade, and for further gains in the U.S.
share of exports in some markets, British measures of
restraint, added to continuing French efforts to check
inflation even at a sacrifice of near-term economic
growth in France, could begin to modify this outlook
somewhat. In the next few months, also, we may see more
of a rise in U.S. imports than was occurring from last
spring through October. We have just learned that in
November imports were up sharply to above a $20 billion
rate, from under a $19 billion rate in the late summer
and early autumn. But in considerable part this was
due to a speeding up of shipments to get ahead of the
threatened port strike.
All things considered, it looks likely that our over
all deficit on the official settlements basis will be
higher in 1965 than the $1 billion level we have had in
the past year and a half. This will tend to produce a
further swelling of U.S. gold sales. To counteract these
tendencies, and to help cope with the international political
as well as financial problems they will involve, it will
become increasingly necessary this year to look for policy
measures that hold promise of halting the spill-over of
1/12/65
-31-
bank reserve availability and of time deposits into
foreign term loans and other foreign credits.
The seriousness of this problem of spill-over into
foreign lending is indicated by the confidential data on
foreign term loan commitments gathered by the Treasury from
U.S. banks. These data show substantial increases in commit
ments since the middle of last year, to Europe as well as to
other areas, and they suggest the continuation of the outflow
on term loans at an annual rate in excess of $1 billion.
This compares with an average rate of about $3/4 billion from
the spring of 1963 to mid-1964. But since midyear the rate
has been about $1-1/4 billion,
The sterling crisis is for us a timely reminder that,
if not now, then perhaps later, acute problems can arise
for a reserve currency country with a persistent disequilibrium in its international accounts. Perhaps we need a
different mix of fiscal and monetary policies than any we
have yet tried out.
Prior to this meeting the staff had prepared and distributed
certain questions and responses for consideration by the Committee.
These materials were as follows:
1. Business activity. In view of the length of this expan
sion period, are there indications of developing imbalancesin inventories, production relationships, or the composition
of consumption--that suggest the possibility of either a
cyclical topping-out or an overheating of the economy in the
relatively near future?
The well-balanced expansion through September 1964 has
since been disturbed by auto strikes and the possibility of
a steel strike in the spring. Auto output is scheduled to
be maintained at very high rates for some months ahead, at
a time when steel output is responding to enlarged demands
for precautionary stocks.
Subsequently, we may face
sharply reduced auto and steel output. Nevertheless, the
bulge in inventory buying as it has developed thus far does
not seem to be leading to overly buoyant business expecta
tions and commitments or to a subsequent cyclical topping
out.
Limiting the overheating possibility are the facts that
the labor force and industrial capacity are growing more
rapidly than earlier and are adequate to meet most current
1/12/65
-32-
and deve.oping demands. For some of the nonferrous metals,
the supply situation, which had been very tight, is improving.
Consumer purchases of durable goods other than autos have
been on a plateau for six months, and the earlier rapid rate
of expansion in spending for nondurable goods has slowed.
While reidential construction activity may have bottomed
out after its decline of last year, it is hardly an expansive
factor. Federal purchases seem destined to change little in
the months immediately ahead.
Other final demands, however, remain moderately expan
sive. Consumer incomes are rising at a fairly steady pace
and consumer demands for autos appear strong. Business
spending for fixed capital is still rising, as is State and
local government spending. Such a balance of forces would
be likely to result in a continued substantial increase in
over-all output for several months, with the possibility of
some slowing in the pace of exparsion later in the year.
2. Labor markets. To what extent have recent labor contract
settlements and recent developments in productivity been
exerting upward pressures on unit labor costs?
Only a few major contracts have been negotiated since
the auto settlement. Some of the settlements have provided
for larger than guidepost increases, while others have pro
vided for smaller gains, but the average appears to be about
in line with over-all changes in productivity.
With the auto settlement not providing for any increase
in hourly money wages this year, average hourly earnings in
manufacturing have shown no acceleration in their rate of
rise. At the end of 1964, average hourly earnings in all
manufacturing were only 7 cents, or 2.8 per cent, above
December 1963, a smaller rise than in the previous 12-month
period.
Fringe benefits have been rising more rapidly than money
wage payments; over the past year, fringes increased 4.3 per
cent per employee in manufacturing. Total compensation per
employee in manufacturing, including both money wages and
fringes, was about 3.3 per cent higher in late 1964 than a
year earlier, close to the guidepost and below the indicated
rise in output per manhour.
In recent months, changes in output per manhour in
manufacturing have been obscured by the auto strikes but
there is no evidence of a slackening over the past year
in the high rate of increase of about 4 per cent. This
increase was about the same percentage as in 1963 and 1962.
1/12/65
-33Total labor costs per unit of output in manufacturing
have been showing no significant trends this year. Unit
costs in individual months have been up as well as down.
In September and October unit labor costs rose somewhat,
partly because of the auto strikes. In November, with
output at G.M. resumed, they declined. With the automobile
industry back at full production and with total manufacturing
output continuing to rise, unit labor costs in manufacturing
in December probably dropped back to pre-strike levels.
3. Price developments.
Is there any evidence to suggest
that businessmen are expecting an inflationary price drift
in the period ahead? Or that demand pressures are extending
the area of price increases or accelerating the recent slight
updrift :n the over-all price indexes?
There are occasional indications in the press that some
businessmen are expecting an inflationary price drift, but
these reports are too limited to provide evidence of any
developing inflationary psychology among businessmen.
Actual price performance to date has not been such as
to confirm inflationary expectations. Following a rise of
.4 per cent between mid-September and mid-October, the
industrial commodity price index increased only .2 in
November and .1 in December. The four-h-quarter rise
reflected primarily recovery in fuels, back to the year
ago level, and further increases among nonferrous metals.
General spreading of price increases to other markets in
response to demand pressures does not appear to be occurring.
However, current strong demands for most types of steel,
partly to hedge against a strike threat to supplies, are
sustaining higher prices for some steel products. The
industry has announced increases of 2 to 3 per cent for
galvanized products, citing in part the increased cost of
zinc. The direct effects of these increases on the total
index is negligible.
Recently, upward pressures appear to be abating for
some nonferrous metals. Tin prices fell sharply after
announcement of an increase in the amount of the metal
available from the stockpile. Copper production has
recovered from the strikes and other disturbances of last
summer and recently prices in the London metal market and
in domestic markets for futures and scrap have declined
substantially.
1/12/65
-34-
There is no evidence of acceleration of consumer price
increases and the consumer index in November continued
1.2 per cent above a year earlier.
4,
Balance of payments. How have developments with respect
to the pound sterling affected the U.S. balance of payments
and the willingness of foreigners to hold dollars?
So far, Britain's difficulties have probably had little
net effect on either the U.S. balance of payments or the
willingness of foreigners to hold dollars. Both favorable
and unfavorable effects can be identified, although few of
them can be measured closely.
During the first 9 months of 1964, Britain's large
current account deficit contributed to the U.S. current
account surplus. The U.S. balance on current transactions
with Britain was $320 million more favorable in this period
than it had been a year earlier, and U.S. exports to some
other countries may also have berefited temporarily as a
result of unsustainably large U.F. imports from those
countries. As Britain cuts its deficit, these favorable
influences will be reversed. But there is no evidence
that such a development was yet making itself felt by the
end of 1964.
Postponement of the British Government loan repayment
at year-end increased the U.S. deficit by $138 million in
the fourth quarter. But changes in private capital flows
seem to have worked in the other direction. Short-term
outflows of U.S. private capital to Britain were reversed
in the fourth quarter during the sterling crisis, and long
term outflows probably diminished. Fragmentary data on
securitie; transactions suggest that flows of foreign
capital from Britain into U.S. noliquid assets stopped
shrinking during the fourth quarter, ard may even have
increased.
There is little evidence of any reduced willingness
of commercial banks abroad and other private foreigners
to hold dollars. Flows of foreign private capital from
all countries into liquid assets in the United States do
not seem to have changed greatly in total as a result of
sterling's difficulties; they continued to be exception
ally large through November, and the December reversal
seems to have been of roughly the usual seasonal
proportions.
1/12/65
-35-
Some recent central bank decisions to purchase gold
for dollars may have been influenced by sterling's dif
ficulties and related uncertainties. But France had
repeatedly intimated its desire to exchange dollars for
gold for a variety of reasons, although the sterling
crisis may have provided the excuse and influenced the
timing. Spain was already exploring the possibility of
buying gold, in line with its earlier policies, several
months before the sterling crisis broke.
Private demands for gold have been stimulated by the
uneasiness about the future of exchange rates and gold
parities--an uneasiness generated by the sterling crisis
and recently accentuated by the prospect of French con
versions of official dollar holdings into gold. Private
purchases of gold cannot, however, be taken as a reflec
tion of distrust solely of the dollar. Frenchmen, for
example, have recently been moviig into gold out of
French francs. Increased private demand for gold in the
past two weeks makes it likely that the United States will
be called upon to supply additional gold to the London
pool.
5. The money market, bank credit, and money supply.
(A) How has the mixture of higher short-term rates, including
the higher discount rate, and the lower member bank borrowing
affected the rate of expansion in bank credit and money?
(B) As yar-end money market and bank reserve pressures
subside, what relationships are Likely to emerge among the
proximate target variables of policy, i.e., free reserves
and money market conditions? In turn, how are these likely
to be re ated to credit and monetary expansion in the
near-term?
A. The rate of expansion in bank credit and money
continued in December at a pace not very far below that
for the year as a whole, as the influence of higher dis
count rates and associated higher short-term rates was
counteracted by higher nonborrowed reserves and reduced
member bank borrowings. The daily average bank credit
expansion in December, at 7.1 per cent (annual rate),
however, was considerably slower than November's exceptional
12.1 per cent; this turn-around was influenced in part by
bank sales in December of Treasury tax bills acquired in
late November, and a paring down of Government security
dealer borrowing. The rate of growth in money also slowed
in December, and was below the 4 per cent growth for the
1/12/65
-36-
year as a whole, but time and savings deposit growth was
slightly above its yearly rate, even though major banks
were less active in the CD market.
