FOMC Minutes

A meeting of the Federal Open Market Committee was held in

the offices of the Board of Governors of the Federal Reserve System

in Washington, D. C., on Tuesday, November 2, 1965, at 9:30 a.m.

PRESENT:

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Martin, Chairman

Hayes, Vice Chairman

Balderston

Daane

Ellis

Galusha

Maisel

Mitchell

Patterson

Robertson

Scanlon

Shepardson

Messrs. Bopp, Hickman, Clay, and Irons, 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. Hackley, General Counsel

Mr. Brill, Economist

Messrs. Baughman, Garvy, Holland, and Taylor,

Associate Economists

Mr. Holmes, Manager, System Open Market Account

Mr. Coombs, Special Manager, System Open Market

Account

Mr. Molony, Assistant to the Board of Governors

Mr. Cardon, Legislative Counsel, Board of Governors

Mr. Partee, Associate Director, Division of Research

and Statistics, Board of Governors

Mr. Williams, Adviser. Division of Research and

Statistics, Board of Governors

Mr. Hersey, Adviser, Division of International

Finance, Board of Governors

Mr. Axilrod, Associate Adviser, Division of Research

and Statistics, Board of Governors

Miss Eaton, General Assistant, Office of the

Secretary, Board of Governors

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Messrs. Eisenmenger, Eastburn, Mann, Ratchford,

Jones, Tow, Billington, and Green, Vice

Presidents of the Federal Reserve Banks of

Boston, Philadelphia, Cleveland, Richmond,

St. Louis, Kansas City, Kansas City, and

Dallas, respectively

Mr. Lynn, Director of Research, Federal Reserve

Bank of San Francisco

Mr. Meek, Manager, Securities Department, Federal

Reserve Bank of New York

Mr. Kareken, Consultant, Federal Reserve Bank of

Minneapolis

The Chairman reported that the Secretary had received advice of

the election by the Federal Reserve Banks of Atlanta, St. Louis, and

Dallas of Mr. Patterson, President of the Federal Reserve Bank of

Atlanta, as a rember of the Federal Open Market Committee to fill the

unexpired portion of the term beginning March 1, 1965, and that Mr.

Patterson had executed the oath of office prior to this meeting of the

Committee.

Upon motion duly made and seconded, and

by unanimous vote, Daniel H. Brill was elected

to serve as Economist of the Committee until

the first meeting of the Committee after

February 28, 1966, with the understanding that

in the event of the discontinuance of his

official connection with the Board of Governors

he would cease to have any official connection

with the Federal Open Market Committee.

Upon motion duly made and seconded, and

by unanimous vote, the minutes of the meetings

of the Federal Open Market Committee held on

September 28 and October 12, 1965, were approved.

Before this meeting there had been distributed to the members

of the Committee a report from the Special Manager of the System Open

Market account on foreign exchange market conditions and on Open Market

Account and Treasury operations in foreign currencies for the period

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October 12 through October 27,

1965,

October 28 through November 1, 1965.

and a supplemental

report for

Copies of these reports have

been placed in the files of the Committee.

In comments supplementing the written reports,

Mr.

that the gold stock would remain unchanged again this week.

something more than three months without a cnange.

Fund still

Coombs said

This was

The Stabilization

had nearly $80 million of gold on hand, which should suffice

to see the U.S.

orders appeared.

through the rest of the month unless unexpected new

He expected the French would be in

for no more than

their minimum monthly order of 30 tons; the Bank of France seemed to

have taken in

no dollars during October and night in

rienced some reserve losses.

fact have expe

On the London gold market, Russian sales

had enabled the Pool to pay off the heavy deficits incurred in earlier

months,

and the Pool account was now just about even.

Between now and

next spring it seemed quite possible that the Russians might have to

sell another $250 million or so of gold.

Demand on the London market

continued to run at high levels, however, with recurrent upward pressure

on the price, and it was questionable how much of the prospective Russian

sales would be retained by the Pool for distribution to the member

central banks.

On the exchanges, Mr. Coombs continued, sterling had remained

firm with no need for intervention either by the Bank of England or

the Federal Reserve Bank of New York to support the rate.

to time the Bank of England had been able to take in

of dollars.

From time

sizable amounts

Judging from the movement of the Bank's account with the

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11/2/65

Federal Reserve Bank of New York, it would appear that during September

and October the Bank of England took in a total of nearly $600 million,

of which $190 million was used to repay short-term debt to the Federal

Reserve and U.S. Treasury.

In addition to this net inflow of dollars,

the Bank of England had probably managed to pay off more than $300

million of maturing forward contracts.

Yesterday and today, partly

reflecting a special gold transaction, the Bank had taken in a further

$260 million, of which $100 million was used for a further repayment on

the swap line with the System, thus reducing Bank of England drawings

outstanding to $600 million.

On the other European exchanges

the markets had been remarkably

well balanced, with outflows to the U.K. probably serving to offset

surpluses that might otherwise have appeared.

In the case of Switzerland,

further progress had been made in paying down the System's swap debt,

which would be reduced by Friday, November 5. to no more than $31 million.

There was some expectation in the market, Mr. Coombs noted, that

the year end might see an unusually severe squeeze in the Euro-dollar

market.

The risk had been heightened by the recent appeal of the Com

merce Departmert to U.S. corporations to pull back the bulk of their

short-term balances abroad.

As the Committee would recall, the heavy

reflux of such balances following the inauguration of the voluntary

restraint program last February was largely offset, so far as the Euro

dollar market was concerned, by a compensating inflow of short-term

funds from Italy.

If a new squeeze on the Euro-dollar market should

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now develop, it would be hard to find a similar source of a new funds to

help keep the n.arket in balance.

There followed discussion, at the instance of a Committee member,

concerning the record of French gold acquisitions and indications of tne

recent trend in the French payments position.

Thereupon, upon motion duly made

and seconded, and by unanimous vote,

the System open market transactions in

foreign currencies during the period

October 12 through November 1, 1965,

were approved, ratified, and confirmed.

Mr. Coombs then presented several recommendations for the con

sideration of the Committee.

First, a System drawing of $100 million

under the swap line with the Bank of Italy would mature for the first

time on November 26, 1965, and he recommended its renewal if necessary,

which as of the moment seemed likely.

Renewal of the $100 million drawing,

if necessary, was approved.

Second, Mr. Coombs recommended renewal of a dra ing of $125

million by the Bank of England under its swap line, which drawing would

mature on November 26, 1965, if the Bank of England should so request.

This would be a first renewal.

Renewal of the drawing of $125 million,

if the Bank of England should so request,

was approved.

Finally, Mr. Coombs noted that a $5 million equivalent swap of

German marks for Dutch guilders would mature on November 30, 1965.

recommended its renewal for another three months in the likely event

He

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that the System was unable to acquire sufficient guilders in the mean

while to liquidate the transaction.

Renewal of the $5 million equiv

alent swap of German marks for Dutch

guilders, if necessary, was approved.

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 October 12 through October 27,

1965, and a supplemental report for October 28 through November 1, 1965.

Copies of both reports have been placed in the files of the Committee.

In supplementation of the written reports, Mr. Holmes commented

as follows:

System open market operations have been conducted since

the last Committee meeting against the background of a

gradual but persistent erosion in the prices of Government

securities. In this environment the System has sought to

maintain an even keel in the money market as the Treasury

priced and offered for sale the 4-1/4 per cent note on

which the subscription books closed yesterday.

In fact, conditions have been som?what more comfortable

in the money market in the past two weeks than prevailed

earlier, as the Desk paid increased attention to the

cautious atmosphere in which short-term rates tended to

edge higher. Federal funds have traded mainly at 4-1/8

per cent, but they also traded at 4 per cent or below on

several days. Pre-week end trading at 4-1/4 per cent has

been rare and member bank borrowing from the Reserve Banks

has been more moderate than in a number of months. Dealers

have generally been able to finance their portfolios at

lower rates than have prevailed for some time.

The System's role during most of the recent interval

was, of course, conditioned by the usual need to absorb

reserves over mid-month. Thus, open market operations

withdrew $355 million in the period from October 12 through

last Wednesday. Since then, we have supplied $1,067 million

reserves on a commitment basis--and $891 million of this has

taken the form of purchases of Treasury bills in the market.

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The Treasury's offering of a 4-1/4 per cent 18-month

note yesterday for cash subscription was intended to be as

routine as possible. However, while the new issue was

generally regarded as fairly priced, no real enthusiasm

developed for the issue--partly because the larger banks

and corporations are reluctant to commit for 18 months in

the face of expected cash demands upon them. Smaller banks

and public funds are reported to have nad a fairly good

interest in the issue, but the Treasury will not have a

good idea of the size of the subscriptions until later today.

Market ideas of the allotment percentage on large subscrip

tions have been scattered over an unusually wide range of

from 25 to 40 per cent, with the weight of sentiment probably

toward the upper end of this range.

It is not easy to put one's finger on the forces behind

the erosion of Treasury note and bond prices since mid-October.

There has been no extensive dealer liquidation or investor

selling such as occurred in September. The decline has taken

place in spite of an apparent subsidence of the fears of an

imminent shift in monetary policy that contributed to the

accelerated price decline of later September--although some

concern on this score may linger on. Market participants

seem to be impressed instead with the other demands falling

on their bank and nonbank customers and the very limited

investor appetite they foresee for Government issues as the

economy continues to expand. There is as well considerable

market talk that the volume of corporate bond issues in the

discussion stage for either public offering or private place

ment is mounting. With a near record volume of bond proposals

going before the voters today, the municipal market also

exhibits an air of caution. Thus, the Treasury's new 4-1/4's

will have to be distributed in an environment where underlying

expectations are for bond yields to work higher over the months

ahead. In general, the markets continue sensitive to new

economic, financial, or other developments.

In the Treasury bill market the redistribution of the

March and June tax anticipation bills from the banks that

bought them to dealers and corporations has proceeded far

more smoothly than had been generally expected a month ago.

