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, D. C. on Tuesday, August 10, 1965, at 9:30 a.m.
PRESE,:
Mr. Martin, Chairman
Mr. Balder ton
Mr. Daane
1/
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Galusha
Maisel
Mitchell
Robertson
Scanlon
Shepardson
Bopp, Alternate for Mr. Ellis
Irons, Alternate for Mr. Bryan
Treiber, Alternate for Mr. Hayes
Messrs. Hickman and Clay, Alternate Members of
the Federal Open Market Committee
Messrs. Wayne, Shuford, and Swan, Presidents of
the Federal Reserve Banks of Richmond, St.
Louis, and San Francisco, respectively
Mr. Young, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Noyes, Economist
Messrs. Baughman, Brill, Garvy, Holland,
and Taylor, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open
Market Account
Mr. Molony, Assistant to the Board of Governors
Mr. Partee, Adviser, Division of Research and
Statistics, Board of Governors
Mr. Reynolds, Associate Adviser, Division of
International Finance, Board of Governors
Mr. Bernard, Economist, Government Finance
Section, Division of Research and Statistics,
Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
1/ Left the meeting at the point indicated in these minutes.
8/10/65
Messrs. Latham and Patterson, First Vice
Presidents of the Federal Reserve Banks
of Boston and Atlanta, respectively
Messrs. Eastburn, Mann, Ratchford, Jones, Tow,
Green, and Craven, Vice Presidents of the
Federal Reserve Banks of Philadelphia,
Cleveland, Richmond, St. Louis, Kansas City,
Dallas, and San Francisco, respectively
Mr. Sternlight, Assistant Vice President,
Federal Reserve Bank of New York
Mr. Anderson, Financial Economist, Federal
Reserve Bank of Boston
Mr. Kareken, Consultant, Federal Reserve Bank
of Minneapolis
Upon motion duly made and seconded,
and by unanimous vote, the minutes of the
meeting of the Federal Open Market Commit
tee held on July 13, 1965, were approved.
Upon motion duly made and seconded, and
by unanimous vote, the actions taken by mem
bers of the Federal Open Market Committee
on July 28-29, 1965, authorizing negotiations
to increase the outstanding swap arrangements
with (1) the German Federal Bank from $250
million to $500 million, and (2) the Bank for
International Settlements from $150 million to
$300 million, on the understanding that the
additional facility with the Bank for Inter
national Settlements would be used by the
System to acquire currencies other than Swiss
francs in which the Federal Reserve Bank of
New York had been authorized by the Committee
to operate, were ratified.
Chairman Martin then invited Mr. Daane to report on the meeting
of the Group of Ten Deputies that he had attended in Paris on August 3
and 4.
Mr. Daane remarked that the first afternoon of the meeting
had been devoted to a review of the question of the next steps to
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be taken with respect to future international monetary arrangements,
with particular attention given to the feasibility and desirability
of an international monetary conference, since Secretary of the
Treasury Fowler recently had indicated U.S. willingness to partici
pate in such a conference.
Except for the U.S. representatives, the
Group was unanimously negative with respect to an international
monetary conference at this juncture or in the near future, and they
were skeptical for the period beyond that.
The consensus was that
there were a number of basic differences in view on appropriate
international monetary arrangements, but they reflected differences
within the Group of Ten itself, and therefore should be worked out
by that Group.
Thus, the principal conclusion of the Deputies was
that their owr efforts to prepare for changes in the international
monetary system should be intensified without prejudging the
question of the urgency of putting any changes into effect.
The Deputies envisaged three phases for future discussions
of international monetary arrangements, Mr. Daane said.
In the
first phase the objective would be to resolve differences among
themselves on basic points.
They hoped to get a mandate from the
Ministers of the Ten at the time of the World Bank-Fund meetings
in September that would permit them to move ahead and really come
to grips with the problems as they saw them.
They considered this
phase to be an absolutely essential prelude to the second, negoti
ating phase; it was necessary, they thought, to see the outcome of
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phase one before moving on to more formal negotiations on the specific
form of monetary arrangements.
This left an international conference
as a remote possibility for a third phase.
From the discussion it
was clear that there were serious doubts around the table as to
whether such a conference ever would be necessary or even useful.
Two other questions were discussed at the meeting, Mr. Daane
continued.
One concerned renewal of the General Arrangements to
Borrow, on which agreement was required by October 1965, as he had
mentioned on earlier occasions.
At the previous meeting the
Deputies had divided evenly on the issue of duration, with five
countries favoring a two-year term and five a four-year term.
At
this meeting the discussion revolved almost entirely around a
compromise British proposal, under which the GAB would be renewed
for a four-year term, but with a specific provisio that a review
would be made at the end of two years.
Reaction was generally
favorable, with the only unresolved question that of whether a
country would have the advance consent of the others to withdraw
from the Arrangements at the end of the two years; under the terms
of the present GAB consent to withdraw was necessary.
Of course,
the whole question of renewal of the GAB was not one for decision
by the Deputies, but rather for the Ministers of the Ten, and the
matter was left open for decision at the Ministers' meeting in
September.
8/10/65
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There also was a brief discussion of the measures that
Britain had taken recently, Mr.
Daane said.
Those measures were
viewed as a further step in the right direction, and the reactions
to them were quite favorable.
Before this meeting there had been distributed to the
members of the Committee a report from the Special Manager of the
System Open Market Account on foreign excharge market operations and
on Open Market Account and Treasury operations in foreign currencies
for the period July 13 through August 4, 1965, and a supplemental
report for August 5 through 9, 1965.
Copies of these reports have
been placed in the files of the Committee.
In comments supplementing the written reports, Mr. Coombs
said that the
,old stock would remain unchanged this week.
The
Stabilization Fund still had $83.4 million cf gold on hand, with
prospective central bank orders this month cf roughly $57 million.
In addition to such official demands for gold, however, the cost of
financing intervention in the London gold market had become heavier
From the beginning of the year through the end of July, total inter
vention by the London Gold Pool amounted to roughly $200 million, of
which the U.S. Treasury share was $100 million, or 50 per cent.
During the first week of August, the Pool had had to put up an
additional $35 million to keep the price under control.
Chinese
buying continued to be a significant factor in the market, with
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purchases of $2 million or so occurring every few days.
The great
bulk of demand for gold, however, seemed to be coming from all over
the world and to reflect a fairly general feeling of anxiety; in a
sense it reflected all of the troublesome problems of the day, of a
political, military, and economic nature.
In an effort to relieve
the pressure somewhat, the price had been allowed to ride up to just
a shade under $35.20, the informal ceiling under the Pool arrange
ment, at which point some expectation of a price dip might appear.
That situation was a potentially dangerous one and had to be
watched closely.
On the exchange markets, Mr. Coombs remarked, since the
last meeting of the Committee sterling had been hit by recurrent
bursts of selling with speculative pressure becoming particularly
intense just before the weekends.
During July, British reserve
losses exceeded $400 million and that compelled the government to
announce new policy measures just before the end of the month.
As
Mr. Daane had reported, those measures were fairly well received
among the European governments and central banks, and the initial
market reaction to the program also was favorable.
However, a new
wave of pessimism struck the market last week as a result of a
combination of events, including particularly the publication of
British reserve figures giving evidence of the magnitude of the
July reserve losses.
During the first week of August the Bank of
England suffered further reserve losses of roughly $225 million.
8/10/65
The market's lack of confidence in sterling was compounded
of many things, Mr. Coombs observed, but he did not sense any wide
spread conviction that British prices and wages at the present moment
were so seriously out of line as to render devaluation inevitable.
The crisis of confidence seemed, instead, to be rooted in what the
market regarded as a basic unwillingness of the present British
government to come to grips with the problem.
The government had
acted in piecemeal fashion, and each set of measures had appeared
to the market to be inadequate to the magnitude of the problem.
When one considered all of the measures that had been taken they
added up to an impressive package and it was possible that relatively
little more in the way of either fiscal or credit restraints would
be needed.
There remained, however, the major risk that the present
voluntary program for limiting price and wage increases would prove
ineffective and consequently would result in a gradual undermining
of the present exchange parity.
That, he thought, was what the
market most feared.
Perhaps the most urgent need was fo: some dramatic move
designed to demonstrate the Labor Government's determination to hold
the price and wage line, Mr. Coombs said.
If such a move were made,
in view of all the other measures that had been taken there was a
reasonable chance of producing a turn in the situation.
With sterling
so heavily oversold, there was an enormous technical position that
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could be exploited.
The U.K. trade figures for July, just released
this morning, showed a considerable narrowing of the deficit--from
about £80 million in June to £50 million.
There had been a sharp
increase in exports, with the rise well distributed by type of
commodity.
On the whole, the situation appeared to be far from
hopeless, the outcome rather depended on whether the British could
make a final determined effort.
In other exchange markets, Mr. Coombs continued, there had
been continuing flows of funds to Italy, partly reflecting seasonal
patterns, and new inflows into Switzerland, the Netherlands, Belgium,
and France, reflecting both the sterling crisis and a tightening of
credit conditions in certain of those markets.
As a result, it had
been necessary to make new drawings on the swap lines with the Dutch
and
the Belgians, and additional drawings of Swiss francs might
shortly be required.
Mr. Coombs then referred to the action by members of the
Committee on July 28-29 that had been satified today, approving his
request,
transmitted by telegram, for authority to negotiate increases
in the swap lines with the BIS and the German Federal Bank.
He
regretted having had to resort to the unusual procedure of asking
for such an authorization between meetings of the Committee, but the
combination of a prospective Presidential message on Vietnam, the
rapid build-up of speculation against the pound sterling, and the
heavy pressure on the London gold market all seemed to urge an
8/10/65
immediate reinforcement of the country's financial defenses.
The
increase in the swap line with the BIS had been consummated quickly,
and would provide the System with a further source of guilders and
Belgian francs in the event of heavy inflows into Amsterdam and
Brussels.
In that event, drawings would, of course, first be made
on the direct swap lines with the central banks of the Netherlands
and Belgium.
He was disappointed that it had not been possible as
yet to consummate the recommended increase in the swap line with
the German Federal Bank.
Although the senior officials of that
Bank would have preferred action earlier, they felt it was desirable
to bring the matter before a meeting of their full board of directors,
which was scheduled to convene this coming Thursday (August 12).
Mr. Coombs was hopeful that he would get an affirmative response
at that time and that it would be possible to announce an increase
in the swap line with Germany on Thursday afternoon.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
July 13 through August 9, 1965, were
approved, ratified, and confirmed.
Mr. Coombs noted that the interest rates applicable to
drawings by either party under each of the System's reciprocal
currency arrangements had been negotiated on a country-by-country
basis and that for the most part it had been possible to secure
agreement to employing the U.S. bill rate.
In four instances,
8/10/65
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however, it had been found desirable to acquiesce in the suggestion
of the other party that a fixed rate of interest should be employed.
In the case of the National Bank of Belgium, for example, a rate of
3-3/4 per cent had been agreed upon under the $50 million standby
arrangement, and a rate of 3-7/8 per cent or the fully-drawn arrange
ment for another $50 million.
He thought those rates were roughly
appropriate and should be allowed to stand.
On the other hand, the
rate of 2 per cent on the swap lines with the Bank of Canada and
the Bank of England and the 3 per cent rate under the agreement
with the Bank of Japan were set when U.S. Treasury bill rates were
considerably below their present levels, and had become unrealistic
with the passage of time.
Therefore, he requested authorization
to renegotiate those rates, either securing agreement to use the
U.S. bill rate or, if the other party preferred an arbitrary rate,
establishing one that approximated the present U.S. bill rate more
closely.
He had informally sounded out both the Bank of England
and the Bank of Canada on the matter and thought they would be
agreeable to such a renegotiation.
Renegotiation of interest rates
applicable to drawings on the standby
swap lines with the Banks of England,
Canada, and Japan, as recommended by
Mr. Coombs, was approved.
Mr. Coombs then recommended two revisions in the Committee's
continuing authority directive for foreign currency operations.
8/10/65
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First, he recommended that the dollar limit on the aggregate amount
of foreign currencies that might be held under reciprocal currency
arrangements, specified in the first paragraph of the directive,
be increased from $2.65 billion to $2.8 billion, in view of the
$150 million increase in the swap arrangement with the BIS that had
been approved by members last week and ratified today.
Such an
increase in the aggregate limit would be consistent with the
Ccmmittee's practice of establishing that limit at an amount equal
to the sum of all individual swap arrangements.
Secondly, he
recommended that the following language be added as a new final
paragraph of the directive:
The Federal Reserve Bank of New York is also authorized
and directed to make purchases of sterling on a covered or
guaranteed basis in terms of the dollar up to a total of $50
million equivalent.
In connection with the latter recommendation, Mr. Coombs
noted that the Account Management now had authority to hold up to
$150 million of foreign currencies acquired as a result of outright
purchases.
sterling,
At present,
$28 million was employed in
$63 million in German marks,
holdings of
and $10 million in
other
currencies, for a total of $101 million, leaving an unused margin
of $49 million.
He would be reluctant to acquire any more sterling
outright at this time; in
fact,
the Account's sterling holdings had
been brought down by 50 per cent from the peak of $56 million reached
last fall.
However, there had been some recent indications that the
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British might be prepared, within limits, to provide an exchange
guarantee on sterling holdings of the System and the U.S. Treasury.
The Treasury had indicated that it would be willing to acquire a
moderate amourt of sterling on such a basis.
In Mr. Coombs' judgment, an additional limited authority
such as he was recommending would be useful on several counts.
First, it would enable the System to acquire additional sterling
without exchange risk.
That sterling could be used to meet any
future needs not only for sterling but also for other currencies
that might be urgently needed and that could be acquired through
sterling swaps.
Secondly, a relatively small amount of dollars
put through the exchange markets as a result of such covered
purchase:; could have a substantial effect at critical moments.
Finally, there was the possibility that such an arrangement could
be generalized.
For example, the International Bank had a large
amount of money placed in dollar assets in New York.
If the
British government were able to provide a guarantee, it was con
ceivable that a substantial part of those holdings could be exchanged
into sterling.
In response to a question by Chairman Martin, Mr.
Coombs
said that either of two alternative procedures might be followed
in implementing the authority he proposed.
Under one possible
procedure the System would buy sterling at, say, an exchange rate
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-13
of $2.79, and simultaneously sell it forward to the Bank of England
at a rate of, say,
$2.78.