Bas:cally, the continued December money and credit
expansion was sustained by a substantial increase in the
growth of nonborrowed reserves supplied by the System, as
borrowed reserves declined from pre-discount rate action
levels. In this way Federal Reserve open market operations
counteracted much of the constricting effect on money and
credit expansion which might otherwise have stemmed from
increased member bank reluctance to borrow at the higher
discount rate. Such operations, undertaken in the context
of continuing heavy demands for credit and a shift in
reserves away from city banks in the latter part of
December, produced larger free reserves in the banking
system as a whole and prevented tautness in the money
market from becoming extreme.
B. Money market and bank reserve pressures normally
subside after the year-end, but there are more uncertain
ties thar usual in the picture this year. The Treasury
refinancing operation, discussed in the following question,
is one. The strength of loan demand is another, as the
extent of borrowing to finance inventory accumulation is
not yet clear. The maintenance cf money market pressures
throughout the second half of December and into early
January--as typified by a consistent 4 per cent Federal
funds rate and relatively high dealer loan-rates--may
ind.cate some continuing heavier than usual credit demands,
as well as the sharp movement of reserve funds away from
major city banks.
The continuing money market tautness has contributed
to moderating the usual seasonal decline in bill rates
(intensified this year by demands coming out of the advance
refunding), and the 3-month bill rate closed at 3.78 per
cent on Friday, down 11 basis points from its recent high.
A reflux of reserves to central money markets would tend
to reduce this tautness, as will the unwinding of the
financing pressures arising out of the advance refunding.
Offsetting these easing influences, in part, will be the
Treasury sale of tax bills later this month and possibly
also continuing contraseasonal strength in loan demands.
Given these developments, bill rates might fluctuate
within perhaps the 3.75 to 3.85 per cent range, although
the shortest-term money market rates might adjust down
ward. This could be consistent with member bank borrowings
1/12/65
-37-
averaging somewhat above and free reserves somewhat below
their December levels, but not. back to their fall peaks.
Money and credit expansion could continue substantial,
nevertheless, reflecting both the assumed strength in
loan cemands and the large volume of Treasury financing
activity this month.
Should credit demands relax seasonally over the
balance of January, and particularly if there should
simultaneously occur a redistribution of reserves from
country to city banks, free reserves averaging around
the levels of the past few weeks would probably be
associated with a bill rate at current or even at some
what lower levels. Federal funds would trade below the
discount rate more frequently than recently and borrowings
would be relatively low.
If the maintenance of a firm Federal funds market and
the restoration of a higher bill rate is desired, this
would then probably require an increase in borrowing and
a reduction in free reserves to around the target levels
prevailing last fall. It is hard to say how much the bill
rate might increase with free reserves back to such levels,
but a reasonable guess might be in the 3.85-3.95 per cent
range.
6. Money and credit markets. What is likely to be the
short-run effect on money and capital markets of the
current Treasury financing operation, and what constraint
(if any) does it place on current monetary policy?
The current Treasury advance refunding, which involves
$22.1 billion of publicly-held securities and is the third
largest such offering on record, will place some constraint
on monetary policy in coming weeks. Books were closed for
the financing on January 8, and settlement date will be
January 19. But the terminus of an "even keel" monetary
policy in a refinancing such as the current one is clearly
not susceptible to a hard and fast rule. It depends
essentially on actual market developments in the period
after the books are closed. At a minimum, however, it
seems likely that "even keel" will be required for much,
if not all, of the balance of this month.
It appears that dealers will come out of the advance
refunding with relatively large holdings of long-term
securities. Indeed, early indications suggest that their
holdings of the 4-1/4 per cent bonds of 1987-92 alone will
exceed $500 million. International financial developments
1/12/65
-38-
will be among the major factors conditioning the speed
and price at which dealers will be able to distribute
these securities to investors.
In the week following announcement of the current
refunding, long-term interest rates showed little change,
although earlier they had risen slightly in anticipation
of the exchange offering. The mildness of this initial
long-term interest rate adjustment was similar to exper
ience in the July refunding. But after that refunding,
long-term rates did come under upward pressure later in
the summer. Dealers had emerged from the July refunding
with a record net long position of $1.2 billion in
securities maturing in more than 5 years. Nevertheless,
the System did shade its policy very cautiously toward
less ease beginning in mid-August.
An advance refunding of large magnitude poses problems
for monetary policy not only in the long-term market but
also in the short-term area. In last July's operation,
bill rates came under considerable downward pressure before
the books were closed in mid-July. These pressures were
moderated in some measure by a Treasury bill strip offering;
and the months following July were a period of rising rates,
partly for seasonal reasons. By contrast, the current
advance refunding will be followed by a period in the latter
part of January and in February when seasonal pressures have
at times in the past tended to produce lower bill rates.
But so far in the current financing only moderate downward
pressure has been in evidence, as dealer bill positions have
remained substantial, dealer financing costs have remained
high, and the Treasury has announced a $1-3/4 billion auction
of June lax bills to raise new cash.
7. Monetary policy. In light of these and other considera
tions, what policy with respect to bank reserves and money
market conditions would be appropriate for the next three
weeks?
Chairman Martin then called for the go-around of comments and
views on economic conditions and monetary policy, beginning with
Mr. Hayes, who made the following statement:
I would like to make a brief comment on the new pro
cedure whereby the Board's staff lists specific questions
for our attention and discussion. While I can see that
1/12/65
-39-
we have gained important advantages by this encouragement
of a focusing of Committee members' comments on issues of
current significance in policy formation, I also feel that
some of the questions, such as that dealing with the bal
ance of payments, were rather narrow--although I realize
there was no effort to confine our discussion within these
narrow limits. In several of the areas covered by the
questions I have purposely ranged over somewhat broader
territory in formulating my comments.
1. Domestic business activity. The domestic economy
moved up coward the end of 1964 in almost automatic response
to the end of the October-November auto strikes. While the
year ended on a strong note, not all of the momentum of the
first three quarters appears to have been regained. However,
apart from the steel industry, the economy is still demon
strating well-balanced growth; and the outlook for 1965
remains relatively bright. Strength ir retail sales, which
seems likely, together with the expected continuing accumula
tion of steel inventories, could well push GNP up very
rapidly early in the year. High consumption of steel, as
well as stockpiling, is gradually reducing excess capacity
to produce unfinished steel; finished steel capacity is
already tight. The extent of business sluggishness in the
second half of 1965 will depend importantly on the size of
the first-half steel build-up, and also on the extent to
which fiscal policy provides a stimulus in the second half.
While it is much too early to try to quantify any such
stimulus, there will doubtless be a corsiderable improvement
in this respect in the second half, not only because of
probable excise tax cuts and larger planned expenditures,
but also because of elimination of the drag arising in the
first half from 1964 personal income tax underwithholdings
and the speed-up of corporate tax payments.
2. Labor markets. Except for the automobile industry,
most major wage settlements in 1964 appear to have been
within a range roughly consistent with national productivity
gains. However, it is too early to judge to what extent the
more generous auto settlements may set a pattern. The steel
settlement will be of crucial importance, and at the moment
there is no indication of its probable terms. It was
disturbing that the announced increase in prices of galvanized
steel found an immediate response from the steel union to the
effect that this would provide an additional reason for a
generous wage settlement.
1/12/65
-40-
It seems unreasonable at this time to expect any
material improvement in total unemployment during 1965.
But as many of us have stressed so often, the problem
cannot be solved merely by increasing over-all demand
through expanding credit more rapidly than we have been
doing--even if other considerations permitted us to
follow such a path, and of course they do not.
3. Prices. Price indices continue to show a high
degree of stability, although industrial wholesale prices
are still under some moderate upward pressure. Fortunately,
there has been some easing recently in world commodity
markets at a time when, domestically, cost pressures are
threatening to build up. The price threat is still a
serious long-range danger rather than an immediate problem.
But I think its seriousness is perhaps minimized a little
too much in the staff's answers to the relevant questions.
4. Balance of payments. The international situation
contrasts sharply with the relatively satisfactory domestic
picture. I have become increasingly disturbed by the
uneasy state of international markets, and their suscep
tibility to rumors and distorted interpretations of current
developments. The dollar is particularly vulnerable in
this sort of situation, and it has become a matter of first
priority for us to move our balance of payments far closer
to equilibrium. While the final data for December are not
yet available, the over-all deficit expanded sharply in the
fourth quarter to somewhere close to a $4 billion annual
rate, and the full-year 1964 deficit is now likely to
exceed $2.5 billion. Despite the high proportion of last
year's deficit financed through enlarged private holdings
of dollars, dollars are finding their way into the hands
of European central banks which are unwilling to increase
their holdings, and our gold stock faces significant inroads
over the coming months. While sterling has of course been
the main focus of fears in financial markets, the general
feeling of uncertainty has spread to other currencies,
with the resulting sharp rise in speculative demand on
the London gold market--abetted, of course, by the inex
cusably long drawn-out and exaggerated press coverage of
the French gold takings and by foreign misinterpretation
of newspaper leaks with respect to the 25 per cent gold
requirement. The latter might well have been avoided had
it been made clear at the outset that the main purpose of
eliminating the 25 per cent requirement would be to show
the world dramatically that our entire gold stock is avail
able to meet our international obligations.
1/12/65
-41-
We cannot afford to temporize any longer with our
payments problem, which lies at the root of the erosion
of confidence in the dollar and the erosion of American
bargaining power in international economic negotiations.
As we analyze the composition of our payments deficit,
we find that an unexpectedly strong gain in our trade
balance in 1964 was offset by an increase in private capital
outflows, which can be estimated to aggregate about $5.6 to
$5.8 billion in the year. Bank loans to foreigners accounted
for a good share of this total and were especially high in
October and November, with Europe an important outlet.