Corporate demand for the March bills was particularly good.

At the moment, however, a cautious atmosphere prevails in

the bill market. In part, this reflects some dealer dis

appointment that the Treasury's refinancing was on a cash

rather than an exchange basis so that there has been no

reinvestment demand for bills stemming from the sale of

rights. System purchases in the market of almost $900

million Treasury bills during the past three days have

served to moderate, but not offset fully, the upward pressure

11/2/65

on rates. Yesterday's auction resulted in average issuing

rates of about 4.08 and 4.22 per cent on the 3- and 6-month

issues, the highest levels since early 1960.

Some mention should also be made of a slight stiffening

in other short-term rates. Certificates of deposit are

sporadically available at major New York City banks at

4-1/2 per cent for 3-month maturities, and the 3-month CDs

of prime name banks are trading at rates just under 4-1/2

per cent in the secondary market. The major sales finance

companies have also been adjusting their rate schedules

higher so that they are now generally offering 4-3/8 per

cent on paper maturing in over 60 days, up 1/8 per cent from

the rates prevailing in late September.

The timing of the next instalment of the Treasury's

financing program--an offering of $2 to $2-1/2 billion

June tax anticipation bills--has not been finally deter

mined. The bills will probably be auctioned in two to

three weeks and paid for a week later. Thereafter, the

Treasury should be out of the market until early next year.

Mr. Balderston asked whether Mr. Holmes felt that the degree

of restraint intended by the Committee's directive had been lessened

recently, and Mr. Holmes replied that it was hard to make an over

all statement.

Interest rates had risen gradually and in an orderly

way to a higher level, reflecting the pressure of demand on the

supplies of funds.

At the same time, statistical measures of bank

reserve positions, including net borrowed reserves and Federal funds,

had reflected a comfortable, though certainly not an easy, situation.

Thereupon, upon motion duly made and

seconded, and by unanimous vote, the open

market transactions in Government securities

and bankers' acceptances during the period

October 12 through November 1, 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.

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Mr. Brill made the following statement on economic conditions:

Little in the way of hard new economic facts has become

available since the last meeting of the Committee. What

fragments one can come by, however, might be read to suggest

even greater current strength and stability in the economy

than were apparent earlier.

Partial data on industrial pro

duction lend hope that the production index for October may

hold at the slightly reduced September level, even with steel

output down an additional 10 per cent, and preliminary clues

on the unemployment picture are encouraging.

On the demand side, the well-timed moderate fiscal

stimulus of retroactive and higher social insurance payments

is being reflected in a resumption of the rise in retail sales,

after a slight sales decline in August and September.

And

despite continued scattered press reports of price boosts for

individual commodities, the official indexes have shown little

change in average industrial prices in recent months.

This is entirely too comforting a picture, and I have

been looking for

gremlins under the tables and behind the

charts. One can easily find many. For example, the Bureau

of Labor Statistics may be deluding us with numbers suggesting

that prices have stabilized. I don't have to advise this

Committee to take the official price measures with some

skepticism, or to suggest that the indexes may have been

understating the price advance over the past year, as they

undoubtedly understated the actual price declines of the

The official measures may very well again be

early '60's.

concealing further advances, and in this connection one must

note that purchasing agents are reporting higher prices with

increased frequency.

of price

But these measures could also be concealing signs

weakness in areas where over-capacity is beginning to emerge.

Given the mores of industrial pricing practice, which encourage

publicity about price advances but tend to conceal concessions

and reductions, and given some known biases in the official

data collction and manipulation techniques, we can't look

to measures based on quoted prices alone to provide early

On balance, and

warning of impending weakening of demands.

taking into account the most recent increases in copper and

aluminum, my impression is that the general level of prices

is continuing to creep up--uneven and moderately, but never

theless up.

Another gremlin threatening to derail the economy from

the sustainable growth track is the increasing imbalance in

the structure of production. This imbalance is evident from

a number of perspectives. For example, over the past twelve

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months production of business equipment has increased more

than twice as rapidly as production of consumer goods, even

including automobiles.

Again, manufacturing industries'

spending for new plant has consistently outpaced shipments

of products since 1963, and by a steadily ;idening margin.

Again, as best as we can estimate, industrial capacity appears

to have grown by between 5 and 6 per cent this year, as

against a growth in real final demand for goods of between

4 and 5 per cent.

Have we reached the point where businesses are beginning

to doubt the capacity of markets for their expanded and

modernized plants? Evidently not yet. The latest survey of

business capital spending plans will predict capital outlays

to rise next year about as rapidly as they did this year.

Such business optimism poses policy makers with a two

edged problem. In the short run, the continued rapid pace of

spending for plant and equipment will tend to sustain order

metals

backlogs, and maintain upward pressure on machinery and

prices and on wage rates f6r scarce skilled labor. But over

the longer run--and I speak here of months, not years--one

must wonder whether this business optimism will be validated

by the rest of the economy's performance. The experience of

1956-57, when plant spending accelerated while final demands

were slipping, should serve as warning of the dangers of

business overoptimism. Moreover, even during the rapid

expansion in activity earlier this year, capacity utilization

didn't reach the peaks of earlier booms, and with growth in

industrial output temporarily stalled by steel inventory

liquidation, the overall utilization ratio has edged down a

little. We calculate, roughly, that it will take continued

gains in GNP of $10 and $12 billion a quarter to keep the

utilization ratio from slipping further.

I have probably succeeded in finding enough gremlines.

They shouldn't detract from the very fine performance the

economy is turning in at the moment, but we do have to antici

pate the challenges to policy that are developing. As I see

it, the complex of future problems includes the following:

(1) a need to put final demands--housing and State and local

outlays, as well as consumer spending--on a faster growth

track than has been the case recently, in order to avoid

increasing the imbalance in output; (2) a need to moderate

the stimuli now operating on business investment plans, so

that real as well as financial resources will be available

for increases in other types of spending; (3) a need to repress

inflationary expectations, which I suspect tend to stimulate

business capital spending more and sooner than they affect

consumption habits; and (4) a need to keep total demands,

for both investment and consumption, moving up at a $10 to

$12 billion per quarter rate in order to keep resource

utilization rates from slipping.

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11/2/65

For monetary policy, the problem is aggravated by the

likelihood that fiscal policy will become somewhat less

stimulative over the first

half of next year.

Moveover,

fiscal changes will bite directly into the kinds of final

demands that need stimulation; the social security tax

increase will be offset only in part by the second stage of

the excise tax cut.

Frankly, it is difficult to conceive of the monetary

policy that would reconcile all cf these potential aggrega

tive and compositional problems.

Higher interest rates,

particularly at the long end, are likely to fall as heavily

on final demands as they are likely to restrain business fixed

The consequent slowing in aggregate demand might

investment.

kill any budding inflationary expectations, but I see no

assurance that it would tend to restore balance in the composi

tion of output or keep resource utilization rates high. Alter

natively, rolling back interest rates at this juncture might

serve to encourage even more expansive business investment

plans, which in turn would lend aid and comfort to factors

making for upward price and wage pressures, particularly in

the sensitive commodity and machinery areas.

It is probably fortunate, therefore, that at this time

even keel considerations urge a "no change" policy, or at

least a policy that would lead to no change in long-term

This is not because I am convinced that it

interest rates.

is positively the right policy fcr the prospective domestic

ecoromic scene, but because I see unhappy consequences arising

from alternative measures.

In reply to a question, Mr.

Brill said the capacity utilization

rate was estimated currently at about

89 per cent.

During the steel

inventory buildup the rate got close to 91 pr cent, but then it

began to slip.

Mr. Partee made the following statement concerning financial

developments:

Interest rates have edged up in most sectors of the money

and capital markets over the past two weeks, in an environment

of continuing investor caution and hesitancy.

The Treasury's

cash refinancing offer, limited to an 18-month -aturity as

expected, failed to buoy long-term markets, and heavy seasonal

System buying of bills in recent days met a similar lack of

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response in the short-term area. Indeed, even the announce

ment that the Treasury would be borrow:ng somewhat less at

the end of this month than had been anticipated earlier was

greeted without a ripple in market quotations.

Many market participants evidently are holding firmly

to the view that any near-term change in interest rates is

almost bound to be upward. The economic justification for

this view is basically the same as that which has propelled

the stock market on to new highs in very heavy trading and

with growing evidence of speculative exuberance. A continua

tion of vigorous economic expansion well into 1966, dominated

by rising military expenditures and further substantial gains

in business capital outlays, seems certain to be accompanied

by a more than proportional increase in aggregate credit

demands. But financial saving is likely to expand more

gradually in line with rising incomes, it is argued, so that

market forces will tend to bring upward pressures on interest

rates.

For these market analysts, the principal uncertainty

in the near-term outlook is what the response of the Federal

Reserve to stronger demand pressures might be, since provision

of sufficient reserves would tend to balance supplies and

demands at higher aggregate levels. Even with this uncertainty,

however, the range of possibilities seems to include only

stable rates at the one extreme to a substantial upward adjust

ment at the other. Hence, these investors see little risk in

betting on higher rates, at least for a time.

There is a good deal of evidence, it seems to me, to

support this view. To be sure, newly available flow of funds

data for the third quarter show a decline in total funds raised,

from a first half average annual rate of $71 billion to about

$59 billion. But this is misleading. Two-thirds of the decline

came in Federal borrowing and reflected, the absence of a third

quarter cash financing. Partly as a result, there was an even

sharper drop in the Treasury cash balance, and funds provided

to the credit markets by the private sectors of the economy

actually rose. Another result is the relatively heavy fourth

quarter Treasury financing schedule, the first instalment of

which contributed to a large bank credit increase in October.

The rest of the decline in net credit expansion last

quarter was accounted for by a slowing in bank loan growth,

mainly to nonfinancial business. The drop, however, was

from a very high rate of expansion in the first half that

had reflected a variety of temporary influences. Perhaps some

further moderation in business loan growth can be anticipated

in the current quarter, as the inventory shift in steel and

related industries proceeds. But business loans in total

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have continued to show considerable strength--though there

was a more than seasonal decline in New York last week--and

borrowing by the metals industries has held up surprisingly

well.