For the holding period the funds could
be invested in Britain, where they would yield a return higher than
the U.S. bill rate.
As interest accumulated the original cost of
the sterling could be written down to $2.78 and the interest return
calculated on the basis of that price.
The alternative possibility
would be much simpler; instead of arranging for forward cover, the
Bank of England would guarantee at par--a rate of $2.80--some
specified amount of sterling that the System would acquire.
Bank of England extended such a guarantee,
however,
Mr.
If
the
Coombs
suspected that they would be unwilling to sec the funds invested in
the London market.
in
They might suggest instead that they be placed
a "money-employed"
to the U.S. bill rate.
account at the Bank of England at a rate equal
Whichever procedure was followed, sterling
acquired under
such an authorization would not be exposed to the risk
of devaluation,
unlike currencies acquired under the present authori
zation for holdings of up to $150 million of currencies bought on an
outright basis.
Mr.
Daane said he would agree that the proposed authority
would be useful under present circumstances, although he found the
second reason Mr.
Coombs had mentioned to be a little
more persuasive
than the first; there clearly were times when relatively small sums
put through the exchange markets could make a great difference.
The
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action would align the System with the Treasury in
the effort to be
of maximum help to the British, and at the .,ame time would be very
much in this country's own interest.
There was no risk to the System
in the suggested arrangement, and Mr. Coombs was proposing that it be
employed on a limited scale.
The question of which of the two proce
dures should be followed was largely a technical matter, but he would
expect the British to favor the forward cover alternative.
To give
a dollar guarantee might imply some reflection on the standing of
the pound and might have undesirable implications for other sterling
holders.
Mr. Mitchell remarked that the System obviously would be
protected against financial loss on sterlin, acquired under a
guarantee by the Bank of England.
He noted, however, that it was the
policy of the U.S. Treasury not to guarantee outright foreign official
holdings of dollars.
Under the proposal, therefore, the System would
be accepting a guarantee from a foreign central bank of a type the
United States was not prepared to offer other countries.
Such an
act, in his judgment, was likely to expose the U.S. to demands for
similar guarantees of foreign official dollar holdings.
The kinds
of techniques the System presently employed seemed to him to be more
consistent with the posture of the U.S. Treasury on the subject of
guarantees.
8/10/65
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Mr. Coombs commented that he personally was inclined to favor
the forward contract procedure.
Under that alternative, however,
agreement would have to be reached on the focward rate to be employed
in each transaction, and operations could become rather cumbersome,
particularly if others also entered into such transactions with the
Bank of England.
Accordingly, the British might feel that limited
guarantees were preferable on grounds of simplicity.
The magnitude
of the risk that Mr. Mitchell saw would depend on the form of the
guarantees.
If they were made for relatively short periods--say,
6 or 12 months--and for limited amounts of sterling, the transactions
would not differ very much in substance from forward contract
transactions.
Mr. Daane observed that in principle Mr. Mitchell's point
was well taken; if transactions of the type suggested were carried
too far they could easily raise questions of guarantees for foreign
official dollar holdings.
He doubted, however, whether such demands
would be provoked by guarantees of System sterling holdings on the
limited scale contemplated.
On that scale the differences from
forward contracts were more of form than substance.
Mr. Wayne said that he would be concerned that the United
States might be put in the position Mr. Mitchell feared if the System
simply requested the British to guarantee outright sterling holdings.
However, he thought a distinction should be drawn between such a
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8/10/65
request, on the one hand, and acceptance of a proposal by the British,
on the other, that the guarantee procedure should be followed as an
alternative to the forward contract procedure.
In reply to Mr. Hickman's question concerning the possibility
that other central banks might ask for similar guarantees of their
sterling hold:ngs, Mr. Coombs commented that continental European
central banks now held virtually no sterling.
In the past, under
the so-called European Monetary Agreement, their sterling holdings
had been on a guaranteed basis, for the most part, but the guarantee
privilege had been largely withdrawn about two years ago because of
concern by the Bank of England that sterling-area countries might
ask for similar guarantees.
He was not able to predict whether, in
an emergency, the British would feel that they could justify
restoring such arrangements with the continental central banks.
The earlier guarantees had been in terms of dollars, but that was
not a necessary element of the arrangements; any new guarantees
might be in terms of the currency of the sterling holder.
Chairman Martin commented that Mr. Mitchell's point was well
taken.
For present purposes, however, he thought the choice between
the two alternative procedures was primarily a technical question,
and perhaps the opinions of British officials had not yet solidified.
On the whole, the proposed additional authorization struck him as a
useful precautionary measure, since it offered an additional means
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for helping to stabilize the market, although it was possible
that it might not be used.
Mr. Daane said that if Mr. Coombs' recommendation was
approved it would be important, in his judgment, not to give the
impression that the arrangement was open-ended and capable of
indefinite enlargement.
The Chairman concurred in this view.
In response to questions, Mr. Coombs said that he was
limiting his proposal now to sterling out might later want to
request similar authority in connectio. with other currencies,
and that he had no present intention of increasing the Account's
outright holdings of sterling.
As he had noted earlier, such
holdings had been reduced by half since last autumn.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the continuing authority directive
for foreign currency operations was
amended to read as follows, effective
immediately:
The Federal Reserve Bank of New York is authorized
and directed to purchase and sell through spot trans
actions any or all of the following currencies in
accordance with the Guidelines on System Foreign Currency
Operations as amended March 23, 1965; provided that the
aggregate amount of foreign currencies held under
reciprocal currency arrangements shall not exceed
$2.8 billion equivalent at any one time, and provided
further that the aggregate amount of foreign currencies
held as a result of outright purchases shall not
exceed $150 million equivalent at any one time:
8/10/65
-18Pounds sterling
French francs
German marks
Italian lire
Netherlands guilders
Swiss francs
Belgian francs
Canadian dollars
Austrian schillings
Swedish kronor
Japanese yen
The Federal Reserve Bank of New York is also authorized
and directed to operate in any or all of the foregoing currencies
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 disturbances.
The Federal Reserve Bank of New York is also authorized and
directed to make purchases through spot transactions, including
purchases from the U.S. Stabilization Fund, and concurrent sales
through forward transactions to the U.S. Stabilization Fund, of
any of the foregoing currencies in which the U.S. Treasury has
outstanding indebtedness, in accordance with the Guidelines and
up to a total of $100 million equivalent. Purchases may be at
rates above par, and both purchases and sales are to be made
at the same rates.
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The Federal Reserve Bank of New York is also authorized
and directed to make purchases of sterling on a covered or
guaranteed basis in terms of the dollar up to a total of
$50 million equivalent.
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 securities
and bankers' acceptances for the period July 13 through August 4, 1965,
and a supplemental report for August 5 through 9, 1965.
Copies of
both reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes commented
as follows:
Money market developments and a routine Treasury
refunding operation in recent weeks have been overshadowed
by uncertainties about the interest rate outlook generated
primarily by external factors. A foremost source of concern
to domestic financial markets has been the outlook for sterling,
with U. S. bond market participants now watching for Britain's
reserve statistics and trade data with an avid interest
previously concentrated on more domestic matters such as
business loans, free reserves, or unemployment. The market's
concern about sterling rests on a belief that drastic action
to aid the pound will quickly put pressure on the dollar,
presumably calling for a tighter monetary policy to protect
our own currency. Alongside this concern, there has been a
growing conviction that stepped-up hostilities in Vietnam
will, before long, make greater demands on the U.S. economy
in general and on the Treasury in particular. Bond prices
have moved significantly lower in this atmosphere, not in
a drastic or disorderly fashion, but also without generating
much of a feeling that a more "tradable" price level is
being reached. Perhaps a little paradoxically, the continuing
sizable dealer positions in bonds over five years to maturity
help to explain both the heavy feeling of the market, and the
moderation of the price decline, as dealers have sought to
protect the value of existing positions.
8/10/65
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Against this background, the Treasury's August refunding
went as well as could be expected. Dealers expressed some
dismay at the Treasury's reopening of a 3-1/2 year bond, and
they clearly would have preferred a single issue in the 18
month area--a preference that was underlined not only in their
comments but also in their very limited participation in the
offering. Investors did have some moderate interest in a
longer option, however, and about $800 million of the roughly
$3 billion of public holdings was exchanged for the reopened
bond. Of the remaining public holdings, all but about $200
million was turned in for the 18-month notes, leaving a modest
amount of attrition.
Through most of the past four weeks, the Treasury bill
market enjoyed a resurgence of demand that carried rates down
from the higher levels that had been reached in early July.
Demand in mid-July was enlarged in part by dealer purchases
in anticipation of increased activity that was expected to
be associated with the Treasury's August refunding. By the
end of July, however, the bill market turned around and rates
tended to back up--partly because the demand related to the
refunding fell short of expectations while System buying of
bills was also lower than expected by the market. Toward the
end of the period, with a generally nervous atmosphere
beginning to affect bills as well as coupon issues, the
System was able to provide reserves through sizable bill
purchases with no significant impact on rates. In yesterday's
auction, the three- and six-month issues were sold at average
rates of about 3.85 and 3.95 per cent, respectively, compared
with a low point in the recent period of 3.80 and 3.87 per cent,
respectively (on July 26), and not far different from the rates
prevailing in the auction four weeks ago.
System open market operations alternately withdrew and
provided reserves over the past four weeks, mirroring the
injections and absorptions of reserves by market factors
while maintaining fairly persistent firmness in the money
market. On balance, operations in Treasury issues added a
net of $133 million of reserves on a commitment basis. Large
scale use was made of repurchase agreements during the period,
both to meet temporary reserve needs and on occasion to avoid
adding to the immediate pressure of demand for Treasury bills.
While some use was made of the Desk's authority to arrange
repurchase agreements against a broader maturity range of
issues during financing periods, this authority was used
less extensively than in May.
8/10/65
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Net borrowed reserves during the period moved in a range
from around $100 million to $230 million, while member bank
borrowings hovered around the $1/2 billion level. Federal
funds traded largely at 4-1/8 per cent, that being the
effective rate on three out of five days.
Over the four weeks as a whole, outright System holdings
of Treasury bills were increased by $91 million while holdings
under repurchase agreements rose a net of $42 million. Out
right holdings of coupon issues were unchanged during the
period, except for the commitment to exchange the Account's
holdings of maturing notes for new notes and reopened bonds.
Looking ahead to the next three weeks, current projections
suggest only a modest need for System operations--probably
starting with some absorption of reserves as mid-month
approaches and then with a net provision toward the end of
the month. Given a continuation of the current heavy atmosphere
in the bond market, some of that later provision of reserves
might appropriately be accomplished through purchases of coupon
issues.
Corporate bonds, like Treasury issues, tended to decline
in price over the recent period, and the relatively attractive
yields available on corporate issues remained a factor tending
to divert investors to this area and away from Governments.
New issues won mixed receptions, with some higher-yielding
offerings moving out quickly and others remaining in under
writers' hands and requiring subsequent price cuts. Tax
exempt issues benefited from a pick-up in bank buying that
succeeded in reducing advertised inventories over the
interval.
Payment for the current Treasury financing takes place
this Friday. The Treasury's next debt operation, apart from
routine bill rollovers, is likely to be a cash borrowing in
the bill area--possibly not until early autumn.
Thereupon, upon motion duly
made and seconded, and by unanimous
vote, the open market transactions
in Government securities and bankers'
acceptances during the period July 13
through August 9, 1965, were approved,
ratified, and confirmed.
Secretary's Note: On August 2, 1965, the
following message had been transmitted to
members of the Committee, by telegram to
those outside Washington, by Mr. Young:
-22-
8/10/65
Referring to current Treasury refunding, System Account
holds $3,891,732,000 of notes maturing August 13, 1965, about
53 per cent of total outstanding. Account Management proposes
that Account exchange its entire holdings through subscription
for $2,891 million, about three-quarters, of the 4 per cent
notes maturing February 15, 1967 and $1 billion, one-quarter,
into 4 p.r cent bonds maturing February 15, 1969. System
Account already holds $84 million of the bonds. Principal
reasons for proposal are avoidance of excessively heavy System
holdings of any single Treasury issue, the ample System holdings
maturing in one and two years, the relatively short term of the
bond offered by the Treasury.
1. Assuming the public subscribes to $1 billion
4's of 1969, the amount of 4's of February 15, 1967
taken by System Account would be about 57 per cent of
the new issue, only a slightly larger proportion than
the System's present holding of the issue being
refunded. If the System's entire holding of the
maturing issue were exchanged into 4's of February 15,
1967 it would represent 64 per cent of the issue.
2. The amount of the 4's of February 15, 1969
taken by the System Account would be about the same
as the amount expected to be taken by the public, but
would represent only 28 per cent of the total issue,
including the amount already outstanding.
3. After the exchange 59 per cent of the total
System Account will mature in one year and 84 per cent
in two years.
Please wire today whether you agree with Manager's proposal.
Advices subsequently were received
from all available members of the Committee
that they agreed with the Manager's proposal.
Chairman Martin noted that a prospectus for a proposed study
of the dealer market in Government securities, dated July 9, 1965, had
been distributed to the Committee on August 2, primarily for information
purposes at this time.
He had discussed the matter with the Secretary
8/10/65
-23
of the Treasury, Mr. Fowler, and with Under Secretary Deming, and had
found that they were amenable to the proposed study and were anxious
to cooperate with the System on it.
The thinking was that the study
should not be undertaken immediately, but rather sometime this fall.
The Chairman thought it would be desirable for all members of the
Committee and other Reserve Bank Presidents to review the prospectus
carefully and offer any thoughts they had on the matter.
The Chairman then remarked that in light of recent develop
ments in Vietnam and in view of the sterling situation there had been
some discussion with the Treasury of problems that might arise in the
Government securities market, which he would ask Mr. Young to summarize.
He personally did not consider it necessary for the Committee to take
any action in this connection today, nor did he anticipate that action
would be required later.
However, since it was impossible to predict
what might happen, he thought it would be desirable for Committee
members to have the matter in mind in case a problem should arise
suddenly.
Mr. Young said that Messrs. Balderston, Holland, and he had
met on Friday (August 6) with Mr. Volcker, Deputy Under Secretary of
the Treasury for Monetary Affairs, to discuss informally the nature
of possible reactions in the Government securities market if the market
was suddenly confronted with a devaluation of sterling or other drastic
8/10/65
-24
actions by the U.K. authorities, or if developments in Vietnam should
greatly heighten nervousness.