(December data are not yet available). In November term
loans alone rose by $165 million.
5. Money supply and liquidity. December data on bank
credit are always hard to evaluate, and this December is no
exception. I think it is safe to say, however, that the
impact of the System's late-November moves has so far
remained mainly confined to money market rates. Credit and
the money supply have continued to expand at about the same
rates over the last two or three years despite the System's
gradual moves toward lesser ease.
As year-end pressures
subside, somewhat lower bill rates are likely to be associated
with a given level of free reserves than in the past few weeks.
6. Money and credit markets, and Treasury financing.
With settlement for the advance refunding still to be
completed next week, and with the market ending up with a
large volume of the longer issues still to be distributed
to investors, we shall have to avoid, probably for the
rest of this month, any actior that would unduly affect the
long-term area. Granted the need for abiding by this limita
tion, we should at least see to it that short-term rates do
not come under downward pressure. And by the time of the
next meeting, in view of the routine nature of the February
refunding, we can probably feel very little inhibition be
cause of Treasury considerations.
7. Monetary policy. It seems to me undeniable that
our international problem has advanced closer to the center
of the stage than a few months ago and that monetary policy
should be moving to help reduce our deficit. In other
words we should, I believe, be seeking a somewhat reduced
rate of growth of bank credit, with open market operations
directed toward this end. Were it not for Treasury con
siderations, I would like to see a fairly rapid move to
money market conditions and bank reserve positions that
would result in a slowdown of bank credit expansion, even
if this involved moderate net borrowed reserves; but for
1/12/65
-42-
the immediate future, it would probably be best merely to
counteract any seasonal tendencies toward lower bill rates.
If we preserve about the present atmosphere in the money
market, with bill rates in the 3.80 per cent to 3.90 per
cent range, we shall be providing adequate support to the
Treasury's program. After the Treasury financing is
settled next Tuesday this policy would probably result
in a somewhat reduced level of free reserves.
The directive should be charged, I believe, to give
greater emphasis to our concern for the dollar's interna
tional position, and to recognize the Treasury financing.
I am coming reluctantly to the conclusion that our
critical balance of payments problem calls not only for
a less easy monetary policy but also for some form of
direct restraint on foreign bank lending. To my mind
some form of moral suasion is greatly preferable to
extension of the interest equalization tax to cover
bank loans. Moral suasion would, in my judgment,
probably be more effective, besides being more palatable
and less likely to become permanently frozen into our
financial system. There is only a rather small number
of banks ready and able to lend abroad in very substantial
But it also seems to me apparent that any
amounts.
selective effort of this kind will be made a great deal
more acceptable here and abroad and more effective if
it can be demonstrated that the System is simultaneously
doing its part to reduce the prevailing degree of general
credit availability.
A policy aimed at reducing the grcwth of bank credit
from the 8 per cent annual rate that has prevailed for
some time would not, in my opinion, significantly affect
the further growth of the domestic economy. But it would
imply that more of the burden of stimulating growth, if
such stimulus is needed, will have to be provided by
fiscal policy. Perhaps this is already in the cards.
Mr. Ellis said the most noteworthy aspect of New England's
year-end performance had been a reversal of the relative positions
of financial compared with production activities.
When measured by
manufacturing output, factory and nonfactory employment, unemploy
ment, construction contracts awarded, and consumer spending, the
1/12/65
-43
year-end gains compared more favorably with the national performance
than earlier.
On the other hand, when measured by loan, investment,
and deposit trends, regional expansion since the discount rate
action in November had lagged both national performance and year
end 1963 activity.
Boston banks, Mr. Ellis continued, reported across-the
board strength in loan demand and an expectation of a less-than
seasonal run-off during the next two months, partly traceable to
inventory hedging in steel.
Several bankers reported an increase
in the frequency of customer inquiries on how to hedge against de
valuation, on when and under what conditions gold could be bought,
and even on what effect could be expected on domestic business if
the British should devalue sterling.
Mr. Ellis said he would consider the first three questions
on the list suggested for discussion today as a group.
As to
whether there was evidence that the economy was heading for either
a cyclical topping-out or an overheating, in all honesty and some
what begrudgingly he had to conclude that the available evidence
was not conclusive on either score.
The recent run-up from October
to December in industrial commodity prices had, in his analysis,
tended to support an expectation that price pressures were about
to break out, given the recent rate of expansion in bank credit.
And yet, since the sharp advance in October, the price rise had
1/12/65
-44
virtually petered out in the reported index, although he sensed
that the pressures were still present.
Mr. Ellis remarked that the green book analysis of wage
cost increase; in manufacturing was quite reassuring when related
to estimated productivity gains, but that analysis applied only to
the manufacturing sector.
It seemed probable that the wage and
salary advances in services and construction had less opportunity
to be offset by productivity gains and would show up in price
pressures.
Concerning question 4 on the balance of payments, Mr. Ellis
could only underscore the obvious point that
the sharply increased
attention to the possibility of devaluation of the pound had in
creased concern about the position of the dollar.
Release of
balance of payments data for 1964 could not help but attract
attention to the deterioration from the first to the fourth
quarter.
He had great sympathy with Mr. Hayes' position that
reduced general credit availability would tend to restrict
foreign lending, but he (Mr. Ellis) lacked evidence that the
initial impact would be on foreign loans.
He had some reserva
tions about the usefulness of moral suasion.
It would be easy to
bring suasion to bear on the largest banks, but many other banks
were ready and willing to make foreign loans.
He was unwilling
to accept the thesis that domestic credit availability should be
1/12/65
-45
reduced for the only purpose of reducing foreign lending.
Such an
approach would be too blunt; more specific neasures were needed.
He would be inclined to extend the interest equalization tax to
banks.
As to question 5, it seemed apparert to Mr. Ellis that the
recent mixture of interest rates and reserve availability had
allowed busiress loan expansion to match last year's rapid advance.
Total bank credit had not matched year-ago advances because of a
different Government financing schedule, but projected loan demand
suggested that credit expansion over the next few months would be
substantial.
If it were not for the fact that the current Treasury
refunding required an even keel atmosphere, Mr. Ellis said, he
would be inclined to emphasize the importance of not allowing
covered interest rate differentials to open widely against the
dollar with the recovery of sterling that was expected later this
month or next month.
He would accept the staff's guess that a
free reserve level in the neighborhood of the targets before the
discount rate action--about $50-$100 million--would be associated
with a bill rate in the 3.85-3.95 per cent range.
Such bill
rates, he thought, would be consistent with the goal he had
described for covered rate differentials.
Borrowings under those
circumstances might rise somewhat from their $170 million average
1/12/65
-46
to about $300 million.
But the need for even keel during the
Treasury financing had to take precedence over his inclination
toward a higher target for bill rates.
Mr. Ellis remarked that he personally would prefer to see
the Committee adopt the staff's draft "trial" directive as its
official directive for this meeting.
However, assuming that the
majority favored the present format, he would propose one revision
in the draft of the regular directive prepared by the staff.1/
His suggestion was to delete the words "may continue to" near the
beginning of the second paragraph, and simply say ". .
. seasonal
pressures require a larger than usual degree of flexibility in
operations . .
."
Mr. Irons reported that the Eleventh District was experienc
ing a moderate expansion somewhat similar to that in the country
as a whole, although some indicators were showing slight devia
tions in both directions.
Construction had declined a bit in
the last month or two, but construction of downtown office buildings
was continuing.
Farm cash receipts were estimated to be off this
year, probably by 7 to 9 per cent.
On the other hand, District
industrial production was strong, and crude oil output was rising.
Employment was moving up and unemployment down, and retail trade
was quite strong.
1/ Appended to these minutes as Attachment A.
1/12/65
-47
Mr. Irons noted that member bank borrowings had declined
recently to levels that often were nominal, and the year-end seasonal
rise was less than normal.
District banks were active in the Federal
funds market, with purchases recently averaging over $500 million
and sales almost that much.
Use of Federal funds by small country
banks was increasing; many were playing their reserve margins
closely, expecting to avoid deficiencies by buying Federal funds
at the last minute.
With respect to District bank credit as a
whole, loans had increased substantially more than investments had
decreased.
Demand was strongest in the consumer loan category,
but other loans also were up.
to grow.
He
Demand and time deposits continued
was concerned by the tendency of some small country
banks that were not market wise to gain deposits by increasing
their use of CDs, and he planned to watch developments of this
type closely.
Mr. Irons thought that there was an increasing trend toward
credit pyramiding in the Eleventh District, and cited some illustra
tive examples.
He did not know whether this trend was widespread
nationally, but he thought it might lead to trouble in the future.
In talking with District businessmen, Mr. Irons remarked,
he did not get the impression that they were thinking about potential
inflation in the usual terms, such as rising wage costs.
Their
primary concern was with the position of the dollar and what could
1/12/65
-48
be done about the present difficulties.
They also were giving
thought to the possibility of a rather substantial increase in
Federal spending in the second half of 1965 after the passage of
legislation implementing the "Great Society."
Their concern about
potential inflation was related to the international problem and
to this expected increase in Federal spending.
Mr. Irons said his views on national conditions did not
differ greatly from those contained in the staff responses to the
questions that had been distributed.
The over-all situation
appeared to be one of continuing strength and moderate expansion,
with few actual imbalances.
There were some threats of future
problems, however, including the destabilizing potential of
inventory developments and the possibility that wage increases
and labor difficulties would lead to rising costs.
He was inclined
to believe that the unemployment rate would remain near 5 per cent
in the next few months.
He could see no strong indications of
inflationary developments in the price sta istics; individual
prices were going in both directions.
He thought, however, that
the trend would be toward higher prices as rising elements of costs
began to seep through in the period ahead.