More generally, it seems to me that business needs for

external financing are much more likely to be rising than

falling in the months ahead. Growing capital outlays, expand

ing working capital requirements, relatively thin liquidity

positions, and a leveling in profits and hence in the flow

of internal funds are all factors pointing to increased reliarce

on outside sources of funds. It is difficult to predict whether

such financing is likely to fall more on the banks or on the

capital markets, although current interest rate relationships

the limiced receptivity of the public market, and the presump

tion that market rates are cyclically high seem to me to favor

the bank loan route. Even so, there is likely to be continuing

supply pressure in the bond market. Corporate offerings were

light in October, but the calendar has built up sharply in

recent days, and a substantial increase is now indicated in

November volume.

In view of the continuing weakness in housing starts,

one might look for some slackening in mortgage lending volume

This is by far the largest taker of finds in financial markets,

so that even a marginal reduction could free substantial credits

for use by other sectors. But residential construction expenc

itures have been well maintained this year, reflecting higher

values per housing unit, and mortgage debt has continued to

expand at a steady rate. The three major types of institutional

lenders for which data are available, moreover, have continued

to report mortgage loan commitments running well above year

ago totals.

In other credit areas, too, there seems little prospect

of significant reductions in the demand for funds. Consumer

credit has been growing at an advanced rate this year, and so

long as incomes are rising and sales of cars and household

durables remain strong, there is little prospect for a slowing

in credit use. New security issues of State and local govern

ments have about equaled the 1964 volume, though with some

month-to-month variations; given the intensity of demands for

local services, there would seem to be more likelihood of

increase than decrease in the months ahead.

Thus there appear to be no important areas in which

credit demands are likely to wane, except for a temporary and

probably mild slackening in inventory financing

An on top

of these continuing demands, credit markets must accommodate

the current increase in Treasury financing and prospective

further expansion in capital-markets-type business financing.

More of these credit demands probably could be met, either

directly or indirectly, through sales to individual investors

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11/2/65

rather than through financial intermediaries, but such a

development usually is accompanied by rising interest rates.

If the institutions are to finance a larger share of total

credit expansion, on the other hand,there will have to be

some acceleration in deposit growth.

This would require the

maintenance of a competitive interest rate structureparticularly in the case of CD's--and, for the banks, probably

a more rapid growth in total and nonborrowed reserves.

Continuing strength in credit demand thus seems likely

before long to present the Committee with the problem of

reconsidering its interest rate, bank reserve, and credit

growth objectives as relationships among these variables

continue to shift. For the present, however, the Treasury

cash refinancing would seem to dictate an even keel policy,

aimed at maintaining current rate levels and extending at

least to the mid-November payment date and perhaps for some

time after, depending on market conditions and dealer progress

in distributing the issue. Looking further ahead, the decisicn

whether or not to make an overt change in policy will of course

rest on broader economic considerations, but developing pres

sures in credit markets could well force the issue.

In reply to a question, Mr. Partee said he would expect a more

rapid growth of total bank credit in the final months of 1965 than

during the summer.

On the other hand, nearly everyone expected a

slower rate of growth than in October.

of opinion.

borrowed

In between there were shades

The consensus seemed to be that the growth rate of non

reserves might be about the same as the average since March.

Personally, he leaned a little toward the high side, as his statement

had indicated.

Mr. Mitchell referred to Mr. Partee's comment that flow of

funds data for the third quarter showed a drop to $59 billion in total

funds raised, from a first half annual rate of $71 billion.

He asked

for further explanation, and Mr. Partee cited as a reason the fact

that the Treasury cash balance was much lower at the end of September

than at the end of June.

of the figures,

He went on to provide a more detailed analysis

11/2/65

-15Mr. Hersey presented the following statement on the balance

of payments:

Straws in the wind in the past three weeks have given

us no clear indication of which way the balance-of-payments

wind is blowing. One quick gust gave us trade figures for

September that look quite satisfactory

But another gust

showed an adverse balance in September, on current and

capital transactions combined, that was much larger than

anyone thought possible who had seen the preliminary

indicators.

For the third quarter as a whole, early trials at

piecing together estimates for the various categories of

current and capital transactions have foundered on trying to

guess capital outflow for direct investment. We simply have

no way of telling whether direct investment outflows were

nearer a seasonally adjusted quarterly rate of a billion

dollars, which was the average for the first half of 1965,

or half a billion, as in the first three quarters of 1964.

A drop to this lower level was hoped for, and seemed con

sistent with the known plans for overseas capital expenditure.

But if American capital expenditures abroad are still growing,

and especially if companies are worrying about the possibility

of new controls or taxes on outflows, then it might not be

very strange if the level of outflow in the third quarter

were still rather high. It will be several more weeks before

we have statistics to clear up this uncertainty.

The figures we do have show that the temporary causes

of the payments surplus in the second quarter--large reflows

of liquid funds and of bank credit, a low level of new foreign

security issues, and a trade surplus swollen by strike-delayed

shipments--either were no longer present in the third quarter

or were much attenuated. Some other temporary factors need

to be considered, connected chiefly with the sterling situation.

I will mention these in connection with a longer-range comparison

I would like to make between the quarter just endedand the

first three quarters of 1964.

That base period is before the sterling crisis broke, and

before the great wave of U.S. capital outflows of late 1964

and early 1965 got going. The wave of capital outflows in

cluded bank loans and also corporate financing of direct

investment subsidiaries abroad, and some parts of both we e

motivated by fears of coming governmental interference. The

interference came, with the activation of the Gore Amendment

and the voluntary programs, and it successfully halted the

bank loan part of the wave. If we take the official settlements

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measure of our deficit and apply certain adjustments for

temporary factors, we will find that there has been an

apparently significant net improvement over the past 15

months or so. But the U.S. balance of payments has not

been brought into equilibrium, and the reserve gains of

Continental Europe have not been halted.

In the third quarter of 1965 U.S. liquid liabilities

to foreign reserve holders rose, U.S. reserves declined,

and France prepaid debt obligations to us; the total financ

ing by these official transactions was somewhat under $500

million. Seasonally adjusted (by near y $600 million) that

meant a small adjusted surplus, on the official settlements

basis, of about $100 million. But because the statistics

were affected by the liquefying of the United Kingdom's

holdings of American corporate securities, we ought to

adjust the figure again; this brings the adjusted surplus

up to about $300 million.

This very considerable surplus was a highly temporary

phenomenon. It was concentrated in July and August, and it

was caused by an unusually rapid buildup in the balances held

here by foreign commercial banks, including U.S. bank branches.

That buildup, which amounted to nearly $700 million, reflected

the weakness of sterling during the summer, and also, in some

degree, the movement of Italian reserve funds through Italian

commercial banks to the Euro-dollar market. In September the

movements of Italian funds continued, but sterling's position

changed very greatly, and it was undoubtedly for that reason

that the inflow of foreign commercial bank funds to the

United States fell off in September.

To get away from these fluctuating special influences

and closer to measuring the underlying position of the U.S.

balance of payments in the third quarter of 1965, the device

I would use is to substitute for the actual inflow of

foreign commercial bank funds an average amount that might

reasonably be expected over the years, assuming a strong

upward tilt in the trend of outstanding balances. I would

put this quarterly growth expectation at about $200 million.

The actual inflow in the July-to-September quarter was much

more than this, half a billion more. Without the abnormal

extra inflow, the adjusted payments balance would have been

not a surplus of over a quarter of a billion, but a deficit

of around $200 million.

A somewhat similar calculation applied to the first three

quarters of 1964 gives an adjusted deficit at that time of

about $350 million a quarter on the average. In the quarter

just ended the adjusted deficit was appreciably less than that.

-17-

11/2/65

In appraising this change and trying to judge whether

the improvement will be sustained, we should look at the

components. The trade surplus, after dropping in the first

half of 1965, is back up nearly to its earlier level; further

improvement is likely, but may be slow for a while.

There

has been a great cut in the flows of bank credit and liquid

funds; these will certainly remain far below the 1964 levels,

but may increase somewhat.

And there has been worsening in

sone other categories--among these, perhaps, though we can't

be sure, direct investment cutflcws.

We emerge with a rather mixed picture, at a time when

the United States ought to be approaching the coming inter

national monetary reform talks with clear prospects of

equilibrium ahead. Perhaps we should be asking ourselves

again some basic questions. For example, is current monetary

policy doing all it reasonably can, given the primary claims

of the domestic economic situation, to help bring about the

long-run realignment of cost levels that is needed if American

companies are to be encouraged to export more from the United

States instead of from more and more plants abroad?

There followed a discussion, at the request of Mr. Maisel,

regarding the effect on the U.S. balance of

payments of swap operations

as compared with liquidation by the British cf their portfolio of U.S.

investments.

Chairman Martin then called

views on economic conditions

began the go-around, made

for the

go-around of comments and

and monetary policy 1/.

Mr. Hayes, who

the following statement:

1/ In light of the discussion at the October 12 meeting, staff ques

tions and comments relating to factors bearing on monetary and credit

As a part of

policy had not been distributed prior to this meeting.

a transition to new procedures, however, the introductory section of

the "green book" (Current Economic and Financial Conditions) had been

expanded to include additional material of a type simiilar to that

There had

formerly included in the staff comments on the questions.

also been distributed a "blue book" (Money Market and Reserve Relation

ships), which analyzed in an integrated way the material formerly dis

tributed to the Committee in the staff comments on the sixth question

and in the memorandum on member bank reserves--past and prespective.

Copies of the "green book," the "blue book," and the supplement to

the"green book" have been placed

in

the files

of

the Committee.

11/2/65

-18-

Today it is quite obvious that because we are in the

midst of a Treasury refinancing program we have no alterna

tive but to maintain policy unchanged and thereby facilitate

the Treasury's operation. The next time we meet we shall

have additional data at hand which may or may not provide

support for some prompt change of posture. I would stress,

however, that a policy change can rarely be justified on

the strength of developments during only a few recent weeks.