It was agreed that the market was
particularly sensitive at present because of the large dealer positions
in
longer-term issues,
and that the first
question to be faced was
whether the dealers should be relieved of those holdings by official
purchases.
The consensus was that dealer holdings should be lightened
by official buying, at prices somewhat under those prevailing at the
time, with the System and the Treasury coordinating operations closely
in achieving that end.
It also was agreed, in light of earlier expe
rience, that the market should be permitted to make downward adjust
ments, perhaps with some cushioning purchases, but that there should
be no massive intervention until it was felt the point had been
reached where such intervention could turn market psychology, thus
making the market self-supporting.
If the external crisis was only moderate in nature, Mr. Young
continued, it would not be likely to have serious repercussions
either
internally or on other countries abroad.
In that event the
adjustment in the Government securities market could be expected to
be moderate, making it possible to improvise tactics on the basis
of market reactions.
If, however, the crisis was more serious, it
could have extensive repercussions on other countries, and the impact
on the Government securities market could be far more serious.
What
ever the market intervention problem, the Treasury probably would want
to limit its buying to the longer-term sector, leaving the intermediate
and shorter-term sectors to the System.
It was thought that little if
8/10/65
-25
any intervention would be needed in the market for bills and short
term coupon issues because the short-term sector would be attractive
to investors under the circumstances assumed.
Although the discussion did go some distance, Mr. Young
concluded, it was, of course, entirely hypothetical.
He added
that Mr. Holmes would be invited to participate in any future
discussions of a similar nature.
Mr. Daane commented that it might be useful to recirculate
a basic planning document that had been prepared in 1959 by
Charls Walker, then of the Dallas Reserve Bank, Spencer Marsh of
the New York Reserve Bank, and himself, then at the Richmond Bank,
While the study was concerned with open market operations in the
event of an enemy attack, he thought it had some relevance to the
present situation, particularly to consequences of possible
developments in Vietnam.
Mr. Young noted that additional relevant material was
included in the "blue book" containing the Board's Emergency Plan,
copies of which were in the possession of all Committee members
and other Reserve Bank Presidents.
The discussion with the
Treasury on which he had reported was, in his judgment, not
inconsistent with those documents.
Chairman Martin suggested that the staff bring together any
such materials that might be helpful to the Committee for back
ground purposes.
It was his hope that such steps would prove to
8/10/65
-26
have been needless precautions but it was important for the Committee
to be alert to possible developments.
The materials in question
might, incidentally, be valuable in connection with the proposed
study of the dealer market in Government securitites.
Mr. Hickman said he was concerned about the possibility of
moving into something close to a pegging operation if the Vietnam
situation worsened.
Mr. Young replied that it had been agreed in
the discussion with the Treasury that the approach to the problem,
if one arose, should not be one of reestablishing a peg.
The
objective would be to provide some general support to the market,
but such intervention as might be appropriate would be directed to
the stabilization of market psychology, so that the market could
settle down to self-reliant functioning.
Chairman Martin commented that this was the kind of
questicn that members of the Committee had to bear in mind in
considering how to deal with potential problems of the sort under
discussion.
Chairman Martin called at this point 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.
Mr. Brill made the following statement on economic conditions:
A first impression of the domestic economic scene, on
the part of one returning after a short absence, is that of
surprising vigor in both activity and expectations. When I
8/10/65
-27-
last reviewed the situation for the Committee, almost two
months ago, expectations were generally for a slowing in the
rate of economic expansion. The impetus provided by steel
inventory accumulation was apparently beginning to lose force,
and auto sales had already adjusted down in April, May, and
early June from the exceptional winter rates. With consider
able new plant coming "on line," and an influx of teenagers
into the labor force expected, prospects were for some
slackening in the rate of resource utilization.
This prospect may still be ahead, but July data do not
suggest that it has already started. Even though inventory
accumulation has undoubtedly moderated, industrial production
rose in July by at least as much as in each of the preceding
three months, and final figures may show an even greater
increase.
Auto sales picked up in late June and the momentum
carried through in July, with domestic car sales for the month
rising to a 9.0 million unit rate. Most auto plants are now
shut down for model change-over, and maintenance of the July
sales pace should permit dealers to reduce their relatively
large inventories of new cars to manageable proportions by
the time of introduction of the new models.
Strength in consumer spending was not limited to autos
last month. Other categories of retail sales, which had
shown some lag in June, were up again, in July, and total
sales rose substantially.
Most heartening of all the July developments was in
the youth employment area. The expected flood of teenagers
hit the market in July, but this year they found jobs. We
finally appear to be making some progress in this hitherto
intractable area. The unemployment rate for young workers
declined somewhat, and long-term unemployment also declined,
bringing down the total unemployment rate to 4-1/2 per cent,
the lowest in nearly eight years.
Does the economy have the momentum to continue to turn
in such a performance? To answer this, one must assess a
pretty fine balance of forces, and do it blindly for lack
of relevant historical experience or adequate current data.
On the one hand, we're only 3 weeks from what, hopefully,
will be a termination of the long drawn-out steel wage
negotiations. Output is likely to suffer whatever the
outcome--strike, continuation under a Taft-Hartley injunc
tion, or settlement. There doesn't seem to be a consensus
among industry or Government economists as to how adequate
or excessive steel stocks have become, but the recent
slackening in pace of advance steel ordering suggests that
the bulk of steel consumers are pretty well satisfied with
their inventories in the context of expected rates of
8/10/65
-28-
activity. At a minimum, then, we can expect some reduction
in steel output after September 1, and the drop could be
substantial. A more-than-seasonal drop in auto stocks is
also possible this month and next. Reflecting both steel
and autos, total inventory accumulation in early fall is
likely to be at a much slower rate than in recent months.
But in assessing the outlook for aggregate demand,
there are several potential offsets to a slackening in
inventory demand to keep in mind. Plant and equipment
spending is scheduled to rise further, and the latest
(June) data on new orders suggest that spending schedules
are likely to be met. Unfilled orders for durable goods
continued to expand in June, with most of the rise for
the month representing further growth in machinery back
logs, and commercial and industrial construction outlays
continued strong through July.
The mailing of checks to Social Security beneficiaries,
including both the new higher scale of payments and lump
sum retroactive benefits, will be adding to disposable
personal incomes shortly. The amounts involved would about
offset the steel payrolls that might be lost in a month
long strike. How rapidly, and for what goods or services,
recipients of the benefits will spend their funds is a
big unknown; we have very little basis for estimating the
consumption function for this older age group. But it's
hard to believe that the bulk of it won't get into the
spending stream fairly promptly.
Further stimulus to the economy will come from ex
panded Government procurement for Vietnam hostilities.
The recent request for additional appropriation authority
is not a good guide to the pace at which actual outlays
will be made, particularly since substantial unobligated
appropriations exist which could be drawn on promptly.
As noted in the staff comments on question 1,1/ the
increases in spending and in the armed forces now pro
posed do not appear significant enough to touch off
widespread commodity or labor shortages or widespread
price increases. Nevertheless, the increases will bolster
aggregate demand to some extent, and operate to offset
the letdown that might follow a steel settlement.
1/ Certain questions suggested for consideration by the Committee,
and staff comments on them, are given at a later point in these
minutes.
-29-
8/10/65
All in all, though I'd be hard pressed to quantify
the judgment, the balance of economic forces seems to
me to be likely to resolve on the plus side. That is,
barring an unusually severe adjustment in steel, I would
expect the economy to continue to expand at close to
the pace of recent months, perhaps not fast enough to
keep up with resource growth over the longer-run, but
also not fast enough to create additional upward price
pressures in the near-term. If this judgment is right,
it would seem premature now to add monetary stimulation
to the picture--at least not until the dimension of
consumer responses to the Social Security payments
becomes more evident or the pace of the defense buildup
becomes clearer. It would seem particularly inappro
priate to take an easing step on the eve of a major wage
settlement, one which might eventuate, as did the
aluminum settlement some weeks ago, in an above-guidepost
wage increase and an unwarranted price rise.
But uncertainties also argue against any significant
move toward monetary restraint. SteeL stocks may be much
higher than we or most other analysts have estimated, and
the adjustment process may be correspondingly more diffi
cult. Moreover, we may have run out the string on
favorable automobile years. Consumer tastes are fickle,
and in the absence of major innovations even the most
sophisticated analysis of demand factors can be frus
trated.
While the mild industrial price creep has continued,
there are no signs of its turning into a gallop. Stocks
of consuner goods are high, and industrial capacity
increases already underway should serve to limit the
possibility of shortages. The market response to
Vietnam developments doesn't suggest any widespread
fears of shortages, rationing, or inflation. On
balance, then, the domestic evidence isn't clear enough
to me to justify a significant policy move in either
direction at this juncture.
Mr. Holland made the following statement concerning financial
developments:
It seems possible that some days of trial could lie
ahead for our financial markets.
8/10/65
-30-
Discussion this morning has already reviewed the
market's immediate reactions to the stresses to date, and
its technical position for withstanding further strainsfairly strong in some sectors, but weak especially in the
long Government area. Let me try to assist your delib
erations this morning by appraising the trends in
underlying financial flows and judging whether they are
such as to weaken or strengthen the market's technical
ability to weather a financial crisis.
There have been times during this expansion when such
an appraisal would have led to a pessimistic conclusion,
but--to give my conclusion today in a nutshell--I judge
the present status of underlying supplies and demands
for funds is such as generally to cushion rather than to
aggravate any immediate market shocks.
Such a conclusion cannot be reached, of course, with
out making a good many assumptions--the more so because
our knowledge is still at a stage where judgments have to
substitute for tested objective relationships with respect
to a good many linkages in the financial process. But the
most important caveats I should sound concerning this
conclusion are three:
it would become unrealistic (a)
if our Vietnamese build-up grows rapidly enough to produce
a marked expansion of demands for real resources, or (b)
if it is expected to do so by businesses and consumers,
or (c) if for these or other good reasons monetary policy
is tightened significantly.
Let me briefly sketch the main facts that lead me to
my conclusion. The market for Treasury coupon issues is
demonstrably thin, and has remained in rough balance
chiefly because no major group of holders has been led
to attempt really large-scale unloading of Treasury notes
or bonds in order to accommodate other earning assets.
In fact major changes in private supplies and demands
for funds have evolved over the past year, but the finan
cial system has fairly well adjusted to these without
major pressure on the Government bond market.
The most significant change that took place was the
enlarged external financing of the corporate sector, as
its over-$50 billion annual rate of spending on capital
equipment and inventories outstripped the high but no
longer rising flows of internally generated business
funds. Somewhat higher rates of return on corporate
borrowing have already sweetened its attractiveness to
lenders. Given the general preference of banks and
insurance companies for such debt, no further big market
8/10/65
-31-
rate adjustment on corporate instruments seems required
unless the net increase in business borrowing grows even
bigger, and that eventuality is rendered less likely by
the expected imminent shift from steel inventory accumu
lation to decumulation.
In the municipal market the story may be a little
different. More than once before in this expansion,
analysts--myself included--have cried "Wolf!" over the
municipal market, anticipating a major upward rate move
ment as the high level of borrowing seemed to be out
stripping the buying capacity of a banking system
constrained by tightening reserve availability. On each
occasion, the worst failed to happen, mainly because
banks continued to be able and willing to issue enough
time deposits to meet loan demands and buy an impressive
amount of municipals besides. With corporate demands
for bank funds now strong and dealer inventories of
municipals still heavy, some further relative upward
yield adjustment in municipals has to be counted a
possibility, but the necessity for this action will
depend importantly on banks' continued success in
attracting time depositors.
The viability of the mortgage market at current rate
levels may also be partly dependent cn the competitiveness
of banks for savings. After some reduction in the net
increment of growth last year, demand for housing is
showing signs of strengthening. At the same time, banks
are again being appreciably more successful in attracting
deposit-type savings than are the more specialized
mortgage lenders. While banks have also been sizable
mortgage lenders in this expansion, the strengthened
credit demands of their preferred business customers
could lead banks to direct more savings away from
mortgages. The consequence could be a mortgage market
in which demand is beginning to rise faster than credit
supply, with some resultant tendency for a little firming
of both credit standards and terms.
You can see that, in my view, the key to a stable set
of underlying financial flows in these major markets is a
continued large--but not too large--expansion of bank time
deposits. That requires, in turn, that banks continue
willing to pay the cost of raising time money, rather Lhan
stepping up their liquidation of securities as a source
of funds; that the nonfinancial sector continue willing to
expand its time deposit holdings, even as it goes on
borrowing; and that the Federal Reserve continue to supply
the reserves to accommodate the consequent bank expansion.
-32-
8/10/65
So long as these circumstances obtain--and they still seem
to, on the latest reading of the evidence--the network of
underlying financial flows should remaii reasonably in
balance.
I do not see enough strength in this fabric to
stabilize the market without official help in any financial
crisis, for the expectational shifts in the market could
be very sharp and the dealer mechanism, with its exposed
long bond position, is peculiarly susceptible. But big
expectaticnal shifts do not persist unless sustained by
some corresponding shifts in basic flows. For that reason,
I think that the rough balance of underlying flows that I
have described provides some measure of hope that well-timed
official ,tabilization purchases could calm a crisis market
atmosphere effectively.
Mr. Reynolds then presented the following statement on the
balance of payments:
This morning, as Mr. Coombs has mentioned, the United
Kingdom announced a 12 per cent jump in exports, seasonally
adjusted, in July. This may justify merely a sigh of relief
all round, rather than a loud cheer, since the export figures
typically zig-zag widely. So far, the market is not quite
cheering. Sterling made some gain early in the day immediately
after the announcement of the trade figures. The Bank of
England reported an hour ago, however, that there was little
steam behind the movement, and that the rate had since drifted
off a bit.
But averaging July with earlier months shows that there
has been a significant improvement in Britain's trade position
so far this year. In the first 7 months, exports were up
5 per cent from the average rate for 1964 while imports were
down 1 per cent. The trade deficit in this period averaged
only half as large (on a balance of payments basis) as during
1964. This suggests that the current account deficit so far
this year has been running at only about one-third of last
year's swollen $1 billion rate. Substantial further progress
is needed, of course, to eliminate the current deficit
entirely this year and achieve a surplus in 1966 and later
years. Some short-run help in this direction may reasonably
be expected later this year from a decline in imports as
domestic restraints finally begin to bite.