Mr. Irons observed that the Committee was prevented from
making any substantial policy change in the next three weeks by
the Treasury's advance refunding.
He thought the international
-49
1/12/65
problem was th
most serious of those facing the Committee now.
It seemed to him that the position of the dollar could not be
disassociated from that of the pound, and that developments of
the past several weeks had tended to weaken the dollar.
The
large volume of dollars that had been accumulated by European banks
represented a potential future claim on the U.S. gold stock, and
that in itself tended to weaken the U.S. position.
He did not
particularly like the idea of using mcral suasion to reduce bank
lending abroad, but he thought it might be worth trying before
applying more formal controls, such as extending the interest
equalization tax to banks.
As he understood it, the banks in
volved in foreign lending were relatively few in number and large
in size, and he thought they would recognize their patriotic
responsibilities.
Mr. Irons favored retaining reserve availability about
where it was.
He thought this would yield a bill rate in the
3.80-3.90 per cent range, and would bring covered international
rate relationships roughly into balance.
This probably was the
most the Committee could expect to accomplish in the next three
weeks.
After that period, Mr. Irons would be inclined to place
greater emphasis on the international situation and to look
seriously toward some further lessening of credit availability.
He did not think such a move would damage the domestic economy
1/12/65
-50
if it was not carried to excess.
One could
not be certain that it
would help th; international situation, but it would be a step in
the right direction.
In conclusion, Mr. Irons said that the
staff's draft directive was acceptable to him.
Mr. Swan said he found little to disagree with in the staff
comments on the distributed questions and he had little to add on
these subjects except for a few footrotes relating to District
developments.
One concerned current steel inventory accumulation
and the possible unsettling effects when it ended.
Steel producers
in his area reported that customers were making little or no effort
to increase stocks by buying from western mills, in contrast to the
national situation.
The reason, in part, might be that the canning
industry--which along with construction was the District's largest
user of steel -expected the steel labor situation to be settled
before their peak season in the fall.
There also had been no
signs in the District of hedge buying of steel from foreign
producers.
Mr. Swan's second point concerned one aspect of the price
situation.
There had been some fairly substantial lumber price
increases in recent weeks related to shutdowns of mills because
of flood damage and to interruption of shipments because of similar
damage to railroads and highways.
However, this was a temporary
development, and the situation should return to normal in a few
1/12/65
months.
-51
Flood damage in the lumber industry had been confined
largely to the redwood area in Northern California, and redwood
production accounted for about 12 per cent of the total lumber
production in the District.
Mr. Swan observed that there was little question about the
appropriate policy for the next few weeks in view of the Treasury
refunding.
However, he shared the increasing concern about the
international
situation.
He was not certain about the extent to
which the situation might have deteriorated recently but obviously
it had not improved.
He had to admit that he did not have any
ready solution to the problem.
He shared Mr. Ellis' uncertainties
about the effectiveness of moral suasion and about the possible
impact of a substantial reduction in credit availability on foreign
relative to domestic loans.
Considering the problems of sterling,
the question of the U.S. gold cover, the matter of direct invest
ment abroad, and the question of extending the interest
equalization tax to foreign term loans of banks, it seemed to
him that some kind of consistent, coordinated approach to the
problem had to be developed, some elements of which presumably
would lie outside the Committee's authority.
He was not sure just
how this could be accomplished, but he felt that it would be
undesirable to take any one of the various possible actions with
out giving considerble thought as to how it would be related to
-52
1/12/65
other possible actions.
With respect to the gold cover, he shared
Mr. Coombs' view that it would be desirable to remove the require
ment entirely and not in part.
Mr. Swan agreed that in carrying out an even keel policy
until the next meeting it would be necessary to be concerned with
money market conditions other than bill rates.
But the bill rate
also had to be considered, and he favored a rate in the 3.75
3.85 per cent area.
He doubted that downward seasonal pressures
were going to be as strong in the coming period as they might have
been under different circumstances, and he would not be particularly
concerned if free reserves declined somewhat.
The staff's draft
directive was acceptable to him with the amendment that Mr. Ellis
had proposed.
In calling on Mr. Deming, Chairman Martin noted that he
recently had been designated as Under Secre ary of the Treasury
for Mone:ary Affairs and consequently that this was the last
meeting Mr. Deming would attend as a member of the System and
as an alternate member of the Committee.
Mr. Deming said that business activity in the Ninth
District was moving along reasonably well at present, although
conditions were a shade less expansive than in the nation as a
whole.
Loan expansion was quite strong in December--larger than
in 1963 and only a little below the record of 1962.
The increase
1/12/65
-53-
was particularly strong at country banks, where farm refinancing
A recent business survey
was becoming increasingly important.
revealed about the same degree of business confidence as a year
ago.
Mr. Deming's only comment with respect to the staff's
list of topics was in connection with item 4, on the balance of
payments.
He had no quarrel in general with the facts given
relative to the immediate effects of the sterling crisis on the
U.S. payments balance, but the tone of the discussion was con
siderably more optimistic than he felt.
The situation was quite
delicate and was likely to remain so for some time.
Mr. Deming said he would make no comment on policy for the
period ahead except to emphasize the possible problems in the
after-market
for the 4-1/4 per cent bond that had been issued in
the refunding.
He had found Mr. Holland's analysis of the
appropriate definition of even keel at present to be quite
interesting, and he agreed with it in general.
Mr. Deming noted that he had been attending meetings of
the Committee for almost eight years and that recently he had
read over the record of policy actions for 1964 and had looked
back over some of the earlier entries.
It seemed to him that the
performance of the Committee was impressive.
There was a healthy
element of self-criticism and the Committee was constantly
striving to improve its operations.
But perhaps the Committee
1/12/65
-54
was so concerned with shortcomings in such matters as the state
of knowledge regarding linkages in the economy and the quality of
available date that it tended to underrate its own performance.
In his judgment the Committee's record of policy decisions over
the past several years was one of which it could be proud.
Mr. Scanlon said he was in general agreement with the
staff comments on the first three questions regarding business
activity.
He had one regional comment on wges.
Wage increases
in the construction and farm machinery and auto parts industries
were reported to be causing these firms to
attempt price increases.
Analysts close to those industries believed that recent wage
increases exceeded gains in productivity.
In general, however,
the strengthening of prices appeared more closely related to
increased demand for products than to wage adjustments, as, for
example, in steel.
His views on question 4 were similar to those of Mr. Ellis,
Mr. Scanlon remarked.
He was certain that a less easy monetary
policy would eliminate some marginal loans--both foreign and
domestic.
He had been surprised to find a hesitancy on the part
of some large banks in the Seventh District to agree that such
action would necessarily change the attractiveness of some of
their sizable foreign credits.
While he was not opposed to
trying moral suasion he was not as convinced as Mr. Hayes was
-55-
1/12/65
that it would be completely effective, in view of the attractive
rate differential on foreign loans.
With respect to the U.S. gold cover, Mr. Scanlon observed
that the attitude of District bankers was quite different from a
few years ago.
To many, the question was not whether the require
ment should be changed but when and how this should be done; and
some were quite critical that more had not already been done to
accomplish a change.
Regarding question 5 concerning the money supply and
liquidity, Mr. Scanlon agreed with the staff comments in section
A.
He also agreed with the discussion in ;ection B, except that
he tended to assume a rather strong loan demand whereas he
inferred that the staff had some uncertainties on this score.
Despite this difference,he came out at about the same place as
the staff had.
Contrary to the experience in most areas, Chicago
banks had sold an exceptionally large volume of CDs over the past
two weeks.
This might have been done in anticipation of strong
loan demand, although that was not certain
Mr. Scanlon agreed with the staff comments on item 6,
relating to money and credit markets.
He noted that in the
December returns of the Reserve Bank's quarterly survey of the
District's ten largest banks, dealing with interest rates charged
on loans to business borrowers, there was no evidence that rates
had risen.
In fact, some small declines had been reported.
1/12/65
-56
Mr. Scanlon favored no change in policy.
He would continue
to place primary emphasis on the short-term bill rate and preferred
a range in the 3.75-3.90 per cent area, with free reserves
permitted to find their own level.
The staff's draft directive
was acceptable to him and he did not favor a change in the dis
count rate.
Mr. Clay considered the staffs draft answers to the
questions submitted for Committee consideration to be well done
and acceptable as the basis for policy formulation.
He thought
it was obvious that the Committee continued to be faced with the
dual problems of encouraging expansicn of domestic economic
activity and alleviating problems cn the international financial
front.
For the period immediately ahead, there also were
seasonal financial pressures to deal with and Treasury financing
to take in account.
Over all, Mr. Clay said, monetary policy should remain
essentially unchanged for the period ahead
In view of the
Treasury financing activities, it would be desirable to make no
overt change in policy in any case.
Quite apart from Treasury
financing, in his judgment analysis of the domestic economy
called for a continuation of monetary expansion.
And,
in
the
present context of international financial developments, con
tinued pursuit of the interest rate objectives of recent weeks
1/12/65
-57
seemed to be advisable.
Thus, it appeared logical to him to
maintain the general monetary posture adopted at the time of
the discount rate increase.
However, Mr. Clay felt the uncertainties of seasonal
financial developments would require somewhat more latitude in
open market operations with respect to the range of both money
market conditions and reserve availability.
In his view, money
market conditions should be the primary guide with a Treasury
bill rate generally in the range of 3.70-3.90 per cent.
While
reserve availability should be a secondary consideration, it
should be the aim of operations to provide reserves on a scale
that wculd permit bank credit to increase on a seasonally
adjusted basis.
The economic policy directive draft prepared by the
staff appeared quite satisfactory to Mr. Clay, and he would
make no change in the discount rate.
Mr. Wayne said that recent business developments in the
Fifth District generally reflected continuation of established
trends and appeared to be substantially in line with national
conditions.
There were, however, two items that might be of
interest for future policy considerations.