Usually the evidence of the latest weeks merely serves to

confirm convictions that have been building up over a much

longer period on the basis of wht have seemed to be more

lasting tendencies in the economy. Today offers a good

opportunity to take a look at some of these more persistent

factors bearing on policy determination.

I should like to start with the balance of payments

and our general international problem, for it is in this

area that we may see the most urgent need for action in tne

near future. Clearly, balance of payments developments

have taken a turn for the worse since our last meeting.

The current estimate of $465 million for the September

deficit has dashed any hopes tha, the backslide in the

third quarter would be held to a minimum. It looks now

as if the third quarter regular deficit on a seasonally

adjusted basis might be at the annual rate of $2.4 billionalthough a substantial part of this reflects further liquida

tion of the British long-term security portfolio. The

deficits for the four weeks ended October 27 aggregated

about $400 million, with especially heavy payments in the

third week to Canada and Venezuela. It looks now as if

the regular deficit for the full year 1965 right easily

approach $2 billion--perhaps $1.6 billion after special

items such as debt prepayments. This result strikes me

as anything but encouraging, especially in the light of the

firm assurances by President Johnson and Secretary Fowler

at the recent Bank-Fund meetings that our payments gap will

be closed. Also, the U.S. is entering into a series of

difficult negotiations on the future of the international

financial system--negotiations in which a major premise is

that our deficit will indeed soon be eliminated.

There has been a very sharp cut in foreign bank lending

and a heavy reflux of liquid funds this year, yet we are a

long way from equilibrium. There is no evidence as yet of

underlying forces that would close the gap and permit ultimate

relaxation of the special restraints that have been placed on

capital exports. And I see no reason why we should assume

that the economy is to be saddled permanently with such

artificial restraints. In fact the country has been told

11/2/65

-19-

often that these are temporary measures. For the time being

they must not only be retained but must in all probability be

strengthened in view of the payments problem's urgency. I

believe we should seek a firmer monetary policy both to give

more support to the voluntary program and to reinforce the

hope that it may eventually be abandoned. Over the longer

run this might require a different mix of monetary and fiscal

policy. This is not the occasion for a detailed analysis of

the ways in which a firmer monetary policy could help our

balance of payments. But there is no lack of evidence that

this probably would be a fruitful approach. Certainly most

of the other major industrial nations Lelieve we have cone

too little along these lines, the latest comments in this

vein having been presented at the recent OECD session in

Paris.

Turning to the domestic economy, we find that it exhibits

considerable underlying strength and that the business out

look remains excellent. The current rundown of the excess

of steel inventories is depressing some monthly indicators,

but expansionary forces elsewhere in the economy are strong,

and total output keeps growing at a good pace. GNP grew

more rapidly in the third quarter than in the average of

the preceding three quarters, and the improvement

is some

what greater if final demand alone is considered. It is

striking also that the latest survey of business capital

spending plans shows considerably more strength for 1966

thar did the comparable surveys for 1964 and 1965.

The labor market appears to be tightening further. The

unemployment rate for married mer has reached 2.2 per cent,

which means that it is back down to the low range of the

mid-1950's; and long-term unemployment has been lower

than

at any time since 1957. A further sign of labor tightness

lies in the attainment of a new all-time high in the help

wanted advertising index. With plant capacity also showing

a high rate of utilization, there is ample reason to fear

emerging cost and price pressures. Admittedly the upward

tilt of the major price indices does not show any recent

acceleration--but the current state of business profits

and business euphoria, as reflected, for example, in the

stock market, is certainly conducive to price increases.

Cost-price stability is always one of our major objectives.

In the present international setting this objective becomes

doubly important. Thus, not only does the economy look

strong enough to absorb a tightening of monetary policy

without adverse effects, but also such a policy change may

even be required in the near future to help prevent an

inflationary outburst.

11/2/65

-20-

The third major area to be considered is that of bank

credit and liquidity. Bank credit appears to have expanded

strongly at weekly reporting banks through the first three

weeks of October, even after allowance for the effects of the

October 11 tax anticipation bill financing. For the third

quarter we find contrasting cross-currents, with bank credit

growing less rapidly than in the first half while money supply

and other liquidity indicators, including total nonbank liquid

assets, rose more rapidly. Many of these intra-year gyrations

in the relative expansion rates of bank credit, bank reserves,

and liquidity can be traced to the first-half buildup and third

quarter decline of U.S. Government deposits. By and large, the

growth of the financial indicators for the first nine months

remains ahead of last year. For example, total bank credit

rose at an annual rate of 9.4 per cent, money supply plus time

deposits at 9.1 per cent. While growth in bank reserves was

appreciably slower, this is amply accounted for by the sizable

change in deposit mix. The overriding fact is that the rate

of growth of the various intermediate financial variables

this year has been excessive. On several occasions over

the last few years the Committee has tried to damp down an

8 per cent rate of growth in bank credit. With the recent

growth rate even higher, and the margin of safety of unused

resources in the economy decidedly lower, a renewed effort

along these lines appears fully warranted.

As I said at the outset, there is no problem in deciding

on policy for the next three weeks. Open market operations

should be conducted to maintain the existing condition of the

money market, and the directive might well be adopted sub

stantially as proposed by the staff, except that the apparent

deterioration of the balance of payments should be recognized.

By the time of the next meeting, however, it is not

unlikely that we may wish to give serious consideration to

a possible discount rate increase. Three weeks ago I spoke

of the possibility of a prompt increase of 1/4 per cent, this

modest size of increase being suggested by the shortness of

the period between Treasury financings, solicitude for the

rather nervous state of the money and security markets, and

the absence of adequate domestic statistical support for a

stronger move. However, action at tha: time was not feasible.

It now seems to me that we should probably be thinking in

terms of a 1/2 per cent increase, especially because one of

the prime reasons for a discount rate rise would be to obtain

beneficial effects on our balance of payments and on psycho

logical attitudes abroad on the dollar and our determination

to defend it.

11/2/65

-21

As we have recognized at earlier meetings, another

factor that may suggest the need for early discount rate

action is the untenable situation that seems to be developing

with respect to the Regulation Q ceilings and the growing use

of bank promissory notes. Our Bank addressed a letter to the

Board of Governors on this matter last week, and copies were

sent to the other Presidents. The key point I would like to

make today is that action to raise the Regulation Q ceilings,

in the present setting, might well set in motion market

forces that would make a discount rate increase almost

inevitable--yet such action on Regulation Q may soon be

forced upon the Board by the logic of market deelopments.

All of this tends to confirm my view that the time for

decision on discount rate action may not be far distant.

Mr.

Shuford observed that economic activity continued to

advance strongly.

pause in

Although some commonly used measures

recent months,

indicated a

most areas of the economy were still

expanding.

Evidences of pause reflected primarily cutbacks in steel, which inci

dentally

were less than some analysts had feared and now appeared to

have about run their course.

Because of interruptions and spurts of activity caused by

strike threats and other factors, the course of activity might be

clearer if a somewhat longer period was used for comparison.

in that manner, activity had been rising markedly.

had risen about

8 per cent since a year ago,

cent average rate since 1960.

Personal income

compared with

Industrial production

Viewed

a 5.4 per

had increased

6.6 per cent as against a 5.0 per cent rate since 1960.

Employment

had risen 2.4 per cent since last September while the population of

labor force age had grown less than 2 per cent.

An indication of a

strong demand at near-capacity levels was that wholesale prices,

11/2/65

-22

which changed little from 1960 to 1964, had gone up 2.3 per cent in

the last 12 months.

Eighth District activity had likewise shown strength over

the past year, Mr. Shuford noted.

In the District, steel production

was of less importance than in some other regions, and the upswing

in economic activity had continued during the late summer and early

fall.

Payroll employment had risen at a 4 per cent rate since June,

with relatively sharp gains in manufacturing

Little Rock areas.

in the St. Louis and

The unemployment rate had declined since June

in each of the District's four largest labor markets.

Manufacturing

output in the District had been at a high level recently and rose

moderately from August to September while production in the nation

reflected the cutbacks in steel.

It appeared to Mr. Shuford that the upward trend in national

economic

activity would continue in the near future.

In addition

to the forward momentum and widespread optimism, both fiscal and

monetary actions had been quite stimulative.

The Government had

increased social security payments, salaries and wages, and defense

spending, and it had reduced excise taxes.

As a result, the "full

employment budget" surplus had declined from a rate of about $6.7

billion in the first half of 1965 to an estimated zero in th: last

half, the lowest level in many years.

The money supply had expanded

at a relatively rapid 4 per cent annual rate over the past year, and

since summer the rate had been especially high.

11/2/65

-23

As to policy, Mr. Shuford felt that additional monetary

restraint was going to be needed to limit inflationary pressures.

The economy wa,

operating near capacity,

and at this time the rate

of increase in spending appeared to be faster than the growth in

ability to produce.

Also, somewhat higher interest rates relative to those of

other countries

should be beneficial to the chronic U.S. balance of

payments problem, which so far was not being solved but only avoiced.

The voluntary credit restraint program, as it applied to banks, had

worked well,

but it

was only a stop-gap measure.

Such restrictions

on movements of funds were fundamentally undesirable, and other more

fundamental

adjustments must be made.

Although many of the needed

actions were in other areas, monetary policy must continue to con

tribute to the fullest possible extent

The change toward a more

expansive fiscal policy had placed upward pressure on interest rates

and at the same time reduced the need for stimulative monetary actions

However,

Mr.

Shuford continued,

it

might be premature

to

take

an overt tightening step at this time when the economy was adjusting

to the runoff of steel inventories.

was going on and,

move slowly.

Then,

too,

unless the need was urgent,

a Treasury financing

the Committee should

For the next three weeks he favored maintaining money

market conditions about as they were, but he thought the Committee

should not be disturbed

market demands.

if

there was some additional firming from

Although the discount rate was low relative to other

money market rates, he would not suggest increasing it at this time.