There are signs that these restraints are beginning to
exert some of their intended effects internally. But, of course,
-33it will take a run of good trade figures to demonstrate
that resources freed at home can be shifted to exports.
Particularly troublesome still, as Mr. Coombs noted, are
excessive price and wage increases, and also scattered
wildca; strikes.
For the United States, our own merchandise trade
position is becoming increasingly worrisome. In June,
exports were no higher than last autumn, while imports
were up 18 per cent. Steel imports have about doubled
in this period, but they account for less than one-third
of the total import expansion, other imports are up more
than 10 per cent in the 9-month period.
The rise in imports has been sharper than at any
time since 1959, and has been spread over a wide variety
of goods, excepting only foods. From the second quarter
of 1964 to April-May 1965, imports of industrial supplies
other than steel--a category that covers nearly half of
total imports--rose 12 per cent, compared with only 3 or
4 per cent in each of the preceding 2 years.
Imports of
consumer goods rose 20 per cent, as they had the year
before; this fast-rising group which used to be small now
approaches one-fifth of total imports. Imports of capital
equipment are up a whopping 43 per cent, compared with 24
per cent a year earlier and only 7 per cent the year before
that. By areas, for which we have complete second quarter
data, imports are up from a year earlier by 44 per cent
from Japan, 29 per cent from continental Europe, 19 per
cent from the U.K. (19 per cent being also the increase in
total imports), 15 per cent from Canada, 14 per cent from
Latin America, and 10 per cent from all other countries
except Australia, New Zealand, and South Africa, the latter
group having been almost unique in suffering a decline in
sales to this country.
I cite this long string of figures because I think
they indicate a very wide-ranging boom in U.S. imports.
To some extent, no doubt, our imports have been temporarily
swollen by heavy inventory demands that will later subside.
But the boom in imports of consumer goods and of capital
equipment is unlikely to be of this kind. Furthermore,
earlier import expansions associated with inventory upswings
here have tended to leave a residue of further penetration of
U.S. markets, notably in the case of steel.
In short, recent import expansion is a sobering reminder
of the adverse effects that rising domestic pressures on
capacity can have upon the trade balance, even when broad
price averages are not moving adversely. The flattening out
8/10/65
-34-
of our exports may also owe something to internal U.S.
demand pressures, although a leveling off of foreign
demands in almost every major area except Canada has
probably been much more important.
The National Foreign Trade Council Balance of
Payments Group felt able last month to forecast a trade
surplus for the full year of $5-1/2 billion, equal to the
second-quarter rate that was swollen by favorable, post
strike effects, and well above the $4-1/2 billion rate of
the first half-year. For this cheerful forecast to be
fulfilled, the trade balance will have to average $400
million a quarter better in the second half year than in
the second quarter.
Other elements in the balance of payments seem certain
to weaken by more than this amount, Reflows to the United
States of U.S. bank credit and of liquid funds exceeded
$600 million in the second quarter. These will almost
certainly give way to moderate renewed outflows later in
the year. The banks have considerable scope for renewed
lending within their VFCR targets. Also, foreign borrowing
through new security issues here, particularly by Canada,
is expected to be larger in the second half.
Finally--a point that overlaps those already noted
but is to some extent additive--it seems likely that a
return of confidence in sterling, whenever and however it
comes, will adversely affect a number of items in our
payments accounts. You will recall that in 1962, the
Canadian exchange crisis and its subsequent resolution
(partly through a devaluation) made our deficit very
small in the first half year and very large in the second.
Our connections with Britain are less close and direct than
with Canada. But, on the other hand, the British crisis
has been of much larger dimensions. Canada lost less than
$1 billion of reserves in 6 months. Britain has lost some
$3-1/2 billion in 10 months. This must have helped our
balance of payments almost across the board: on trade,
services, and particularly on certain kinds of capital
flows. British losses of more than $400 million in July,
for example, are likely to have had significant, though
not closely identifiable, effects that helped to hold
our overall July deficit to less than seasonal proportions.
Thus, the fact that July has now been added to the
string of recent months in which there has been an overall
surplus on a seasonally adjusted basis does not at all
contradict the view Mr. Hersey expressed at the last
that the U.S. balance of payments is likely to
meeting:
be deeper in deficit during the second half year as a
whole than it was in the first half.
-35-
8/10/65
Prior to this meeting the staff had prepared and distributed
certain questions suggested for consideration by the Committee,
comments thereon.
and
These materials were as follows:
(1) Business conditions and prices.--What are likely to
be the short-term effects of the step-up in U.S. activities
in Vietnam on prices, inventories, unemployment, and
economic developments generally?
Expenditure plans arising from the latest increase in
U.S. military operations in Vietnam have been undergoing
almost daily change.
Although additional amounts may be
appropriated now, the Department of Defense has considerable
flexibility in placing orders, because of both unobligated
appropriations carried over from fiscal 1965 and plans to
request supplementary appropriations in January.
Preparations for a much greater degree of mobilization have
been under way, moreover, should a still larger military
effort be deemed necessary.
The increases in defense spending and the armed forces
proposed now, however, appear small--both in relation to
recent levels of the defense program and to total spending
and the labor force.
The President has, requested $1.7
billion in addition to the $45.2 billion Department of
Defense appropriation request for this fiscal year now
before Congress. Defense spending was already on the rise,
and from the second quarter of 1965 to the second quarter
of 1966 the annual rate of expenditures is now expected
to increase by about $4 billion rather than by $2 billion.
These magnitudes must be appraised against the recent
annual rate of defense spending of $55 billion (GNP basis),
total GNP of nearly $660 billion, and quarterly increments
to GNP that have averaged about $10 billion over the last
2 years.
The armed forces will be increased by 340,000 over the
next year to a total of 3.0 million. At the time of the
Korean outbreak, it may be noted, only 1.5 million men and
women were in the armed forces, and more than 2.0 million
were added in less than two years. Compared with mid-1950,
8/10/65
-36
the labor force currently is 13 million or nearly 20 per
cent greater, and the absolute number of unemployed and
the rate of unemployment are somewhat higher.
Use of the draft, as opposed to calling up reserves,
tends to minimize the impact on labor markets. Most of
those to be drafted are in the 20 to 22-year-old group
and are among the employed. (Defermnts are high for
those in school, and rejections are high among the un
employed.) But workers in this age group are generally
below average in training and skill and probably can be
replaced more easily from among the unemployed and those
outside the labor force than would more highly skilled
reservists.
Since the extent of the defense expansion as
announced is relatively small and is sheduled to come at
a time when moderation in the pace of expansion in
economic activity was widely anticipated, the increases
now contemplated in military requirements, while adding
to aggregate demand, should not push it to excessive
levels. Moreover, any substantial acceleration or
enlargement of the defense build-up would undoubtedly
reduce the possibility of a tax cut or other fiscal
stimulus next year. Given the manner in which the
armed forces will be increased and the nature of pro
curement, widespread or serious production bottlenecks
are unlikely. Commodities now in or close to a tight
position, such as copper, may be noticeably affected,
but should these or other stockpiled materials threaten
to cause serious production bottlenecks and upward price
pressures, legislative authority exists for the President
to order supplies released from the stockpile "for
purpose of the common defense."
The announced program is smaller than was widely
expected, and the behavior of commodity and security
markets since the announcement does not suggest much
public concern over shortages, inflation, or direct
economic controls. With business and consumer stocks
of many goods already large, no significant move to
protective buying has been provoked.
(2) Balance of payments.--What implications do changes
in international interest rate relationships over the
past several months have for the U.S. balance of pay
ments?
8/10/65
-37-
The tightening of Canadian and major European capital
markets in recent months increases the likelihood that net
outflows from the United States of over-one-year capital
other than direct investments will be larger in the second
half of 1965 than in the first.
Even though the voluntary
program for bank and nonbank lenders, and, with lessening
force, the Interest Equalization Tax, are restraining major
categories of capital outflow, there remains scope for
outflows to increase.
European domestic long-term interest rates have risen
on the order of 3/8 per cent since March, reflecting
increasing market pressures of demand for lendable funds
and unremitting efforts of the monetary authorities in
all countries but Italy and France to restrain bank credit
expansion. Such rate increases have been considerably
larger than the rise in new issue yields in the United
States.
Further tightening of capital market conditions in
Europe does nothing to increase chances for borrowers in
less developed countries to obtain long-term funds there,
and it is likely that the United States will continue to
be their primary source of funds. Moreover, some borrowers
subject to the I.E.T. (including British and Australian, and
also Japanese borrowers on term loans) have entered into
commitments to pay the tax on its present rates.
The claims on foreigners of U.S. banks that are subject
to the VFCR are nearly $400 million below the 105 per cent
target, so that there is room for a renewed net outflow of
bank credit, long- and short-term, in the rest of 1965. The
voluntary program for nonbank financial institutions is
helping to restrain placements with these institutions of
obligation; with maturities up to 10 years, and of longer
term continental European securities. However, the nonbank
ceilingsdo not apply to longer-term, IET-exempt, issues by
Canadian provinces, municipalities, and corporations.
Weakening of the Canadian balance of payments on current
account, partly in response to domestic inflationary
pressures, is among the factors that have led the Canadian
authorities to permit an advance in Canadian interest rates,
both short-term and long-term, on the order of 1/4 per cent
since March. These developments will encourage heavier
Canadian borrowing through new issues in the United States.
8/10/65
-38
Recent developments in the London market for Euro
dollars have not been such as to induce outflows from the
United States through Canada. Euro-dollar interest rates
eased off in June and July, partly in consequence of
movements out of sterling. Short rates are up less from
a year ago than rates for U.S. CDs ard Federal funds, and
some U.S. banks have again been drawing money from the
Euro-dollar market for use in the United States. The
longest Euro-dollar rates have not eased much and remain
relatively high, perhaps partly because the foreign
branches of U.S. banks have continued bidding for longer
term funds to finance transfers of head-office foreign
loans to the branches in order to reduce claims subject
to the VFCR,
The small recent fluctuations in U.S. Treasury bill
rates have been of no significance for the U.S. balance
of payments during a period when forward exchange rates
for sterling have varied widely under the influence of
confidence factors and when liquid flows between the
United States and Canada have been deminated by the VFCR.
(3) Bank credit.--What do June-July bank credit developments
suggest as to the Underlying strength of loan demands?
Total bank credit in July, adjusted for seasonal
influences, probably declined a little, after the sharp
expansion of June. This variation in movement over the
last two months, however, is due principally to the
unusually large end-of-June borrowing by security
dealers and finance companies, which was repaid in July.
Nonfinancial loans have continued to increase and banks
ha.e reduced their security holdings further.
On the
and
demand
has
been
strong,
whole, underlying loan
appears likely to remain so in the near-term.
Real estate and consumer loans continued to expand
in July at about the same rate as during the second
quarter. Business loans appear to have increased at an
annual rate of about 15 per cent in July, and about 19
These growth rates
per cent in June-July taken together.
are considerably below the unusually high rate of the
first
quarter, but considerably above those in 1964 and
other recent years.
8/10/65
-39-
This strong business loan expansion has occurred
despite several months of increased capital market financing.
Plant and equipment and inventory experditures by manufacturing
corporations appear to have exceeded their internally-generated
funds in both the first and second quarters, and this gap is
probably persisting in the third quarter. Increasing business
capital expenditures may also be reflected in the contraseasonal
rise in term loans at New York banks in July, to a near-record
high proportion of total business loans, outstanding.
Industry data (including figures through July 28) indicate
that a large portion of the July increase in loans to business
has resulted from demands of public utility firms and the metal
and metal products industries. When the steel negotiations are
settled--or a strike comes--liquidation of steel stocks will
lead to some loan repayments. However, general financing needs
arising from the capital goods boom may have become more impor
tant than inventory financing in the loan demands of steel
producers and users.
(4) Bank reserves.--Assuming no major change in monetary policy
or in prevailing economic trends, what are the likely dimensions
of bank reserve needs over the remainder of the year and what
problems, if any, might arise in meeting these needs through
open market operations?
Member bank reserve needs are expected to fluctuate widely
during the remainder of the year and should cumulate to seasonal
highs by early November. Staff projections of the usual type,
plus some allowance for continued deposit growth,1/ imply that
(a) gross open market operations may need to be somewhat larger
1/ These projections, shown in the accompanying table, allow for
moderate gold outflow and growth in currency outside banks,
consistent with the more detailed projections shown in the reserve
memorandum. An additional arbitrary allowance for growth in
private deposits at the 1964 rates--13 per cent annual rate for
time and 3 per cent for demand deposits--is included in the
accompanying table, but not in the regular reserve projections.
These trend factors, if appropriate for the months ahead, would
cumulate over the period and constitute a permanent absorption of
a sizeable portion of the reserves injected to meet peak seasonal
needs.
8/10/65
-40-
over the rest of this year than in recent months to offset
expected wide intra-monthly fluctuations in market factors
and required reserves; and (b) operations will need to meet
a sharp and partly permanent reserve drain around the end
of October and early November. Such operations might give
rise to short periods of downward pressure on Treasury bill
rates, but probably not of a dimension or duration great
enough to pose serious market problems given the offsetting
influences that would be present in the market or might be
exercised by optional official actions.
Peak reserve needs--about $1.6 billion higher than current
levels--are projected for the week ending November 10, largely
reflecting a rapid two-week expansion of required reserves and
drains from float and currency. A similar peak is projected
for the week ending December 8, following intra-monthly swings
in float and required reserves which are expected to reduce
reserve needs by about $600 million in the two intervening
weeks. Cumulative reserve needs are expected to remain above
current levels by a minimum of $1.0 billion over the 12 weeks
from October 28 to January 19.
Assuming that the System maintain net reserves near
recent levels, the above projections call for several sizable
concentrations of operations, the largest in the period
October 28 - November 10. Such open market operations, if
confined to Treasury bills, would exert some downward pressure
on bill rates. This pressure might not be great enough to
override the usual firming in bill rate; that accompanies
seasonal shifts in private and public needs for funds over
the fall as a whole, but the necessity "or concentrated System
purchases in some weeks could tend to depress bill rates
slightly for brief periods.
As on occasion in the past, such downward rate pressure
could be mitigated by several types of official action. Some
offsetting influence might be exercised by Treasury debt
management operations. The Treasury is expected to increase
the supply of bills at least by early October to cover its
seasonal cash needs, and the timing and dimensions of such
bill sales might be partly adapted to counter any undesired
strength in bill markets.