First, this year's
flue-cured tobacco acreage had been cut nearly one-fifth, but
the reduction in dollar income would depend on other variables,
1/12/65
-58
particularly on yield per acre which increased sharply last year.
Second, a change in the sentiment of businessmen and bankers was
discernible in the Richmond Bank's most recent survey.
While a
sizable majority still expected business to hold steady or
improve, there was a distinct decline in the strength of these
expectations.
Mr. Wayne agreed in general with the staff analysis on
the first question, relating to business activity.
He saw no
significant evidence of any impending cyclical topping-out or of
any overheating in the economy in the near future.
Available
data indicated that inventory increases now in progress were
related chiefly to fear of a steel strike rather than to
inflationary expectations.
Despite a continuing high level of
business investment, there was yet no evidence of a large build
up of excess capacity.
On the subject of labor markets, while Mr. Wayne had
serious reservations about statistical measures of productivity,
available evidence suggested that recent wage increases generally
had been about in line with the productivity guideposts.
The
major test in this area,however, was still ahead and the proof
of the pudding would come with the steel settlement.
Indications of higher prices, Mr. Wayne noted, were less
in evidence now than they were four weeks ago.
Domestic capacity
and foreign sources of supply appeared sufficient to prevent
1/12/65
-59
demand pressures from extending or accelerating price increases
in the immediate future.
As to the balance of payments, Mr. Wayne remarked that
if the whole range of forces now pressing on the international
exchanges were included, it was clear that major consideration
in policy decisions had to be addressed to the problems found
here.
Mr. Hayes' analysis was most persuasive to him.
Mr. Wayne noted that the rate of expansion of bank credit
and the money supply in December appeared to have been slightly
below that in other recent months.
For the next few weeks,
downward seasonal pressures on short rates, reinforced perhaps
by
money market effects associated with the latest Treasury
refunding, would probably mean that a lower level of free
reserves would be necessary if short rates were to be held
within the recent range.
Mr. Wayne saw nothing in the currert or prospective
business situation that suggested the need for any change in
monetary policy at this time.
In the international field,
however, the situation was much less satisfactory.
The
suggestion by Mr. Coombs that the Committee should attempt from
month to month, or from season to season, to shift credit flows
in geographic terms by moral suasion was inherently dangerous,
he thought.
This seemed to him to fall somewhat more clearly
1/12/65
-60
in the field of foreign relations than in that of monetary policy.
He was impressed, however, with the desirability of some form of
direct intervention to restrain further flows of credit abroad
rather than resorting to what he believed would be massive and
untenable reductions in credit availability to the domestic
economy if the Committee should rely solely on monetary policy
to apply this restraint.
Perhaps some form of moral suasion
should be tried, but in his opinion the Committee would have to
and should underscore its concern by reducing credit availability
somewhat.
It seemed to Mr. Wayne that the Ccmmittee had to maintain
and perhaps raise short-term rates so long as the international
situation remained as precarious as it was now.
In the face of
the large return flow of reserves to be expected in the next few
weeks and the apparent net reduction in available supplies of
short-term securities as a result of the current Treasury
financing, such a policy probably would require substantially
lower free reserves than had prevailed recently.
He favored
a continuation of the policy of placing primary emphasis on the
bill rate, and he would aim to keep that rate within the range
discussed at the last meeting, i.e.,
3.75-3.90 per cent, although
he would hope it stayed in the upper portion of that range.
The
draft directive was probably acceptable for the next three weeks.
1/12/65
-61-Mr. Robertson then made the following statement:
I want to say a word of commendation to the staff
for the material they have supplied to us for this
meeting. I do not know how much longer they can keep
this up--coming up with new and relevant questions, or
even with new answers to the same old questions--but
I find it very helpful and I would like to encourage
it.
In particular, I appreciate the efforts, in the
answer to question 5, to nail down a little more the
possible linkages among money market, reserve, and
credit variables. I know this is hard to do, but
it is central to good decision-making on the part of
the Committee and good communications with the Desk.
By and large, I find myself in accord with the
conclusions drawn by the staff in answering the
questions distributed last week. I am gratified
by the way the rest of the economy is responding
with seeming moderation to the spurt of inventory
accumulation in automobiles and steel. It reminds
me somewhat of the way the economy earlier with
stood :he potentially inflationary imact of the
snarp bulge in nonferrous metal prices, with the
resulting sensible over-all price performance noted
in the answer to question 3. I have no special comment
on question 4 other than to question the completeness
and the significance of the assertion, in the third
paragraph of the answer, about a reversal of short
term outflows of capital to Britain and the surmise
about long-term outflows, and to assert that if the
last sentence of that paragraph is correct, the
result is not one to have been hoped for in light
of the British plight.
I have some reservations about the easy
assumption in question 5 that a reflux of reserves
from th, country banks to the central money market
will occur soon enough to take any lasting sting
out of the unusual money market tightness of the
last few weeks. It seems to me that tightness needs
to be relaxed promptly, and if the natural reserve
flows should not be quick and sizable enough for
this, then open market operations should step in.
In this connection, I suggest the bill rate alone
will probably not be a dependable guide to general
money market conditions, just as it has not been
these past few weeks, under the special depressing
1/12/65
influences of both the reversal of year-end seasonal
pressures and the purchases of bills by the sellers
of "rights" in the Treasury refunding. If bill
rates should drop so far as to be of concern from
a balance of payments point of view, there is, as
all of us know, a selective instrument ready for
use in coping with such special pressuresadditional Treasury issues of new bills. Similarly,
there is available another selective instrumentIET for banks--to resist another development of
concern, the increased volume of foreign term loan
commitments by a handful of big banks.
In applying the general instruments of
monetary control, our focus should be on general
market considerations. At this moment, our
immediate general responsibility should be to
keep the complex of money narket conditions on
an "even keel" while the Treasury advance refunding
is in process. Underlying that responsibility is
another--not to permit money market and reserve
pressures to develop in a way that will restrain
the availability of money and credit at what could
be a very unpropitious time, given the undoubted
lags in the influence of monetary policy and the
prospective change of pace in domestic demands.
Mr.
Robertson added that the proposed directive was, in
general, adequate.
amplify the
However, he thought it would be desirable to
inal clause, which read "open market operations over
the next three weeks shall be conducted with a view to maintaining
about the same conditions in
in recent weeks."
the money market as have prevailed
This clause, in effect, called for an even
keel; but an even keel posture could be maintained while leaning
toward either tight or easy conditions, and he was concerned about
the possibility of tightness.
He thought it would clarify the
instruction and be helpful to the Manager if a phrase was added
1/12/65
-63
after the words "recent weeks" along the following lines:
"and
to the extent consistent with this, maintaining growth in non
borrowec' reserves at a rate about in line with that of the last
quarter of 1964."
Mr. Robertson noted that the growth rate in
the last quarter had been 4.9 per cent.
Mr. Shepardson said he had only one general comment to
make on the questions suggested for discussion.
Although he
recognized that it was hard to find much evidence in the figures,
he still had the feeling that potential pressures on costs and
prices were latent in the domestic situation and that the
Committee needed to be constantly alert to them.
The status of
the current labor negotiations did not seem to be encouraging
in that respect.
Mr. Shepardson agreed that the foreign situation had
become more serious in recent weeks and that more attention had
to be given tc it.
In his opinion, there were disadvantages
both to moral suasion and to applying the interest equalization
tax to longer-term bank loans.
Moral suasion was not a particularly
desirable technique for a supervisory agency to use because it
gave an advantage to those who did not cooperate.
An equalization
tax on longer-term bank loans probably could be avoided by
borrowers and lenders through short-term credits made with the
understanding that they would be renewed on maturity.
On the
-64-
1/12/65
other hand,
he did not know of any alternatives
that were likely
to be effective, and perhaps one or both of these approaches
should be tried.
He thought that if such nethods were used
they should be accompanied by some reduction in the availability
of reserves.
Reduced reserve availability need not impinge on
domestic needs for credit if the special measures were effective
in curtailing foreign lending.
Mr. Shepardson agreed that the immediate situation called
for a policy of even keel.
He shared Mr. Robertson's view that
the proposed wording of the directive could be interpreted in
various ways; it could be taken to call for maintaining market
conditions as easy as in the last two weeks or for maintaining
the somewhat firmer conditions of earlier weeks.
He would hope
that the words "recent weeks" would be interpreted to encompass
this whole period, thus allowing for the possible development
of market conditions similar to those of three or four weeks
ago.
He favored the draft directive with the changes that had
been suggested.
Mr.
Mitchell said that an even keel policy was the only
alternative available to the Committee for the period until the
next meeting and that he was willing to accept Mr. Holland's
analysis of the appropriate definition of even keel now.
In
his judgment the bill rate should be permitted to reflect the
expected seasonal weakness in the market.
He suspected that
1/12/65
-65
the overhang of the securities issued in the advance refunding
would last beyond the date of the next meeting, and that the
Committee might be faced with the need fo, continuing to main
tain an even keel then.
This was particularly likely if there
were market rumors of a tightening of policy to supplement a
program of moral suasion against foreign lending.
Mr. Mitchell was pleased to note the increased degree of
acceptance cf the proposition that selective measures were needed
to deal with the balance of payments problem, which he and some
other members had advanced for a long time.
He agreed with
Mr. Coombs that some positive steps had to be taken.
He thought
Mr. Coombs' suggestion concerning the gold cover was exactly
right; it should be removed completely, ard on the grounds of
making gold available for international purposes.
The second
essential was to get the U.S. balance of payments into the black.
But he disagreed somewhat with the suggestion that moral suasion
be used as a major means of achieving this end.
In his judgment
the technique of moral suasion was hostile to the tradition of
creating an environment in which people could seek their own
advantage in terms of costs and returns.
It was for this reason
that he preferred use of the equalization tax or something
similar.