11/2/65

-24

However, he agreed with Mr. Hayes that it would deserve careful

consideration in the near future.

The policy directive suggested

by the staff appeared satisfactory.

Mr. Patterson said economic information that had become

available for the Sixth District since the last meeting of the Com

mittee showed no general change in previously established trends.

Although District employment statistics for the latest month showed

a slower rate of gain than characterized the preceding months,neither

those nor other data suggested any new tendency toward "overheating,"

on the one hand, or a downturn on the other.

Turning to the national scene, Mr. Patterson commented that

the people in the room, the President's economic advisers, the press,

bankers, and others seemed to be unanimous about the desirability of

not allowing the economy to become so overheated that it would

eventually end up in a major downturn.

There was unanimous agreement

on the desirability of continuing an orderly rate of expansion.

The

trouble, as the Committee knew, lay in the great divergence of opinions

about the policies to follow in order to continue the orderly expansion.

Lack of unanimity about the proper posture suggested that even minor

changes might have results that could turn out to be quite contrary

to those desired or expected.

A discount rate increase to 4-1/4 per cent, with policy

designed to keep the short-term rate structure just about where it

was now and an upward revision of Regulation Q ceilings, would be

11/2/65

-25

something that many persons might go along with, Mr. Patterson

believed.

This would recognize the tightening of the money market,

including the part that was self-imposed, ard might make policing

of the discount window less difficult.

Nevertheless, by making it

easier for banks to compete for time deposits, such a package might

restrict bank credit expansion very little.

be a variation:

There could, of course,

raising the discount rate slightly but making no

amendment to Regulation Q.

Such a step, by limiting the banks'

ability to compete for time deposits, would seem to be more effective

in limiting bank credit expansion.

On the other hand, Mr. Patterson continued, an increase in

the discount rate, whether to 4-1/4 or 4-1/2 per cent,

accompanied

by a shift in policy designed to push the short-term rate structure

near the new discount rate, would be a move that to many persons would

seem unwarranted by present economic and credit conditions.

How

effective it would be in limiting bank credit expansion might well

depend on the action taken in respect to Regulation Q.

There were other possible combinations of those three factorsraising the discount rate,

shifting policy actions in

respect

to short

term rates, and the treatment of Regulation Q, Mr. Patterson said.

Nevertheless, it seemed evident that a change in the discount rate

might or might not be restrictive, depending upon the accompanying

actions.

The basic decision whether to tighten or not remained with

the Committee despite any action taken on the discount rate.

11/2/65

-26

No new developments since the last meeting of the Committee

seemed to Mr. Patterson to justify further tightening at this time.

A continuation of the policy adopted at the last meeting therefore

seemed appropriate.

Mr. Boop noted that in recent weeks there had been another

flurry of announcements and stories in the business press concerning

price increases and various upward price pressures.

As had been

recognized in Committee meetings on many occasions, it was often

the price hikes that made news, while little comment was recorded

on the other side of the ledger.

In the past week he had spoken with

several businessmen in the Third District in an attempt to gain some

further insight into the extent of any price pressures.

bore out in di:ection, but not in magnitude

What he found

reports of recent price

behavior.

Representatives of industries ranging from electrical equip

ment, chemical;, and instruments to metals, machinery, petroleum, and

construction materials described industry conditions as characterized

by noticeable, but not massive, elimination of price concessions and

by a few increases in some base prices (offset to an extent by decreases

in some others).

ever.

Most companies were finding competition as stiff as

It was also interesting to note that several of those contacted

felt that general price pressures might develop in 1966 which later

would be reflected in their own firms and industries.

11/2/65

-27

Mr. Bopp said he had also spoken with several of the large

Philadelphia banks to find out more about recent reports of selective

increases in interest rates.

In general, the banks were finding

credit demand strong and had been making a few selective increases

in interest rates when possible.

from 1/4 to 1/2 per cent.

Typically, the rate increases ranged

Criteria considered in the selective rate

hikes were varied, but they included such factors as type of loan,

permanence of a borrower's relationship with the bank, and credit

rating.

Most of the banks had raised their standards of eligibility

for the prime rate.

Fear of unfavorable customer reaction, however,

was a deterrent to many selective rate increases.

it:

As one banker put

"How do you explain to the borrower that he has been selected

for a selectively higher rate?"

Turning to policy, Mr. Bopp commented that the Treasury financ

ing of course precluded any action at this time.

Beyond that, however,

he continued to be impressed by the moderation existing at the

high level of economic activity.

present

Though demand was strong, capacity

to produce was keeping pace with output, and price increases were

holding within narrow bounds.

It was true that unit labor costs had

risen since the steel settlement, but this seemed attributable to the

decline in production as industries worked off excessive inventories.

When that adjustment was completed, he would look for a return to the

pattern of stability characteristic of the past few years.

On the international front, Mr. Bopp felt that the trend of

direct corporate investment abroad would bear close watching in the

11/2/65

-28

fourth quarter.

The prognosis offered by the staff was uncertain.

In

any event, however, monetary policy was not the most promising method

of dealing with outflows of direct investment.

In the current business expansion, Mr. Bopp said, monetary

policy thus far had contributed to the goal of growth without infla

tion.

The longer the present high level of economic activity was

continued in relation to capacity, especially with some firming in

prices, the more difficult it became to judge the appropriateness of

current policy.

For the present, however, he was inclined to recom

mend no change.

The proposed directive was agreeable to him.

Mr. Hickman commented that the optimism that emerged at the

time of the steel settlement in early September might now be moderat

ing.

Such a change in sentiment would be welcome and in itself would

not endanger a continuation of the general business expansion.

Within that expansion some of the business news was, and would

continue to be, unfavorable.

Steel output dropped about 20 per cent

in the past two months, and was expected to decline another 10 per cent

or so between now and the year end.

Cutbacks in steel were resulting

in rising unemployment in major steel centers, particularly in the

Fourth District.

Auto output, although high, would add little to the

production index in this quarter, and might be a cause for concern

later on if inventories became excessive.

In September, new orders

for machinery and equipment declined for the second successive month.

Residential construction remained sluggish, and corporate profits in

the third quarter were unlikely to show much increase over the second

quarter level.,

11/2/65

-29

On the price front, Mr. Hickman said, there still was no concrete

evidence of general inflation, although actual transactions prices might

be increasing more than the official indexes.

Prices, along with busi

ness inventories, were areas where the Committee knew too little.

A

large part of the sharp boost in unit labor costs in September would

probably prove to be temporary, as was the case last October when there

was a similar drop in production caused by the auto strike.

Even so,

serious production or labor imbalances were always possible at current

levels of activity, and either or both of those developments could put

increasing pressure on prices and profits.

On th, financial side, some of the recent apprehension in the

bond market seemed to have subsided, but the market remained nervous,

and extremely responsive to bearish news of any kind.

On the brighter

side, it was encouraging that corporate demand for Treasury bills had

reappeared as yields on the 91-day bills moved above 4 per cent.

or perhaps even slightly lower, bill rates could result if loan

Stable,

demand

at commercial banks were to moderate, making it unnecessary for banks

to sell large amounts of Governments.

While growth in bank credit had

rate

slowed progressively in each quarter of the year, the annual

of

gain thus far exceeded that for 1964 as a whole.

Mr. Hickman recommended no change in monetary policy at

time, especially in view of the Treasury financing program ahead.

this

If

the balance of payments deteriorated seriously, or if he thought that

tighter money would remedy the present situation, he might support a

-30

11/2/65

more restrictive policy.

In the absence of such evidence, and with the

likelihood that some of the domestic business news would get worse before

it got better, he saw no grounds for changing policy now.

Accordingly, Mr. Hickman supported the draft directive.

He

recommended attempting to hold net borrowed reserves below $150 million,

bank borrowings around $500 million, and the Treasury bill rate close to

4 per cent.

Mr. Maisel said that as he reviewed the minutes of the last

meeting and listened to some of the presentations today, he detected

three basic arguments for raising the discount rate.

(1) The expan

sion of the economy had been too great or might become too great; there

fore, a

rise in interest rates and a slowing down of credit availability

was necessary.

(2) Because of pressure fron the Administration, bank

lending rates had gotten out of line.

The banks were not willing to

fight the Administration by themselves, but would like the Federal

tended up, banks could

Reserve to take the lead for them.

If rates

ration with a different technique.

It would mean either that more

credit would be available or that less credit would be available,

depending upon which one felt was the better situation.

(3) The

balance of payments deficit required a shift in monetary policy.

Obviously, how one felt with respect to those arguments

depended on one's own analysis of the current situation.

Mr. Maisel

believed progress had been good and should be maintained.

Mr. Maisel did not agree with the concept that there would

be a recession because the economy was too prosperous.

Such a concept

11/2/65

-31-

assumed either that demand would run cut or that the type of demands

would differ so that the economy would slip into a recession before

they became effective.

He felt the needs were too evident.

In fact,

he agreed with the opposite point of view that the most dangerous

possibility was that demands could rise too high.

He might like to

agree with the idea that the economy was getting too much capacity,

but he did not agree.

Moreover, if the Committee was concerned that

demand might be too great six months or a year from now, clearly it

would be best to get as much investment and production as possible

at present instead of attempting to curtail

it through monetary action.

The Committee should want the fullest possible use of resources and

additions to supply rather than a waste of resources.

that one could argue that a discount rate

He did not agree

increase was necessary both

because of a redundancy in supply and because of shortages.

With respect to the balance of payments, Mr. Maisel believed

that the current approach of depending on specific policies was proper,

both for the short and long run.

He felt that before monetary policy

was used to deflate the economy for balance of payments reasons, the

Administration had other and better ways of achieving equilibrium

through military or aid expenditures or tax policies.

the balance of payments effects of monetary

Clearly, if

policy adopted upon a

careful consideration of domestic needs were favorable, that was all

to the good.

