FOMC Minutes
A meeting of the Federal Open Marke: Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washington, D. C., on Tuesday, September 28, 1965, at 9:30 a.m.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Cha.rman
Balderston
Daane
Ellis
Galusha
Maisel
Mitchell
Robertson
Scanlon
Shepardson
Irons, Alternate for Mr. Bryan
Messrs. Bopp, 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, Holland, Koch, and
Willis, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Molony, Assistant to the Board of Governors
Mr. Cardon, Legislative Counsel, Board of Governors
Messrs. Partee and Williams, Advisers, Division of
Research and Statistics, Board of Governors
Mr. Reynolds, Associate Advisor, Division of
International Finance, Board of Governors
Mr. Axilrod, Chief, Government Finance Section,
Division of Research and Statistics, Board
of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
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9/28/65
Mr. Patterson, First Vice President of the
Federal Reserve Bank of Atlanta
Messrs. Link, Eastburn, Mann, Parthemos, Brandt,
Jones, Tow, Green, and Craven, Vice Presidents
of the Federal Reserve Banks of New York,
Philadelphia, Cleveland, Richmond, Atlanta,
St. Louis, Kansas City, Dallas, and San
Francisco, respectively
Mr. Geng, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. MacLaury, Manager, Foreign Department,
Federal Reserve Bank of New York
Mr. Kareken, Consultant, Federal Reserve Bank
of Minneapolis
Upon motion duly made and seconded, and
by unanimous vote, the minutes of the meetings
of the Federal Open Market Committee held on
August 31 and September 8, 1965, were approved.
Upon motion duly made and seconded, and
by unanimous vote, the action was ratified that
had been taken by members of the Federal Open
Market Committee on September 14, 1965, authoriz
ing use of the authority for covered purchases of
sterling in a manner involving combined System
Treasury participation in the program of assistance
to Britain in the amount of $400 million, shared
equally by the System and the Treasury, rather
than the lesser of this sum or 40 per cent of the
total amount of assistance to Britain.
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 exchange market conditions and on Open Market
Account and Treasury operations in foreign currencies for the period
August 31 through September 22, 1965, and a supplemental report for
September 23 through 27, 1965.
in the files of the Committee.
Copies of these reports have been placed
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In comments supplementing the written reports, Mr. MacLaury
said the gold stock would remain unchanged again this week, and the
Stabilization Fund was expected to finish the month with holdings of
about $70 million.
France would be buying about $50 million in gold
on September 30, on the basis of its adjusted reserve gains in August.
The effecc of that French purchase on U.S. reserves would be offset,
however, by a sale of $50 million of gold by the Bank of England.
The
British sale was arranged toward the end of August to help keep U.S.
gold losses at a minimum during a period of more than usual uncertanties.
It looked as though the International Monetary Fund gold mitiga
tion arrangement would be put in operation very shortly, Mr. MacLaury
said.
As the Committee would recall, that arrangement involved the
deposit with the Federal Reserve Bank of New York by the IMF of gold
purchased from .he U.S. by countries making their gold subscription to
the IMF as part of their quota increases.
That deposited gold would
continue to be shown as part of the total U.S. gold stock, but the
amount due to the IMF on demand would be identified in monthly data in
much the same manner as was the $800 million sold to the U.S. several
years ago under repurchase option by the IMF to obtain investment income.
In the London gold market, Mr. MacLaury continued, the price had
remained in a fairly narrow range during September--$35.11-1/2 to $35.15with Russia continuing on the sidelines.
The gold pool, which was able
to distribute $74 million to its members early this month on the basis
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9/28/65
of August's operations,
had on balance lost about $30 million so far
in September.
The cumulative deficit thus had risen again to about
$155 million.
That decline reflected not only the absence of Russia,
but also a smaller volume of gold coming on the market from new
production and from South African reserves; and,
as had been learned
just yesterday, some renewed buying by Communist China through
Switzerland, starting last week.
The Chinese purchases helped explain
why turnover had remained at higher levels than had been expected
after quieting down following the Pakistan-India hostilities.
Since the last meeting, Mr. MacLaury went on, the focus of
attention in
sterling.
the exchange markets had been,
more than ever,
on
To date, at least, there was every reason to be encouraged
by the market response to the central bank operation that had been
put into action on September 10.
Since that date, the Bank of England
had taken in more than $350 million from the market while the spot
rate had been bid up--at first
by official intervention,
from 2.7918 to nearly parity,
the market itself--some 80 points,
the announcement of mediocre U.K.
the sterling market,
des,ite
trade figures for August and the
unsettling effects of the Pakistan-India war.
of events in
and then by
In view of the importance
the day-to-day
(and,
during the first
day, the hour-to-hour) account of that operation and the market's
response had been spelled out in more detail than usual in the written
reports submitted to the Committee.
9/28/65
In general outline, Mr. MacLaury said, the sequence was this:
On Friday, September 10, following negotiaticns of which the Committee
was aware, the Bank of England announced at 2:00 p.m. London time
(9:00 a.m. New York time) that it had entered into new arrangements,
in various--unspecified--forms, with all of the banks that had
cooperated in support of sterling last November except the Bank of
France.
The announcement, which the New York Bank read immediately
to the exchange trading rooms of banks in the New York market, said
that the arrangements would enable appropriate action to be taken in
the exchange markets.
As soon as all of the banks had been advised,
the System Account began to bid the fourteen banks simultaneously for
a total of £
10million on each round of bids, gradually raising the
bid in corsultation with the Bank of England as the market backed away,
and buying only a small amount.
By the close in New York that Friday,
the System had bought only $13 million equivalent of sterling while
raising the market price some 25 points.
With the European markets already moving toward their pre-weekend
close by the time the announcement by the Bank of England was released
on Friday, Mr. MacLaury said, it was not to be expected that there would
be any sudden move to cover in size that day.
The following week, however,
there was a surge of buying, mainly from London and the continent, as the
markets became persuaded that the cooperating central banks had the means
and the determination to make speculation against sterling costly.
During
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9/28/65
the week following the announcement the Bank of England took in
$230 million as the rate rose another 40 points without official
intervention.
The initial rush to cover near-term commitments was
quite naturally most evident during the first week following the ini
tiation of the operation.
Last week, the week of September 20, the
markets were much less hectic, and on a few occasions the rate started
to drift off in light trading.
However, it took only a small amount
of intervention by the Federal Reserve in New York and the Bank of
England in London to turn the market around again, and by the end of
last week the spot rate was up another 10 points and the Bank of
England on balance had taken in almost $50 million.
Yesterday that
Bank took in $35 million and today another $40 million, raising their
total acquisitions since the announcement to about $350 million.
That
figure did not include some amounts taken in prior to the current
operation.
Mr. MacLaury went on to say that the ;olt administered to the
market by the central bank operation carried over into the forward
market as well, although no intervention was undertaken in that area.
The discount on three-month sterling, which had been about 2-1/2 per
cent at the beginning of September, narrowed to less than 1-3/4 per
cent, cutting the theoretical arbitrage advantage in favor of New York
considerably, to about 1/4 per cent today.
While that strengthening
of sterling forwards undoubtedly reflected some covering of open
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positions, his impression was that the covering done so far had been
largely by outright speculators or by those with near-term commitments.
The vast bulk of the hedging and commercial covering operations still
remained to be reversed, and while there was every reason to believe
that if economic conditions in the U.K. continued to improve those
positions would be closed out, it was difficult to gauge the timing
of the covering.
There was no doubt, however, that market sentiment
regarding the short-run prospects for sterling had changed completely
within just a little over a month.
That change, based partly on the
technical strength resulting from the oversold position of sterling
and partly on the measures dealing with prices and incomes announced
by the U.K. government, was beginning to take place even before the
central bank operation was put into effect.
However, it was the
announcement of new central bank arrangements, followed up immediately
by forceful concerted action in the market, that provided the catalyst
to translate changed sentiment into market response.
For the longer run, Mr. MacLaury remarked, it was clear that
many hurdles still remained to be cleared and it was essential,
therefore, that the U.K. authorities not let up their efforts to achieve
their stated balance of payments objectives.
Whatever the developments
during succeeding weeks might be, however, the operation, as he had
said at the outset, had clearly been very useful and had cost very
little.
It had not been necessary for the Bank of England to call
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-8
upon any of the facilities made available by the other participating
central banks and the Bank for International Settlements, and the
total amount of sterling acquired by the System in the operation to
date--and thus subject to the exchange guarantee--had been only a
little over $20 million equivalent, as against $350 million taken
in by the Bank of England.
As far as other currencies were concerned, Mr.
the turnaround in
MacLaury said,
sterling had had less effect on continental rates
against the dollar than might have been expected.
In the cases of
the French and Belgian francs, there definitely had been some easing
against the dollar which could be ascribed to covering into sterling.
Although it was difficult to keep track of changes in French reserves,
it appeared that they had risen by perhaps $35 million so far this
month with almost all of the increase occurring in the first few clays
of the month prior to the announcement of the sterling arrangements.
The flow of dollars into Italy, while continuing to be sizable,
had
tapered off noticeably, but the change was due less to the recovery
of sterling than to the tapering off of seasonal inflows.
The Italian
authorities were continuing to increase their dollar swaps with the
commercial banks, thus reducing published reserve gains.
In Germany
and the Netherlands, any tendency toward easing had been offset by
some tightening in the domestic money markets associated with tax
dates.
The rise in German reserves during September reflected mainly,
9/28/65
-9
if not entirely, the unwinding of previous central bank swaps with the
German commercial banks, not new inflows of funds.
In general, changes
in continental currency rates and, for that matter, in the rate on the
Canadian dol:ar had been limited.
Mr. MacLaury noted that Mr. Sanford had reported at the August 31
meeting that the Bank of England and the Bank of Canada had agreed to use
90-day U.S. Treasury bill rates as the basis for interest rate charges
under swap drawings.
Since then the Bank of Japan also had agreed to
that procedure, thus putting all of the arrangements except that with
the National Bank of Belgium on the same footing in that respect.
Thereupon, upon motion duly made
and seconded, and by unanimous vote, the
System open market transactions in foreign
currencies during the period August 31
through September 27, 1965, were approved,
ratified, and confirmed.
Mr. MacLaury then asked the Committee's approval of renewal
for a further period of one year of the $450 million standby swap
arrangement with the Bank of Italy, which was due to mature October 20,
1965.
He noted that the System's drawings under that arrangement
currently amounted to $100 million.
Renewal for a further period of
one year of the $450 million standby
swap arrangement with the Bank of Italy,
as recommended by Mr. MacLaury, was
approved.
9/28/65
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Mr. MacLaury then noted that a drawing of $275 million by the
Bank of England under its swap arrangement with the System was due
to mature September 30 and was likely to be renewed in whole or in
part.
That would be a first renewal.
Possible renewal for a further
period of three months of part or all
of the $275 million drawing by the Bank
of England under its standby swap arrange
ment with the System was noted without
objection,
Mr. MacLaury reported that a Federal Reserve drawing of $48
million under tne arrangement with the Swiss National Bank, represent
ing the remaining balance of a drawing of $60 million originally made
in January 1965, was due to mature October 20, 1965.
From the market
point of view prospects were not good at the moment for repaying the
drawing before maturity, and it appeared that it would have to be
renewed for a third time.
Mr. Shepardson observed that a third renewal would put the
drawing into the 9-12 month category, bringing it close to the limit
of one year the Committee had placed on drawings under the swap lines.
He hoped that there were definite plans to repay the drawing within
the next three months.
Mr. MacLaury commented that there was no question in his mind
but that the drawing would be repaid in the coming period, in accordance
with the Committee's guidelines.
9/28/65
-11Renewal of the $48 million drawing
under the standby swap arrangement with
the Swiss National Bank for a further
period of three months was noted without
objection.
Finally, Mr. MacLaury noted that it was expected that the
System's swap with the Bank for International Settlements of German
marks for Swiss francs in the amount of $40 million equivalent would
be rolled over for a second three-month period on October 8, 1965.
Renewal of the German mark-Swiss
franc swap with the Bank for International
Settlements for a further period of three
months was noted without objection.
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 August 31 through September
22, 1965, and a supplemental report for September 23 through 27, 1965,
Copies of both reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes commented
as follo.s:
Viewed from our current vantage point, and without the
benefit of perspective that only a longer period of time can
provide, the highlight of the period since the last meeting
of the Committee has been the performance of short-term rates,
particularly bill rates, in just the past few days. For the
first three weeks of the period since August 30, Treasury bill
rates showed comparatively little change--the three-month rate
hovering around 3.88 to 3.90 per cent and the six-month rate
slowly inching up from about 4 per cent to 4.04 per cent. One
year bills were bid at rates close to the six-month level.
9/28/65
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During the past week, in contrast, the three-month rate has
moved to 3.99 per cent and the six-month rate to 4.13 per
cent, and the one-year bill (which was bid at 4.03 per cent
at the time of the last meeting) closed at 4.20 per cent bid
in market trading yesterday after having, been auctioned last
Friday at no less than 4.24 per cent.
For the most part, the rate rise seems to be traceable
to market apprehension about increased supplies of Treasury
bills as the Treasury raises new cash in the closing months
of the year. The Treasury's announcemert last Wednesday of
a $4 billion borrowing through the issuance of two tax antic
ipation bills seemed to surprise the market both by its size
and specific content--although certainly the market had expected
some cash borrowing at this time. Adding to the unreceptive
atmosphere was a rather tight money market in the wake of the
September dividend and tax dates, particularly as reflected
in higher dealer financing costs. Also in the background,
various investor groups that are normally active in the bill
market, including corporations and various State and local
funds, appear to have had relatively light demands. Indeed,
it would appear that many of the same factors which, a few
months ago, were tending to produce a relatively low level
of bill rates compared with other money market conditions are
now being felt in reverse with resultant upward yield adjust
ments.
In yesterday's regular auction for three- and six-month
bills the average issuing rates were about 3.98 and 4.13 per
cent, with rather cautious bidding for each bill so that some
three-month bills were bought as high as 4.02 per cent in rate
while the six-month issue tailed out to a rate of 4.15 per cent.
For the recent period as a whole such measures of the general
condition of the money market as member bank borrowing, net
borrowed reserves, and the Federal funds rate were about unchanged
from the level of recent months, but as already indicated there
was a tendency toward a tighter atmosphere in the latter part of
the period, when required reserves were running strongly above
seasonal levels. The weight of heavy credit demands and the
redistribution of other financial assets associated with the tax
date pressed heavily on the central money market at the time. In
part this seemed to result from Treasury fiscal operations, as
balances built up to meet quarterly tax payments remained only
briefly with money center banks and were soon channeled through
out the country to meet Treasury outpayments. The fact that the
tax date coincided with the end of a country bank reserve period,
after which there is typically a flow of funds from the money
centers to country banks, tended to exaggerate the process.
9/28/65
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The combination of these factors produced a substantial
demand for reserve balances, from banks both in New York and
out of town. Demands for Federal funds expanded; the supply
diminished and there was a gradual increase in the willingness
of banks to pay the 4-1/4 per cent rate for Federal funds.
It was in this atmosphere that the market experienced, last
Friday, the first occurrence of a 4-1/4 per cent effective
Federal funds rate with slightly more money moving at that
rate than at 4-1/8 per cent. Another factor in the banks'
willingness to pay up for Federal funds. in a few instances
at least, has apparently been the desire to avoid repeated
borrowing at the discount window. Majo banks have also been
more aggressive in their efforts to replace the large volume
of certificates of deposit which matured over the dividend and
tax dates. In this connection rates of 4-1/2 per cent have
been offered by New York City banks for maturities of six months
or less. In the last day or two some of these special influ
ences have been reversed--notably, the basic reserve deficiency
of the major New York City banks has declined substantiallybut some effects of the recent tightness, have lingered on.
Through most of September, the market for Treasury notes
and bonds tended to fluctuate indecisively after moving lower
in price during the previous month. With an assist from System
purchases in the early part of September and intermittent
buying by Treasury accounts throughout the month, prices
steadied in the intermediate area, although longer bonds
continued to drift downward--apparently reflecting some con
tinued supplies from investors switching into corporate
securities. The corporate market itself tended to develop
some greater assurance, as a $100 million Aaa-rated telephone
utility offering sold out quickly on September 15, and several
other slow-moving corporate bond offerings were distributed
in the wake of that sale. Toward the close of the period,
however, some of the weakness developing in the short-term
area also permeated the markets for longer issues, and some
further price declines occurred in the Treasury bond market;
corporate issues held fairly steady in price but tended to
lose the glow that had begun to develop after the successful
sale of Aaa-rated bonds on September 15. In the meantime,
the market in tax-exempt bonds, which had come through
August comparatively unscathed, adjusted higher in rate
during September as sizable price concessions were needed to
move recent and current offerings into the portfolios of more
reluctant buyers.