Defects of the present tax could be remedied--it could
be extended to banks, the one per cent tax rate could be increased
1/12/65
-66
by legislation, renewals of short-term credits could be treated
as long-term lending, and so forth.
Mr. Mitchell thought that something also had to be done
to limit direct investment abroad.
While the immediate problems
of taking steps in this area might be more difficult than in other
areas, it was important to remember that tax deferral privileges
under present law added to the advantages of foreign over domestic
investment
The previous Administration had been unsuccessful in
its attempt to remedy this situation, but the present environmen:
was more conducive to a change in :egislation.
However, while
he disagreed on methods, he considered the question of specific
techniques to be less important than the need for corrective
action on the deficit.
Returning to the subject of moral suasion, Mr. Mitchell
said he was not sure who would do the persuading but he hoped
whoever did would not commit the Committee to some particular
course of action.
The Committee had never bound itself to a
specific policy; it always had taken the position that it would
make its decisions from meeting to meeting in light of the
circumstances prevailing at the time.
He thought it would be
extremely unwise to give assurance to anyone that the Committee
would depart from this principle if it possibly could be avoided.
-67
1/12/65
Mr. Hickman said that, contrary to the staff report in
the green book, he did not believe that "sustained moderation"
was an accurate description of the mood an
the performance of
At the moment the fcrward movement of the
the domestic economy.
economy, which in his judgment was neither moderate nor sustain
able, reflected an accidental conjuncture of two unbalancing
forces--the frenetic post-strike catch-up cf the auto industry
and hedge buying of steel.
During December, Mr. Hickman noted, the auto industry had
produced cars at about a 9 million annual rate, and the steel
industry had operated at a rate well in excess of 135 million
ingot tons per year.
Neither of those rates, by any stretch of
the imagination, could be regarded as moderate or sustainable for
any appreciable length of time.
It was his impression that there
had not as yet been much foreign buying of steel as a hedge
against a steel strike.
The behavior of the index of industrial production during
recent months, Mr. Hickman continued, could be analyzed into a
subcycle of rapidly changing activity in steel and autos super
imposed on moderate growth of most other sectors of the economy.
Some indication that steel and autos were the prime movers was
provided by the fact that, according to the latest figures of the
Board's staff, two-thirds of the 1-1/2 point increase in the
1/12/65
-68
industrial production index in December was attributable to a
0.7 point increase in autos and a 0.3 point
increase in steel.
Looking back a bit, the trough of the steel-auto subcycle was
in October when the General Motors strike occurred.
The timing
of the upper turning point of the subcycle obviously lay aheadprobably only a few months ahead if one looked to the auto
industry to finish replenishing dealer inventories and probably
somewhat further ahead if one looked only to the steel industry.
If the two industries turned down together, there was apt to be
a fairly sharp jolt to the economy which would be difficult to
absorb.
The jolt would be somewhat easier to absorb if the
downturns came at different times.
Mr. Hickman reported that in the Fourth District almost
all measures of business activity had advanced in December, but
like the national economy most advances were due to the rebound
following the auto strikes.
One factor in the District of perhaps
national interest was a sharp jump in the nonbuilding component
of construction contracts due to a $175 million electric generating
plant being installed near Pittsburgh.
Th:s was by far the
largest project reported for the entire nation in 1964 and one
of the largest on record.
Mr. Hickman then turned to the staff's questions.
1.
Business activity.
In his judgment there was over
heating going on now in the auto and steel industries in the
-69
1/12/65
sense of unsustainable rates of production, pressures on capacity,
and scrambling for inventories.
The direct causes of this over
heating were exogenous (recent auto strikes and impending steel
negotiations) rather than the length of the current business
expansion.
He noted that in the staff's answer to this question
overheating was referred to as a "possibility" and the risk of
a cyclical topping-out was minimized.
His own feeling was that
overheating was an actuality and a cyclical topping-out was a
very real possibility.
2.
Labor markets.
Mr. Hickman said he doubted very much
that additional costs arising from recent labor contracts were
fully reflected in the official statistics.
Pension costs, for
example, were difficult to estimate precisely.
The wage part of
the auto settlement would not be included in the figures until
In the absence of a full statistical showing the
October.
Committee was out back on its own guesses.
His guess, which was
consiste t with strongly-held views of industrialists on the
Cleveland Bank's Board of Directors, was that if the generous
auto settlement was passed on to steel and other industries labor
costs would rise faster in 1965 than productivity, and profit
margins would be squeezed.
3.
Prices.
Mr. Hickman remarked that according to
Steel Magazine's recent survey, businessmen in metalworking
industries expected selling prices and unit costs to increase
1/12/65
-70
in 1965 by 1.7 per cent and 3.0 per cent, respectively.
Another
indication of possible price pressures was revealed by the fact
that the price diffusion index of the National Association of
Purchasing Agents in November and December was at the highest
level of the current expansion.
Many purchasing agents reported
that they were attempting to combat future price increases by
negotiating long-term contracts.
The staff's answer to this question focused only on
prices, Mr. Hickman noted, with no reference to cost increases
that might have to be absorbed.
Businessmen appeared to be more
concerned with upward cost pressures in 1965 than with price
increases.
4.
In short, they were worried about profit margins.
Balance of payments.
Mr. H ckman noted that pressures
on sterling caused a postponement of British interest payments
to the U.S. in the fourth quarter of 1964, which brought an
immediate deterioration in the U.S. balance of payments.
The
15 per cent surcharge on British imports would have an adverse
effect on U.S. exports as long as it was in effect.
More
importantly, British sales of dollars to support the pound had
added substantially to dollar holdings of central banks.
Unless
the pound strengthened appreciably and the British gained dollars
and used them to repay drawings on its swap line with the
System, excess dollar holdings of foreign central banks might
-71
1/12/65
be converted into gold.
Against this background, Mr. Hickman
would be willing to try moral suasion to check the flow of
foreign credit, perhaps coupled with some slight shift in credit
availability after the refunding.
He felt that the interest
equalization tax was a blunt and unpalatable instrument, and he
would consider it a second choice.
5.
Money supply and liquidity.
Mr. Hickman commented
that the Administration's concern about the level of interest
rates had placed the System in the position of having to main
tain the 91-day bill rate below the discount rate.
The discount
rate had thus become a penalty rate in the sense that member
banks sold bills and other short-term securities rather than
borrow at the discount window.
Accordingly, to prevent short
term rates from rising, the System had allowed free reserves to
rise in December, while member bank borrowings declined.
The
net result was that the marginal credit supply increased.
Despite this, the actual rate of growth in bank credit was not
excessive in December, reflecting the absence of Treasury
financing and a sharp decline in dealer loans.
6.
Money and credit markets.
Mr. Hickman said the
Treasury advance refunding had added substantially to the volume
of long-term securities outstanding in the market and had
reduced almost equally the amount of short-term issues outstanding.
-72
1/12/65
This was a reverse "operation twist," which increased long-term
rates and lowered short-term rates.
The operation, like other
debt-lengthening measures, affected economic growth, since it
reduced the volume of long-term funds available to finance
private investment.
In light of the various factors he had discussed, which
did not all point in the same direction, Mr. Hickman favored no
change in monetary policy, at least for the next three weeks.
That was to say, he would attempt to promote an increase in the
money supply of about 3 to 4 per cent, and in bank credit of
about 6 to 8 per cent.
He thought that this would call for
free reserves in a range of $75 million plus or minus $100 million
and a bill rate in a range of 3.75-3.90 per cent.
Mr. Hickman would accept the staff's draft directive with
the revision suggested by Mr. Ellis.
He favored leaning toward
the side of slightly less ease during the period of even keel.
Messrs. Daane and Young returned to the room during the
course of Mr. Hickman's remarks.
Mr.
Bopp said that rather than comment on each of the
questions prepared he would limit his remarks mainly to the
subject of inventories.
Perhaps the greatest present threat of
imbalance arose from the potentially sizable swing from accumula
tion to decumulation of inventories associated with labor
1/12/65
-73-
negotiations in the steel industry.
He had reviewed inventory
movements associated with steel contract negotiations since 1953
and one particularly pertinent fact emerged.
Only in 1953 did a
recession follow immediately after a negotiation period.
In all
other cases, economic activity continued at high levels for a
considerable number of months following the steel settlement.
One other fact distinguished the negotiation period in
1953 from those occurring since then, Mr. Bopp noted.
The later
negotiations all came fairly soon after the beginning of cyclical
upswings.
The talks in 1953, however, began almost four years
after the trough point in 1949.
The record of the 'fifties and
'sixties, then, indicated that the economy had weathered most
of the inventory swings associated with steel contract discussions.
The outstanding exception was the one case when the contemporary
business expansion had lasted for an unusually long time.
The record supported one other obvious point, Mr. Bopp
said. Fluctuations in durables inventories were greater the
longer a period of negotiation extended and, of course, they
were severest when a steel strike occurred.
The Reserve Bank's contacts in the steel industry indicated
that if the current steel negotiations led to a settlement by May
there might be about 8 or 9 million tons of extra steel in
inventory.
Superimposed on a normal inventory of 12 or
14 million tons, this was enough to cause a considerable
1/12/65
-74
inventory ruroff at a time when a Federal cash surplus also would
temporarily inhibit further economic advances.
was the evident strength in total demand.
Offsetting this
Nevertheless, a
settlement early in May implied a combination of depressing
events occurring at the same time.
If settlement came later in the year, following a Taft
Hartley "cooling-off period" and perhaps a strike, the inventory
swing was likely to be considerably greater, Mr. Bopp said.
According to the Bank's local sources, the steel industry now
found it difficult to supply steel at the rate users wanted to
accumulate it, but industry estimates were that between 3 and
4 million more tons would be accumulated by July.
occur after
This would
the period of temporary Federal cash surplus, and
perhaps after Federal action to stimulate the economy through
new tax reductions and spending programs.
But the business
upswing would then be that much older, and stimulus from
increased capital spending, according to present estimates,
might by then be weak or nonexistent.