Mr. Maisel was not impressed by the views of countries with

a dismal record of handling their own currencies as to what would be

11/2/65

-32

good for the U.S. and the world.

He did believe, however, that the

U.S.

international posture required a major reorientation with respect

to what the U.S. and other countries could and would do.

of payments problems were international.

willingness of the U.S.

The balance

They were based on the greater

to give military support and aid,

and on develop

ing U.S. trade and investment policy to aid foreign countries, without

an equivalent movement abroad.

For those reasons, before raising the

discount rate for balance of payments reasons in conflict with basic

domestic goals, he would want a statement from the Administration that

all other possible balance of payments policies had been considered

and had been rejected in favor of a belief that tighter monetary policy

was the best method of correcting the balance of payments problem.

Mr.

Maisel felt that the posture of the Committee

for the past

three weeks had been satisfactory, judging that additional reserves had

been furrished to help moderate the interest rate rise.

further moderalion would be still

He thought a

better and hoped the Committee could

continue along present lines.

Mr. Daane noted that an even keel policy clearly was called for

through the period until the Treasury financing was out of the way.

Looking beyond that, he would simply reiterate that the question of

timing was all important, and his personal views were twofold.

First,

the U.S. could find itself at the end of the year with a much worse

balance of payments for 1965 than it had anticipated or others had been

led to anticipate.

This would weaken the U.S. position in the negotia

tions on international monetary reform now in process.

Second, the

-33

11/2/65

System might already have gone too far, in

in meeting those credit demands that, as Mr.

distorted flow of funds,

Partee had indicated,

terms of accommodating a

were concentrated on the banking system.

counts, he was worried that the Committee might find itself

Mr.

Hersey's question--whether it

On both

answering

had done enough with monetary policy

for balance of payments purposes--in the negative.

On the domestic

side of things, the Committee might find itself in the unhappy position

of locking the barn door after the horse was stolen.

Mr.

it

Daane did not think that a discount rate increase, whenever

became feasible, would result in

thought,

rather,

deflating the domestic economy.

He

would permit a more balanced flow of funds and

that it

eliminate those market distortions that affected the economy adversely.

A discount rate increase would not conflict, in his opinion, with basic

domestic goals; in

of those goals,

fact,

it

could very well prove to be in

furtherance

particularly the sustainability of the current expansion.

For the present,

Mr.

Daane favored a policy of even keel,

.ccept the staff draft directive.

he would

Mr. Mitchell noted that the Commmittee seemed to be precluded

from considering any change in policy today because of the Treasury

financing.

Therefore,

he would reserve his comments until the next

meeting of the Committee.

mittee members'

He did wish, however, to call the Com

attention to the summary report of the staff of the

International Monetary Fund, presented following the recent annual

and

11/2/65

-34

consultation of the IMF with the United States.

(A copy of the report,

which was distributed to the Committee for its information by Mr. Young

on a confidential basis, has been placed in the files of the Committee.)

He especially called attention to pages 10 to 16, dealing with U.S.

balance of payments policy, which contained a statement of views

different from those expressed by Messrs. Hayes and Daane.

Mr. Shepardson remarked that the general trend of the econony

was still extremely strong.

He thought the rate of recent expansion

was unsustainable, and at some point steps must be taken to try to

dampen it.

The Committee, of course, should never be in the position

of trying to push the economy down.

The Committee, however, should

try to curb the rate of expansion so to avoid excesses that were getting

more and more to the point of explosion.

While the Treasury financing

admittedly precluded any action at this particular time, he would favor

taking corrective action shortly.

On the balance of payments, Mr. Shepardson thought the situation

was serious and was not showing the improvement that had been hoped for.

There were many causes, and he agreed with Mr. Maisel that other areas

should be attacked.

Nevertheless, with money as fluid an item as it

was, and in view of the abundance of credit that the Committee had

been making available, the situation deserved attention, even without

regard to the question of closing the interest rate gap vis-a-vis Europe.

Part of the outward flow of funds was inevitible if excess funds were

available to flow to Europe.

If the excess was cut down somewhat, he

11/2/65

-35

could not believe that people were going to sacrifice meeting the

needs of their permanent, regular customers at home for whatever

margin of higher return they might obtain abroad.

If excess credit

availability were cut down at this time, that was bound to have some

effect on the movement of funds that was aggravating the balance of

payments problem.

Mr. Shepardson said he would accept the proposed policy

directive for this meeting.

The Committee had been supplying reserves,

apparently, at about the rate that the current market situation justified.

He would let market pressures, as they developed, continue to reflect

themselves in an interest rate crawl upward.

Mr. Robertson made the following statement:

It seems to me that we have no basis for changing

monetary policy at this meeting, either with regard to

our own independent responsibilities or in terms of the

consideration we owe others.

For one thing, we are clearly in a period when the

considerations of even keel should take precedence. And

I would argue that the condition ought to prevail at

least through the next meeting date of the Committee if

not beyord, given the touchy nature of the current market

and the fact that it will have to absorb another cash

financing in bill form even before the current coupon

issue cash refunding is likely to be fully digested.

Furthermore, I would argue that--even keel asidecurrent economic and financial developments do not call

for further credit tightening at this time.

To sum up

my views, I see no sign of cumulating price increases

domestically and no worsening in those balance of pay

ments accounts alleged to be interest-sensitive. At the

same time, credit conditions have already tightened enough

over the past three months to make me want to wait to

judge the extent of that dampening influence on economic

activity before considering any further steps in such a

direction.

11/2/65

-36-

On this point of judging our influence to date, let

I sometimes detect a note of frus

me say something more.

They point to the

tration in comments around this table.

fact that "bank credit is still rising at an undiminished

rate" and "business activity is still expanding rapidly,"

and seem to deduce that our monetary tightening to date

has therefore had no effect and that still further turns

of the screw are necessary to brng this expansion under

control.

On the other hand, the larger bankers repeatedly tell

us that their primary response now to a reserve squeeze is

not sales of liquid assets, but more aggressive issuance

of liquid liabilities--CD's, promissory notes, and the

like.

Thus, the first indicator of a progressive tighten

ing of bank positions is not a slowing of bank credit and

deposit growth--as it used to be.--but a more frenetic effort

to push out more bank liabilities, with consequent congestion

of those market sectors and an accompanying upward escalation

of money market rates.

This makes monetary tightening less a

quantitative restraint upon the bank credit side of the finan

cial structure, and more a generalized pressure upon interest

rates and terms throughout our financial markets.

This kind

of credit restraint has a more diffuse influence than before,

and may be more effective and equitable than in days gone by

when the effects of credit tightening were reflected more

directly in the growth of bank credit.

Some supervisory

problems are being spawned by this change in banker reflexes,

but we should not be fooled into thinking we have developed

some slippage in our monetary brakes that requires us to

compensate by jamming down thepedal still harder. If we keep

trying to slow bank credit down by further and further tighten

ing we may succeed in generating overall financial conditions

so tight as to make the economy falter.

Our chances of misjudgment on this score are compounded

when we allow for the likelihood that any consequent falter

ing will not develop until several months after we act.

Monetary conditions influence real economic activity with

considerable lags.

Consequently, it is almost irrelevant to

point out there has been no let-up yet visible in business

investment as a result of the tighter credit conditions dat

ing from last August.

Practically speaking, most of the

economic statistics we are reading now date back to within

a month of the rapid interest rate rise in September, and

several more months are likely to be needed before the avail

able statistics can reasonably be expected to reveal any

significant response in real business activity.

11/2/65

-37-

To be sure, sometimes the onrushing pressure of events

denies us the chance to wait for conf:rming evidence of the

influence, or lack of influence, of our actions. At such

times, we have to substitute our guess as to likely responses,

and move on with additional policy measures calculated to

compound those responses. But this moment, in my judgment,

is not one in which conditions are deteriorating so rapidly

that we cannot wait to determine our further actions in the

light of observed responses. I think we have the time to

"wait and see," and that not to take it would be a mistake.

These views also lead me to regard the suggestions

as to an early increase in the discount rate as being dis

tinctly premature.

To the extent that advocates of higher

discount rate ideas are exercising their frustrations over

our appa-ent lack of monetary ccntrol, I suggest they are

looking for results in the wrong places and with the wrong

timing in mind.

To the extent that a higher discount rate is felt

necessary to reinforce the administrative restraint at the

discount window, I suggest it is simply not needed at this

juncture. We are indebted to one of Sylvia Porter's last

letters for reminding us how often and how long our discount

windows have functioned with discount rates below the three

month bill rate. She has counted 21 different occasions

when that has happened since the end of 1955, with a com

bined duration of nearly three full years out of the past

ten. Discount operations may not always have been ideal

during this period, but they were generally effective. I

would expect any discount officer today who is worth his

salary to be able to deal with whatever additional borrow

ing demands are generated by the fact that three-month bills

have now joined the already long list of many other bank

assets and liabilities whose interest rates are higher than

the discount rate.

Finally, to the extent that a higher discount rate is

envisioned as simply realigning one or two technical rates

with the rest of the market, I suggest the underlying mar

ket analysis is badly misconceived. With big banks as much

in debt to the Reserve Banks as they already are, and with

so large a volume and variety of other highly interest

sensitive bank liabilities outstanding, I think it is

reasonable to expect the whole structure of day-to-day mar

ket interest rates to adjust upward almost pari passu with

the discount rate, with reverberations also extending

throughout all debt maturity ranges. This kind of policy

shock might be therapeutic for a speculative "run" on the

dollar, or a wave of inflationary spending; but these

emphatically are not our problems now.

11/2/65

-38-

What we need to do now is to be very careful to adjust

the force of application of our policy tools to the power

of the excesses we want to curb. Wherethose excesses are

as few, as mild, and as conjectural as we face today, our

policy should be equally gentle and tentative in application.