For the past four weeks taken together, System operations
were pretty much offsetting, as reserve absorption in the first
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three weeks was nearly counterbalanced in the last week by
large-scale provisions to meet current month-end needs.
Projections indicate that further reserve provisions will be
needed in the next few weeks; it would appear appropriate at
some point to meet a part of this need with purchases of coupon
issues, as well as with more purchases of bills and acquisitions
under shoct-term repurchase agreements.
Next Tuesday the Treasury will auction the aforementioned
$4 billion of tax anticipation bills--$3 billion March bills
and $1 billion June bills--with payment to be made on October 11.
Payment may be made in full by direct crediting of Treasury
tax and loan accounts, and it is accordingly to be expected
that commercial banks will initially underwrite the entire
offering. At the same time, given the limited availability
of bank reserves and the prospective demands for credit
ahead, it seems likely that banks would want to resell a
sizable part of their takings in fairly short order. The
substantial volume of bills to be redistributed would certainly
suggest that upward pressures on short-term rates may persist
during this period. Moreover, in late October the Treasury will
be announcing the terms of its November refinancing, which is
expected to raise some additional cash in the relatively short
term area. Then, an additional offering of tax bills is expected
in late November. Technical factors, then, are apt to be exerting
some upwa-d pressure on rates for some time to come.
Mr. Hickman observed that, in view of the recent sharp rise in
bill rates, during the next few weeks the Desk might use the repurchase
agreement technique less frequently than usually to supply reserves, and
rely mainly on market purchases.
Mr.
Holmes agreed, noting that there
certainly was no reason to avoid bill purchases in supplying reserves
at present.
Repurchase agreements would continue to be useful when it
was expected that operations to supply reserves would have to be reversed
shortly.
Mr. Mitchell commented that according to Mr. Holmes' description
of the events of the past week there had been a change in market conditions,
9/28/65
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whereas the directive issued at the meeting of August 31 in effect had
called for no change.
He asked what particular circumstances had led
to the Desk's decision not to operate more aggressively in an effort
to ease the tighter market conditions.
Mr. Holmes replied that the period in question had been a most
difficult one for the Desk, partly because the reserve estimates were
much less consistent than usual with the tone of the market.
One
morning about a week ago, for example, the estimate for net borrowed
reserves was at the relatively low level of $68 million.
There was
an opportunity to sell some bills to foreign accounts, and at the
time of the eleven o'clock call he had felt that some additional bills
might advantageously be sold in the market.
During the day, however,
it had been decided not to sell bills in view of the pressures in the
market, and that turned out to be the right decision.
The reserves
were in the banking system, but they seemed to be concentrated mainly
at country banks.
Net borrowed reserves recently had been running
lower, not higher, than earlier, except for the latest week when they
were back within the previous range.
Required reserves apparently had
been rising much more than seasonally, particularly in the last two
reserve periods.
The combination of the psychology that had been
developing in the bill market, the desire of many banks to avoid
discounting at the Federal Reserve, and the willingness of many to
pay 4-1/4 per cent for Federal funds produced a situation that was
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9/28/65
extremely difficult to deal with if very low levels of net borrowed
reserves were to be avoided.
Mr. Mitchell commented that evidently the Desk was watching
the figures on net borrowed reserves closely, and the fact that they
were running below the range that Committee members had mentioned at
the August 31 meeting was the reason it had not intervened more
aggressively.
Mr. Holmes replied that the level of net borrowed reserves
was one consideration the Desk had taken into account.
The market
reaction to the Treasury financing was another; psychological factors
such as were involved in that reaction were hard to deal with by the
provision of a few more reserves.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Gov
ernment securities and bankers' accept
ances during the period August 31 through
September 27, 1965, were approved, ratified,
and confirmed.
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. Koch made the following statement on economic conditions:
At the time of our last meeting the two main uncertanties
on the domestic economic scene were the likely future effects
of Vietnam on military spending and the prolonged wage bargaining
9/28/65
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in the steel industry with its potential disrupting effects
on wages, prices, and inventory investment.
It now seems highly likely that some early talk about
the size of military expenditures in the near-term future
was exaggerated. Last spring, defense spending for the 1966
fiscal year had been projected at about $1-1/2 billion above
fiscal 1965. Vietnam may have increased this figure to
perhaps $3 to $4 billion. The net expansionary effects of
the second stage of income tax reductions, excise tax re
ductions, and the new social security program will perhaps add
up to ano:her $5 to $6 billion. Other forms of Federal spending
are also likely to go up a little, but the net effects of all
this expansionary Federal activity could be only moderately
larger than the normal revenue growth associated with current
tax rates and the expected growth in corporate and individual
incomes.
As for the likely effects of the ultimate wage settlement
in the steel industry, and looking at inventories first, the
prospects for further economic growth--both overall and more
specifically in the steel-using industries--suggest that steel
inventories will be reduced less than had been anticipated
earlier. Nevertheless, the net effect of such decumulation
could decrease total business inventory growth from the third
to the fourth quarter by $2 to $3 billion on an annual rate
basis.
Inventory accumulation in most lines other than steel,
however, will no doubt continue, so that the total inventory
change will still be positive.
Time permits only brief mention of the likely future
course of other major elements of the GNP, but they are
expected either to expand or to show little change. Total
consumer spending, which has increased sharply and steadily
throughout the current long expansion, will no doubt con
tinue to be strong. The relationship between such spending
and personal incomes is relatively stable, and incomes have
recently teen augmented by a large lump-sum social security
benefit peyment as well as by an increase in current payments.
The spending propensities of the aged are no doubt higher than
those of other segments of the population.
Total retail sales in the third quarter are likely to be
up 2 per cent from the second. New auto sales, after declining
in the spring months, have risen again this summer, perhaps
aided by the excise tax cut. High recent sales and the latest
surveys of consumer buying intentions suggest a fourth consecutive
good auto year.
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Turning to business spending, increased outlays for
new plant and equipment have been another important factor
in the continuing economic expansion. The latest Commerce
SEC survey projects further strength in this area during
the remaining months of 1965. Capital appropriations data
covering manufacturing firms suggest a continuation of high
investment by business well into 1966. Rounding out the
picture, State and local government spending will certainly
continue its long, strong rise, net exports will at least
remain stable and possibly rise further, and residential
construction may continue at current levels, somewhat
below earlier highs.
Adding all these elements together suggests to me a
GNP of perhaps $680 billion or even a little larger in the
fourth quarter and about $670 billion or so for the year
as a whole, or a year-to-year gain of a little over $40
billion. These figures are at the top-end of the range we
had projected earlier in the year, after adjustment for the
recent basic revisions in the GNP accounts.
There is still too little evidence available to frame
a defensible outlook for next year, but many forecasters
are now projecting a dollar rise in GNP of about $40 billion,
little changed from that this year, and a rate of increase
in constant dollars of about 4 per cent, a little less than
this year. All I think one can say with any assurance at
this time is that recent developments, including those on
the international front, now make it very likely that the
current, long-lived expansion will continue well into 1966.
In the foreseeable future we still have a good chance of
steering the middle course of maintaining our current rate
of expansion without veering off into the ditches of either
inflation or recession.
The relevance of this discussion about the likely future
course of the GNP to monetary policy lies mainly in its
probable effects on resource utilization and prices. As for
resource utilization, the unemployment rate has now been at
4.5 per cent for 2 months, while the utilization rate of
manufacturing capacity was at about 90 per cent through the
first half of the year. The utilization rate may have crept
up another point in July and August, but it no doubt dropped
again in September with an expected decline in the industrial
production index of about 1 point resulting mainly from the
reduction in steel output.
Of course, this utilization rate is an aggregate measure
for total manufacturing; some lines are at practical capacity
9/28/65
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and others are significantly below it, including now the
key steel industry. The important fact for policy, however,
is that a projected further leveling off or even decline
in industrial production and increase in business plant and
equipment spending do not suggest any large further decline
in the unemployment rate and probably imply some decrease in
the capitol utilization rate for manufacturing in the near
future.
Recent price developments have indicated no tendency
for "overheating."
The total wholesale price index has been
stable during the past 8 weeks, with industrial prices rising
less than earlier and foodstuffs actually declining following
earlier marked increases. Wages have continued to rise at
the approximately 3 per cent annual rate characteristic of
earlier months. Unit labor costs in manufacturing as a whole
have probably risen slightly in recent weeks as the pace of
output slackened, but this should be temporary.
These recent price developments, plus the fact that the
wage settlement in the steel industry was moderate, should
keep further price increases selective and small. Of course,
business optimism and corporate profits are high, and the
stock market is strong. Selective price increases will no
doubt continue. Some such price increases will stick but
others will not, for competition among domestic producers,
as well as foreign importers, continues strong.
Despite the lagged effects of monetary policy, the
current domestic economic situation still does not seem to
me to call for a further restraining monetary policy move,
particularly since more buoyant business expectations,
increased actual demands for financing, and the cumulating
effects of declining bank and corporate liquidity, as I'm
sure Mr. Partee will point out, have led to a significant
firming of interest rates and other credit conditions in
the Last 2 months. This has come about in part accidentally,
as a result of a steel strike threat and international ten
sions. But for whatever reasons, we've been able to make
welcome inroads into the sticky unemployment and capital
utilization problems. I see no reason to risk curbing such
economic progress unless the inflationary thrust becomes
more evident or present efforts at improving the balance
of payments become less effective.
Mr. Hickman noted that in the statement just made--which he
thought was an excellent one--Mr. Koch had expressed the view that net
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9/28/65
exports would be stable or rising.
He (Mr. Hickman) had been under
the impression that the trade surplus was expected to decline.
Mr. Koch replied that there already had been some decline in
net exports this year and his comment had been based on the assumption
that the adjustment had been completed,
He added that even a relatively
large change in net exports would have little effect on GNP since it
was a small item in the total, and Mr. Hickman agreed.
Mr. Partee made the following statement concerning financial
developments:
Financial markets since the last meeting of the Committee
have been in transition to a higher yield structure. Mr. Holmes
has discussed the succession of market events contributing to
this movement. Now I would like to focus on the development
in a somewhat broader perspective, since it seems to me that
the changes occurring in recent weeks represent a sizable and
significart upward movement in interest rates. Since mid-year,
3-month bill yields have risen 20 basis points, 6-month bills
30 basis points, yields on intermediate Governments around 20
basis points, and long-term private and public bonds 10 to 15
basis points. All of these adjustments have taken place
during a period when there was no overt change in monetary
policy, and when net borrowed reserves--though fluctuating
between $100 million and $200 million on a weekly basishave centered fairly closely on $150 million or a little more.
It is evident, therefore, that earlier relationships
among financial market variables have been altered by other
factors. Principal among these has been the improvement in
business expectations, based largely on increased Federal
spending, the continuing boom in plant and equipment, and
the constructive wage settlement in steel. Improved business
expectations have been transmitted to financial markets--most
obviously in stocks, where prices have recovered to their
spring highs on very heavy trading volume, but also in the
credit area, where the implications for financing volume
and possibly for interest rates are widely interpreted as
bullish by the financial community. The large current
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-21
Treasury financing, with the indication that $3 billion more
will be coming in November, has tended to reinforce this
view, even though the total for the half year apparently
will not be much larger than had been expected earlier.
Heavy financing demands during the summer, particularly
by businesses, also have contributed to the pressures in
financial markets. Public offerings of corporate bonds since
the beginning of June have exceeded the year--earlier volume
by $1 billion, or 80 per cent; about half of this increase
was in bank capital issues, which remained in the investment
stream but nevertheless enlarged demands for long-term funds
in the corporate market. Bank business loan expansion, at a
17 per cent annual rate in the June-July-August period, was
nearly double that of a year ago. Loan demand weakened
temporarily after mid-August, but tax date borrowing was
very large--one-fifth more than a year ago and nearly twice
the average of the three preceding years, at weekly reporting
banks.
Inventory accumulation in steel and steel-using products
has been a significant factor in loan expansion this year,
and a working down of these stocks now will doubtless permit
some loan repayment. But the prospects still seem to be for
substantially more than seasonal loan expansion this fall.
Similarly, looking beyond the immediate calendar, the pros
pect seems to be for a continued large volume of bond flotations.
The extent to which external financing of business will be
from banks or in the market depends on a variety of factors,
including yield relationships and expectations. Taking into
account Treasury needs, however, no significant reduction in
aggregate financing demands seems indicated.
Tightening in financial markets also appears attributable
in part to the cumulative effects of decreasing liquidity in
key sectors of the economy. Corporate holdings of liquid
assets have been declining since last fall; the reduction in
the second quarter was unusually sharp and it seems unlikely
that there was any appreciable rebuilding in holdings during
the summer. This has special relevance for banks both in
terms of loan demand and in potentials for further expansion
in CD sales. Banks have relied heavily on these instruments
to finance loan expansion this year, as some corporations
apparently shifted liquidity holdings from bills to CDs; a
less expansive and more volatile market now could influence
both supplies of loanable funds and bank views as to minimum
liquidity needs. This, in turn, has implications for bank
buying of municipals and mortgages, as well as for the
availability of bank credit to businesses and consumers.
9/28/65
-22
Under the circumstances, it is not surprising that we
have been hearing increased banker comment lately about
efforts to ration credit. And our systematic roundup of
such comments, from the September lending practices survey,
seems to confirm a marked further shift toward firmer lending
policies in the business credit and finance company areas.
Similarly, there have been fragmentary indications from
other sources of some firming in attitudes regarding mortgage
and consumer lending standards.
Thus, it appears that an appreciable firming in financial
conditions has been in process, not only in market yields but
also in terms of the availability of bank credit. The very
large bank credit increase reported for August, it seems to
me, should be discounted. The series is volatile and presents
serious seasonal adjustment problems; moreover, the member
bank credit proxy--essential, total deposits--declined in
August and apparently again in September to rates of increase
well below the average for this year and last.
Similarly,
the very large increase for the money supply indicated for
September reflected an even sharper decline in Government
deposits; partial restoration of unusually low September
balances may exert a depressing effect on private money
holdings over the next few weeks.
In view of the present ebullience of business and finan
cial sentiment, it may well be appropriate that the combination
of strong demand, declining liquidity, and anticipation has
been permitted to exert some self-tightening influence on
credit markets. Further increases in the structure of rates,
however, would bring into question the viability of the dis
count rate and Regulation Q ceilings. At present market
rates, many banks are likely to have trouble competing for
CDs under the existing ceilings; farther firming in rates
would almost certainly bring correspondingly greater pressure
to bear on use of the discount window.
For the present, it seems to me that any indication of
further moves toward monetary restraint should be avoided.
The size and sensitivity of the Treasury cash financing, and
the need to avoid additional upsets to the market while new
rate relationships are being worked out and tested, would
seem to dictate an "even keel" policy stance.
Should the Committee decide that "no change" for this
meeting is the appropriate course, there are two further
aspects to the problem on which I think the Manager deserves
some direction. First is whether primary emphasis should be
placed on marginal reserves or on money market rates, since
9/28/65
-23-
these relationships have changed in recent weeks. Second,
in view of the changes that have taken place in both rates
and reserves, there is the problem of whether a "no change"
policy means maintaining money market conditions as taut as
they have been most recently, or as they have been on average
since the last meeting of the Committee. Even if "even keel"
is taken to mean maintenance of current conditions, the term
probably should contemplate permitting some rates that have
advanced most sharply to back down a few basis points, while
laggard rates are still in process of adjusting upward.
Mr. Reynolds presented the following statement on the balance
of payments:
It now appears that the third-quarter payments deficit
on "regular transactions" may work out at an annual rate of
about $1-1/2 billion, a little above the rate for the first
half year. Probably $1-1/2 billion is also still a reasonable
guess for the year as a whole, assuming that the United Kingdom
will not draw on its credit line with the Export-Import Bank or
postpone its year-end debt service payments; but earlier hopes
that we might do better than that this year have waned.
Detaled data for July, or July-August, suggest that the
trade balance has improved a little compared with the first
half, but that net U.S. private capital outflows may have
increased more. Earlier reflows of U.S bank credit and of
nonbank liquid funds have diminished on a seasonally adjusted
basis (the seasonals being large at this time of year), and
outflows through new foreign security sales to U.S. residents,
for which third-quarter data are fairly complete, increased.
Also, net foreign sales of U.S. corporate securities, mainly
for British account, totaled $110 million in July alone,
three times the average rate of the first half year.