All things considered,
the potential disturbance to the economy seemed likely to be
greater the longer a settlement was postponed.
In any event, Mr. Bopp remarked, whether the settlement
came earlier or later, postwar history suggested that steel
negotiations were less troublesome to the economy when demand
-75
1/12/65
was strong.
Thus, it would seem the prudent course for monetary
policy in coming months to provide moderate stimulus to promote
that demand.
Turning to the nearer-term future and abstracting from the
even keel required during the next few weeks, it seemed to Mr. Bopp
that recent developments provided little basis for any general
tightening of monetary policy.
Over-all wholesale commodity
prices remained stable; indeed, even the industrial commodity
component appeared to have leveled off.
Moreover, capacity in
place ard that coming on stream seemed ample to meet prospective
final demand.
Meanwhile, unemployment remained unacceptably high
and, with large prospective additions to the labor force in 1965,
might well go higher.
The balance of payments, of course, remained a difficult
problem, Mr. Bopp observed.
The widening deficit in the fourth
quarter was discouraging; yet, the special factors responsible
had to be kept in mind and the dangers of
a tradeoff in favor of
less ease had to be weighed carefully in the present business
environment.
On balance, Mr. Bopp would make no change in the general
posture of monetary policy.
He would be prepared to retain the
recent flexibility in marginal reserve availability if needed to
maintain substantially unchanged longer-term interest rates and
1/12/65
-76
moderate growth in money and credit.
He was agreeable to the
d:aft directive with Mr. Ellis' proposed amendment.
Mr. Eryan said there were few developments in the Sixth
District calling for comment.
Trends in the District differed
a little from those in the nation in a few areas, such as con
struction contract awards, the money supply, and total deposits
and currency, but none of the differences seemed particularly
significant.
He would make a selective response to the staff
questions.
On the first question, regarding business activity,
Mr. Bryan was perhaps not as concerned with the current inventory
build-up as some others because, aside from fabricated metal
products lines, inventory-sales ratios had not changed signifi
cantly.
He also was inclined to expect considerable stability
in productior over the next few months.
Because capital
expenditures were continuing to rise, an abrupt drop in out
put did not seem likely.
His general answer to the first
question, then, was that no great imbalances were obvious at
the present time.
But he would temper this conclusion with the
observation that it was not the obvious but the obscure hazard
over which one usually tripped.
Regarding labor market developments, Mr. Bryan said he
would withhold judgment for the reason Mr. Hickman had indicated.
-77
1/12/65
As to prices, it seemed to Mr. Bryan that if businessmen
were expecting inflationary price developments their expectations
apparertly were moderate and by no means universal.
Otherwise the
evidence of hedging would be clearer; the :iquidity of the economy
and the Committee's policy of providing reserves would have provided
ample means to expand as a hedge against an expected inflation,
and by now the economy would have been tho;oughly overheated.
He
agreed, however, with those who had suggested that there was
widespread concern about the prospects for the dollar.
At a
meeting of the directors of the Atlarta Bank last Friday many
questions had been raised on the gold cover and on developments
in
the foreign exchange markets.
With respect to the balance of payments, it appeared to
Mr. Bryan that the prospect was for a turbulent situation in which
massive forces, whose net effects he could not foresee, would be
at work.
Mr. Bryan said that at this time of the year he ordinarly
would expect bank reserve positions to ease and corporations to
be buyers of securities, but because of recent and prospective
Treasury financing operations it was by no means certain that the
Committee could count on such developments now.
With an inter
national situation that at best was confused, and with a national
situation in which there were confusing forces of great magnitude,
1/12/65
-78
he felt that a bill rate objective was once more the logical one
for the Committee to pursue.
He favored a policy of essentially
even keel, with the bill rate in the 3.75-3.90 per cent range.
Speaking to the longer term of perhaps three or four
months, Mr. Bryan believed the money supply and reserves could
not long continue to increase at recent rates without laying the
groundwork for a considerable inflationary development.
There
had been an essentially moderate and probably sustainable increase
in the money supply narrowly defined.
Put in his judgment, under
present circumstances some portion of time deposits should be
included in the money supply--the Committee had to go back to the
old idea that money was anything that did money's work.
Recent
increases in time and savings deposits had been rapid; they had
expanded ac annual rates of over 15 per cent in the last three
months and over 12 per cent in the last year.
When some portion
of these increases were added to the 4.[illegible]
per cent rise that had
occurred in the narrowly defined money supply in the last year,
it revealed a development that Mr. Bryan did not think was sus
tainable.
Similarly, he did not believe that total reserves,
nonborrowed reserves, and reserves against private demand deposits
could continue to increase for long at the rates that had been
achieved in the last quarter without developing an inflationary
potential.
-79-
1/12/65
Mr. Bryan noted that there had been
a great deal of dis
cession today on the relative merits of moral suasion and
legislation for dealing with capital outflows.
something had to be done.
He agreed that
Generally speaking, he disliked moral
suasion, although he thought it might work in the present situa
tion.
But he would much prefer to have the interest equalization
tax extended to banks, whether by administrative act or by new
legislation.
In his opinion some controls also would be required
over direct investments abroad.
Experience with loan administra
tion under section 13b of the Federal Reserve Act suggested to
him that there was likely to be a problem of leakage--of loans
made for nominally domestic purposes that in fact facilitated the
flow of funds abroad.
Mr. Shuford commented that economic activity in the
Eighth District had been on a plateau during the early months
of 1964 but rose markedly from August to the end of the year.
District employment increased at a 3.7 per cent annual rate
from August to November, recovering from the auto strikes in
October.
Manufacturing output rose at more than a 10 per cent
rate from August to November and spending, as measured by check
payments, increased at a rate a little higher than 3-1/2 per cent
in that period.
1/12/65
-80Most indicators of banking activity in the District rose
from August to December, Mr. Shuford observed, continuing the
growth trend of the preceding eight months
at more than a 1 per cent annual rate and
at nearly a 4 per cent rate.
Total loans increased
investments expanded
However, business loans in the
District declined at nearly a 5 per cent rate from August to
December, despite a rather marked rise in the St. Louis area.
Deposits at District banks expanded from August to December at a
much higher rate than loans and investments.
resulted fron an increase in time deposits
Most of the growth
which rose at more
than a 12-1/2 per cent rate; demand deposits increased at about
a 7-1/2 per cent rate.
Borrowings from the Reserve Bank had
been nominal recently.
Mr. Shuford commented that he had
found the staff questions
and answers quite helpful, and he had no areas of serious disagree
ment with respect to either the facts or the conclusions presented.
From discussions about prices with District businessmen and bankers
he had gained the same general impression others had reported
today--that there was increasing concern in the business community
with respect to the position of the dollar and of the U.S. balance
of payments.
However, he had found a little more concern about
possible price developments than some others had.
Many of the
businessmen with whom he had talked expected price advances as
1/12/65
-81
a result of the steel situation.
ment in
They thought that the settle
the steel labor negotiations probably would be in
excess
of the administration's guideline, and they expected the steel
industry to attempt to raise prices even if the settlement was
within the guideline.
Various factors would, of course, set
limits to these expected price increases, but they still would
be in
the upward direction and their effects would carry over
into other areas.
In sum, business and other opinion in the
Eighth District was that there was somewhat more pressure on
prices now than had been evident earlier.
Mr.
Shuford commented that it
was clear from today's
discussion that everyone recognized the international problem as
He could
paramount among those facing the Committee at present.
not be sure what course he would favor with respect to moral
suasion until he had given the question more thought.
Like
others, he would be highly reluctant to see any specific controls
imposed to restrict the free flow of trade and of funds.
But the
situation was serious, and he felt that the System should take
whatever helpful actions it
responsible.
could in
the areas for which it
was
He thought that the interest equalization tax
should be extended to banks with any desirable and feasible
elaborations of its
provisions,
but he feared that this might
take more time than was available in the circumstances.
Perhaps
-82
1/12/65
the Sys:em should do what it could in the area of moral suasion
rather than simply wait for enactment of legislation.
Two years
ago, in a roughly similar situation, the Committee had felt that
actions outside the area of monetary policy were called for and
had hoped that monetary policy could be relieved of part of the
burden.
Some actions had been taken by the Administration then,
but the necessary fundamental improvement had not been achieved;
even though the balance of trade had moved in a favorable direc
tion the country once more was faced with a serious problem.
Actions beyond the System's jurisdiction again were called for,
but the System also had to carry some part of the burden.
In
his judgment both lines of attack should be pursued.
There were some questions in Mr. Shuford's mind as to
the best approach, from psychological and other standpoints, to
the matter of removing the gold cover requirement.
However, he
personally favored removing the requirement. entirely.
Mr.
Shuford favored no change in monetary policy for the
reasons already discussed,
financing was predominant.
of which the imminent Treasury
He appreciated Mr. Holland's analysis
of the appropriate definition of even keel for this period.
How
ever, he would not favor using dealer lending rates and similar
factors as the main guide to operations; in his judgment short
term rates should continue to be the principal guide for the
1/12/65
-83
Desk, and he favored a bill rate in
cent.
Mr.
the range of 3.70-3.90 per
Shuford thought he had developed a better understanding
of the meaning of "tone and feel" of the market from having
participated in the daily conference call for the last four
weeks.
The Desk had been faced with some difficult problems
during this period,
well in
and in his opinion it
had done unusually
dealing with them.
Mr. Daane said that the prescription for policy in the
next few weeks seemed crystal clear in
light of the size of the
Treasury refunding and the need for the market to digest the
securities issued.
He thought the current tone and feel of the
market should be maintained as nearly unchanged in
as was humanly possible.
coming weeks
Looking further ahead, he would be
somewhat concerned about continuing the current degree of credit
availability in light of the expansion already experienced and
against the background of the present critical situation with
respect to the balance of payments and the position of the dollar.