8/10/65
-41
The bill rate impact of System buying might also be
moderated somewhat by supplying part of the indicated reserve
needs through purchases of coupon issues and through repurchase
agreements with dealers. Dealer financing needs may be sizable
as a result of Treasury financing this fall and on such
occasions there should be considerable opportunity for making
repurchase agreements. In particular, if a "rights" issue is
included in the November refunding, sizable repurchase
agreements against rights and other issues might be feasible
around late October and early November, the period when
projections indicate the largest increase in reserve needs.
One other means of accommodating short-term fluctuations
in reserve needs with minimum bill purchases would be the
occasional lowering of the Treasury balance at Federal Reserve
Banks, thereby injecting reserves and lightening pressures on
the large money market banks.
8/10/65
-42-
Projected Reserve Needs--August 1965 through January 1966
Period
Changes in reserves Allowance for con- Cumulative
as projected in
tinued growth in change (from
reserve memorandum 1/ private deposits 2/ week of
July 29-Aug. 4)
(millions of dollars change
in reserve week averages)
540
106
646
Sept. 9-22
- 895
42
- 207
Sept. 23-Oct. 13
1,080
63
936
Oct. 14-27
- 770
42
208
Oct. 28-Nov. 10
1,360
42
1,610
Nov. 11-24
- 570
42
1,082
565
42
1,689
- 970
148
867
Aug. 5-Sept. 8
Nov. 25-Dec. 8
Dec. 9-Jan. 26
1/ Projections in the reserve memorandum reflect principally estimated
seasonal changes in factors affecting reserves and in deposits absorbing
reserves. In addition, those projections allow for growth in currency
outside banks at a 3 per cent annual rate, gold outflow after August at
the rate of about $50 million per month, and estimated reserve absorption
by U.S. Government demand deposits reflecting anticipated receipts,
expenditures, and cash financing operations. Projections above also
reflect effects of System operations through August 4, including
scheduled maturities of repurchase agreements against U.S. Government
securities in current weeks.
2/ Annual rates of expansion assumed at the same rates as in the year
1964--about 13 per cent for time deposits and 3 per cent for demand
deposits. Such expansion would absorb about $525 million of reserves,
or about $21 million per week.
8/10/65
-43-
(5) Money market relationships.--Assuming a continuation of
current nonetary policy and taking into account the Treasury
refunding, what range of money market conditions, interest
rates, reserve availability, and reserve utilization by the
banking system might prove mutually consistent during the
coming weeks?
In recent weeks net borrowed reserves and member bank
borrowings have averaged about $160 million and $525 million,
respectively, although with considerable week-to-week
fluctuation. The 3-month Treasury bill rate, affected by
swings in investor demand and dealer psychology, has moved
back and forth in a 3.80 to 3.88 per cent range. Federal
funds have traded mainly at 4-1/8 per cent, although occa
sional trading below that level was induced by the relatively
comfortable reserve position of major New York banks, which
experienced some seasonal decline in their loans in July
along with an expansion in their CD deposits.
If net borrowed reserves continue at their recent levels
and market concern with the international situation does not
mount, bill rates appear likely to remain within their recent
range, with the 3-month bill probably fluctuating between
3.80-3.90 per cent. Seasonal influences will be tending to
firm bill rates in the weeks ahead, and such a tendency could
be accentuated by international uncertainties. The market
is in a good technical condition, however, with dealer bill
inventories reduced. This should help to restrain an increase
in rates, especially if the basic reserve positions of major
New York banks do not tighten further. On the basis of
current projections, the System will not be an important
factor in the bill market for several weeks ahead; reserve
needs will require only minor operations on both sides of the
market.
Long-term interest rates, which have fluctuated in a
fairly narrow range in recent weeks, are not likely to show
significant change in the weeks ahead, barring a sudden shift
in expectations related to developments in Vietnam or the
United Kingdom. Some further up-drift in U.S. Government
yields and some down-drift in corporate yields could occur
as a result of investor arbitrage. Also, dealer positions
in intermediate- and long-term Government bonds remain large,
at just over $1/2 billion. Recent Treasury investment account
purchases, however, have reduced some of the overhang in the
market and dealer acquisitions of 1969 bonds in the current
8/10/65
-44-
refinancing were small. The corporate and municipal calen
dars in August will be seasonally light--although there are
indications of a pick-up in volume in September--and further
distribution of recent underwritings should proceed with
little impact on yields.
Given the economic prospects and credit trends outlined
in the staff comments on questions 1 and 3, expansion in
bank credit and money is likely to be vigorous over the next
few months, although loan growth may moderate somewhat after
a resolution of the steel labor situation. Banks probably
will continue to encourage growth in their time deposits,
both to meet current needs and in anticipation of seasonal
loan demands later. The projected decline in Treasury
deposits at commercial banks in the weeks ahead should
contribute to continued growth in private demand deposits.
On balance, an annual growth rate in private demand deposits
of between 4 and 5 per cent may be a reasonable expectation
for the months immediately ahead. This growth rate would
be considerably smaller than the June-July average, but
substantially above the 2.7 per cent average rate for the
first 7 months of the year.
Chairman Martin then called for the go-around of comments and
views on economic conditions and monetary policy, beginning with
Mr. Treiber, who made the following statement:
Business activity continues to expand, and further
growth is in prospect. Developments in Vietnam have had,
and will continue to have, an importan: stimulative effect
on the domestic economy; they have virtually removed any
prospect of an economic let-down in the second half of 1965.
It is apparent that there will be increased spending in
connection with Vietnam, although the amount of the spending
and its timing are uncertain. It is quite clear, however,
that the changed situation is already having an effect on
the thinking of businessmen and of the public in general.
Except for automobiles, inventory increases at the
wholesale and retail levels remain moderate. The recent
build-up in inventories has taken place largely at the
manufacturers' level. The speed and size of inventory
liquidation following a wage settlement in the steel
industry will, of course, have an important effect on the
total business expansion. The Vietnam build-up will
probably moderate the liquidation, making it easier for
the economy to absorb it.
8/10/65
-45-
Trends in prices, both wholesale and retail, are
disturbing. The first half of 1965 witnessed a
substantial increase in employment. While there are
still a number of areas of substantial unemployment
those areas are declining, and in many there are special
situations which would be affected in only a very
limited way by an increase in over-all demand. A
number of wage increases under collective bargaining
in the first half of 1965 apparently have exceeded by
significant amounts the guidelines of the Council of
Economic Advisers. Labor costs per unit of output in
manufacturing apparently are now rising after declining
gradually over a period of several years. Although in
the past an increase in unit costs has usually occurred
on the upswing of the business cycle, fortunately it
did not occur on the upswing beginning in 1961. But
this development now seems to be with us. In the meantime,
profits continue to rise. We have not seen many instances
where the fruits of greater productivity are being passed
on to consumers in the form of lower prices.
As for the international situation, our second-quarter
balance of payments surplus rests largely on special and
nonrecurrent factors. There is little evidence of a
fundamental improvement in our basic balance of payments
position. Indeed, so far this year our trade surplus has
not been as good as it was in the corresponding period
last year; and now it appears probable that for the year
1965 it will be less than it was in 1964. Tourist and
transportation expenditures are likely to increase
substantially. And we continue to lose gold.
The voluntary credit restraint program has had its
greatest effect on the repatriation of short-term capital
funds. It is doubtful that the movement of such funds
from abroad will continue at the rate experienced in the
first half of 1965. Indeed, the program and the weakness
of sterling have tended to make international rate comparisons
less significant. While movements of funds from the United
States in order to take advantage of short-term rate
differentials are not likely, there is still plenty of
incentive for longer-term credits and investments abroad.
Since most of the major banks are now below their 105 per
cent credit ceiling under the voluntary program and the
credit leeway of the whole banking system is fairly large,
a moderate outflow of bank credit may be expected during
the remainder of the year. It is hard to see any
significant improvement in our balance of payments position
in the second half of 1965 compared with the first half;
indeed, some deterioration seems likely.
-46-
8/10/65
There have been increasing uncertainties in
international financial sentiment, as evidenced by the
highly delicate situation of sterling and the rise in
the demand for gold, and the price of gold, in the London
gold market. Further deterioration in sentiment could
bring pressures on the dollar in international markets
and on our highly sensitive domestic markets.
The demand at home for bank credit continues to be
strong. The large New York City banks are projecting
significantly greater, than seasonal gains in business
loans for the third quarter as a whole.
Bank credit,
and the money supply, have continued to rise in recent
months, at about the same rate they have risen over the
last several years. Bank credit and all types of credit
taken together have risen more rapidly than has overall
production.
The ratio of total nonbank liquid assets to
GNP has risen further; it is now near the highest level
in a decade.
In considering the need for supplying reserves to
the banking system this fall, it seems to me that the
System should bear in mind the possibility of reducing
member bank reserve requirements as well as using open
market operations.
Later this week the new securities offered by the
Treasury to refund maturing notes will be issued and
Dealer participation in the
delivered to the purchasers.
refunding was quite moderate, and "even keel" considerations
related to the Treasury's operation would not in normal
circumstances be a matter of serious concern to us in our
own policy deliberations. There was, however, considerable
uncertainty in
the Government bond market last week
stemming from discussion about the future of sterling
and the implications of the Vietnam situation.
As we approach policy, there are four basic factors
to consider:
(1) Recent domestic developments show forces operating
in the direction of an inflationary disequilibrium;
(2) Some deterioration appears in prospect for our
balance of payments;
(3)
The situation in international financial markets
continues to be most delicate; and
(4)
These factors and perhaps other factors have
produced uncertainties in the U.S. Government
securities market.
-47-
8/10/65
In my opinion, this combination of circumstances counsels
a cautious restriction in domestic credit availability.
The weakness in sterling rules out, it seems to me,
a dramatic move such as an increase in the discount rate
at this time. Such a move on our part might be interpreted
here and abroad as an indication of a withdrawal by the
United States of its concern for the pound, and of a con
centration on our own problems; resultant market reactions
would, no doubt, place greater pressures on sterling. But
a judgment that, on balance, a dramatic move at this time
might do more harm than good need not result in no action
at all. We still have the danger of excessive domestic
liquidity and the distortions that excessive use of credit
are likely to breed; and we st.ll have the balance of payments
problem.
Therefore, it seems to me that we should move with
caution toward somewhat firmer conditions in the money
market. Somewhat higher net borrowed reserves and some
what greater member bank borrowing fron the Federal
Reserve Banks would seem appropriate. The effect of
the move might become apparent in the statistics published
next wee or the week thereafter. As for the form of the
directive, I favor alternative B. 1/
Mr. Shuford commented that economic activity this summer had
proceeded with all the strength that could have been anticipated and
that was appropriate.
Employment had been increasing rapidly.
The
rate of increase in personal income had accelerated in recent months.
As further evidence of strong aggregate demand, wholesale industrial
prices had increased more rapidly than in the last several years.
Recent and current monetary and fiscal developments had been
quite stimulative, Mr. Shuford said.
The money supply had increased
rapidly since May and at a rate of about 3 per cent since the beginning
Three alternative drafts of the directive prepared by the staff
1/
are appended to these minutes as Attachment A.
8/10/65
-48
of the year.
expansionary.
The planned Federal budget recently had turned more
Beyond the current strength of the economy and recent
monetary and fiscal developments, continued and additional fiscal
expansion would be faced in coming months.
The planned budget would
continue stimulative during the second half of the year and, as
already had been noted, there would be a further increase in military
spending.
In view of the impact of the fiscal stimulation which had been
anticipated earlier and that which would result from the new military
situation, Mr, Shuford continued, excessive total demand could become
more definitely the major stabilization problem.
It might be that
over the next few months a more restrictive combination of monetary
and fiscal measures would be appropriate.
It was not likely that
fiscal policy--to any great extent--could be made more restrictive
during the remainder of the year.
Consequently, developments in
stabilization policy during the next few months would have to be
primarily on the monetary side.
If monetary restraint should be appropriate during the next
few months, Mr. Shuford observed, it would not only help to prevent
excessive total demand for goods and services and resultant price
inflation but it should tend to bring U.S. interest rates into better
alignment with those in some other major countries.
That would aid
in restoring reasonable balance to the international accounts, and
8/10/65
-49
it would be a contribution to the fundamental adjustment which, sooner
or later, had to take the place of the present temporary voluntary
restraints on the flow of capital.
He hoped that at the same time
certain foreign countries could be persuaded to adopt tighter fiscal
and easier moretary policies, thereby pushing down their interest
rate levels.
As far as the next few weeks were concerned, Mr. Shuford did
not suggest that the Committee should take any overt action.
For the
immediate future he favored moderate rates of increase of reserves
and money, lower than the average rates of the past twelve months.
Reserves should not be supplied so rapidly as to support unduly
large increases in bank credit.
In view of the strength of business,
the fiscal situation, and developing seasonal pressures, he thought
such a policy stance would be consistent with some upward movement
in interest rates.
Somewhat higher interest rates would be appropriate
if the domestic economy generated greater credit demands, from either
the private or the Federal sector.
As at the previous meeting, Mr. Shuford said, his position on
policy was close to one of "no change," and the first paragraph of
alternative A of the draft directives was acceptable to him.
However,
he again would recommend a revision of the second paragraph, as he had
last time, in order to emphasize the need for preventing any excessive
increase in demand.
Specifically, he would revise the language
following the phrase "with a view to maintaining" to read, "at least
8/10/65
-50
as firm conditions in the money market as have prevailed in recent
weeks, and to permit some tightening if demands for credit
strengthen."
Mr. Patterson said that at the risk of overworking an
attractive definition introduced by Mr. Noyes at the previous
meeting of the Committee on the "new semantics" that had developed
along with the "new economics"--when he said that nowadays things
were "unchanged" when they were increasing at the same rate as
before, and things were going up only when the rate of increase
exceeded the one previously established--he would carry Mr. Noyes'
theme a little further and say there also was a "new semantics"
with respect to declines.
For example, there seemed to be three
sorts of declines developing in the Sixth District, only one of
which constituted a decline in the old serse.
Some of the District
statistics showed rates of gain lower than those previously
established, and some were showing relative stability, both of which
were declines according to Mr. Noyes.
In addition, there were a
few actual declines.
In the first category (rates of increase less than formerly),
Mr. Patterson went on, one had to classify the behavior of the most
recent statistics on employment, manufacturing payrolls, and personal
income.