Since the last meeting, we have learned that in the
second quarter there was another very large outflow of direct
investment capital. Most analysts had earlier braced them
selves for somewhat larger outflows this year than last,
despite some attempts at voluntary restraint. But no one,
I think, had imagined that such outflows would shoot up to
more than $2 billion in a single half year, compared with
$2.4 billion for the full year 1964, which was itself a record.
There has been a larger than usual quota of identifiable
special elements in this year's outflow. International petro
leum companies made large retroactive tax payments, following
9/28/65
-24-
renegotiation of agreements, and also leased some new conces
sions.
The counterpart of these payments is clearly seen in
the statistics of Iran, Iraq, Saudi Arabia, and Libya, whose
combined gold and foreign exchange reserves increased by
$450 million, or more than 25 per cent, during the first 7
months of this year. When people say that primary producing
countries are doing badly this year, they should be careful
to exclude the oil countries.
Another special transaction was the conversion of a
$100 million U.S. investment in Canada from loans to a direct
investment, without net effect on the balance of payments.
Finally, there appear to have been some anticipatory transfers
of funds early in the year for later use. Altogether, the
transactions I have listed may have accounted for $1/2 billion
of the direct investment outflow in the first half year. But
even without these, the outflow in the first half would have
been well above last year's rate.
It seems clear that voluntary restraint has not yet
amounted to much in this area, and that direct investment
should still be thought of as being on a strongly rising trend,
sustained by large U.S. corporate profits, cash flows, and
credit availability, and by rapid economic growth abroad.
Direct investment outflows will almost certainly be lower
in the second half year than in the first. Indeed, despite
the special oil payments, such outflows diminished by nearly
$300 million in the second quarter. Even if for the full year
they are up by as much as 40 per cent over last year, as
Government analysts are now guessing, they would decline by
$700 million between the first and second halves. Within
total capital flow, this decline could offset--and is perhaps
already offsetting--much of the adverse impact of renewed bank
lending and of the cessation of reflows of liquid corporate
funds.
For the long run, direct investment outflows may not pose
They pay out in about 8 years on the
very serious problems.
average, so that recent large outflows may only briefly interrupt
the faster rise of income than of outflow, while later contributing
to it. But they raise awkward problems for the middle-range period
of these two or three years during which the United States is
trying decisively to reestablish payments equilibrium. In particular,
it is difficult to keep banks on a tight leash when corporations
making direct investments appear to be running free. Therefore,
one may now reasonably expect the Commerce Department to try to
stiffen its restraint program, difficult though that may be.
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9/28/65
I come back, now, to my guess that the overall deficit
on "regular transactions" may be $1-1/2 billion for the year.
How would such an outcome be interpreted? From one point of
view it would be a remarkable achievement--all that had been
hoped for as of last February, despite lower exports, higher
imports, and larger direct investments than anyone had then
envisaged. Also, it should be noted, British Government
conversions of roughly $1/2 billion of its nonliquid portfolio
into liquid assets during the year will have made our results
that much worse than they would otherwise have been, and this
might be regarded as a flaw in the bookkeeping, helping to
overstate our problem.
On the other hand, the good 1965 result will have been
achieved with the aid of some once-for-all transfers, notably
the repatriation of $600-$700 million of corporate liquid
funds. Also, bank lending to foreigners will have been held
well below the level of most recent years, and this would
probably have been more difficult, without disrupting other
flows, had it not been for last year's extravagant burst of
lending.
People seem always to ask of deficit countries the same
question that they ask of politicans: "Yes, but what have you
done for me lately?" Thus a key question now being asked is
whether further improvement in the balarce of payments can be
foreseen for next year. At the moment, visibility is limited
and it is difficult to see where improvement will come from.
The current account surplus may well turn up again, but capital
outflows also seem likely to increase, unless they are restrained
by further changes in relative credit conditions or by inten
sification of special restraint programs.
Mr. Hickman said he was somewhat puzzled by Mr. Reynolds'
conclusion that it was hard to see where futtre improvement in the balance
of payments would come from if one accepted the earlier part of his
statement.
Mr. Reynolds had suggested that direct investment would
decline if the Commerce Department stiffened its restraint program and
he had noted that the British conversions into liquid assets this year
had had the effect of overstating the size of our portfolio investment.
-26
9/28/65
If the trade balance also was better, as Mr. Koch expected, the
balance of payments should improve further--unless,
of course,
banks stepped up their foreign lending.
Mr.
Reynolds replied that he had not meant to imply by his
statement regarding the expected reduction in direct investments
in the second half of 1965 that such investments would be lower
next year than this year.
The Commerce Department would be fighting
a rising trend and in his view their restraints would have to be
made much stronger in order to bring about on absolute reduction from
the 1965 level of direct investments.
Mr. Maisel noted that both of the alternative directives
suggested by the staff 1/ included the statement that "our international
payments have been in deficit since midyear," presumably on the basis
of the "regular transactions" figures.
He asked whether it was not
correct that U.S. payments were in surplus in July and August when
the measurement was on an "official settlements" basis.
Mr. Reynolds replied that a surplus probably would be recorded
on the official settlements basis for the third quarter, primarily
because of large movements out of sterling into dollars in July and
August.
Although figures for all of September were not yet available,
there probably was a deficit in the month associated with the return
1/
The two alternative directives prepared by the staff are appended
to these minutes as Attachment A.
-27
9/28/65
flow into steling.
continued,
If
the improvement in
the British situation
there was likely to be a deficit on the official settle
ments basis for the year as a whole.
In
re:ponse to a question by Mr.
Daane,
Mr. Reynolds said
that the size of the 1965 deficit on that basis corresponding to his
estimate of a $1-1/2 billion regular transactions deficit would
depend on developments for sterling.
It might be on the order of
$1 billion, but perhaps would be less than that if sterling did not
do well.
Mr. Balderston commented that however the deficit was cal
culated the crux of the problem seemed to him to lie in the fact
that gold outflows were continuing.
Mr. Hayes expressed the view that it
was important to keep
close watch on the payments figures on both bases of calculation, as
well as on changes in the gold stock.
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) Prices and costs.--How have near-term prospects for wages,
unit labor costs, and prices changed since the steel settlement?
The overall cost of the new labor contract in the steel
industry, which runs to August 1, 1968, represents neither a
Terms of
new pattern nor an acceleration in wage increases.
the contract are roughly in line with estimates of the gain in
output per manhour in the steel industry--and in the economy
Consequently, they imply continued stability in
generally.
labor cost per unit of steel production and remove one
9/28/65
potential basis for a general steel price rise. This new agree
ment should exert a major influence in holding coming settlements
to noninflationary levels.
(The next major negotiation, in the
electrical machinery industry, does not occur until the middle
of next year.)
As contract negotiations are completed in other metal
industries where employees are represented by the United Steel
Workers, prices may be raised for some products. These devel
opments, however, do not have the potential for a cumulative
price and cost rise such as followed the very large increase
in steel wages and prices in 1956.
The cost of the new contract is estimated by the Council
of Economic Advisers at 3.2 per cent per year. Productivity
in the steel industry advanced at an annual rate of 3 per cent
over 1957-64, after correction for variations in operating
rates. Continued productivity advances at this rate would
about offset the scheduled rise in wage rates and fringe
benefits. It must be recognized that estimates of both costs
and productivity are highly approximate. The actual cost of
the new contract will depend importantly on the response of
workers to the more liberal retirement privileges; continued
gains in productivity will depend importantly on maintenance
of a high rate of production. But as best as such factors can
be estimated at this time, the settlement seems to promise
that steel wage costs will not outpace productivity increases.
The outlook for stability in unit labor costs does not,
Increases in list
of course, guarantee stability in prices.
prices for selected steel products are still widely expected,
but there is room for doubt that any considerable number of
increase; would stick in a period of declining production and
inventor liquidation. Even later, market conditions may
provide constraints. Competition from imports and from other
metals i. strong. Capital spending by steel producers has
been high, new mills and furnaces will soon begin production
at below-average unit costs, and pressure will exist to
increase volume by recapturing some of the production lost to
imports or competing products. But even if selective price
increases are effected, they are not likely to be large
enough to raise costs appreciably at later stages of production.
(2) Business conditions.--What are the implications for continued
economic expansion of business plans for fixed capital and
inventory outlays?
9/28/65
-29-
Business plans for increasing fixed capital outlays
continue strong and appear sufficient to about offset the
probable decline in inventory accumulation. Likely increases
in consumption spending and government outlays should bring
the rise in total GNP for the third and fourth quarters into
the $8 to $10 billion range, about the same as in the second
quarter and on average over the past year.
The latest survey of plant and equipment spending
reaffirmed business intentions to continue to expand their
outlays through the end of the year. Business expenditures for
new plant and equipment are now planned to expand by about
$3 billion (annual rate) from the second to the fourth quarter
of this year. Sharply advanced capital appropriations reported
in a survey of large manufacturing companies suggest that the
expansion momentum should carry forward well into 1966. On
the other hand, business inventory investment has been tending
down from the exceptionally high rate reached in the first
quarter and, with excessive steel stocks now being liquidated,
this slowdown should continue at least through the end of this
year. The survey of manufacturers' inventory plans indicates
a significant reduction in expected additions to their stocks,
from an average of $800 million in the first three quarters
of 1965 to $500 million in the fourth quarter.
Additional offsets to the inventory down drag will be
provided by rising consumer and government spending.
Consumption expenditures this year have been stimulated by
rapidly rising incomes. In the third quarter total consumption
expenditures apparently increased nearly 2 per cent, about the
same as in the second quarter. Further increases in consumption
expenditures even at about this rate would constitute a strong
expansive influence on the economy; and beginning in September
personal income is being given an extra fillip by the increase
in social security benefits, including a large retroactive
payment, and by the military pay raise.
The Government sector is also providing expansive strength.
Federal defense outlays are now increasing by more than $1
billion per quarter (annual rate) and other Federal purchases
of goods and services are continuing to rise. In addition,
State and local government purchases are also rising by $1
billion plus (annual rate) per quarter.
(3) Balance of payments.--How is recovery in the sterling
exchange market affecting international money markets and
central bank reserves?
9/28/65
-30-
Earlier heavy drains of about $400 million a month on U.K.
official reserves and special credits were halted late in
August and reversed, at least temporarily, in September. The
sterling exchange rate has risen from about $2.79 to nearly
$2.80 and the 3-month forward discount on sterling has declined
from about 2-1/2 to 1-3/4 per cent per annum. Most of this
improvement reflected changes in leads .,ndlags in commercial
payments and other speculative movements. Adverse movements
of these kinds had probably accounted for more than one-third
of the total drain of $3-1/2 billion in the 14 months through
August.
Market purchasers of sterling in September must have been
reducing, net, their investments or cash assets held outside
Britain or held in the form of dollar or other foreign currency
claims against banks in London. Withdrawals of funds from the
Euro-dollar market by persons moving into sterling may have
been among the factors that have brought the downward drift in
Euro-dollar rates to an end this month. In turn, the tightening
tendency in the Euro-dollar market may help to explain the
reduction in U.S. bank branches' balances with head offices up
to September 22; in July and August the branches had increased
these balances substantially.
Effects of the strengthening of sterling on the reserves
of continental European central banks cannot yet be quantified.
The softening of the French franc and the Belgian franc in
foreign exchange markets is thought to be partly the result of
heavier demands for sterling in those countries. Italian
reserve gains diminished sharply in September, but seasonal
factors cculd explain much of this.
In the Netherlands and
Germany, seasonal tightness in the domestic money market in
Septmber would normally have tended to increase the demand
for local currency and add to official foreign exchange reserves;
these tendencies seem to have been partly offset by the strength
ening of sterling.
If the recent improvement in sterling should be followed
by further reflows on a large scale, continental European
reserve gains would certainly be expected to diminish, just
as earlier they had been swollen by the flight from sterling.
At the same time, there would probably be some worsening of
the U.S. balance of payments deficit. Outflows of U.S.-owned
funds to London would worsen the deficit on both the official
and the regular transactions bases of calculation. There
9/28/65
-31-
would be an additional deterioration on the official settle
ments basis to the extent that British reserve gains reflected
withdrawal by private foreigners, including U.S. bank branches
abroad, of liquid assets from the United States.
Presumably British reserve gains would be used first to
repay swap drawings from the United States, and thereafter to
repay the IMF, and hence would not be used to buy gold.
Meanwhile, smaller reserve gains elsewhere in Europe would tend
to reduce demands for gold from that quarter.
(4) Bank credit and money.--How should the strength of fall
bank loan demand now be assessed, taking into account recent
developments and the influence of likely inventory changes and
other factors?
Loan demand at banks this fall is expected to remain strong,
although perhaps not as strong as in recent months. Continued
rapid expansion in loans to most types of nonfinancial businesses
will be offset in part by liquidation of inventory borrowings by
metals companies and of the recent bulge in loans to finance
companies.
This estimate of continued vigorous loan expansion is based
on the premise that GNP will show substantial further gains
despite a slowing in business inventory accumulation, as outlined
under question 2 above. Under these conditions, business needs
for funds are likely to remain large for the financing of rising
outlays for plant and equipment ard continued large additions
to receivables. These requirements for funds are coming at a
time when internally generated furds are increasing relatively
little anc when corporate liquidity is low, External financing
demands are consequently expected to be relatively heavy, but
how they will be distributed between banks and the capital
markets is uncertain.
Bank loans to most groups of nonfinancial businesses are
expected to show considerably greater than seasonal strength.
The reduction in business loan demand since mid-August seems
to have been a temporary lull, particularly in light of the
strong tax period borrowing in September. It does seem likely,
however, that liquidation of inventory borrowings by metals
companies will reduce the growth rate of business loans at
banks considerably below the 17 per cent annual rate of the
preceding three months.
9/28/65
-32-
In contrast to nonfinancial businesses, finance companies
may make larger than usual repayments of bank credit over the
next two months, working down their bank loans from the high
levels a.tained recently in financing unusually large dealer
inventories of autos. Consumer loans at banks are likely to
continue expanding in line with the experience so far this year,
an annual rate of about $4.5 billion. Growth in real estate
loans will depend in part on bank willingness to invest in
mortgages, but the continuing nature of most mortgage origina
tion arrangements suggests that there is unlikely to be an
abrupt further slackening in the rate of additions to such
portfolios.
(5) Securities markets.--How have developments since the last
meeting of the Committee affected the near-term outlook for
securities markets?
Most long- and short-term interest rates have advanced
further since the last Committee meeting, and investors remain
highly sensitive to the possibilities of further yield increases.
Around mid-September yields on long-term U.S. Government bonds
showed signs of stabilizing, and quotations on new and recently
offered corporate issues actually turned down several basis
points. But pressures on short-term markets around the tax
date, and announcement of the Treasury's fall financing plans,
have rai.ed short-term rates sharply, and this developmentunless reversed--may generate another round of upward pressure
on long rates.
With respect to the U.S. Government bond market, its
technical position has improved since the end of August. Dealers'
holdings of bonds maturing in more than 5 years now have been
reduced to less than $150 million. But this has been wholly
the result of official purchases; private investors have
remained moderate net sellers of Government bonds throughout
this period. Thus, while the pressure on the market from
professional holdings has been considerably reduced, investors
still appear to be backing away from Governments and could be
the source of some further upward pressures, especially if
corporate securities continue to be relatively attractive.
In the corporate bond market, it appears that investor
attitudes about prevailing and expected levels of interest
rates are delicately balanced. On the one hand, the unusually
high levels reached by yields on new corporate bonds in mid
September attracted investor demand. While this response
9/28/65
-33-
undoubtedly reflected an awareness that the calendar of new
publicly-offered issues scheduled for late September and early
October is smaller, it also represented some modification of
earlier, more extreme interest rate expectations. Looking
somewhat farther ahead, however, the continuing need of
corporations for external financing is likely to sustain the
volume of their borrowings in capital markets at high levels.
Although the visible supply of municipal offerings also
shows a moderate decline over the next few weeks, thereafter
the volume of offerings will undoubtedly rise again. The
likely strength of future bank demand for municipals is
questionable, particularly since their ability to raise funds
through CD sales may be limited by the level of short-term
rates in relation to Regulation Q ceilings.
(6) Money market relationships.--Assuming a continuation of
current monetary policy, what range of money market conditions,
interest rates, reserve availability, and reserve utilization
by the banking system might prove mutually consistent in coming
weeks?
Since late August, relationships have changed markedly
among the major elements customarily encompassed in "money
market conditions." Over the first three weeks ending in
September net borrowed reserves declined to about $100 million,
while member bank borrowings were about unchanged, and Treasury
bill rates moved up. In the last full statement week, net
borrowed reserves returned to the August level of about $170
million, borrowings increased, and bill rates rose further.