I think there is a good chance that the not-so-gentle

change in credit conditions already effectuated this fall is

about as strong a medicine as a prudent monetary doctor ought

to order for a patient in the current rather delicate con

dition. Accordingly, I favor a policy of "no further change"

between now and the next meeting of the Committee. By "no

further change" I mean to emphasize that I would want the

Manager actively to resist--through an easing of bank reserve

positions--any tendency for either short-term or long-term

rates to move further upward. With that in mind, I would

go along with the draft directive as submitted by the staff.

Mr. Wayne reported that business in the Fifth District con

tinued to improve and prospects for the near-term future remained

quite favorable.

The Richmond Bank's latest survey showed a further

extension of business optimism, with more than half of the respondents

expecting better-than-seasonal advance, in the weeks ahead.

Business

loans at the weekly reporting banks had risen more than seasonally

and, in recent weeks, at a considerably more rapid rate than for all

U.S. weekly reporters.

low levels in

Rates of insured unemployment were at unusually

ll parts of the District,

and evidences of tightening

labor markets continued to be seen.

So far as the national economy was concerned, it seemed to

Mr. Wayne that the Committee could be confident of a rising level of

activity for the remainder of the year.

In the policy area, while both the domestic business picture

and the U.S. balance of payments situation might provide some arguments

for more restraint, the overriding considerations for the immediate

11/2/65

-39

future were the new Treasury financing, which demanded even keel, and

the unsettled situation in the capital markets.

Mr. Wayne was still

concerned about the possibility of bottlenecks and rising costs at

home, and he was impressed by the recent purchasing agents' report

that the list of goods in short supply was the largest in ten years.

So far as he could see, the external accounts remained a problem, but

he had doubts about the contribution that could be expected on that

score from an extra degree or two of monetary firmness.

For the

present he was reluctant to take any action that might disturb what

he considered to be a delicately poised situation in the capital

markets, especially in view of the fact that even keel was obviously

in order for the next three weeks.

Mr. Wayne added that he agreed with

Mr. Patterson that in

looking at any discount rate change, careful consideration should be

given to other policy aspects.

involved.

A whole constellation of rates was

The prime rate would surely move up, and the Treasury

would find itself confronted with the effect on debt management

imposed by the 4-1/4 per cent statutory limitation on coupon issues.

A change in the discount rate would create additional problems for

the Treasury.

Mr. Wayne concluded by saying that he favored maintaining

about the same money market conditions as had been experienced over

the past three weeks, with no change in the discount rate at this

time.

-40-

11/2/65

Mr. Clay reported that the pattern of economic activity in

the Tenth District continued essentially unchanged, with the agricul

tural performance better than nationally and the nonagricultural

performance poorer than nationally.

The fact that agricultural income

was showing a larger increase than nationally was attributable in

part to larger increases in crop output.

In addition, the higher live

stock prices over the past year had had a greater impact in the Tenth

District because of the greater importance of the livestock industry

in that region.

Despite the improved agricultural income situation, growth in

nonagricultural activities compared unfavorably with the country as a

whole.

Nonfarm employment had increased slightly in recent months,

but the increase was distinctly less than nationally.

The employment

gains that had been achieved were primarily in the Government sector

and secondarily in manufacturing and services.

There had been no striking changes in the national economy,

Mr. Clay noted.

Developments were about in line with expectations.

If there had been any significant deviation from that generalization,

it was the same that had applied ever since last spring, namely, that

activity had been somewhat greater than anticipated.

That advance had

been achieved in a relatively orderly fashion and without any marked

break-through in prices.

It must be recognized, however, that the

sensitivity of price advances was greater under present circumstances

than earlier.

-41

11/2/65

In the period immediately ahead, Mr. Clay concluded, Treasury

financing would appear to call for an even keel unless there were

compelling reasons to the contrary.

Even apart from

Such reasons were not apparent.

the Treasury financing, a ccntinuation of essentially

the current policy would seem to be in order at this time.

The draft

policy directive appeared satisfactory.

Mr. Scanlon said that economic conditions in the Seventh

District continued to reflect overall expansion in output, employment,

income, and credit.

Order backlogs in major industries other than

steel continued to increase.

Labor markets in the District remained

very tight.

In contrast with the United States over all, District centers

had reported inpressive gains in homebuilding permits in recent months.

Builders and building material firms believed there had been an

appreciable tightening in the availability of mortgage credit in

recent weeks, with some credits that banks had been accommodating

now going to savings and loan associations.

Price pressures, on balance, continued to be up and appeared

to be strengthening.

favorable.

The outlook for the agricultural sector remained

A sample of country banks reported farm land values had

continued to rise and in October were up 7 per cent from a year

earlier.

Gains were particularly large in the corn belt, where income

had risen because of large crops and high livestock prices.

Most

country bankers expected a continued heavy demand for loans to pur

chase feeder cattle and farm equipment.

-42

11/2/65

The continued advance in business activity was reflected in

the financial sectors, Mr. Scanlon noted.

markets remained firm.

Both the money and capital

Short and long-term rates had continued to

creep upward since the last meeting, while, ntermediate--term rates

had risen relatively more and, in the Government sector, now exceeded

yields on long-terms.

As to policy, Mr. Scanlon agreed that the Committee's posit.on

today, because of the Treasury financing, must be one of even keel.

However, it seemed clear that seasonal forces would be exerting upward

pressure on rates in the weeks ahead.

He hped the Committee would

not feel it necessary to offset those pressures completely for it

seemed to him that to follow a rate objective rigidly in a period

of upward seasonal pressure would, in effect, amount to adopting a

more expansionary policy.

He found the draft directive acceptable,

and he would not change the discount rate at this time.

Mr. Galusha reported that Ninth District economic news con

tinued to make pleasant reading.

Preliminary reports indicated a

3.8 per cent uremployment rate for September, which was low even by

the standards cf earlier this year.

Industrial activity, whether

measured by production worker manhours or use of electrical power,

continued to increase.

District cash farm receipts for January through August, up

6 per cent from a year ago, were at a ten-year high.

Crop receipts

were the same as last year, but livestock receipts were up sharply.

11/2/65

-43

Further, the likelihood was that cash receipts

up quite sharply from 1964.

for all

of 1965 would be

Prices--both for crops and for live

stock--would probably hold near present levels.

District livestock

output was increasing, though, and crop output should exceed the

1964 output by a fair margin.

Cattle traders in the Rocky Mountain

area expected present price levels to hold for 12 to 15 months,

a gradual

with

weakening as hog numbers built up.

Two other food price components were deserving of mention,

Mr. Galusha added.

The field run price of potatoes was $1.75, con

trasted with the peak of $5 reached last spring.

packaging was the one area of price increase.

The cost of food

Wheat sales to Russia

and China by Canada had focused attention in the District on the

archaic U.S.

farm policy.

While the political implications

inherent

in this and associated national attituces bearing on international

trade and the maritime industry were imposing--in fact almost in

the

area of the sacred and untouchable--the economic potentials, includ

ing balance of payments assistance, were impressive.

On the banking side, Mr. Galusha continued,

there had been

no instances in the District of which he had knowledge where alloca

tion of credit had been made other than on the basis of normal criteria. 1/

Twin City banks had been approached by

national companies

in increasing numbers

to fill

credit gaps left

1/

A sentence has been deleted at this point for one of the reasons citec

in the preface.

In the deleted sentence Mr. Galusha reported that two

companies had lost their prime rate status at a named national bank.

11/2/65

-44

by defecting coastal banks.

Because the applicants were usually seeking

a rate advantage, arguing the social prestige attached to their business,

their blandishments had been resisted and the usual criteria had been

generally applied.

As for monetary policy, it appeared to Mr. Galusha that in view

of the Treasury financing an even keel was appropriate.

mented favorably on the new look in

Mr.

He also com

the green book.

Swan said that the Twelfth District economy seemed to

progressing, with no marked recent changes.

be

The District was lagging

behind the country in residential construction, gains in retail sales

were somewhat less than for the country as a whole, and the unemployment

rate was higher,

but these were all factors

that had existed for some

time.

The seasonally adjusted unemployment

States dropped in September from

small rise in

ment in

5.8 to 5.6 per cent as a result of a

employment and a small decline

defense-related

rate in the Pacific Coast

industries continued

in

the labor force.

to expand,

Employ

and the upward

trend seemed likely to be maintained during the rest of the year.

Orders

for commercial aircraft were playing an important part in the rising

employment in the aerospace industry, which, even though it

mercial planes,

produced com

was part of the whole defense industry complex.

It

was

of interest to note that despite the District's high overall unemploy

ment rate, one Southern California aircraft company reportedly ,as

negotiating with the Labor Department for a movement of 1,500 unemployed

11/2/65

-45

workers from the Long Island area, stating that the supply of skilled

workers in Southern California had been exhausted.

Local unions

reportedly were contesting the company's position.

Mr. Swan reported that supplies of fruits and vegetables for

District canners were smaller than in 1964.

Canners had been quoting

higher p-ices than a year ago for a number of items, including peaches,

pears, tomatoes, and tomato products.

For the three weeks ended October 20, the increase in District

bank credit resulted entirely from expansion of security holdings.

Weekly reporting banks showed a decline in loans, the primary factor

being a rather sharp decline in business loans.

At the same time,

although reserve positions were somewhat easier, purchases of Federal

funds rose rather sharply after the middle of October.

Mr. Swan agreed that the Committee should maintain an even keel

policy in the next three weeks, given the Treasury financing.

He shared

Mr. Partee's concern, however, that perhaps three weeks from now the

Committee would be confronted with some difficult questions with respect

to the relationships between net borrowed reserves, interest rates, and

the rate at wh ch total reserves were supplied.

While the Comittee

had recently given some increased emphasis to interest rates, this

seemed to have been accompanied by remarkably little change in total

borrowing.

He did not know what the extent of seasonal pressures would

be for the rest of the year, but the Committee might have to take a

rather long look at the situation in the next few weeks.

11/2/65

-46

Mr. Irons reported that there had been relatively little

change in Eleventh District conditions.

The economy continued to

expand, and for the most part showed reasonable stability and lack

of imbalances.

The production pattern reflected increases in durables and

nondurables, with relatively slight changes in other components such

as mining.