The softness in manufacturing payrolls helped explain the
slackening in the growth of personal income, although cash farm
8/10/65
-51
receipts, derived partly from rapidly rising farm prices, had helped
to maintain income.
For example, the first week's market for
Georgia-Florida flue-cured tobacco, which opened July 28, yielded
prices averaging $64.95 per 100 pounds, $12.75 above the same period
last year.
District livestock producers were, of course, sharing in
the income gains from higher prices for cattle and hogs.
In the second category of declines--those sectors exhibiting
relative stability--one had to classify the behavior of retail sales,
Mr. Patterson said.
If the ups and downs from month to month in 1965
were smoothed out, a chart would show an almost horizontal line.
Construction outlays and construction employment also were moving
horizontally on a high plateau.
Finally, Mr. Patterson said, the District had been experi
encing a few old-fashioned actual declines.
For example, construction
contract awards had been in a downtrend since December 1964, with the
decline concentrated in nonbuilding types such as missile and space
projects, highways, and bridges.
The downtrend in residential
contract volume evidenced throughout 1964, however, had apparently
been reversed, although the new uptrend was still in its infancy.
Turning to banking, Mr. Patterson remarked that the District
definitely had been experiencing increases measured by any man's
semantics, new or old.
For example, loans at the end of July were
up 15 per cent from a year ago; investments, 4 per cent; and deposits,
8/10/65
-52
12 per cent.
twice as
Placed in perspective, those increases were roughly
large as the increase in economic activity as measured by
personal income.
Moreover, there had been no letup in the rate of
credit expansion over the first half of 1965, notwithstanding the
firming of Federal Reserve policy this spring.
Loan and deposit
increases in the second quarter were equal to those in the first.
Viewed from several angles, Mr. Patterson continued, firming
in Federal Reserve policy had not retarded credit expansion at
District banks.
Those banks, which had been in a net borrowed
reserve position in June, moved into a free reserve position in July,
a movement that was accompanied by a decline in borrowing; on the
average, the banks had been net sellers of Federal funds; and the
member banks had been able to increase their loans with only a
slight loss in their holdings of Government securities and municipals.
Judging from the response of 73 member and nonmember banks to the
recently completed survey of lending practices, changes in bankers'
attitudes to their loan requests seemed to be related more to the
strength of the business loan demand than to Federal Reserve
operations.
At the moment, Mr. Patterson was not prepared to say what all
of those contrasting trends meant in terms of Federal Reserve policy.
However, if he were voting and had to make a choice among the
alternative draft directives it would be in favor of alternative A.
-53
8/10/65
Mr. Bopp reported that economic activity in the Third District
had continued to expand in recent weeks, but at a somewhat slower rate.
Steel production in the Northeast Coast region decreased considerably
more than nationally, and the rise in department store sales in the
past four weeks was much less there than for the United States,
Loans
of reporting banks declined in July, reflecting substantial repayments
by securities dealers and sales finarce companies.
Reserve positions
of reserve city banks had tightened considerably, resulting in larger
net purchases of Federal funds and additional borrowing from the
Reserve Bank.
Country bank borrowing from the Reserve Bank, however,
had declined to a low level.
Discussions with bankers and businessmen revealed, Mr. Bopp
said, that except for a helicopter manufacturer who planned to add
over 1,000 employees to meet increased defense orders, most saw the
proposed buildup of U.S. armed forces in South Vietnam as having
little effect thus far.
There had been no tendency to mark up
prices, and a possible increase in inventories was mentioned only
once.
A textile producer with inventory somewhat low as compared to
others in the industry reported that he was seriously considering
building up his stocks somewhat in order to be in a better position
to handle new orders that might come from the stepped-up defense
program.
Some expressed the view that steel and metal product
inventories might not be reduced so much following a wage agreement
in the steel industry as would have occurred otherwise.
-54
8/10/65
Larger draft calls were unlikely to have much effect on
unemployment in the Third District, Mr. Bopp thought.
The average
age of draftees currently was 21, and was expected to fall to about
20-1/2 in the next year.
The unemployment rate in that age group
was far below that for teenage males.
Also, nearly one-half of the
men examined by Selective Service were rejected, and the probability
was rather high that those rejected were not qualified for the kinds
of work for which job opportunities were good.
Those findings for the local area conformed with Mr. Bopp's
expectations for the nation as a whole.
The proposed step-up in
defense expenditures apparently could be absorbed without any
significant inflationary pressures.
The increase estimated for the
remainder of this year was small in relation to current GNP (only
about 1/4 of 1 per cent), and the impact would be distributed among
a number of industries.
Moreover, it came at a time when the
existing margin of unused resources, together with additions to
capacity resulting from the high level of capital expenditures,
appeared sufficient to meet prospective increases in aggregate
demand.
Mr. Bopp could find no evidence thus far of a general upward
pull or push on the wholesale price level.
The rise in wholesale
prices of the past few months reflected primarily supply situations
in farm products, processed foods, and nonferrous metals, rather
than total demand pressing against productive capacity.
Reduced
8/10/65
-55
marketings of livestock as a result of low prices last year and
short supplies, of fruits and vegetables because of unfavorable
weather were the principal reasons for the rise in the prices of
farm products and processed foods.
The rise in nonferrous metals
reflected the usual price response of those products to wide
cyclical swings in demand against a relatively inelastic supply.
Generally stable labor costs per unit of output in manufacturing
(the small fractional increases in the past three months were not
sufficient to have much significance) and the rise in manufacturers'
after-tax profits in the second quarter, and also in their profit
margins, indicated no upward push on prices.
It appeared to Mr. Bopp that the absence of any significant
inflationary pressures would continue.
At the same time, liquidation
of steel inventories might soon become a downward drag on the
economy.
Those considerations, plus the fact that the improved
balance of payments position was continuing, led him to the
conclusion that additional restraint was not called for.
On the
other hand, he would not relax the present degree of firmness in
view of the stimulus that would be provided by larger defense
expenditures and a more expansionary fiscal policy.
He recommended,
therefore, that current policy be continued for the next three weeks.
An additional reason for that view was the current feeling of
uncertainty in the Government securities market.
Any change in policy
would be likely to have a greatly magnified effect.
alternative A of the draft directives.
He favored
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Mr. Hickman remarked that, while the economy continued to
inch upward in July, the latest data on the leading indicators
showed that a majority had either leveled off or declined slightly.
Looking ahead, some uncertainties in the business outlook referred
to at the previous meeting of the Committee had been alleviated by
increased defense spending for Vietnam, but the steel settlement
was still a major element to be resolved.
It probably would be
late September before it could be determined which way the economy
would respond.
In assessing recent business developments, the major
contributions provided by steel and autos should be noted, Mr.
Steel production, which amounted to a seasonally
Hickman said.
adjusted annual rate of 149 million ingot tons in July, would hold
near that rate in August, but would decline appreciably in
September, irrespective of a steel settlement.
Assuming a settle
ment, the extent of the decline would be determined by the amount
of inventories to be liquidated and the level of consumption, two
measures about which there was a great deal of talk but little
real knowledge.
Because of Vietnam, steel inventory liquidation
would not be as great as previously expected, but the extent of
the adjustment could not be estimated until more was known about
price developments and the impact of defense spending.
The record of the automobile industry continued to confound
the experts, Mr. Hickman commented.
Auto production in July amounted
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to 9.7 million cars, seasonally adjusted annual rate, while
estimates for August indicated adjusted output at a rate of nearly
9.5 million cars.
Car sales declined moderately in July, but were
a record for the month; inventories increased slightly but were
now declining sharply.
Although some price indicators subsided in early July, the
odds now seemed to Mr. Hickman to have shifted away from price
stability in favor of moderate price inflation.
Because of short
supplies of pork, beef, and vegetables, the upward drift of the
consumer price index had accelerated.
Increases that were first
reflected on the farm in February and March subsequently showed up
in wholesale prices of processed foods and finally in consumer food
prices.
If typical lead-lag relationships held, a further rise
could be expected at the consumer level before the modest decline
that occurred in farm prices in July took hold.
Vietnam had already had an impact on industrial prices,
Mr. Hickman noted, with nonferrous meals, textiles, and hides and
leather firming somewhat since mid-July.
Upward pressure in non
ferrous metals in some cases reflected tight supply situations.
While industrial prices would probably not move up as rapidly as
they did at the outbreak of the Korean conflict, the general climate
was now more conducive to price increases than at any time in the
recent past.
8/10/65
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At this juncture, past trends seemed to Mr. Hickman to be
even less reliable guides than usual to future developments.
The
key question concerned the effects of the step-up in defense spending
on economic activity.
Whereas previously a rate of growth in GNP
had been anticipated during the second half that would not close
the gap in the economy's potential--implying an increase in the
aggregate rate of unemployment--the expansion could not proceed
at a faster rate.
At this point, he felt intuitively that it would
take a much sharper escalation than presently appeared to be in the
cards to overheat the economy.
But to formulate appropriate monetary
policy the Co.mittee clearly needed to know much more than it did
now about defense spending and the steel situation.
Unfortunately,
that was something it might not know for several weeks, perhaps
until late September.
In recent months, Mr. Hickman noted, he had felt that
monetary policy was slightly firmer than it should have been on
the basis of information then available.
Now, however, with the
advantage of hindsight, he thought that it had been about right
after all, although perhaps for the wrong reasons.
In any event,
in view of the current Treasury financing, hesitancy in the capital
markets, uncertainties in the domestic business outlook, and growing
pressure on the pound sterling, no change in policy seemed to be
desirable at this time.
By "no change" he meant net borrowed
reserves around $150 million and borrowings around $500 million,
8/10/65
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with a personal preference for a shading downward from those
figures.
He favored alternative A for the directive.
Mr. Maisel agreed with the staff that the step-up in
Federal activities resulting from Vietnam was nearly sufficient to
offset the curtailment in private expenditures that had been
expected during the coming periods.
As a result, if the programs
went forward as now projected, the rate of growth in the economy
should continue about as it had recently.
That would mean that
existing slack would remain at the present levels.
The relationships which had developed among international
interest rates made it imperative, Mr. Maisel said, for the Commit
tee to undertake the careful reconsideration of current interest
rate policy that was considered necessary when the present directive
was adopted on March 23.
Current indications were that the major
European countries had decided to put the bulk of their faith in
monetary rather than fiscal policy.
That raised serious questions
as to wh ther or not the United States could afford to be one of
the few countries with its capital market open freely to buffeting
from decisions made abroad.
The voluntary foreign credit restraint
program was clearly an indication that such pressures were basically
unacceptable.
As a part of the general reconsideration of its
present policy, the Committee needed to consider the short-run
implications for the balance of payments of existing short- and
long-term interest rates while attempting to determine what type of
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capital markets, under what conditions, could be viable after the
voluntary restraint program had passed.
The Committee particularly
needed a review of what capital market movements were a threat.
Was the Committee concerned with Canada, Britain, developing
countries, or continental Europe?
Did short-run movements have
the same implications as long-run ones?
Mr. Maisel felt that, given the present uncertainties as
a result of Vietnam plus the continued negotiations in the steel
industry, the Committee ought not to alter policy, since any
change could be misinterpreted.
As a result, he would support
the current directive--alternative A.
At the same time he
believed that the creeping growth in the amount of net borrowed
reserves ought to be reversed.
The average of free reserves
expected at the conclusion of each week's operations had risen
by $15 million in each month under the current directive.
Because
most of the biases currently appeared to be on the restrictive
side, the amount of net borrowing had been even larger than
projected at the end of operations.
Since the market would be buffeted by many conflicting
forces during coming periods, it seemed advisable to Mr. Maisel
to recognize the existence of the voluntary foreign credit restraint
program and to allow the bill rate to fall if that occurred as the
result of normal market action.
He did not feel that artificial
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pegging of the bill rate above the rate that the market would
determine with the present level of reserves and demand for money
ought to be the critical criterion for operations.
Mr. Daane said he continued to believe that there were
times when a decision to maintain the status quo with respect to
policy was as significant as a decision to make a change.
strongly that the present was one of those times.
He felt
The uncertainties
existing in the markets for Government securities and foreign
exchange, the absence of clear and compelling evidence calling
for a change in policy noted by Mr. Brill, the considerable
skepticism expressed by the staff regarding the permanence of the
improvement in the balance of payments, the uncertainty as to the
kind of settlement that would be made in the steel industry, and
the fact that some period of digestion with respect to the current
Treasury financing still lay ahead--all of those considerations
quite clearly called for no change in policy.
As to the draft directives prepared by the staff, Mr. Daane
continued, he felt that there was too much change in wording for the
sake of change alone.
Assuming the consensus today was for no
change in policy, he would recommend only a few revisions from the
directive adopted at the previous meeting.
Specifically, in the
first sentence he would substitute the words "early in the year"
for "the first quarter."
Between the seccnd and third sentences
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he would inser: the sentence, "International developments are
creating uncertainties in securities and foreign exchange markets,"
and leave the .:est of the first paragraph unchanged.
In the second
paragraph, he would replace the phrase, "and taking into account
the forthcoming Treasury financing" with the phrase, "and taking
into account the current Treasury financing and unsettlement in
market conditions," and retain the remaining language.
When the Committee was not making a policy change, Mr. Daane
said, revisions of the directive language should be limited to those
necessary to recognize significant developments, and in his judgment
the only recent developments of major significance were the uncer
tainties and unsettlements occasioned by events in Vietnam and
Britain.
To make other revisions might suggest to the reader of the
published reco-d that the Committee had modified policy when in fact
it had not.
One change of the several the staff proposed seemed to
him to be particularly inappropriate--that cf substituting the words,
"to defend the international position of the dollar" for the words,
"to reinforce the voluntary restraint program to strengthen the
international position of the dollar."
Mr. Mitchell said that at the previous meeting he had seen
no reason for making a change in policy and he saw none today,
although he now regarded the economic situation and outlook as
stronger than previously.
The major factor underlying that view
8/10/65
-63-
was the recent rate of consumer spending, which was surprisingly
high.
A second important factor was the improvement in business
psychology as a result of the escalation in the Vietnam situation,
although that improvement might be based on an erroneous reading
of the outlook--Federal expenditures in connection with Vietnam
might not rise as much as many expected.
With the uncertainties prevailing in securities markets,
Mr. Mitchell said, the Committee should do what it could to
reinstill confidence in the viability of the present pattern of
interest rates.