Pressures developed around and after mid-September as
tax and dividend payments were refected in large CD run-offs
and expanded loan demand. Increased reserve availability was
less effective than usual in moderating money market pressures,
apparently because of the redistribution of reserves away from
city banks as Government balances were transferred to private
holders. Another influence at work may have been the adjustments
of banks with extended borrowing records at the discount window.
Announcements last week of the Treasury's tax bill financing
and of its financing needs over the balance of the year resulted
in an abrupt further upward adjustment in rates. Most of the
rate adjustment was in longer bills, where the additional cash
financings are to be concentrated, but yields on both shorter
-34-
9/28/65
bills and coupon issues also have risen in reaction to this
development. The current level of 3.98 per cent on the 3-month
Treasury bill is the highest since late February, despite its
attractive December maturity date. Federal funds have continued
to trade mainly at 4-1/8 per cent, but with more frequent reports
of trading at 4-1/4 per cent.
The upward pressures on short-term rates that have developed
recently do not seem likely to be reversed significantly in the
weeks immediately ahead. Net borrowed reserves of around $150
million should be associated with 3-month Treasury bill yields
in the 3.95 to 4.10 per cent range. Movement toward the upper
end of that range may develop as the 3-month bill maturity
shifts beyond December--the January 6 bill closed Friday at a
yield of 4.06 per cent--even though further increases may be
moderated by substantial System purchases of bills to meet
reserve needs. Long-term rates, which began rising before
pressures developed in short-term markets, may now be subject
to further yield adjustments, as discussed above under question
5.
With 6-month and 1-year bills currently yielding about
4.30 and 4.40 per cent on an investment yield basis, further
upward adjustments in longer-term bill yields may make it
increasingly difficult for many banks to attract time deposits
within present Regulation Q ceilings. This would tend to curb
bank credit expansion, and/or to intensify bank efforts to raise
funds through very short-term CDs, Federal funds, and promissory
notes, or at the discount window. Bank takings of the March
and June tax bills can be expected to lead to a bulge in bank
credit in the early part of October, but this expansion will
moderate as banks sell off the tax bills and U.S. Government
deposits are drawn down. Growth in money supply, which was
large in September as Government deposits were reduced more
than seasonally, is likely to be slower in early October, but
may pick up again in later weeks. For the demand deposit
component, an average growth rate in the 4 to 5 per cent range
seems the most likely expectation.
Chairman Martin then called for the go-around of comments and views
on economic conditions and monetary policy, beginn.ng with Mr. Hayes, who
made the following statement:
9/28/65
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The business outlook has strengthened appreciably
since our last meeting. For one thing, the labor settlement
in the steel industry has removed one of the major uncertainties
that were troubling the Committee a month ago. Despite the
reduction in the strike-hedge inventories of steel that is
now under way, and that will undoubtedly continue at a moderate
pace through the turn of the year, this adverse influence is
likely to be submerged by continuing aggregate gains in spending
by business (on plant and equipment, and on inventories other
than steel) as well as by consumers and Government. In fact
we have now seen a major turnaround in business sentimenttriggered in the first instance by the implications of the
build-up of the Vietnam war, and subsequently abetted by
growing expectation of well sustained demand in key sectors of
the economy. There is now little talk cf a pronounced slowdown
in the clo.ing months of the year, and forecasters are busy
comparing estimates of another solid advance in calendar 1966.
Fears of a fiscal drag early next year have largely evaporated,
mainly because of the prospect of much higher defense spending,
together with higher Government civilian salaries.
On the cost-price front, the steel settlement came out
reassuringly close to the guidelines; but this has removed
only the danger of an over-generous pace-setting settlement.
We still face the pressures on prices and labor costs normally
arising in an economy operating close to capacity. The labor
market appears to have tightened significantly, with growing
shortages of trained and skilled workers. As for industrial
wholesale prices, it looks as if the uptrend which started
in mid-1964 is continuing. Announcements of individual price
increases seem to be becoming more frequent. All in all, the
threat of inflationary tendencies remains quite serious. The
exuberant stock market of recent weeks is doubtless one more
manifestation of incipient inflationary psychology.
Despite the outstanding success of the voluntary credit
restraint program with respect to foreign lending by banks,
I find it hard to feel much encouragemen: with respect to
our balance of payments. Sizable deficits have predominated
in recent weeks--and even after seasonal adjustment the
regular deficit for the third quarter may be close to a $2
billion annual rate. Increases in direct investment and
foreign security issues have played a part. Tne outlook for
the trade surplus is not encouraging. While the prospect for
exports is not unfavorable, imports are almost sure to rise
further as economic activity in the U.S. moves ahead. The
basic payments problem lies in our inability to date to come
9/28/65
-36-
close to equilibrium without the strong support of artificial
barriers to outward capital flows. While foreign confidence
in the dollar is generally stronger than it was some months
ago, this is based in large part on the belief that our payments
disequilibrium has at last been cut to a low level.
With the recent pronounced improvement in the market
for sterling, another major uncertainty at the time of last
month's meeting has at least receded into the background.
As for bank credit, the recent figures, while inconclusive,
suggest the possibility of a continued excessive pace of
expansion, and further strength in the demand for funds seems
likely this fall.
To many of us the 8 per cent rate of increase
that characterized bank credit over the last couple of years
seemed rather excessive, and the Committee has taken several
deliberate steps to check it. Yet the gain in recent months
has been around 9 per cent, whether based on the last-Wednesday
of-the-month data or on the "proxy" series for bank credit.
Business loans have been rising at about 20 per cent per annum;
and money supply plus time deposits at 8.6 per cent, with time
deposits accounting for most of the gain. It is of interest to
note that the banks have been actively adjusting the liability
side of the balance sheets in response to the pressures exerted
by rising credit demands.
Returning to this country after a fairly extended absence
abroad, I have been struck by the increases that have occurred
in market rates of interest, for almost all maturities and for
most types of market instruments. Of course, temporary factors
have played a part in these tendencies. But, more basically,
the pressure of rising demands for credit and growing business
optimism have acted to tighten the market despite our efforts
to maintain stable market conditions and despite the maintenance
of a more or less constant or even a somewhat reduced level of
net borrowed reserves. To my mind we should recognize and
reinforce this tightening tendency in the light of all the
factors I have touched on, both international and domestic. I
believe we should try more decisively than we have done in recent
months to check the excessive rate of credit growth; and for this
purpose an overt move seems to be required, combining a discount
rate increase with some further increase in net borrowed reserves
to the $200 to $250 million level. An increase in the prime
rate would almost certainly follow immediately; but this does
not seem to me a valid obstacle to our own action, especially
since the prime rate is now clearly out of line both with the
underlying availability of bank funds and with the rates
prevailing in the bond market. The ceilings under Regulation
Q would certainly have to be adjusted upward in the event of
9/28/65
-37-
the policy move contemplated; and in order to avoid the
appearance of pin-pointing a new rate level for time
deposits sought by the System, I would think a flat
ceiling of 5 per cent for all maturities would be useful.
It seems to me that there is little justification for
differentiating between shorter and longer maturities,
especially in view of the flatness of the present market
yield curve. Obviously, the directive would have to be
modified also.
There is an important question of timing, whatever
action we may take. On October 5, the Treasury will be
conducting an auction of $4 billion of Treasury Tax
Anticipation Bills for payment on October 11, the day
before the next scheduled meeting of the Committee. In
the last week of October, the Treasury will be setting the
terms for refunding the Treasury notes maturing November 15,
of which a bit over $3 billion are held by the public. These
prospects consel, I believe, prompt action which will afford
an opportunity for the market to adjust before the October 5
bill auction. If action is not taken promptly, it would
probably be necessary to defer action three weeks or perhaps
a month and a half or more. Therefore, it seems to me, it
would be appropriate to act today to change the directive to
call for greater restraint and to act this week to increase
the discount rate.
Whether the discount rate should be raised 1/4 per cent
or 1/2 per cent can be readily debated. In recent years we
have thought of a change of 1/2 per cent as a normal change
when the rate has been somewhere around the present level.
It certainly does not seem excessive, and the adoption of a
1/2 per cert increase would lessen the possible need for any
further increase in the near future.
Moreover, a 1/2 per
cent rise would be much more likely to convince foreign
authorities that we are determined to maintain the dollar's
strength abroad. On the other hand, an increase of 1/4 per
cent would probably suffice to signal that the Federal
Reserve is concerned but not alarmed by current developments.
The important point is to signal the need for further
restraint; the amount of the rate increase is less important.
On domestic grounds alone I would be inclined to prefer an
increase of 1/4 per cent, whereas on international grounds
the larger change would be distinctly better. I would like
to defer judgment on the amount until there has been a full
discussion of the subject today.
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9/28/65
Mr. Shuford observed that although sone recent statistics
had
indicated a pause in the economic upswing total demand seemed to be
strong and rising.
Since April personal income had been expanding at
an annual rate of 6 per cent, and retail sales had risen even faster.
The automobile industry was talking in terms of a 9 million unit year.
Industrial production had been increasing at about an 8 per cent rate
since April, and employment had been rising rapidly.
In the Eighth
District manufacturing output had been rising since early this year
at about the seme rate as in the rest of the nation.
A major question, Mr. Shuford said, seemed to be whether
further expansion in demand would be matched by expanding output or
whether it would result in higher prices.
were difficult
to interpret.
Current price developments
Overall indexes had changed little since
June, but that might reflect a temporary offsetting of general upward
pressures on prices by the cuts in excise taxes and the special situation
with respect to agricultural prices.
He was
inflationary pressures had subsided.
It was his impression that there
not of the view that
recently had been an increase in announcements of "selective" price
markups.
While the price situation in the automobile industry was
not clear, it appeared that at least one company had announced a price
increase, and in St. Louis two large firms in the shoe industry had
raised prices.
prices.
He noted that a Boston shoe company also had raised
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9/28/65
From June to early September, Mr. Shuford continued, financial
and monetary developments turned less stimulative.
marketable securities moved up.
Yields on most
Bank credit expansion moderated
somewhat from its extremely rapid earlier pace, and the rate of increase
in money slowed.
In the same June to early September period the fiscal
situation turned more expansive with the excise tax cuts and expanded
social security benefits.
In view of the strong economic situation,
the mix of public policy--with fiscal actions easier and monetary
actions less expansionary--seemed appropriate; it appeared likely
to foster a sustainable domestic growth and to place moderate upward
pressures on interest rates beneficial in reducing net outflows of
funds from the country.
Most recently, however, the money supply had risen markedly,
Mr. Shuford observed.
While figures for a few weeks should not be
overemphasized, and while, as Mr. Partee had mentioned, recent changes
in Government deposits had influenced the money supply, he felt the
Committee should take care that money growth not continue to be out
of line with what was called for by the current economic situation.
Although money market conditions might have firmed in the past month,
apparently the demands for funds under those conditions were strong
enough to provide an acceleration of monetary expansion.
He was
hopeful that this most recent increase in money would be reversed,
and that the more moderate rate of expansion that had been developing
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9/28/65
earlier would prevail.
The demand for bank credit had been strong,
he noted, and all indications--both formal reports and discussions
with bankers--were that it would continue strong for the remainder
of the year.
Under those conditions Mr. Shuford felt that the Committee
should move to a slightly firmer policy.
That would call for
consideration with respect to the discount rate, but at the moment
he was inclined to feel that a discount rate change could be post
poned a bit.
He would reserve final judgment on that question,
however, and also on the amount of the change, if one was to be
made, until after discussion around the table today.
He did feel,
however, that it was time to move in the direction of a somewhat
firmer policy.
Mr. Patterson reported the single most important recent
Betsy, which
development in the Sixth District was clearly Hurrican[sic]
had hit two widely separated areas in the District--the southern tip
of Florida and southeast Louisiana.
While both the old New Orleans
Branch building and the new building escaped with only minor window
damage, many of the Branch's employees were not as fortunate.
Loss of
property for many was large; in three instances it was virtually 100
per cent.
Even at this point, some of the employees had not fully
determined what their total losses would eventually be.
Thus, it
might not be known for months whether the $1 billon loss figure for the
whole State of Louisiana set by the Governor was correct.
9/28/65
-41
In Florida, however, it appeared that HurricaneBetsy caused
less damage than had Hurricane Hilda last year, Mr. Patterson said.
Apart from the relatively unimportant lime ard avocado crops, damage
to Florida's farm economy was relatively small.
In Louisiana, power
disruption posed a serious problem to the chemical industry.
Oil
operations in the face of the storm were cut, and there was some
damage to New Orleans shipping,
A telephone survey made of farm creditors revealed that
Louisiana's sugar cane crop would be largely salvageable, cotton
output would be substantially reduced, and rice production cut slightly,
Mr. Patterson reported.
Farm creditors said they would be able to
meet the credit needs without difficulty.
One unfortunate aspect
was that some farmers, especially cane growers, had now experienced
two hurricanes in successive years, so that they would need to go
even more heavily into debt.
But all in all, the District's agri
cultural economy had withstood the shock of Betsy quite well.
Still another telephone survey of feel, farm machinery, and
fertilizer suppliers revealed that agricultural credit conditions
in the Sixth District generally remained good, Mr. Patterson continued.
Delinquency rates were near or below those of last year.
employment picture was good.
The
Employment gains in July set some sort
of record for the month, and the August figures pointed to a further
appreciable increase.
pace of early summer.
Incomes were advancing close to the vigorous
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9/28/65
The steady expansion also carried into banking, Mr. Patterson
remarked.
Whereas in past years loans slowed down during the summer,
this year's interruption was short-lived and loans increased considerably
in August and in early September.
was particularly strong.
Loan demand from business borrowers
The intensity of those loan demands had
forced most of the just-surveyed Atlanta and New Orleans banks to
become increasingly selective in their lending, to firm up on rates,
and to demand higher compensating balances from their business
borrowers.
Now that those banks faced peak seasonal demands, they
might find it necessary to raise their lending rates further, irrespective
of Federal Reserve policy.
Mr. Patterson concluded with the observation that it would seem
difficult to change policy at this meeting wiLh the Treasury cash
financing under way.
Mr. Bopp said he would address his coments this morning
primarily to the staff questions on capital spending and bank credit.
Opinions about the outlook for capital spending had become increasingly
optimistic in the past few weeks, he noted.
Evidence from a number of
sources--the upward revision of spending plans for the latter part of
this year, analysis of capital appropriations, new orders for equipment,
and corporate cash flow--all seemed to be pointing toward an increase
in expenditures next year at something like the same rate as in this
year.
9/28/65
-43
Another approach to the overlook for capital spending, and
one which suggested to Mr. Bopp a more moderate view, was to calculate
the likely rate of capacity utilization next year.
It seemed to him
that current capital spending and that slated for the near future
would bring roughly a 5-1/2 to 6 per cent increase in capacity on
stream during 1966.
Given that increase in capacity, a rise in
industrial production of approximately 8 per cent would be necessary
to bring the operating rate as much as 1 per cent above the preferred
rate.
If, as he felt was more likely, industrial production in 1966
increased by on.y 4 to 5 per cent, then the operating rate either
would hover around the present figure of approximately 90 per cent
or would decline slightly to a figure of 89 per cent or so.
But if che majority of recent forecasts turned out to be
correct, Mr. Bopp said, another very strong year in capital expendi
tures might present a dilemma for Federal Reserve policy.
In recent
months there had been increasing evidence of imbalance in an economy
so long characterized by balance.
As had been pointed out at earlier
meetings, that was seen in the componencs of industrial production.
Growth in production so far this year had been concentrated in
materials and equipment; output of final products for consumers had
leveled off.
That kind of gap could not be sustained indefinitely
and, in the past, had been typical of later stages of expansions.
The current decline in steel inventories should help bring the
9/28/65
-44
materials component back into closer relationship with production
of consumer goods, but the prospect seemed to be for a continuing
gap between consumer goods and producers' equipment.
Although monetary policy could make the financing of some
planned capital projects more difficult and expensive, Mr. Bopp
continued, the potential dilemma in pursuing that route was
presented by the likelihood that the imbalance would occur in an
environment lacking overall inflationary pressures.
The prospect
that the operating rate in manufacturing would level out or even
decline slightly suggested that overall pressure on prices from the
capacity side was not ahead.
Many things could happen to change that
outlook, and perhaps he was raising possibilities which would not
develop.
But the current very optimistic predictions for capital
spending did raise questions that deserved some thought.
A more immediate consideration was the demand for loans,
Mr. Bopp remarked.
The principal Philadelphia banks had just
completed their loan forecasts for the fourth quarter.