But it was urnecessary to pursue this subject further at the
present time.
With respect to the new procedure that had been followed
at this meeting and the previous one, Mr. Daane noted that the
Committee was striving to improve its analysis of the economic
and financial developments underlying its policy decisions and
1/12/65
-84
to improve its communications.
He had fourd the staff questions
and answers extremely useful in sharpening the focus on basic
consideratiors.
He was somewhat disturbed, however, by the fact
that there was so much repetition in the discussion.
Although
he had not been present at the last meeting he had read the
minutes closely and noted that many members seemed to feel an
obligation to comment on every question in the list.
In his
judgmert, it would be more useful to view the staff's questions
and answers as a briefing document
that was extremely helpful
in sharpening the Committee's focus on important issues rather
than to assume that they imposed a requirement on every member
of the Committee to present his own analysis of each issue.
To
his way of thinking the latter course unduly extended the length
of the meeting and the length of the minutes.
It also posed a
problem with respect to the policy record entry and it interfered
with the give and take of discussion.
Mr. Balderston said he thought it was fortunate from the
point of view of the Committee's relations with the Treasury that
another alumnus of the Federal Reserve, in the person of
Mr. Deming, would be occupying the position of Under Secretary
of the Treasury for Monetary Affairs.
He was prompted to make
this observation especially because of his pleasure in noting
that Mr. Mitchell and others had implied in their comments this
-85-
1/12/65
morning that finding solutions to the international problem was
as important to the well being of the country as was the state
of the domestic economy.
For the immediate future, Mr. Balderston said, the
Treasury refunding called for maintaining unchanged the conditions
in the money market.
He could not say now how far beyond the
next meeting an even keel would be desirable, but he would not
necessarily favor continuing to protect the Government security
dealers indefinitely until they had disposed of all of the
4-1/4 per cent bonds acquired in the refunding.
In his view it
was appropriate to expect the dealers to assume some risk in
their operations.
The draft directive as amended was acceptable
to him.
Mr. Balderston said he would like to make two further
points now because he thought that Committee members should give
particularly intensive consideration during the coming three
weeks to the question of what action would be appropriate at
the next meeting.
His first point concerned the possible benefit
to the balance of payments of moving toward restraint on bank
credit.
Some change in policy seemed vital to undergird what
ever special approaches to the problem were attempted.
As long
as domestic conditions were as strong as they promised to be in
the first quarter, and as long as the flow of financial savings
1/12/65
-86
remained high,
it
appeared to him that monetary policy could make
some contribution to the international situation without damage
to the domestic economy.
bility
of the System.
Such a contribution was the responsi
Domestic corporations appeared to be
relying more on bank credit than on the capital markets to
finance such investment as could not be financed with internal
funds.
For nearly three years,
from 1952 through the third
quarter of 1964, bank credit had expanded at a relatively stable
rate, averaging about $19-1/2 billion a year, although the ratio
of bank credit to total funds raised during that period had,
course,
dropped somewhat.
of
The annual percentage rate of growth
was contin:ing at around 8 per cent.
He was reminded of the
willingness of the United States to finance German industry
after the
first World War through bonds yielding 8 per cent,
knowing that the money was being invested in
enterprises that
would not earn so high a return.
Secondly, Mr. Balderston said, despite the satisfaction
ofter
being expressed with respect to the health of the current
domestic expansion,
he thought a few telltale
were now beginning to appear.
signs of illness
In his judgment one should not be
content with the facts that the wholesale price index was no
higher now than five years ago and that the rate of increase in
the consumer price index had not accelerated; during those five
years greater progress could have been made in increasing the
-87
1/12/65
price competitiveness of American goods.
The rise in the U.S.
trade surplus was traceable to the fact that other countries had
inflated more than the United States had.
It was not necessary
that all of the gains in efficiency be translated into increases
in wages and fringe benefits.
The test of these propositions was
that dollar holdings were being built up in foreign monetary
centers, and these dollars were being used as bargaining instru
ments aga:nst the United States.
He wanted to see this situation
come to an end.
Moreover, Mr. Balderston said, even the vaunted price
stability was showing signs of terminating; in the fourth quarter
wholesale prices excluding farm and food products rose 0.6 per
cent.
He would not want to say that the economy was faced with
price inflation but, given the fact that
the international situa
tion was the prime consideration at the moment, he thought there
should be progress in the direction of reducing the prices of
exportable goods.
Mr. Balderston observed that bank credit should be used
constructively, not speculatively, and he noted that earlier in
the meeting Mr. Irons had expressed a concern similar to that
which he felt on this score.
The present expansion thus far
had been characterized by balance and by the high degree of
prudence evident in the decisions of business managers.
But
1/12/65
-83
with the change that seemed to have occurred recently in inventory
policies he sensed that there now was an element of speculativeness
abroad that the Committee was helping to feed through its current
monetary policy.
In a concluding observation, Mr. Balderston said that
solution of the longer-run problem of the continuing accumula
tion of dollars by European central banks was of vital importance,
and this problem had to be attacked by both the Administration and
the System.
Much discussion of the problem seemed to blur the
fact that France had enough dollars to demand substantial amounts
of gold, to say nothing of Spain and other countries.
He would
like to see the Government's foreign spending and lending
attacked first;
the country was earning a substantial return on
private long-term investments abroad.
He would favor attacking
next the term loans of banks and direct investments in European
countries.
If moral suasion was to be employed in any form he
hoped that it would be accompanied by sanctions of some sort
because otherwise it could have inequitable effects.
Chairman Martin said he had found the discussion today
stimulating and worth while; it was good to have the opportunity
to bring the various viewpoints of members more sharply into
focus.
He thought Mr. Hickman had made a useful contribution
in his analysis of the staff's answers.
Because the matters
1/12/65
-89
being dealt with involved human choice and judgment, there inevitably
were many imponderables.
The Chairman said he had little to add to the discussion
this morning.
It seemed perfectly clear that everyone was in
favor of maintaining an even keel in
three weeks.
the money market for the next
There was some disagreement as to how "even keel"
should be defined under present circumstances, but the Committee
always was faced with this kind of problem in its deliberations.
In light of a Treasury financing so successful that it led to
some complications, he thought it was apparent that the conditions
in the money narket prevailing during the current period should be
maintained as closely as possible over the next few weeks.
Chairman Martin favored the amendment to the staff's
draft directive that Mr. Ellis had suggested; namely, to delete
the words "may continue to" in the second paragraph.
He noted
that Mr. Robertson had suggested the addition of a clause at the
end of this paragraph, but he questioned whether the clause would
add much in view of the different shades of emphasis around the
table.
He suggested that a vote be taken on the staff's draft
directive with Mr. Ellis' proposed amendment.
Mr. Hayes suggested adding the following language at
the end of the first
paragraph:
"particularly in view of the
current unsettlement in financial markets abroad."
Mr. Mitchell
1/12/65
-90-
concurred in the suggestion, noting that a considerable amount of
concern on this subject had been expressed in the discussion today.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Federal Reserve Bank of New York
was authorized and directd, until
otherwise directed by the Committee,
to execute transactions in the System
Account in accordance with the follow
ing current economic policy directive:
In light of the economic and financial developments
reviewed at this meeting, and taking the current Treasury
refunding into account, it remains the Federal Open
Market Committee's current policy to facilitate continued
expansion of the economy by accommodating moderate
growth in the reserve base, bank credit, and the money
supply, while seeking to avoid the emergence of
inflationary pressures and to strengthen the inter
national position of the dollar, particularly in view
of the current unsettlement in financial markets abroad.
To implement this policy, and recognizing that
international uncertainties and shifting seasonal
pressures require a larger than usual degree of
flexibility in operations, System open market opera
tions over the next three weeks shall be conducted with
a view co maintaining about the same conditions in the
money market as have prevailed in recent weeks.
It was agreed that the next meeting of the Committee would
be held on Tuesday, February 2, 1965, at 9:30 a.m.
Chairman Martin commented that he thought the Committee
was making progress on the matter of the directive.
He noted
that Mr. Daane had spoken about the length of the minutes under
the new procedure, and he had some sympathy with Mr. Daane's
comment.
However,
the Committee did have the problem at each
-91-
1/12/65
meeting of urcovering the various shades of emphasis in the views
of members.
He thought progress was being made in this connection
also.
The Chairman noted that the Committee had planned to discuss
the question of quantification in the directive after conclusion
of the regular agenda today.
He proposed that the discussion be
deferred until the date of the next meeting, to allow more time
for members to think about the question.
Also, Mr. Mitchell had
distributed a memorandum on this subject today that would provide
a good basis for the discussion, and it would be desirable for
the members to have time to study this document.
(Note:
A copy
of Mr. Mitchell's memorandum has been placed in the files of the
Committee.)
There were no objections to the Chairman's suggestion.
Thereupon the meeting adjourned.
Secretary
Attachment A
CONFIDENTIAL (FR)
January 11,
1965.
Draft language for current economic policy directive for consideration
by the Federal Open Market Committee at its meeting
on January 12, 1965
In
light of the economic and financial developments reviewed
at this meeting, and taking the current Treasury refunding into
account,
it
remains the Federal Open Market Committee's current
policy to facilitate continued expansion of the economy by
accommodating moderate growth in the reserve base, bank credit,
and the money supply, while seeking to avoid the emergence of
inflationary pressures and to strengthen the international
position of the dollar.
To implement this policy, and recognizing that international
uncertainties and shifting seasonal pressures may continue to
require a larger than usual degree of flexibility in operations,
System open market operations over the next
three weeks shall be
conducted with a view to maintaining about the same conditions in
the money market as have prevailed in
recent weeks.
Cite this document
Federal Reserve (1965, January 11). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19650112
@misc{wtfs_fomc_minutes_19650112,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1965},
month = {Jan},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19650112},
note = {Retrieved via When the Fed Speaks corpus}
}