The differentials existing among rates on tax
exempt and corporate and Government securities at present perhaps
were unstable, and that might lead to a decline in prices of
Government bonds.
In any event, he would not want to see any
further rise in the levels of long-term rates.
As to the balance of payments, it seemed to Mr, Mitchell
that the results of the voluntary foreign credit restraint program
were all that had been hoped for, if not more.
The program was
not intended to produce a permanent solution to the balance of
payments problem, and no one should be surprised that it was not
doing so.
A permanent solution had to be sought through other
policy measures.
The last measure he would recommend for that
purpose would be an increase in domestic long-term interest rates
to levels equal to those in, say, Germany.
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8/10/65
Mr. Mitchell favored alternative A for the directive with
one change in wording that was consistent with the views Mr. Daane
had expressed.
In the second sentence of the first paragraph he
would replace the words, "to help defend" (the international
To
position of the dollar) with the words, "to help maintain."
his mind, "to help defend" was unduly dramatic language.
Mr. Shepardson said that in preparing for this meeting
he had tried to reconcile his own feelings with the staff's
assessment of the conflicting factors weighing in the present
situation.
There were many uncertainties in the picture, and
while he suspected that some of the concern; that Mr. Treiber had
expressed today were warranted, he found it hard to document that
The nature of the steel settlement would, in his judgment,
belief.
have important implications for the economy,
Because the negotiations
were still in process, and despite the fact that he shared Mr.
Treiber's concerns, he had come to the conclusion that it
probably was best to make no change in policy at present.
He
would not like to see any shading of market conditions to the
easier side under a generally unchanged posture, as had been
suggested; he would hope that there would be no relaxation of
pressure.
As to the wording of the directive, Mr. Shepardson thought
there was merit in Mr. Daane's observations but he found alternative A
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8/10/65
as drafted by the staff acceptable, with Mr. Mitchell's suggested
change in wording.
Mr. Robertson then made the following statement:
There are a number of powerful forces influencing
economic trends at the moment--some pushing up and others
pulling down. On balance I think they call for us to
hold a steady course for monetary policy over the next
few weeks, not turning consciously toward either tightness
or ease.
I would not want to ease policy right now, for a
considerable degree of new fiscal stimulus lies immediately
ahead of us. Some of this will come from the enlarged
Social Security payments, but the more important impetus
is probably the Vietnam buildup, and we have no dependable
idea of how big that might turn out to be. Even before
the new Vietnam action entered the picture, moreover, the
economy was performing a bit better than expected, and
it was being supported by a vigorous rate of monetary
expansion.
One final factor also weighs against easing today,
steel contract talks are coming up against
in my view:
their previously agreed-upon deadline at the end of this
month, ard (without trying to forecast the eventual
settlement) I would not want to have eased policy at this
meeting and then find a big steel wage advance and an
associated round of price increases developing.
But, on the other hand, I also see considerations
that I think would make it unwise to tighten right now.
I am sensitive to a few symptoms of "tired boom" that
could be seen to be developing in the clearer atmosphere
pre-Vietnam. Furthermore, we can expect that some short
run downward pressure from steel stock liquidation ought
to occur whenever we get either a settlement or a strike.
Perhaps our greatest risks of precipitating unhappy
consequences, however, center in our financial markets.
These markets--particularly the long Government bond
market--are already nervous and weighted down by dealer
inventories. I hate to think of how those markets might
drop if the receipt of bad news from abroad (as some people
apparently think may be forthcoming) caught them at a time
when we had already pushed them off balance and strained
their resiliency by an unexpected further tightening of
monetary policy.
8/10/65
-66-
In the absence of domestic developments which would
make a policy change imperative, I would prefer to move
through the weeks ahead on a steady corse, with the
Manager maintaining money market conditions about the
same as in recent weeks. If investors in their nervous
ness, should shift toward liquid assets and depress bill
rates in the process, I think we ought to let a bill
rate decline occur. On the other hand, should bank
deposit expansion continue unseasonally strong and boost
required reserves more than expected, I would not object
to some resultant revisions to deeper net borrowed reserve
figures. But aside from such nuances, I would hold
policy unchanged until the next meeting, or until and
unless the international financial storm breaks over
Britain, If that should occur, its reverberations in
securities and foreign exchange markets are impossible
fully to foresee, and I would want both the Special
Manager for Foreign Operations and the System Open
Market Account Manager to have all the power and flexi
bility it is feasible to give them to deal with the
consequences, although that can be provided in a special
meeting, if necessary. To that end, I would vote for
the proposed alternative A for the current directive.
Mr. Robertson added that like Mr. Shepardson he felt there
was much to be said for Mr. Daane's position against changes in
wording for the sake of change alone.
Nevertheless, he found that
he could accept the staff's draft language with the modification
suggeste
by Mr. Mitchell.
Mr. Wayne reported that business conditions in the Fifth
District continued to display basic strengh,
as a whole.
much as in the nation
In the Richmond Bank's latest survey, however, the size
of the minority anticipating a business downturn had increased.
Among businessmen, 21 per cent now thought some decline was probable,
compared with 7 per cent eight weeks ago.
Among bankers, however,
8/10/65
-67
whose sentiments usually were more volatile
there was not a
single pessimist who foresaw a downturn in the near future.
Except for textile producers, manufacturers in the survey
indicated a lower average level of new and unfilled orders for
the first time in eighteen months but continued to report rising
shipments and small increases in wages and prices.
Textile
producers expected sizable Government orders soon as part of
the defense buildup; that would come on top of an order backlog
which already pre-empted almost a year's production in several
major lines.
In agriculture, tobacco acreage-poundage controls
were expected to cut the District's output of flue-cured leaf
by 17 per cent, but favorable prices would probably reduce the
impact on income.
At the present stage, Mr. Wayne continued, the precise
scope of the current defense buildup was not clear and any
assessment of its implication for business performance in the
second half was probably premature.
For the very short run,
its principal impact was likely to be on business expectations
patterns.
He would expect some adjustment in business inventory
planning in a direction that would work to offset the anticipated
liquidation of steel stockpiles, and perhaps also some scattered
price pressures.
Considering a somewhat longer time span,
consumer spending for durables might be stimulated, especially
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in view of prospective increases in social security payments
and in military and civil service pay scales.
Whatever the
magnitude of the added stimulus, it would be superimposed upon
a basically strong economic situation.
Plant and equipment
expenditures continued high, automobile sales remained at
record levels, the consumer surveys showed that the public was
still in a spending mood, and the latest construction figures
were encouraging.
Mr. Wayne went on to say that the recent relative increase
of long-term rates abroad partially offset the advantages of the
interest equalization tax and might well introduce some stress on
the voluntary foreign credit restraint program.
For the immediate
future, however, he was more concerned over the tendency in some
quarters to view the modest second-quarter surplus in the balance
of payments as evidence that the problem had been solved.
The
current unfavorable prospect for the merchandise account struck
him as more deserving of attention than improvements that were
attributable to a program that could be viewed only as temporary.
In surveying the international scene, however, he was most concerned
with the position of the United Kingdom.
It appeared to him that
the sterling problem had moved into a new and critical phase and,
while no one could predict the next development, he believed the
8/10/65
-69
System might well be confronted over the next few months with
what could be the gravest international payments crisis since
the 1930s.
Bank credit behavior in June and July generally followed
the usual seasonal pattern, Mr. Wayne said.
Loan demand remained
strong, and in view of the low level of corporate liquidity,
rising business capital outlays, and the likelihood of increased
inventory accumulation in many lines, business loans might be
expected to continue at a high and perhaps rising level for the
next few months.
Consumer spending plans also indicated an
increase in the demand for consumer loans.
In view of the prospects for continued strong loan
demand in the second half, Mr. Wayne remarked, the need for
bank reserves was likely to increase, although perhaps not as
rapidly as in the first half.
Developing seasonal needs
coupled with limited new bill offerings by the Treasury might
make it difficult to supply necessary reserves through open
market purchases without unduly depressing bill rates.
That
situation could change if rising defense expenditures became
large enough to require substantial amounts of additional Treasury
financing.
8/10/65
-70
Regarding policy, the current level of reserve availability
appeared to Mr. Wayne to be altogether consistent with the rate of
credit and money expansion required by the domestic economy.
Aside
from the problem of meeting seasonal reserve needs, he saw nothing
in the domestic picture that called for any change in reserve
availability.
In particular, he would be reluctant to move in the
direction of greater ease in view of the possibility that price
pressures might develop from the impending step-ups in defense
expenditures, from the increases in Social Security benefits and
military pay scales beginning in September, and from possible in
creases in Civil Service pay scales.
He believed that any
substantial liquidation of steel inventories that might develop
in the near future would be offset in large measure by those
added fiscal stimuli and would not require any compensation from
monetary and credit policy.
On the international side, the
deterioration in the U.S. trade balance cautioned against any
move in the direction of more ease.
In relation to sterling the
Committee should not compound the problems of the British by any
greater firmness of policy, but the heavily exposed position of the
dollar in relation to the pound required serious consideration
of the strength of this country's own situation.
In brief, it
seemed to Mr. Wayne that the considerations pro and con were quite
evenly balanced, and he favored a continuation of the present
policy and alternative A of the draft directives.
8/10/65
-71Mr. Clay commented that the domestic economy had performed
quite well in recent weeks.
As anticipated,
the rate of expansion
had been lower than during the bulge of the early months of the
year.
However, the performance probably had been somewhat better
than generally anticipated.
The recent military decisions concerning South Vietnam had
injected a new factor into future economic developments, Mr. Clay
said.
The staff analysis under question 1 covered that situation
very well.
The immediate impact on the domestic economy was small,
and the projected impact in the months ahead appeared to be readily
absorbable.
The fact was that the Committee did not really know
what the military program would be in the months ahead, however,
and accordingly the effect on the economy would have to be re
evaluated constantly.
Substantial progress had been made in the fuller utilization
of resources, Mr. Clay continued.
The resource base was still
growing and there appeared to be room for continuing orderly
expansion in economic activity.
If the military impact proved
to be more pronounced than anticipated, however, the resource
utilization situation would need to be observed very closely as
a factor conditioning the formulation of policy.
Loan expansion had moderated, Mr. Clay noted.
Business
loan expansion had moderated somewhat also, although business loan
8/10/65
-72
growth had continued large.
While loan demand remained strong,
increased use of bank credit was taking place in
the
an economic
environment that remained orderly.
To Mr.
Clay,
analysis of the domestic economy seemed to
indicate the appropriateness
policy of recent weeks,
of a continuation of the monetary
and the international balance of payments
situation appeared to permit the pursuit of that policy.
The
staff analysis under question 5 included the necessary informatior.
concerning the targets involved in the implementation of such a
policy approach.
Mr. Clay would not change the discount rate.
In his judgment,
alternative A of the draft directives would serve satisfactorily as
the economic policy directive.
Mr.
Daane left
the meeting followirg Mr. Clay's remarks.
Mr. Scanlon reported that economic activity in the Seventh
District had remained at high levels during recent weeks.
in
still
the rate of inventory accumulation,
particularly in
Reductions
steel, were
considered a potential source of disruption to the pace of
activity but no other weaknesses were evident.
Prospects for a
continuation of the expansion at or near current rates were good.
A Chicago steel industry analyst reported that it was now
apparent that the peak in the buildup of steel inventories had been
reached in the early part of July, Mr. Scanlon said.
Order backlogs
8/10/65
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in the industry were being "worked off" at a slow and orderly
rate.
Unemployment compensation claims continued to decline in
all District states except Wisconsin.
Mr. Scanlon observed that net farm income in the Midwest
was expected to continue above the year-earlier level during the
remainder of 1965, with gains in livestock, crops, and Government
payments.
Hog and cattle prices were expected to remain above
those of a year ago and larger crops of wheat and feed grains
were in prospect.
A continued strong demand for agricultural loans was
reported by the "agricultural" banks surveyed by the Chicago
Reserve Bank in early July, Mr. Scanlon remarked.
The demand for
loans to finance feeder cattle was expected to be especially
strong this fall because of the large corn crop in prospect,
higher feeder cattle prices, and relatively favorable prices for
slaughter cattle.
Loan pay-offs at the agricultural banks had
been favorable, reflecting the rise of farm income.
Current
developments in the Midwest seemed to indicate the continuation
of a strong underlying business loan demand.
Stepped-up issues
of CDs by the major Chicago banks suggested that they expected
substantial loan demand in coming months.
also showed greater gains than a year ago.
Other types of loans
Real estate
loans at District weekly reporting banks were 21 per cent above a
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year ago and loans to finance companies were up 25 per cent.
The gain in consumer (other) loans had been somewhat less
vigorous--17 per cent.
Although the major Chicago banks showed continued tighten
ing in their basic reserve positions in July, Mr. Scanlon said,
their position was still relatively comfortable.
They had not
increased borrowings at the discount window and had not liquidated
Governments in significant amounts.
Speaking specifically to question 4, Mr. Scanlon shared
Mr. Treiber's view that in providing the substantial amount of
reserves
that the System would be required to inject in the period
between September 1 and the end of the year consideration might
be given to meeting some or all of this need by a reduction in
reserve requicements on time deposits.
Looking to the next three weeks, with the steel settlement
and other uncertainties hanging over the economy, Mr. Scanlon
thought the Committee should maintain about the current policy
posture.
On that basis, he would prefer alternative A for the
directive, as amended by Mr. Mitchell.
Mr. Galusha said that he would omit most of the remarks he
had prepared on recent developments in the Ninth District to avoid
reiterating statements already made in connection with other
Districts.
However, he would note one respect in which the District
8/10/65
-75
differed from some others--the major city banks had indicated
in an informal survey that they did not expect a resumption of the
heavy loan demand of a few weeks ago.
On the basis of information now available, Mr. Galusha
was inclined toward no change in policy at the present time and,
accordingly, toward alternative A for the directive.
He had some
reservations about that judgment because he was not wholly
confident about the near-term business outlook.
On the other
hand, it was possible that days to come would reveal evidence that
the expanded military effort in connection with Vietnam would
have greater economic effect than it seemed reasonable to expect
at the moment.
Were he to favor additional monetary restraint
at this time it would be because long-term interest rates had
been rising in other major countries and because of the balance
of payments implications inherent in that shift.
He was not sure
of the significance of those current variations, however, and so
was inclined to wait a bit until the impact of the changing
differentials became clearer.