Two of the
banks had not thus far experienced the net loan liquidation which
usually occurred for several weeks following the September 15 tax
date.
Moreover, business loan demand was exceeding their forecasts
and was expected to continue at a high level.
Another bank expected
loan demand to be generally steady, although not in excess of
expectations at this time of year.
Only one bank expected business
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9/28/65
loans to fall below the usual seasonal increase, and even that bank
expected no overall decline in total loans in the fourth quarter.
That kind of picture added up to a continuing strong loan demand.
As the green book 1/ pointed out, Mr. Bopp said, some of the
uncertainties which obscured the outlook in recent months had now
been resolved.
A steel strike had been avoided, a non-inflationary
wage settlement had been signed, and sterling had gained a stronger
footing.
Meanwhile, industrial commodity prices were generally
stable; the upward pressure of rising ronferrous metal and food
prices had largely subsided.
Although escalation of the conflict in Vietnam could change
the situation, Mr. Bopp thought the prospects were for a continued
absence of overall inflationary pressure.
Therefore, he would
maintain the current posture of monetary policy.
By this he meant
about the current level of reserve availability and interest rates.
If more aggressive purchases of Government securities, possibly
long-terms, were necessary to reassure the market that further
increases in rates were not likely in the near future, he would
favor such action.
1/
The report, "Current Economic and Financial Conditions," prepared
by the Board's staff for the Committee.
9/28/65
-46
The new,
larger, estimate of the deficit in
the balance of
payments for July-August was discouraging, Mr. Bopp said.
But at
present he would be inclined simply to be on the alert for further
deterioration.
He favored alternative A of the draft directives.
Mr. Hickman said that the recent strength and momentum of
the economy provided a strong foundation for the tests of coming
months.
The combination of a downdrag from steel and some setbacks
from Hurricane Betsy would likely result in no gain, or possibly a
slight dip, in the index of industrial production for September.
For the remainder of the year, the key question was whether the
adverse effects
of the steel inventory liquidation would be offset
by advances in other sectors.
On balance, his guess was that the
production index would probably average about the same in the fourth
quarter as in the third.
The downdrag from steel apparently would
be slightly less than anticipated earlier--about 1-1/2 points in
the production index on average in the fourth quarter.
Auto
production was expected to have no significant effect on the
production index, either way, during the fourth quarter; but other
components--reflecting strength in capital spending and in consumer
goods other than autos--should add about as much as would be lost
from steel.
-47-
9/28/65
Such a view was consistent with the consensus of 24 Fourth
District business economists who had met recently at the Reserve
Bank, Mr. Hickman observed.
The group's median forecast for the
fourth quarter was for no change in the production index--which,
incidentally, was a substantial upward revision from the last, pre
Vietnam, forecast of the same group.
In addition, those economists
anticipated successive modest gains in indus:rial production of
about 1 index point for each quarter of 1966.
It was becoming increasingly clear, Mr. Hickman said, that
Federal fiscal policy would be expansionary in 1966, particularly
in the second half.
While the amount of the increase in defense
spending was indefinite, the second stage of the excise tax cut,
further reductions in corporate income taxes, and medicare benefits
would all be stimulating.
The increase in social security taxes at
the beginning cf 1966 would act as a considerable offset to those
expansionary factors.
Mr. Hickman thought there still was no evidence of a general
uptrend in prices, despite the steel wage increase and the escalation
of defense spending.
Nevertheless, there was some indication that
upward pressures on industrial prices might emerge from the cost
side, a view expressed frequently by the business economists attending
the Reserve Bank's recent meeting.
Among potential future pressures
were the expected extensions of the steel settlement into various
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9/28/65
metal-fabricating industries, the costs of wage settlements yet
to be negotiated this year in aircraft and ordnance, the airlines,
and other incustries, and the 2-1/2 per cent "productivity" increase
in wage rates that became effective this month under last year's
auto ccntrac..
In general, with unemployment among adult workers
at 3.7 per cent--which was about as low as at any time during the
past ten years--the shortage of experienced workers might easily
In past business expansions, increased use of inexperienced
worsen.
and less-qualified workers had adversely affected productivity and
cost-price relationships, thus working toward bringing the business
expansion to an end.
On the financial front, there appeared to Mr. Hickman to
be less nervousness than at the time of the Committee's August 31
meeting, largely because of the improved status of the pound.
Yields
on long-term Treasury bonds and on corporate issues apparently had
stabilized around the highest levels in five years.
Somewhat
belatedly, municipal yields had increased recently, due possibly to
large dealer inventories and to bank selling.
Bank selling of municipals was a reflection of strong demands
for bank credit and the apparent "bite" of System policy, Mr.
observed.
Hickman
While borrowing to finance steel inventories would decline,
he expected chat to be more than offset by increased demands to finance
retail inventories and consumer durables purchases.
In addition, a
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9/28/65
reduction in corporate liquidity had caused business firms to turn
increasingly to external financing for working capital and plant
and equipment spending.
Mr. Hickman was pleased to see that net borrowed reserves
averaged about $100 million in the three weeks following the August
31 meeting.
Ir the latest week, however, the first published figures
showed a substantial deepening of net borrowed reserves and a sharp
increase in bark borrowings to the highest level in nearly three
years.
The stringency thus introduced into the money market--along
with seasonal factors, a distribution of reserves in favor of country
banks, and the Treasury decision to finance in the short-term marketcontributed to an increase in the bill rate, which, if continued,
would probably trigger an increase in the discount rate.
That might
be necessary later on, if price increases began to accelerate, but
it hardly seemed justified now on the basis of information currently
available,
In view of domestic and international uncertainties, as well
as the forthcoming Treasury financing, Mr. Hickman supported alternative
A, which called for no change in policy, of the staff's draft directives.
More specifically, he would like to see net borrowed reserves below $150
million most of the time, and borrowings below $500 million.
Moderately
easy reserve availability until the delivery date of the new tax
anticipation bills would facilitate redistribution by the banks and
prevent a sharp rise in bill rates.
9/28/65
-50
Mr. Maisel said he would note first that he thought it
important that the draft directives be changed to show that the
Committee recognized and, he would hope, followed the "official
settlements" basis for the balance of payments.
Since that balance
was running at a surplus, he would suggest that the last clause
in the opening sentence of both draft directives be revised to
read, "our official international payments have remained in
surplus while our gold losses remain moderate."
The Committee's more important task, however, was to
agree on the meaning of the language of its previous directives,
Mr. Maisel continued.
In particular, what was "moderate growth,"
and what were "the same conditions in the money market?" He
assumed that
'moderate growth" of the reserve base, bank credit,
and the money supply meant that they would expand at a rate at
least equal to the growth potential of the economy so that if
there was merely normal growth there
ould be no tightening of
interest rates.
Unfortunately, Mr. Maisel remarked, that did not seem
to have been the case.
The Committee had not been accommodating
the normal growth of the economy.
While GNP this year was growing
at a 6 per cent annual rate, somewhat below the hoped-for level
and that necessary to employ the full labor force, the Committee
had increased nonborrowed reserves at a rate of only 2.4 per cent.
The money supply had grown at a rate of only 3.7 per cent.
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9/28/65
The money and credit to finance the economy's moderate
growth rate had been supplied by the banks' curtailing their
liquidity, Mr. Maisel commented.
Recently the banks appeared
to have come :lose to the end of their ability to make up for
the Committee's lack of accommodation.
That would account for
the rapid increases in money rates.
It seemed clear to Mr. Maisel that the Committee could
rot at this time responsibly put such monetary pressure on the
economy as to cause a cutback in capital investment and a halt
to the expansion of jobs at the same rate as the labor force.
He thought the Committee had to keep its eye on the basic problem
of lack of utilization of resources and nor feel it necessary to
ratify by further action its own failure to allow the economy the
credit it needed.
He felt the argument that because credit was
tight, the Committee should make it tighter was basically circular.
Mr. Maisel said he had though: he understood that the
sense of the Committee's directives was to accommodate the normal
growth rate of the economy.
Recent market actions made it clear
that the Committee had not furnished sufficient reserves for that
purpose.
The liquidity of the banking system had been lived off
long enough.
It was necessary that the Committee now look ahead
and determine that its policy of the past six months of no change
required making more reserves available.
The level of borrowed
9/28/65
-52
reserves should be decreased sufficiently to enable banks to meet
normal demand.
reserves.
rates.
That would mean a more rapid increase in owned
Such a growth would solve the problem of current market
They would decline back at least to the summer's rates.
Action showing that the Committee was not desirous of curtailing
production would return the markets to the more comfortable position
they were in before they became so acutely aware of their lack of
liquidity.
On the assumption that he had correctly stated what was
meant by "moderate growth" and by the "same conditions in the
money market," Mr. Maisel said he would support alternative A
with the necessary correction on the balance of payments.
In
doing so, however, he believed it should be made clear that the
behavior of the markets in the past month had not been consistent
with the basic desire of the Committee to furnish sufficient money
to the economy to meet the needs of normal growth.
Mr. Daane said that he would note at the outset that he
dissented vigorously from Mr. Maisel's proposal that the balance
of payments reference in the directive be formulated solely in
terms of the figures on the "official settlements" basis.
Such
figures did not represent the only "official" concept of the
Administration, nor should they be the only ones considered by
the Committee.
But even if the "official settlements" basis were
9/28/65
-53
to be used, it still would be true that a ceficit was in prospect
for the rest of the year and for the year as a whole.
Mr. Daane remarked that he shared the feeling of Mr. Hayes
and others that the U.S. balance of payments problem continued
to be worrisome, and on that ground alone he felt the Committee
should not take any easing action today.
Also, he was not persuaded
by the staff view that the recent firming of market conditions meant
that it would be inappropriate for the Committee to act in the
direction of further firming.
In light of the strength of loan
demand and the growth rate of the money supply, and of the fact
that the very solid expansion underway certainly had not been
inhibited by the firming of market conditions, he did not think
it was circular to argue that the Committee should reinforce the
market firmness with some further moderate restraint.
He was
sympathetic with Mr. Hayes' position in that respect.
However, Mr. Daane observed, he did have some real question
as to the timing.
He noted that both draft directives gave the
impression that the uncertainties in foreign exchange markets
had been largely resolved.
He did not agree; the fact that the
British effort to restore the position of sterling was continuing
had to be taken into consideration in the Committee's deliberations.
Accordingly, while he had considerable sympathy with alternative B
of the staff's drafts, he was not certain that this was the best
9/28/65
-54
time to adopt such a directive.
He leaned toward some version of
a "no change" directive at this juncture, with the expectation
that the Committee would maintain close surveillance over
developments in the weeks immediately ahead.
Mr.
Daane then noted that there had been meetings over
the past few days of the Deputies, as well as of the Ministers
and Governors, of the Group of Ten.
This morning the latter had
issued a communique concerning, among other things, two matters
on which he had reported to the Committee on previous occasions.
The communique indicated that the Group of Ten had agreed that
the General Arrangements to Borrow should be renewed for a second
term of four years, with a review to be undertaken in two years
of any possible need for adaptation in the Arrangements.
Thus,
by October 1968 the Group would be in a position to make any
adaptation corsidered desirable.
A second point covered by the Communique, Mr. Daane
continued, related to the question of "where do we go from here"
with respect to international liquidity arrangements.
The
agreement announced this morning involved a first phase consisting
of intensified efforts on the part of the Deputies to determine
what basis of agreement could be reached on ways to strengthen
the international monetary system, including arrangements for
future creation of reserve assets as and when needed, looking
-55
9/28/65
toward a preliminary report in the spring of 1966.
The first
phase would not necessarily terminate then, out it presumably
would culminate at some point in a measure of agreement on
essential points.
It was contemplated, Mr. Daane said, that once such a
basis for agreement had been reached the matter would pass from
consideration by the Ten to consideration in a somewhat broader
forum.
Since the problems concerned the world economy as a whole,
the Ministers and Governors had agreed that it would be useful
for the Deputies to seek ways by which efforts of the Executive
Board of the IMF and those of the Deputies could be directed
toward consensus as to desirable lines of action.
The Ministers
and Governors instructed the Deputies to work out procedures to
achieve this a,.m, in close consultation with the Managing
Director of the Fund, with a view to preparing for final enactment
of any new arrangements at an appropriate forum for international
discussions.
Chairman Martin commented that he thcught that the develop
ments Mr. Daane had reported represented progress on the part of
the Group of Ten.
Mr. Mitchell said he thought he fell within the group that
was somewhat skeptical about the prevailing optimism on the business
9/28/65
-56
outlook.
It seemed to him that the optimism was based primarily on
a somewhat exaggerated notion of the economic stimulus that would
be provided by the Vietnam hostilities.
He was more concerned about
the secondary and tertiary effects of the inventory adjustment in
steel and stee
products; time was needed to learn how much of an
adjustment would have to be absorbed.
Mr.
Koch had confined his analysis
largely to projections of components of GNP, but it also was necessary
to consider the future course of industrial production.
he expected little
change in
the production index in
months, and perhaps some decline.
Personally,
the next four
In general, he thought there was
greater uncertainty about business prospects than one might gather
from many of the statements currently being made.
With respect to prices,
Mr. Mitchell thought the steel
settlement overshadowed all other developments of the past few months
and he felt reference to it
should be made in
the Committee's directive.
The settlement was a noninflationary one; while it
would be no selective increases
in
steel prices,
did not mean there
the settlement
itself
and the precedent it established were both on the side of price
stability.
The problems in the international area appeared no nearer
a solution than they had two or three years ago, Mr. Mitchell said,
except that the Group of Ten Deputies were going to study the
liquidity question more intensively and broadly, and hopefully
9/28/65
-57
they would move forward.
But he saw no great need on balance of
payments grounds for altering monetary policy any more than the
Committee already had unconsciously altered it.
On the financial side, Mr. Mitchell found himself in
complete agreement with Mr. Partee's remarks.
He (Mr. Mitchell)
wanted to avoid the very thing Mr. Hayes favored--namely, a change
in the discount rate--because he thought that might well result
in a grinding interruption to the economy's upward progress.
For
the same reason he was disturbed by the recent trends of interest
rates in capital and money markets.
He woul
favor an effort to
tranquilize those markets rather than, as some had suggested,
moving toward further firming in an already firm situation.
For
whatever reason, banks were reluctant to borrow from the Federal
Reserve, and were not getting the reserves they needed.
Under
those circumstances he thought that the System should be supplying
reserves somewhat more freely than it had in recent weeks.
Mr. Mitchell said he was unhappy about the staff's draft
directives.
He would suggest the following wording:
The economic and financial developments reviewed
at this meeting indicate that the domestic economy has
expanded further in a climate of optimistic business
sentiment and firmer financial conditions, and that
our international payments have been in deficit since
midyear. Some of the uncertainties previously affecting
the domestic outlook for price stability and foreign
exchange markets have diminished, but the impact on the
business outlook of contracting steel and steel and
allied product inventories cannot yet be gauged with
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9/28/65
significant accuracy to say that it will be offset
by expansive factors. In this situation, it is the
Federal Open Market Committee's current policy to
conduct its operations so as to promote stability
in money and capital and foreign exchange markets,
while accommodating moderate growth in the reserve
base, bank credit, and the money supply.
To implement this policy, and taking into account
the current Treasury financing, System open market
operations until the next meeting of the Committee
shall be conducted with a view to easirg somewhat the
pressures in the money market that have developed
recently; this would involve net borrowed reserves
averaging about $50-$100 million, borrowing of under
$500 million, and Federal funds trading most often
at the discount rate.
In Mr. Mitchell's judgment the Manager had not had sufficiently
specific instructions to cope with the problems he had faced in the
market recently.
The purpose of the proposed second paragraph was
to provide some criteria to which the Manager could refer if he
continued to ercounter a difficult situation.
While he had
specified certain numerical targets in that paragraph he would
defer to Mr. Holmes' judgment if the latter thought the targets
mentioned were likely to prove inconsistent.
Chairman Martin commented that he would interpret Mr. Mitchell's
proposed directive as calling for a change in policy in the direction
of ease.
There was no reason, of course, why such a course should
not be proposed.
He thought it should be clear, however, that while
Mr. Hayes advocated a firmer policy, Mr. Mitchell favored an easier
one.
928/65
-59
Mr. Mitchell remarked that he would place a different
interpretation on his proposal.
In his opinion policy already
had firmed; what he advocated was a restoration of the market
conditions the Committee presumably had intended to maintain
under its
August 31 directive.
have arisen, he thought,
if
The present situation would not
the Committee had been more specific
about its intentions in the August 31 directive.
The problem
of formulating, instructions to the Manager was, of course, an
old one, but it had plagued the Committee particularly seriously
in the recent period.
Mr. Maisel noted that the Committee's previous directive
had called for maintaining about the same conditions in the
money market.
Nevertheless, as both Mr. Hayes and Mr. Holmes
had noted, and as was clear from all indications, market con
ditions were now tighter than they had been a few weeks ago.
For
purposes of clarification he would ask whether the change in
market conditions should be viewed as a change in
policy; or,
to
put the question differently, whether a restoration of the con
ditions of, say, three weeks earlier should be viewed as maintaining
the prior policy or changing to an easier one.
Chairman Martin commented that the Committee could maintain
market rates at any given levels if it were willing to supply
whatever amount of reserves were necessary for that purpose.
In
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-60
his judgment, however, that was not the Committee's objective under
"no change" directives.
Mr. Daane observed that the present situation, in which
previous relations among money market variables no longer were
consistent, provided an excellent illustration of why the Committee
should not attempt to introduce quantified targets into its directive.
Mr. Swan remarked that he differed with that view; in his
opinion the current situation offered an excellent example of the
need for numerical instructions.
Mr. Hayes said he concurred in Mr. Daane's view that it
was not feasible to quantify instructions to the Manager.
At any
time various cross-currents were at wo.:k in the market, and the
Committee faced a new set of circumstances each time it met.
He
submitted that at the time of the August 31 meeting no one could
have foreseen accurately the manner in which developments subsequently
unfolded.
It also was necessary to recognize that the market could
tighten by itself without any effort or, the Committee's part to create
firmer conditions, and that was what in fact had happened recently.
Mr. Mitchell observed that the Manager nevertheless had not
acted to counter the firmer conditions that had developed in the
market.
He added that he did not mean to imply any criticism of the
Manager; in his opinion the fault lay with tne Committee.
9/28/65
-61
Chairman Martin remarked that it would be possible for the
Committee to ignore market forces, in effect making the market itself
and driving all. others out.
Perhaps it had approached that position
at times; but in recent years it had attempted to give some play to
market forces, in the process obtaining indications of the nature of the
pressures existing.
After :ome further discussion the go-around resumed with remarks
by Mr.
Shepardson.
Mr. Shepardson said that he concurred in Mr. Hayes' analysis
of the present situation.
definitely were at work.
It seemed to him that expansionary forces
He was not ready to accept the statement
that the steel settlement was a noninflationary one.
It was not as
inflationary as some had feared it might be, but he still thought
that upward pressures on prices would be manifest.
He had difficulty
in interpreting, the price indexes against the background of the many
announcements cf price increases being made.
Nevertheless, however
one measured p ices there had been a continuing upward crawl, although
there had not been rampant inflation.
Given the state of business
optimism, there seemed to him to be a definite possibility of an
outbreak of price increases.
In that connection, Mr. Shepardson continued, the situation
would not be so difficult if there were prospects of a correction
when prices got out of hand.
What concerned him was that, as far
9/28/65
-62
as he had been able to observe in the last ten years or so, such
corrections had not occurred.
There were so many built-in rigidities
that the best one could hope for was a leveling off after a burst of
increases, with subsequent increases starting from the higher plateau.
Accordingly, it was important in his opinion to try to forestall any
outbreak.
For some time, Mr. Shepardson said, he had felt that the
Committee should move to a firmer position soon.
As he had noted
at previous meetings, he thought the Committee had about reached the
point where its next move should be a significant one, probably
involving a change in the discount rate.
But he questioned whether
this was the time for such a change; unlike Mr. Hayes, he thought a
better opportunity would arise after the current Treasury financing
was completed.
On that basis Mr. Shepardson favored continuance of
the present policy, and alternative A for the directive, on the
understanding that the money market conditions to be maintained were
those existing at the present time.
Mr. Hayes said he might clarify his reasoning with respect
to the question of timing.
His thought was that if the Committee
made a change in policy now the market would have all of the
circumstances in view at the time of the Treasury financing.
If,
on the other hand, a policy change was made after delivery of the
new securities had been effected, there was the possibility that
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9/28/65
the action would be construed as "pulling the rug out" from under
the market,
Mr.
Robertson made the following statement:
I do not think it can be emphasized too often that
we meet today in an atmosphere of significantly tighter
credit conditions than prevailed one or two months ago.
We know that several factors have contributed to
that run-up in yields--among them increases in demands
for funds from both government and private borrowers
and major shifts in market expectations.
Some people
would go on to argue that the Federal Reserve has had
virtually nothing to do with that tightening, and
presumably therefore bears no responsibility with respect
to it.
I have absolutely no sympathy for that position.
We may not have triggered the tightenirg by an overt act,
but we acquiesced in its taking place. We could have
moderated or resisted the rise in interest rates by a
more aggressive supplying of reserves, and we chose not
to do so,
Now, with tighter conditions prevailing in every
major credit market, we again face a policy choice.
I
think we must be very careful not to fool ourselves with
semantics in the process.
I would argue that, broadly
speaking, we have three alternatives today. First, we
could choose to foster general credit conditions not
much changed from around the end of July, or, if you
prefer, around the end of August--in which case we
would need to tell the Manager to act forcefully to
ease bank reserve positions and relax current money
market pressures.
A second possible choice would be
to maintain money market conditions and reserve availabil
ity about as is--with such relaxation of reserve pressure
(by the Desk) as would be necessary to avoid any further
tightening regardless of the cause.
Finally, there is
a third policy choice--an unappealing one in my view--of
compounding the recent tightening of credit conditions by
instigating (or, if you wish, permitting) still
further
tightening.
Which course we choose, of course ought to depend
upon our appraisal of the underlying business situation.
As 1 review the evidence before us, I am impressed with
9/28/65
-64-
the generally vigorous pace of economic and credit
expansion, particularly in the investment area, but I
note that it has not yet had to bear the full weight
of the inventory adjustment that will follow the steel
settlement, Business sentiment seems cptimistic, but
it has not yet bubbled over into widespread advances in
prices. Our balance of payments picture is still not as
good as one might wish. But in those payments accounts
alleged to be sensitive to interest rates and credit
conditions, we seem to be doing very well. Probably
this is due more to our voluntary rest aint program and
the Interest Equalization Tax than to changes in the
general credit climate in this country, but it provides
no argument for still further credit tightening now.
All things considered, given the strength of credit
demands that have evolved recently and the probable need
for some kind of "even keel" in connection with the
Treasury financing, I am disposed to go along very
cautiously with maintaining for the next three weeks
about the degree of firmer general credit availability
that has developed. To resist further tightening, however,
I think the Manager may need to operate in a manner designed
to achieve a lower volume of net borrowed reserves and a less
tight money market than developed last week. I want to
emphasize that, in my view, such a posture should only be
regarded as appropriate so long as credit demands continue
in their present strength. Any tendency for market pressures
to relax, reflecting some underlying moderation in the
forces of credit demands, should not be resisted by the
Manager; rather, he should be directed to permit and even
reinforce it somewhat by a corresponding easing in bank
reserve positions. I regard this as a delicate period,
with a potentially important influence on the life expectancy
of the current business expansion, and I think we have to be
wary of allowing the current climate of firmer credit con
ditions to overstay its usefulness.
With these thoughts in mind, I deplore the vagueness
of the second paragraph of both alternative directives
distributed by the staff. I would favor a first paragraph
as suggested for alternative A, followed by a second
paragraph that tells the Manager to maintain about the
same money market conditions as prevailed on average
during September, taking into account the current Treasury
financing and also the rate of expansion in reserve utiliza
tion by the banking system. (The September averages I
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9/28/65
refer to are: 3-month bill rate--3.90 per cent; 6-month
bill rate--4.05 per cent; Federal funds rate--4.10 per
cent; and net borrowed reserves--$118 million.)
Mr. Wayne reported that general economic advance continued
in the Fifth District, with strength evident in all major industries.
The Richrond Bank's latest business survey reflected increased optimism
and suggested that the pace of activity might be quickening.
The
employment situation had continued to improve throughout the District.
In West Virgin.a, for example, the rate of insured unemployment was
recently at the lowest point since November 1956.
Reports of labor
shortages, especially in the skilled categories, appeared to be
coming in more frequently.
In the national economy, Mr. Wayne continued, liquidation
of steel stockpiles had already begun and would probably proceed
for several months.
In view of the continuing high rate of steel
consumption and of the prospect of some upward price adjustments,
however, the rate of liquidation might prove to be less than past
experience might suggest.
On balance, with final demand in all
sectors of the economy continuing to rise and with a further in
crease in business outlays for plant and equipment now a virtual
certainty, he would expect the dampening effect of the inventory
development to be more than offset.
The inventory turnaround in
metals might be expected to take some of the edge off business
loan demand.
Inventories would likely increase in other lines,
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9/28/65
however, and further increases in business capital outlays would
appear to insure that business loan demand would remain strong
for the rest of the year.
Despite the recent stability in the price indexes, Mr. Wayne
was not convinced that the present situation was without an inflationary
potential.
Prospects in all sectors suggested expanding final demand
in the months ahead and, on the supply side, it seemed to him that
conditions might favor cost-push pressures.
The Committee had been
interpreting the high rate of business capital outlays as a sign of
expanding capacity that would dampen upward price pressures.
He
wondered if the Committee had given sufficient attention to recent
developments in the labor market.
The effective rate of capacity
expansion was Limited by the scarcest factor and it might be that
significant labor bottlenecks were approaching.
He wondered if the
He
U.S. actually had 4-1/2 per cent of "employables" unemployed.
was impressed with the increasing evidence of labor shortages and
with the growing number of announced price increases.
On the international scene, Mr. Wayne said, the recent
improvement in sterling was encouraging and it appeared that recent
changes in the distribution of international reserves had worked
in favor of the United States.
But the problem in that area, at
least for the near-term future, remained essentially unchanged.
9/28/65
-67
Mr.
Wayne went on to say that the market for Government
securities had been adequately discussed and analyzed, so he
would like to take a brief look at the market for municipals,
which had some interesting aspects.
Commercial banks had been
the mainstay of that market for the past four years, and had
acquired over 70 per cent of the net addition to State and local
debt during that period.
They now held some $36 billion of tax
exempts, or roughly 35 per cent of the total
10 per cent of total bank assets.
and those made up
At weekly reporting banks,
holdings of municipals were now approaching holdings of Governments.
Mr. Wayne was somewhat concerned about the reversibility
of that heavy bank movement into municipals.
The secondary market
in that area was thinner and much less well developed than was
the case with Governments, and if banks should attempt to meet
growing
loan demand through liquidating tax exempts, a particularly
severe strain might develop.
The strain might, indeed, be severe
enough if banks simply slowed down their rate of new acquisitions.
In any event, the fact that weekly reporting banks had added little
to their "other" securities in the past three weeks and reports
that some banks were considering selling some of their holdings
could be a prelude to a significant problem in the municipals market.
What impressed him here was that that market might well have become
the bellwether of money and credit restraint.
9/28/65
-68
In the area of policy, Mr. Wayne continued, recent weeks
had seen a more distinct and more general firming of conditions
in both money and capital markets than there had been thus far
in the long peiod of expansion.
When the Committee moved toward
less ease late last year and early this year, most short-term
rates rose but there was no appreciable change in long rates.
Probably more important, the expansion of bank credit and the
money supply actually accelerated somewhat.
To him it would
seem quite hazardous to back away from the firm conditions that
had developed.
The substantial additions to personal income
this month and next, the high level of business optimism, the
large capital outlays by business, the rising level of defense
expenditures, and developing labor shortages, especially in the
more skilled categories, all would add upward pressures on prices
not likely to be offset by declining activity in the steel sector.
Even with its present posture, the Committee might well see a
continuation of the slow upcreep in prices, and any easing would
be quite likely to speed it up.
If approximately the present level of reserve availability
was maintained, Mr. Wayne said, the firming of financial markets
would probably continue--a movement he would favor so long as it
was moderate and orderly.
On the other hand, he believed that
any tightening move at this time might well produce acute stringency
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9/28/65
in the capital market, especially in the municipal sector, and might
also prejudice the recent improvement in sterling.
Further, the
large sale of tax-anticipation bills just ahead would probably
cause a significant increase in bank credit, at least temporarily,
and any reduction of reserve availability might jeopardize the
success of the offering.
For those reasons he favored continuing
the present policy.
Mr. Wayne added that he had no desire to reopen the discussion
of the subject of quantification.
In his opinion, however, all the
Committee would have achieved if it had included quantified instructions
in its August 31 directive would have been to insure the need for
meeting several times in the interim.
was not in favor of quantification.
For that and other reasons he
For today's directive he would
favor alternative A of the staff's drafts.
He had no objections to
attempts to improve the wording but since he was not optimistic about
the possibility of reaching agreement on new language he would
recommend acceptance of the draft as submitted.
Mr. Clay remarked that the most important issue before the
Committee today was the tightening of the money and capital markets
and the upward pressure on interest rates.
Substantial movement
already had taken place, and the markets appeared to be quite
sensitive to further advances in yields.
9/28/65
-70Economic prospects appeared to be quite favorable, Mr. Clay
said, although readjustments in some areas growing out of the settle
ment of the steel strike were likely to weaken the industrial production
index.
Expansion was likely in final demand for goods and services in all
major sectors of the economy--consumer, business and government.
Moreover, it appeared probable that the economic advance could
continue to take place in an orderly fashion in terms of resource
utilization and price developments.
The principal question in that
connection arose out of the unknown proportions of the military
programs and expenditures.
In evaluating the economic prospects, however, account had
to be taken of the reduced liquidity position of business as compared
with earlier in the economic upswing, Mr. Clay commented.
Accordingly,
business now required more outside financing than earlier for any
particular degree of economic growth.
In addition, the commercial
banking system's liquidity also had been reduced substantially.
Under those circumstances, it was essertial that monetary policy
prevent credit restraint from becoming a disruptive force in the
economic advance.
In approaching the period ahead, Mr. Clay said, the Manager
should not pay much attention to the net borrowed or free reserves
guide, in view of the circumstances prevailing.
The guide should
be the condition of the money and capital markets.
While it was
9/28/65
-71
particularly important to forestall further upward movement in
open market interest rates, some turnaround in yields would be
desirable.
The impact of open market operations to alter the recent
course of interest rates should have a powerful effect upon market
attitudes and expectations, facilitating the desired change in the
money and capital markets.
Moreover, open market operations
supplying seasonal reserve needs in the weeks ahead should be
of assistance
it
in
implementing such a policy.
In
that connection,
was important to prevent Treasury bill yield developments that
would force an increase in the Federal Reserve discount rate.
Neither of the draft directive alternatives appeared to
Mr. Clay to be satisfactory.
Alternative B called for further
firming of credit conditions,
and that would not be appropriate
for reasons he had already indicated.
Alternative A simply accepted
what already had happened with respect to credit tightening and,
judging by developments
since the August 31 meeting, would be
compatible with further tightening in
that in
the period ahead.
He suggested
the second paragraph of alternative A the language following
the phrase "with a view to" be replaced by "attaining somewhat easier
conditions in the money market."
With the Treasury financing a week
away and of the auction type, it should be possible to pursue such
a policy in
the interim.
9/28/65
-72
Mr. Scanlon reported that developments of the past month
appeared to have increased confidence of Seventh District businessmen
that economic expansion would continue through 1965 and, probably,
well into 1966.
Steel producers had been surprised at the limited
extent of order cancellations and postponements following the labor
settlement early in September.
There had been no period thus far
when cancellation of orders exceeded new bookings, as had occurred
in the spring of 1962.
Demand for steel plates, structurals, and
galvanized sheets remained strong.
Heavy inventories and large
imports suggested that any attempt of steel producers to make
general price increases in the near future probably would not be
successful.
Demand for workers continued strong in nearly all Seventh
District areas, Mr. Scanlon said.
Many firns continued to report
great difficulty in hiring sufficient numbers of workers--both skilled
workers and unskilled adult males.
Wholesale prices probably were rising on balance, Mr. Scanlon
remarked.
A recent internal survey of prices paid for identical items
by one large retailer showed a very small increase over last year.
No special adjustment was made in this comparison for the cut in
excise taxes.
Also, higher priced items were added continously to
the lines handled.
9/28/65
-73
Mr. Scanlon expected some moderation in the trend toward
tighter labor markets in the District in the months ahead.
There
had been three prime movers in that area--steel, autos, and machinery.
Steel firms were now reducing labor requirements and needs of auto
producers probably were at a peak.
Of the three, only machinery and
equipment producers were still attempting to increase employment and
their order backlogs continued to rise.
Machine toll builders reported
a high level of interest at their convention now in progress in Chicago.