Also, the effects of the Vietnam
buildup might likewise be clearer in a few weeks.
Mr. Galusha indicated that he agreed whole-heartedly with
Mr. Daane's observation that a decision by the Committee to make
no change in policy was a positive act.
He thought, however,
that Mr. Daane's further observation--that modifications in the
8/10/65
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language of the directive should be kept to a minimum when policy
was unchanged--involved a non sequitur.
The directive adopted at
each meeting presumably should reveal the major factors on which
the Committee based its decision at that meeting, and since those
factors ordinarily would change over time it seemed appropriate
to change the language of the directive even though policy was
unchanged.
Mr. Swan said that there had been some small recovery in
the aerospace and defense industry in the Twelfth District in
recent months, before the current Vietnam developments.
To a
considerable extent the recovery was related to an increase in
orders for commercial aircraft.
In light of recent developments,
it certainly :.eemed that there would be sone further rise in
activity in that industry.
concerned,
However, as far as the District was
he would agree with the staff comments under the first
question that in general there as yet had been little public
concern over the possible impact of the defense buildup
and no
significant movement to date toward anticipatory buying.
The District's lumber industry had been in somewhat
better position in recent weeks, Mr. Swan continued, as a result
of the combination of some increase in orders, some rise in
prices, and vacation shutdowns. However, the position of the
industry had not improved significantly over that of a year ago.
8/10/65
-77The question of the adequacy of the domestic agricultural
labor supply probably would be rising agair soon, Mr. Swan said.
The peak of the tomato harvest period lay ahead, and although
acreage was down sharply from last year there was some question
of whether the harvest could be handled without using Mexican
labor.
Mr. Swan remarked that the advertising compaign of
District savings and loan associations that. he had mentioned at
the previous meeting evidently was not proving to be very success
ful in attracting deposits.
The associations were in a rather
tight position as a consequence of that fact and of the current
efforts of the Federal Home Loan Bank Board to dampen their
borrowing.
As a result, the supply of mortgage funds was likely
to be less than had been anticipated and there might be some
firming of mortgage terms, as had already been noted.
The
reserve positions of District banks continued to be under
considerable pressure.
The banks recently had stepped up their
borrowing from the Reserve Bank and they continued to be net
buyers of Federal funds on a substantial scale.
Mr. Swan agreed with those who felt that in light of
the uncertainties existing at present the Committee should not
make a policy change.
He was encouraged by the fact that non
borrowed reserves had increased by only about 2 per cent in
8/10/65
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July--much less than in June--without any additional upward
pressure on member bank borrowings and net borrowed reserves.
Mr. Swan noted that intra-monthly fluctuations in
reserves were relatively small in August and that the need for
supplying a substantial volume of reserves for seasonal reasons
would not arise until later in the year.
In view of those facts
he wondered whether it might not be appropriate to put a little
more emphasis on the figures for nonborrowed reserves in inter
preting a decision to make no change in policy, at the same time
widening somewhat the target ranges for bo-rowings and net
borrowed reserves in both directions.
If a policy decision for
"no change" was interpreted in terms of supplying about the same
amount of norborrowed reserves in August as in July, a change
toward either stronger or weaker credit demands would be reflected
in the figures for borrowings and net borrowed reserves.
Admittedly,
the Desk might have difficulty in carrying out such an instruction,
but in view of the many uncertainties existing at present it would
be helpful if the Committee could get some better sense of the
nature of market responses during the next few weeks.
Mr. Swan found alternative A acceptable for the directive
with Mr. Mitchell's proposed change.
Perhaps the Committee would
want to use the phrase "to help defend the international position
of the dollar" at some future time, but he did not think it was
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appropriate now.
It seemed to him, as it did to Mr. Galusha,
that if the Committee decided to make no change in policy today
it would be for a set of reasons somewhat different from those
at the previous meeting.
Accordingly, he did not object to the
modifications of language proposed by the staff, although he
agreed that changes should not be made in the directive for their
own sake.
Mr.
Irons reported that there had been little
change during
the past month in most areas of business in the Eleventh District.
Activity was at a high level, and as far as he could tell there
was no evidence of developing softness at this time.
There was
strength in all major categories of employment; unemployment had
declined; department store sales were strong; and both production
and construction were about unchanged at very high levels.
District
businessmen and bankers were quite pleased with economic conditions,
although they were concerned about the various uncertainties that
had been mentioned at the meeting today.
There had been a fractional decline in loans and invest
ments at District banks in the past month, Mr. Irons observed.
The banks were facing strong loan demands, however, and they were
expecting demands to increase in the months ahead.
Several of
the District's larger banks were in a rather tight liquidity
position and had been heavy buyers of Federal funds.
Borrowings
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8/10/65
from the Reserve Bank had not been large--the average was running
at about $35 million--and mainly involved some of the smaller
banks.
However, the Reserve Bank was administering the discount
window fairly strictly under the terms cf Regulation A, and if
administration were relaxed borrowings
substantially.
undoubtedly would rise
Some bankers had commented frankly that they
would prefer to borrow from the Reserve Bank at a rate of 4 per
cent rather than to buy Federal funds at. a 4-1/8 per cent rate.
That situation might raise a question regarding the administration
of the discount window.
He would not pursue the matter at the
meeting, except to note that he was expecting banks as a group
to increase their borrowings and that, with city banks active,
the problem of continuity of borrowing inevitably would arise.
In Mr. Irons' judgment the national economic situation was
strong.
He was optimistic about the outlook, although he recognized
that there would be problems in the months ahead of the kinds others
had noted in connection with inventories, the balance of payments,
and the position of sterling.
Mr. Irons said that his position on policy for the next
three weeks was close to that of Mr. Shepardson.
In view of all
the uncertainties existing he would not want to make an overt change
toward firmness, nor would he move toward greater ease.
As between
no change and a slight shading toward firmness, he had found the
choice to be a close one at the previous meeting and he thought it
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8/10/65
was even closer today.
On balance, however, he would suggest
continuing the posture of the past month during the next three
weeks, maintaining reserve availability and conditions in the
He would not be overly concerned
money market about unchanged.
if the bill rate drifted off; the bill rate had lost much of its
significance recently, with Federal funds often trading at rates
above the discount rate and with the various methods banks had
developed for obtaining funds.
Mr. Irons said he could accept alternative A for the
directive.
He was not particularly happy with the specific
language of the draft, but he thought it would serve the purpose
and did not propose to suggest revisions.
Mr. Latham reported that recent eccnomic trends in the
First District paralleled national trends fairly closely.
Nonagricultural employment registered further gains during the
month of June.
Nonmanufacturing employment slightly exceeded
the normal seasonal pattern, while manufacturing employment was
about in line with seasonal expectations.
Percentage-wise, the
net rise from a year ago remained at 2.2 per cent compared with
3.8 per cent for the country as a whole.
Average weekly hours
of manufacturing production workers rose to 41.4 hours from 41.1
in May and 40.5 a year ago.
There was a slight downward revision
8/10/65
-82
in the manufacturing production index for the District in June,
bringing it to the lowest point since February, but the index
still reflected a net rise of 7.7 per cent from a year ago.
Construction contracts continued their erratic monthly
course in June, Mr. Latham observed.
As a result a cumulative
lag of 5 per cent in nonresidential contracts and a cumulative
gain of 1 per cent in the residential area was recorded for the
first six months of the year in comparison with last year.
Mixed trends were in evidence in consumer spending,
Mr. Latham continued.
Deposits at reporting savings banks showed
a slightly less vigorous growth in June due to heavier with
drawals, which were 9.9 per cent larger than in June 1964 and
compared with new deposit growth of 3.3 per cent.
The 12 months'
gain in the net balance was accordingly further narrowed, to
8.2 per cent.
First District bank experience had generally paralleled
that in the nation, Mr. Latham said.
Total loans, although down,
were not down to the extent that might normally be expected
following the substantial June rise.
to expand.
Real estate loans continued
Government security holdings were further reduced and
the upward trend of time deposits was still in evidence.
ratio of loans to deposits of District reporting banks was
The
8/10/65
-83
75 per cent on July 28 compared with 70.1 per cent for the
country.
Average daily borrowings at the discount window during
the four weeks ended August 4 were relatively light.
Bankers' expectations were that loan demand would continue
its strength on a generally broad base, Mr. Latham observed.
A
steel strike, military needs, or an intensification of the sterling
crisis were the imponderables.
Eliminating extremes in those areas,
it was anticipated that business would continue good and that loan
demand would be on the high side of seasonal limits.
Mr. Balderston said he shared the fears that had been
expressed by some members of the Committee, including Mr. Treiber.
The present season often had been referred to as that of "summer
doldrums' in past years, with that term used to explain, or perhaps
to rationalize, unsatisfactory figures for the domestic economy.
This year, however, there was strength in business at home but
worries abroac.
In view of the complexities of the present
situation he would continue current policy at least until the
next meeting.
At that time the Committee might need to consider
adopting a different policy.
Chairman Martin noted that at the previous meeting of the
Committee he had observed that in his judgment the only important
recent change had been in psychology.
To a certain extent the
same observation seemed warranted at today's meeting.
There was
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-84
one point, however, that he thought needed to be emphasizedas President Johnson had said recently, the country was at war
in Vietnam.
Many might view the hostilities there as a small
war, or a brush fire, but he did not.
In his judgment it was
necessary for the Committee to bear in mind that, while there
had been no declaration of war, a war-time psychology might be
developing more rapidly than was generally realized.
The Chairman went on to say that most members seemed to
agree today that no change should be made in policy.
Those
whose views differed favored so modest a change that it would
be difficult, in his opinion, to spell it out in the directive.
He proposed that the Committee vote on a directive consisting
of the suggested alternative A, with the change Mr. Mitchell
had suggested.
Mr. Treiber commented that Mr. Mitchell had proposed
substituting the words "to maintain" the international position
of the dollar for the staff's suggested words, "to help defend."
In preference to either, he would like to see the words "to
strengthen" used.
He noted that the previous directive had
included the phrase "to reinforce the voluntary restraint
program to strengthen the international positions of the dollar,"
and he thought it would be undesirable to drop the word "strengthen."
8/10/65
-85Mr. Mitchell said that Mr. Treiber's suggestion was agreeable
to him.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Federal Reserve Bank of New York
was authorized and directed, until
otherwise directed by the Committee,
to execute transactions in the System
Account in accordance with the follow
ing current economic policy directive:
The economic and financial developments reviewed at
this meeting indicate that the domestic economy has
expanded further, but at a slower pace than early in the
year, and that the improvement in our international
payments that occurred in the second quarter has been
maintained for the time being, although gold outflows
have continued and international developments are
creating uncertainties in securities and foreign
exchange markets. In this situation, it remains the
Federal Open Market Committee's currer.t policy to
strengthen the international position of the dollar,
and to avoid the emergence of inflationary pressures,
while accommodating moderate growth in the reserve
base, bank credit, and the money supply.
To implement this policy, 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,
while taking into account the Treasury financing about
to be completed and the unsettled conditions in
securities and foreign exchange markets.
It was agreed that the next meeting of the Committee would be
held on Tuesday, August 31, 1965, at 9:30 a.m.
Thereupon the meeting adjourned.
cretary
ATTACHMENT A
CONFIDENTIAL
(FR)
August 9,
1965
Drafts of Current Economic Policy Directive for Consideration by
the Federal Open Market Committee at its meeting on August 10, 1965
Note: Because of the divergent interpretations of recent economic and
financial developments expressed at the July 13 meeting, three alternative
drafts of the directive are given below.
Alternative A (no change)
The economic and financial developments reviewed at this meeting
indicate that the domestic economy has expanded further, but at a slower
pace than early in the year, and that the improvement in our international
payments that occurred in the second quarter has been maintained for the
time being, although gold outflows have continued and international
developments are creating uncertanties in securities and foreign exchange
markets. In this situation, it remains the Federal Open Market Committee's
current policy to help defend the international position of the dollar,
and to avoid the emergence of inflationary pressures, while accommodating
moderate growth in the reserve base, bank credit, and the money supply.
To implement this policy, 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,
while taking into account the Treasury financing about to be completed
and the unsettled conditions in securities and foreign exchange markets.
Alternative B (firming)
The economic and financial developments reviewed at this meeting
indicate that the domestic economy has expanded further, some prices
have been under upward pressure, bank credit and money supply expansion
has been vigorous over recent months, and prospects are that increased
Federal expenditures as a result of hostilities in Vietnam will expand
overall demand in the months ahead. Although U.S. capital outflow has
been moderate, reflecting the large initial impact of the Administration's
balance of payments program, the trade surplus has diminished, gold
outflows have continued, and international developments are creating
uncertainties in securities and foreign exchange markets. In this
situation, it is the Federal Open Market Committee's current policy to
help defend the international position of the dollar, and to avoid the
emergence of inflationary pressures, by moderating growth in the reserve
base, bank credit, and the money supply.
CONFIDENTAL (FR)
-2
To implement this policy, System open market operations over the
next three weeks shall be conducted with a view to attaining somewhat
firmer conditions in the money market, while taking into account tne
Treasury financing about to be completed and the unsettled conditions
in securities and foreign exchange markets.
Alternative C (easing)
The economic and financial developments reviewed at this
meeting indicate that the domestic economy has expanded further,
although at a slower pace than early in the year. Inventories have
continued to accumulate, particularly of steel, and final demands
appear to be rising more slowly than industrial productive capacity.
Recent price movements have been mixed and noncumulative in nature.
Some long-term interest rates are up moderately this year. The
improved position of our international payments has been maintained,
and gold takings by foreign central banks have been somewhat reduced,
but international developments are causing uncertainties in securities
and foreign exchange markets. In this situation, it is the Federal
Open Market Committee's current policy to facilitate fuller utilization
of resources while helping to defend the international position of the
dollar and to avoid the emergence of inflationary pressures, by accom
modating moderate growth in the reserve base, bank credit, and the
money supply.
To implement this policy, System open market operations over
the next three weeks shall be conducted with a view to attaining
somewhat easier conditions in the money market, taking into account
the Treasury financing about to be completed and the unsettled condi
tions in securities and foreign exchange markets.
Cite this document
Federal Reserve (1965, August 9). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19650810
@misc{wtfs_fomc_minutes_19650810,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1965},
month = {Aug},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19650810},
note = {Retrieved via When the Fed Speaks corpus}
}