Reports from District banks indicated that loan demand continued
to be strong, Mr. Scanlon observed, although in recent weeks loan
increases at those banks were slightly less rapid than for the United
States as a whole.
Business borrowing had been only moderately larger
than a year ago but loans to finance companies were up sharply and
real estate loans had risen further.
In the first half of September
borrowings by producers of machinery and other metals products rose
more than last year.
A large share of the rise in business loans in the first half
of September, Mr. Scanlon said, was attributable to public utilities,
which often borrowed to pay taxes.
The rate of growth in business
loans, although rapid by past standards, had slowed in comparison
with the first half of the year after allowance for seasonal factors.
Nevertheless, with growing business expenditures in relation to cash
flows, further vigorous demand for bank credit could be expected,
9/28/65
-74
especially if rates on capital issues continued to rise relative
to rates on bank loans.
Mr. Scanlon went on to say that fiv of the District's eight
reporters in the lending practice survey of September 15 stated that
loan demand was stronger and interest rates on commercial and indus
trial loans firmer than three months ago.
Seven banks indicated
firmer policies with respect to at least some of the lending terms
covered.
Officials of some savings and loan associations reported
that they had observed improvement in quality of loan applications
and attributed that to tightening up by banks.
Reserve pressures on major banks in Chicago and Detroit
over the tax rate were relatively mild but might increase as
deposits declined following the tax payments, Mr. Scanlon said.
The volume of borrowing from the Chicago Reserve Bank by both city
and country banks had been averaging somewhat higher in recent
weeks despite the relatively small national totals of net borrowed
reserves.
However, the number of borrowers had not increased.
Mr. Scanlon shared the view of those who felt that any
change in policy should be one of firming.
He certainly would not
back away from the present position and if ne were convinced market
forces were bringing enough upward pressure on rates to call for a
discount rate change he could accept the change.
However, like
Mr. Shepardson, he did not feel that today was the time to make a
9/28/65
-75
firming move.
Accordingly, he favored alternative A of the
draft directives.
Mr. Galusha commented that, appealing
to the well-known
maxim "good news is no news," he would say little this morning
about Ninth District developments.
The simple fact was that the
District continued to enjoy heartening advances, particularly in
employment.
In August wage and salary employment was up 2.3 per
cent from a year ago.
And the August unemployment rate for the
District was estimated to have been 3.7 per cent.
Average hours
worked and average weekly compensation had continued to increase
more rapidly than in the nation as a whole, and similarly for
retail sales.
Ninth District cash farm income was up from a
year ago, if on a cumulative basis slightly less than in the
nation.
Snow, heavy rains, and early frosts had dimmed the
brilliant prospects of a month ago.
Still, the expectation was
that 1965 would turn out to have been a relatively good year for
agriculture.
Banks in the Ninth District continued relatively tight,
Mr. Galusha noted.
Both weekly and nonweekly reporting banks had
record high average loan-deposit ratios in July.
Those ratios
declined slightly in August, but preliminary evidence indicated
that they would be up rather substantially in September.
Over
the first part of September weekly reporting banks broke their
9/28/65
-76
seasonal pattern and sold large quantities of Treasury and other
securities, presumably to accommodate a larger-than-seasonal
business loan demand.
Finally, Mr. Galusha said, it appeared from the Reserve
Bank's most recent business survey that the outlook continued
bullish.
To a greater extent than a year ago, District firms were
reporting large increases in new orders and order backlogs.
Also,
more firms were reporting slight increases in prices received.
On the other side, more were reporting large increases in
finished inventories.
Turning to the national scene, Mr. Calusha found encour
agement in the steel settlement, if the Council of Economic Advisers
and Mr. Wernick of the Board's staff were correct in their
appraisals of the increase in hourly compensation.
Those appraisals
suggested that if steel price increases occurred in coming months
they would be selective and quite modest.
He also found
encouragement in the continuing virtual stability of wholesale prices
generally; and in recently expressed opinions about the intermediate
term outlook, the most optimistic included, which indicated that
demand inflation was not likely to become a reality over the coming
six to nine months.
He agreed, of course, that Government spending,
particularly for defense, had to be watched carefully.
But it would
seem ,that the Committee could do no more than be guided by the best
9/28/65
-77
current guesses about what level Government spending would reach
in fiscal 1966.
And official guesses--which contrasted oddly with
some hard-to-credit Congressional guesses he had heard--were such
as to suggest that at the moment there was no cause for alarm.
Mr. Galusha thought it was possible that if the Committee
continued to hold average net borrowed reserves in the range of
past weeks the market's expectations would be confounded and rates,
having been pushed up by a change in guesses about monetary policy,
would retreat to levels of a while ago.
Bu- that seemed unlikely.
He personally believed that any attempt to "confirm" the present
rate structure in a market as volatile as that currently existing
would be quickly translated into further increases.
That prospect
had to be viewed against a background of rather considerable
increases in rates generally; the increases recorded in the period
since early 1965 were not insignificant.
Against that background,
moreover, the risk of a slight decline in rates appeared less than
compelli-g.
Mr. Galusha was inclined, however, to regard "no change in
policy at this time" as a conservative statement.
But it should
be clear, he said, that in urging no change in policy he was
urging that deliberate tightening be avoided and further increases
in rates on Treasury securities be resisted.
9/28/65
-78
Mr. Galusha added that there seemed to be a general
discomfort induced by the continuation of the high level of
economic activity, as if that fact in itself was cause for
concern.
There did not appear to him to be any obvious aber
ration across the broad spectrum of business nor in the numbers
being generated to justify the degree of concern.
The market
place had moved to curb credit creation with significant
increases in rates.
Why not see what developed at those rate
levels before making an overt act which could have an unwanted
geometric effect?
Mr. Galusha concluded by remarking that he suspected he
would vote for alternative A of the directive unless it lost its
present flavor through revisions agreed upon by a majority.
Mr. Swan reported that on the Pacific Coast employment
had increased somewhat in August,
as it
had in
the country as a
whole, but the rate of unemployment remained unchanged.
Employ
ment in the aerospace industry rose for the fifth consecutive
month but the major factor seemed to be a r:.se in production of
commercial aircraft rather than an increase in military output.
Retail sales, although well above a year ago, were still lagging
behind those for the nation.
The expansion in credit at District
weekly reporting member banks from mid-August to mid-September
again was less than a year ago and also less than in the rest of
9/28/65
-79
the country.
However, the increase in the business loan category
was larger than a year ago.
Mr, Swan noted that the Twelfth District was one of the
areas in which there had been far less borrowing from the Reserve
Bank during the past several weeks.
At the same time, District
banks had been actively seeking funds in the Federal funds market.
As elsewhere, the survey of bank lending practices, according to
the figures received thus far by the Reserve Bank, indicated some
further firming of rates and some tightening of other terms.
With respect to the national situation and policy, it
seemed to Mr. Swan that some of the earlier uncertainties had
diminished, it they had not been resolved.
On the other hand,
some of the uncertainties seemed to have been transferred to the
securities market.
Since the August 31 meeting of the Committee
there had beer. a steel settlement which certainly was less
inflationary than it might have been.
Some slowdown in overall
inventory growth presumably was underway, although its magnitude
would depend to a considerable extent on developments in steel
inventories.
Also, the pound was in a somewhat better position.
This country's own international position was not good, but as
far as he could see most of the causes were not new; the Committee
had been discussing them for some time.
financing lay just ahead.
A substantial Treasury
Money and credit markets were somewhat
-80
9/28/65
tighter,
even though that resulted from developments in
the
markets themselves rather than from any positive action on the
Committee's part.
Considering all of those factors, Mr. Swan said, it
seemed to him the Committee should not tighten further at this
point.
He thought it quite likely that either a positive step
toward firming by the Committee or any further tightening by
the market itself would produce a reaction that would result in
considerably more than "slightly" firmer conditions.
In such a
situation, System was likely to be confronted with a need to take
the steps Mr. Hayes had recommendedbut which he (Mr. Swan) did
not favor at this time--namely, to raise the discount rate and
the Regulation Q ceilings.
On the other hand, Mr. Swan continued, given the basic
strength in the present economic situation he would not necessarily
try to back away from the conditions existing at the moment.
He would accept a policy of "no change" but he agreed that that
term needed further definition.
The tightening that had occurred
did not appear to him to have been inconsistent with the sense
of the Committee's decisions for "no change" at the late-August
meeting or other recent ones; the Committee, he thought, had
focused primarily on the level of net borrowed reserves in
discussing immediate policy objectives, and the rate structure
9/28/65
-81
had firmed without any appreciable change in the net borrowed
reserve level.
But the Committee had the responsibility for
deciding whether or not to act to offset market forces,
as
Mr. Robertsor. had noted, and at this time he would define "no
change" to call for attempting to offset any tendencies in
market toward further tightness.
the
In other words, emphasis should
be placed on market rates, with the object of keeping the bill rate
around present levels.
If a lower level of net borrowed reserves
was required to keep the bill rate from rising further, as might
well be the case, that would be acceptable to him.
Mr. Swan said he would not suggest any changes in the
second parag:aph of the directive,
even though he would prefer
He agreed with Mr. Mitchell that
a quite different formulation.
it would be desirable to include a reference to the results of
the steel settlement in
Mr.
the first
paragraph.
Irons reported that economic activity in
the Eleventh
District, as reflected in data for production, construction,
employment,
and retail trade,
continuing to expand.
was at a very high level and was
The District was particularly fortunate
in that it probably would have a highly favorable agricultural
situation this year.
Most major crops were showing production
increases over a year ago.
9/28/65
-82
There continued to be tightness in
banking, Mr.
said, and bank liquidity was at relatively low levels.
Irons
Loans
continued to rise, there had been some further reductions in
Governments,
and deposit increases continued.
District banks
were very active purchasers of Federal funds, with net purchases
running at about $250 million.
City banks in particular were
actively seeking funds to meet loan demands, which were strong
and were expected to continue strong over the rest of the year.
At the national level, Mr. Irons continued, some of the
earlier uncertainties had been removed.
A steel inventory adjust
ment was occurring, but he doubted that its consequences would
be drastic; it would have some effect on industrial production,
but probably not a highly significant or long-continuing one.
As to the major categories of demand,
business outlays on new
plant and equipment promised to be very large,
tations were strong,
consumer expec
and government expenditures at both the
Federal and State and local levels were expected to increase.
Personal incomes were rising and the attitudes of consumers
seemed to fortify their willingness to spend.
particularly
that for skilled workers,
The labor market,
continued to reflect some
degree of firmness, despite the persisting 4-1/2 per cent
unemployment
rate.
9/28/65
-83
Mr. Irons thought there might be some lessening of upward
price movements as a result of the steel settlement, but in his
opinion the tendency on balance would be for prices to continue
to move up.
The possibilities of absorbing increased costs were
reduced as the economy moved closer to optimum rates of resource
utilization.
In light of domestic conditions as well as international
developments with respect to sterling and the U.S. balance of
payments, Mr. Irons preferred to continue present policy at this
time.
It seemed to him that the Committee had three alternatives:
it could adopt a policy of somewhat greater ease, move overtly
and strongly in the direction of greater firmness, or attempt
to maintain the availability and cost of reserves about as they
had been during the past month. He favored the last of these
alternatives, having in mind the general patterns prevailing over
the period rather than those existing at any particular time,
such as the last two or three days or some day two weeks ago.
The market appeared to be transmitting signals of changed
conditions, and the basic significance and importance of those
signals should become clearer if an effort were made to maintain
conditions as nearly as possible as they were.
In his opinion
the Manager should not be bound by any statistical guide with
respect to, say, the level of net borrowed reserves or the
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9/28/65
interest rate on some particular market instrument; he should
have the authority to exercise judgment and to operate in terms
of the feel of the market.
Mr. Irons concluded with the observation that he would
accept alternative A for the directive as submitted, and would
not attempt to make any changes in wording.
Mr. Ellis remarked that with the national economy operating
at a high level and manufacturing output advancing on a broad front,
New England's factory-oriented economy was receiving substantial
stimulus. Manufacturing output in August was averaging more than
8 per cent year-to-year gains, with the important electrical
machinery industry posting a 14 per cent gain. Nonfarm employment
had risen to new peaks and unemployment had fallen to lows not
experienced since 1956.
With high employment and rising wages,
aggregate personal income in the region continued a steady growth
that bolstered high levels of consumer spending.
Auto registrations
for the first seven months cumulated to a 7 per cent gain from
last year. Department store sales in the four weeks ending
September 18 had averaged a 12 per cent year-to-year gain.
Mr. Ellis noted that preliminary tabulations of the
Reserve Bank's fall capital expenditure survey for New England
suggested that outlays this year would outstrip spring expecta
tions by 3 per cent, yielding a 22 per cent year-to-year gain.
9/28/65
-85
Substantial carry-over of plant building expected for the year
helped to b ost recorded present plans fcr 1966 outlays to a
9 per cent gain, with many firms yet to be heard from.
In that ebullient atmosphere, Mr. Ellis said, District
bankers both recorded and reported strong loan demands.
Their
records revealed year-to-year growth of 16 per cent in total
loans, with the 21 per cent growth in real estate loans leading
the parade.
Their reports indicated their customers would be
expecting full accommodation this fall, especially in view of the
fact that bank loans at the prime rate of 4-1/2 per cent were
"bargains" in today's market, where the average yield on new
Aaa corporate bond issues had risen to 4 70 per cent.
At 4-1/2
per cent, the prime rate was an artificial rate.
Turning to monetary policy, Mr. Ellis commented that
compared with last spring there was substantially less diversity
in opinions about the business outlook.
Most analysts now would
agree with the green book's summary statement that "...for all
major categories of final demand--business, consumers, and
government--the prospect is for further expansion."
Given the
existing high level of business activity, with factory operations
other than steel at 90 per cent or more of capacity and with
shortages of skilled workers, the central issue revolved around
meeting the expected demand increases without substantial price
inflation.
9/28/65
-86
In
his judgment, Mr.
Ellis said, upward pressures on
prices were likely to continue,
upward movement.
with the indexes showing steady
Since the steel settlement, price increases had
been announced for products in a number of categories which he
would not take the time to list.
He would note,
however,
that
freight handling charges at Atlantic and Gulf ports were scheduled
to rise from 5 to 12 per cent on October 1 to cover higher dock
labor costs.
or threatened:
There were important areas in which strikes existed
Boeing Aircraft,
the oil industry--which was
facing a 5 per cent wage demand--and the United Aerospace Workers.
In
that atmosphere the extent to which demand pressures were
stimulated by rapid--he almost said unsustainable--bank credit
expansion could play a vital role in determining whether price
pressures were contained or escaped to feed inflationary expecta
tions.
Agenda question 6,
Mr.
Ellis noted,
requested views on
what range of monetary developments might prove to be consistent
within an assumed policy objective of "no change" in
coming weeks.
The question seemed to imply that a "no change" choice continued
to be available to and definable by the Committee.
But he was
pleased to see that both the staff comment and Mr. Partee in his
remarks today emphasized the changed relationships among elements
in "money market conditions."
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9/28/65
There were at least three developments suggesting that the
Committee might have to make a choice between internally inconsistent
intermediate goals, Mr. Ellis observed.
One development might be
loosely labeled "changes in rate relationships."
He had in mind the
facts that certificate of deposit rates were more generally touching
their 4-1/2 per cent ceiling while the prime rate remained pegged
at the same ceiling by other forces; that large corporations might
now borrow at the bank prime rate of 4-1/2 per cent less expensively
than in the bond market; and that a divergence existed between the
discount rate and a Federal funds rate that was consistently at
4-1/8 per cent and edging toward 4-1/4 per cent.
A second development, Mr. Ellis said, might be labeled
"changirg market expectations."
As he read the signs, the rate
increases he had noted as well as the gradual upsurge of long-term
bond rates suggested that both lenders, and investors were coming to
believe that higher interest rates were for:hcoming.
That had to
be evaluated as an evolution of the market itself, because monetary
policy certainly had been accommodating during the past several
months.
If anything, the slight dip in average net borrowed
reserves of the past six weeks suggested that the Committee had
been eager to avoid the rate developments that had come anyway.
A third development might be labeled "changed rate-reserve
relationships," Mr. Ellis continued.
Since establishment of the
9/28/65
-88
discount rate at 4 per cent last fall it had proved possible to
hold the short-term bill rate below 4 per cent while holding
borrowings at a $460 million average and ne: borrowed reserves
between $150-$200 million.
During the past month, with net
borrowed reserves averaging only $127 million, borrowings averaged
$550 million and short-term bill rates had .limbed to 3.96 per
cent.
It seemed apparent that market pressures seeking to swell
the rate of bank credit expansion--which, incidentally, had
totaled 10.6 per cent in 12 months--would force a choice between
acceptance of higher rates on the one hand, or faster credit
expansion facilitated by lowered net borrowed reserve targets and
member bank borrowings on the other.
Four weeks ago, Mr. Ellis observed, his own choice between
those alternatives was conditioned by the uncertainties attending
the steel negotiations and the sterling crisis.
problems, while not finally settled,
alleviated.
Both of those
had been substantially
Meanwhile, the evidence of the need to choose between
conflicting intermediate monetary goals had strengthened.
His
own judgment was that the Committee should not seek to maintain
a ceiling on upward interest rate movements, either of bill rates
or the prime rate.
Once such a peg was accepted as a definite
goal, he saw no ready way to abandon it without even more serious
consequences than the Committee now faced.
To attempt to fore
stall rate advances would entail an overt action to ease policy
9/28/65
-89
by setting lower targets of net borrowed reserves.
He submitted
that such action would create more apprehension than it would
inspire confidence in existing rate levels.
Mr. Ellis' choice of policy, therefore, was for a target
for net borrowed reserves centered at $150 million, with an
expectation that borrowings might average about $500 million if
credit demands followed strong seasonal patterns and reserves
continued to expand as they had recently.
He would agree with
the staff's expectation that short-term bill rates might rise to
4.10 per cent. especially as the maturity date on the three
month bill moved into January.
Under his approach, as distinct
from that of Mr. Hayes, a decision on discount rate action would
be withheld until late October, after the Treasury financing.
In Mr. Ellis' judgment the second paragraph of alternative
A of the draft directives did not provide sufficiently clear
instructions to the Manager.
The Comnittee owed the Manager a
statement of its choice between highe- rates with existing reserve
targets or more rapid credit expansion with lower net borrowed
reserves and existing rates.
And the Committee owed itself a
renewed effort to improve the content of the directive, with
specification of choices between targets if not quantification of
targets.
Mr. Robertson had described three alternatives facing
the Committee, and had selected the second alternative of seeking
average September conditions.
Some such type of policy prescription
9/28/65
-90
should be provided the Manager--whether it was the second alternative,
as Mr. Robertson preferred, the third alternative, which he (Mr. Ellis)
favored, or Mr. Hayes' more aggressive fourth alternative.
In contrast
with the view expressed by Mr. Galusha, he expected to vote against
alternative A for the directive unless it was amended to provide more
adequate specification.
Mr. Balderston said that although he had great sympathy for
Mr. Hayes' approach, it was his feeling that today was not the time
to move to a firmer policy.
His position was generally similar to
those of Mr. Wayne and Mr. Ellis.
He thought Mr. Robertson had
clarified the nature of the Committee's problem by differentiating
the several alternatives for policy.
He would like to stress two things, Mr. Balderston remarked.
The first was a point that Mr. Wayne already had brought to the
Committee's attention--the fact that starting in 1962 banks had
been acquiring the bulk of the net additions to outstanding State
and municipal debt.
In that year they had bought $4.4 billion out
of $5.5 billion net additions, or 80 per cent, and they had been
buying such issues at a high rate ever since.
Some of those issues
no doubt were marketable, but some, he thought, had to be called
unmarketable; it was hard to imagine where purchasers other than
banks might be found for the bonds of, for example, many small and
little-known townships.
Having acquired those bonds, the banks
probably would be holding them indefinitely.
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Secondly, Mr.
Balderston continued,
the Committee should
note that the Treasury had announced a financing of considerable
size, involving $4 billion in bills with 100 per cent tax and loan
account credit.
The proceeds of the financing probably would be
expended by the Treasury fairly rapidly over the next few weeks.
During the period when the proceeds were in tax and loan accounts,
required reserves would be increased accordingly.
If the Committee
adhered to a policy of keeping money market conditions unchanged
during the coming weeks the System, at its own initiative, would
supply the reserves to take care of those added requirements.
Meanwhile,
the Treasury would be drawing on those bank deposits
to take care of its fall expenses, and the funds thus expended
would find their way into private demand deposit accounts.
He
recognized that the bulge in bank credit associated with tax
and loan financing might prove temporary;
temporary in
a period of slack credit
the cas., at present,
it
demand.
But that was not
loan demand remained high the
and iffall
Committee might find some of the reserves it
October haunting it
certainly would be
had provided in
in November.
The issue today, Mr. Balderston remarked, centered on the
meaning of "status quo" at a time when a sizable Treasury financing
had been superimposed upon unusually strong credit demand.
the System accommodate both?
Should
If it did, it would be acquiescing in
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the ballooning of bank credit beyond the constructive needs of
the economy.
If the System supplied sufficent [sic]
reserves to roll
rates back to the levels of a month ago, it would be acting to
depress a rate level that had resulted from the forces of the
market--more specifically, from the impact of expectations of
enlarged demands.
It seemed to Mr. Balderston that a more sensible and
prudent interpretation of a "status quo" policy for the next
two week. would involve providing just enough reserves to
accommodate the normal seasonal increase in demand plus those
that were directly related to the temporary bulge in tax and
loan accounts.
In his view, such a policy .ould not interfere
with an orderly distribution of the Treasury's current issue.
He thought the Committee should anticipate that the somewhat
higher rates attending the money market conditions of recent
days might con:inue, and that rates might even rise further.
As he
aad indicated, Mr. Balderston said, he favored a
status quo policy, as suggested by alternative A of the draft
directives.
of the draft.
However, he was somewhat unhappy about the wording
In his opinion the description of economic and
financial developments contained in the first two sentences
tended to lay the basis for a shift of policy toward firmness.
However, the next sentence began with the words, "In this
9/28/65
-93
situation," and went on to indicate,
policy had remained unchanged.
if
the words "In
in effect, that the Committee's
He thought it would help somewhat
this situation" were deleted.
Also, he would
strike the opening words of the second paragraph,
"To implement
this policy and taking into account," and have the paragraph
begin, "In view of the current Treasury financing, System open
market operations shall be conducted with a view .
. .
"
That
change seemed desirable because in his judgment the financing
was the primary reason for maintaining the status quo at this
time.
Chairman Martin remarked that he agreed with Mr. Galusha
that there was no reason to fear prosperity, even though many
people seemed to feel that the current expansion could not last
simply because activity was at so high a level.
He could not
believe, however, that all periods of prosperity floated on
constantly rising levels of credit, or that one could ignore
such matters as loan-deposit ratios of banks or credit quality
and assume that it was possible to propel prosperity forward
without any adjustments occurring in markets.
Everyone wanted
to see the prosperous conditions the country was experiencing
continue, and he personally had no fear of higher interest rates
in that connection.
9/28/65
-94As to policy, the Chairman said, he thought that this was
the wrong time to make a change.
The Treasury already had announced
its October financing and, while one might argue on technical grounds
that if a change were going to be made it should be done in advance
of the actual financing, the Committee had not yet decided that a
change was in order.
The consensus appeared to be against a policy
change today and some members were of the view that the Committee
should ease conditions somewhat.
In his judgment it would be desir
able to keep to the status quo, with the Desk maintaining market
conditions on as even a keel as possible at this juncture.
If that
suggested that the Committee should write some more specific target
levels into the directive, he did not know how that could be done
effectively.
He assumed that the Manager had been trying to carry
out the Committee's previous directive; when forces built up in
the market the Manager could not be expected to adjust market
conditions day by day.
He agreed with Mr. Wayne that any attempt
to specify quantitative instructions in the directive would force
the Committee to meet more frequently.
The Committee had wrestled
with the problem of the directive for years and he personally did
not believe that it was feasible to write it in quantitative terms.
The Chairman then noted that it was obvious from the discus
sion that the Committee had a difficult drafting problem today, and
he invited suggestions.
-95-
9/28/65
Mr. Robertson said he thought that a change of a few words
at the end of the second paragraph of alternative A would give the
Manager a much clearer idea of what the Committee wanted.
The
change involved replacing "as have prevailed in recent weeks," as
the description of the money market conditions to be maintained,
with "as have prevailed on average in September."
In response to
a suggestion that there might be some advant.ge to using the phrase
"since the last meeting" in place of "in September," Mr. Robertson
said he thought either phrase would serve the purpose.
Chairman Martin suggested that there might be some problems
of definition .ith respect to the word "average," and he then turned
to Mr. Holmes for comment.
Mr. Holmes said that he thought the most difficult problem
such a directive would pose for the Desk was in connection with the
three-month bill rate, which this morning was at 4.02 per cent.
He
would interpret the language Mr. Robertson proposed to call for
rolling the bill rate back to about 3.90 per cent, which might be
hard to do in the current atmosphere.
Mr. Robertson commented that he had not intended the proposed
instruction to apply to the rate on any particular instrument; what
he had in mind was the overall span of money market conditions.
Mr. Hayes remarked that the wording suggested by Mr. Robertson
carried more of a flavor of easing market conditions from their
9/28/65
-96
present state than he thought was reflected in the consensus around
the table.
It was true that some members were strongly in favor of
the course indicated by the suggested wording.
More, however, had
spoken in favor of maintaining the recently firmer conditions, and
several had indicated a preference for overt action toward further
firming, although not immediately.
He would suggest retaining the
original language of alternative A.
Mr. Swan commented that he could see little difference
between "in recent weeks" as in alternative A, and "since the last
meeting," as Mr. Robertson proposed.
The real issue, he thought,
was whether an attempt should be made to roll back conditions to
those prevailing four weeks ago or to maintain those prevailing at
present.
Mr. Daane agreed, and added that it.was his impression
that a majority of the Committee had indicated a preference for
the latter course.
Mr. Wayne suggested that the matter might be settled simply
by calling for "maintaining conditions in the money market within
the ranges which have prevailed since the last meeting."
Mr. Ellis said he would not favor avoiding a decision on
what he thought was the real question facing the Committee--whether
or not to roll back bill rates.
As the staff had pointed out,
previous relations among elements of money market conditions were no
longer consistent, and it was necessary to decide what the Manager
-97
9/28/65
was to be asked to do.
Once that decision was made the Committee
could turn to the question of language for the directive.
Mr. Mitchell commented that he had not detected such exclu
sive emphasis on bill rates.
The discussion, in his opinion, had
been more in terms of the whole structure of market rates.
Mr. Ellis replied that he understood the language Mr.
Robertson proposed to imply a rollback of bill rates from their
present level of 4.02 per cent.
That, he thought, was the question
with which the Committee was faced.
Chairman Martin said he would reiterate a point he had made
earlier; namely, that the course that Mr. Mitchell and some cthers
favored seemed to him to involve a definite change in policy in
the direction of ease.
Mr. Mitchell replied that he did not believe he was recom
mending a change in the Committee's policy posture.
It seemed to
him that the Committee had found itself in a situation in which
money market conditions were much firmer than it had intended them
to be.
If he favored a "change" in policy it was only in the
limited sense of advocating the earlier conditions rather than those
of the most recent week.
Mr. Hayes said he thought it was important to distinguish
between the temporary factors that had led to the developments of
the latest week and the underlying situation of strong credit demands
9/28/65
-98
that was producing tighter conditions in the market.
the alternatives were clear:
To his mind,
the Committee could recognize the
basic strength of the forces in
the market and let current rate
levels continue to prevail, or it could try to restore the earlier
rate levels.
Chairran Martin agreed that the choice was between main
taining the status quo with respect to interest rates or rolling
them back.
Mr.
Robertson said that he did not advocate a drastic
rollback of rates; as he had indicated, he favored maintaining the
average conditions prevailing during September.
Mr. Mitchell said he thought there were some unwarranted
implications :.n the way the term "rollback" was being used in
discussion today.
the
The average of net borrowed reserves in
September was $118 million, as compared with $167 million for
the most recent week.
Net borrowed reserves were one of the
factors governing the Manager's actions,
but Mr.
Robertson's
prescription, which he favored, also provided for an average bill
rate of 3.90 per cent and an average Federal funds rate of 4.10
per cent, as other elements in the general pattern of conditions
to be maintained.
Mr.
Ellis commented that he thought market conditions had
gone beyond the point where that pattern could prevail; the
9/28/65
-99
September averages now were inconsistent with one another.
As he
understood the staff and the Manager, net borrowed reserves would
have to be below $118 million if
the bill rate was to be maintained
at less than 4 per cent.
Mr. Holmes agreed that money market relations had changed.
He noted that in its comment on question 6 the Board's staff had
estimated that net borrowed reserves of $150 million were likely
to be associated with a bill
rate near the upper end of the 3.95
4.10 range.
Mr. Hickman asked what level of bill
rates was likely to
be consistent with net borrowed reserves of about $118 million.
Mr. Holmes replied that he found it
with any precision.
hard to answer that question
Some market forces would be tending to push
bill rates higher and some to move them lower, and he did not
think one could be specific about the outcome.
Chairman Martin then proposed that a vote be taken,
essentially on the question whether to maintain the status quo as
presently constituted with respect to market rates or to roll
rates back to lower levels.
That, he thought,
was what the issue
amounted to.
Mr. Shepardson suggested that the vote be taken on a
directive with the last phrase of the second paragraph of
9/28/65
-100-
alternative A modified to read, "with a view to maintaining about
the current conditions in the money market."
Thereupon, upon motion duly made
and seconded, and with Messrs. Maisel,
Mitchell, and Robertson dissenting,
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 following current economic policy
directive:
The economic and financial developments reviewed at
this meet.ng indicate that the domestic economy has expanded
further in a climate of optimistic business sentiment and
firmer financial conditions, and that our international
payments have been in deficit since midyear. Some of the
uncertainties previously affecting foreign exchange markets
have diminished. In this situation, it remains the Federal
Ope Market Committee's current 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, and taking into account the
current Treasury financing, System open market operations
until the next meeting of the Commmittee shall be conducted
with a view to maintaining about the current conditions in
the money market.
Chairman Martin then noted that there had been distributed
copies of a letter dated September 21,
Patman,
1965,
from Congressman Wright
Chairman of the House Committee on Banking and Currency,
requesting that certain recent records of the Open Market Committee
be made available in his office at an agreed time, with necessary
personnel from the Committee present, so that he might review and
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9/28/65
examine the records.
These included records relating to the dollar
value of the portfolio,
trading in the Account,
income of the Account,
the procedural way in which it was obtained, the procedural way in
which it was transferred, and the way in which the Federal Reserve
Board and the Reserve Banks received their operating income.
After discussion, the staff of the Committee was authorized
to assemble appropriate records bearing on the questions raised, with
the understanding that arrangements would thereafter be made for
their transmittal.
Secretary's note: The following letter
was sent to Congressman Patman, over
the signature of Chairman Martin, on
October 1, 1965:
This is in reply to your letter dated September 21,
in which you request information relating to the securities
in the System Open Market Account: and the income derived
from these securities. The staff of the Federal Open
Market Committee is getting together the records bearing
on the questions raised in your letter.
I have asked Mr. Cardon to get in touch with Mr. Nelson
when this material is ready, so that arrangements may be made
for the review and examinations referred to in your letter.
It was agreed that the next meeting of the Committee would be
held on Tuesday,
October 12,
1965,
at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
September 27, 1965
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on September 28, 1965
Alternative A (no change)
The economic and financial developments reviewed at this
meeting indicate that the domestic economy has expanded further in
a climate of optimistic business sentiment and firmer financial
conditions, and that our international payments have been in deficit
since midyear. Some of the uncertainties previously affecting
foreign exchange markets have diminished. In this situation, it
remains the Federal Open Market Commictee's current 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, and taking into account the current
Treasury financing, System open market operations until the next
meeting of the Committee shall be conducted with a view to maintain
ing about the same conditions in the money market as have prevaile
in recent weeks.
Alternative B (firming)
The economic and financial developments reviewed at this
meeting indicate that the domestic economy has expanded further
in a climate of optimistic business sentiment and firmer financial
conditions, and that our international payments have been in deficit
since midyear. Some of the uncertainties previously affecting
foreign exchange markets have diminished. In this situation, it is
the Federal Open Market Committee's current policy to move further
to strengthen the international position of the dollar, and to counter
the emergence of inflationary pressures, by moderating somewhat the
pace of growth in the reserve base, bank credit, and the money
supply.
To implement this policy, while
current Treasury financing, System open
the next meeting of the Committee shall
to attaining slightly firmer conditions
taking into account the
market operations until
be conducted with a view
in the money market.
Cite this document
Federal Reserve (1965, September 27). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19650928
@misc{wtfs_fomc_minutes_19650928,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1965},
month = {Sep},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19650928},
note = {Retrieved via When the Fed Speaks corpus}
}