Employment continued strong and the unemployment rate

was around 3.3 per cent, with increases in employment appearing in

both the manufacturing and non-manufacturing areas.

The labor mar

ket was tightening somewhat, according to random reports heard more

and more frequently, especially in these areas in which skilled and

mature workers were needed.

Constriction was strong in the District.

Although the month

to-month changes varied, the gain against a year ago was significant.

The figures were rather difficult to appraise, but the greatest

strength centered in the large cities.

There were signs of contruc

tion continuing strong for some time into the future, and there were

beginning to be signs of significant Federal construction expenditures

in the District.

There were also large private ventures in prospect.

Retail trade was strong, and the agricultural picture was

good.

The western part of the District, where some concern was felt

with respect to agriculture not long ago, now seemed very promising.

Banks in the Eleventh District continued to tighten a bit,

Mr. Irons noted.

As in the San Francisco District, bank loans were

-47

11/2/65

down fractionally during the last month and securities investments

were up somewhat.

However, city banks and -nany country banks were

running with loan-deposit rates around 60-75 per cent or higher.

The

They were, therefore, scrambling for funds wherever obtainable.

most recent period showed substantial purchases of Federal funds,

with

relatively small sales.

As to the national situation, it seemed to Mr. Irons that there

were few soft spots in the economy.

Among the soft spots he could see

were the inventory workdown, which was going along better than many

had anticipated, private housing, which was lagging a bit, and the

higher social security rate in 1966.

The balance of payments apparently

was not improving, and it remained one of the major problems.

For the

domestic economy, there might be further expansionary push from the

fiscal side.

Welfare expenditures and military expenditures for

Vietnam probably would be expansive rather than merely supportive ;or

the economy.

The employment situation nationally was strong.

There had been a slight persistent tightening in the money

market during the past three weeks, Mr. Irons observed, and he was

inclined to feel that this would continue.

The demand for funds was

strong, and the banks were extending credit at a good pace.

Obviously

the Committee should not change position at this time with the Treasury

in the market, and he did not think it worth while to speculate on

what might happen over the next three weeks.

He would take advantage

of this period to observe developments until the Committee met again.

11/2/65

-48

Meanwhile, he would maintain an even keel, keeping market conditions

as steady as pcssible.

He would accep: the proposed directive, and

would make no change in the discount rate at present.

Mr. Ellis said the New England economy showed continued

steady expansion.

Employment in both manufacturing and non-manufactur

ing activities kept breaking new ground, considering the season of

the year.

Hours of work, income payments, and consumer spending all

reflected what one expected of high employment.

usually strong.

Optimism was un

At the time of the Boston Reserve Bank's fall survey

of capital sperding plans, manufacturers usually had not set their

sights for the coming year.

preliminary 1966 plans.

This fall nine out of ten could indicate

For the first time in 8 fall surveys, New

England manufacturers contemplated a spending gain.

In the financial field also, the trends continued as earlier

reported, with the most notable activity arising in the real estate

and commercial loan fields, each category having scored a 19 per cent

year-to-year gain in the latest reports.

Because monetary policy changes were precluded at this meeting

by the need to preserve an even keel during the current Treasury

financing, Mr. Ellis commented instead concerning the new trial format

of the green book.

He thought the new format provided a framework

that should prove helpful to focusing attention on issues that were

central to the Committee's responsibility, and the experiment should

be continued.

But the Committee should be aware of a potential

disability in that approach, by which he referred to the changed

11/2/65

-49

objective of the introductory material.

material labeled "In

Heretofore the introductory

Broad Review" had attempted a balanced and com

prehensive summary of major and recent economic trends.

It now

attempted to present major and recent economic developments in an

analytical framework that was designed to help in

formulating answers

to the perennial questions of monetary policy making.

The potential

drawback of such an approach was that either the analytic framework or

the developments selected (or omitted) to support the analysis might

excessively and inadvertently prejudice the Committee's conclusions.

The Committee's staff was not monolithic in

its

viewpoints,

and it

seemed appropriate to expect there would be some opportunity for

divergent views to be expressed in

the staff summaries.

mittee, of course, could not expect the staff

every time,

The Com

to catalogue everything

and he wished to reaffirm his opening comment that the

experiment was worth a trial--in full recognition of its pitfalls.

Concerning the Committee's policy decision at this meeting,

Mr.

Ellis recognized the inappropriateness

monetary policy

in

of any material shift in

the midst of Treasury debt refinancing activities.

However, he would urge that the Committee adopt a position of readiness

to supply reserves adequate to meet both seasonal needs and a moderate

rate of growth.

Bank demands for reserves in excess of such provision

should be allowed to reflect themselves in firmer markets in which

fluctuating interest rates continued to serve a useful allocation

function.

He endorsed Mr.

IMF staff report,

Mitchell's suggestion about reading the

but would call attention particularly to pages 8

11/2/65

-50

and 9 thereof, wherein the System was given substantial credit for

firming monetary conditions since last spring and maintenance of an

alertness of monetary policy was suggested.

Mr. Ellis noted the comment in the blue book that net borrowed

reserves in the $100-$150 million range might be associated with

3-month bill rates at 4.00 to 4.10 per cent under a "no change"

policy.

His own targets were the old-fashioned "no change" position

the Committee held in September.

He would prefer net borrowed reserves

centered at $150 million, with no 4.10 per cent ceiling on 3-month

bill rates in view of the 4.08 auction rate yesterday.

He saw a

3-month bill rate fluctuating from 4.00 to 4.15 per cent as consistent

with emerging trends in the market, with borrowings at $550 million

plus.

The draft directive, in his opinion, adequately reflected a

"no change" policy.

Mr. Balderston observed that, as Mr. Brill had pointed out,

one could easily be deceived by official price indexes.

on under the surface must be taken into account.

What went

As to the searching

question with which Mr. Hersey had ended his report, Mr. Balderston's

answer was in the negative.

Monetary policy had not done all that

it should do, and could do, in connection with the international

situation in which the country found itself.

It was one thing, as

Arthur Burns had observed, to keep economic advance orderly and

steady when the economy was operating somewhat below a full employ

ment level.

It was quite another thing when the economy was operat

ing close to full employment.

If one did not believe Mr. Burns'

11/2/65

-51

observation, he could take a look at the employment surge and the

cost situation in Britain's manufacturing area.

Believing as he did that the ability of the U.S. Government

to exert world leadership turned on curbing U.S. investing, lending,

and spending abroad, including that of the Government itself, Mr.

Balderston turned to where the responsibility of the Committee really

centered.

He suggested that it centered in helping American firms

to expand their export competitiveness, because the ability of this

country to discharge its responsibilities in the world at large

would be dissipated if its gold stock dwindled and dollar claims

against the U.S. built up.

would then beccme weakened.

The voice of the U.S. in economic meetings

The ability of the U.S. to manage its

affairs was affected by speculative ebllience at home as well as by

waste of resources abroad, either by its own citizens or by foreigners;

he referred here to the waste involved in giants and so-called loans.

That there was ebullience at home seemed evident to him, if not to

some of his colleagues.

He called the Committee's attention to the

volume of daily trading on the New York Stock Exchange in October,

which averaged 7.8 million shares against 7.4 million in September.

The latter figure was itself 40 per cent above the year-ago level.

As to policy, Mr. Balderston supported no change as of today

in view of the Treasury financing.

Chairman Martin remarked that the points pertinent to today's

meeting had been covered quite clearly and that he had little to add.

11/2/65

-52

He did not think anyone ought to prejudge the future.

It was clearly

evident to him, however, that the time was coming when the System

would have to move one way or the other.

simply to stay put.

It would not be possible

The Treasure's financial problem, which he saw

as the major problem ahead, would either be solved by a pause in

business activity and a decline in the demand for business loans or

else it would have to be solved, assuming the requirements were

financed at current rates, by an aggressively easier policy on the

part of the Federal Reserve.

The situation was getting again to a

point similar to that which existed at the Lime of the Treasury

Federal Reserve accord in 1951.

There was not a complete analogy,

of course, but the problem was not going to go away, assuming current

trends continued.

He hoped that everyone would be considering the

matter carefully in the remaining time that was available.

Personally,

he would be glad if there was a little pause in economic and financial

activity, for this would ease the problem, but forces seemed to be

moving inexorably in a direction that made it unlikely that the

System could avoid a decision one way or the other.

As to policy for the next three weeks, the Chairman noted

that there appeared to be general agreement on a directive such as

proposed by the staff.

Thereupon, upon motion duly made

and seconded, and by unanimous vote,

the Federal Reserve Bank of New York

was authorized and directed, until

otherwise directed by the Committee,

-53-

11/2/65

to execute transactions in the System

Account in accordance with the following

current economic policy directive:

The economic and financial developments reviewed at this

meeting indicate that over-all domestic economic activity has

expanded further in a continuing climate of optimistic business

sentiment and firmer financial conditions, and that our inter

national payments have remained in deficit. In this situation,

it remains the Federal Open Market Committee's current policy

to strengthen the international position of the dollar, and to

avoid the emergence of inflationary pressures, while accommodat

ing moderate growth in the reserve base, bank credit, and the

money supply.

To implement this policy, and taking into account the

Treasury financing schedule, System open market operations

until the next meeting of the Committee shall be conducted

with a view to maintaining about the same conditions in the

money market that have prevailed since the last meeting of

the Committee.

Cnairman Martin noted that a memorandum from Mr. Holmes dated

November 1, 1965, had been distributed regarding the data proposed for

submission in response to the request from Chairman Patman of the

House Banking and Currency Committee, by letter dated September 21,

1965, for various records of the System Open Market Account.

request had been considered previously at the

(This

Committee meeting on

September 28, 1965.)

No objection was raised to the furnishing of the materials

described in Mr. Holmes' memorandum.

It was understood that Chairman

Martin would write to Chairman Patman listing the materials to be

submitted and advising of the approximate date contemplated for

delivery thereof.

Secretary's Note: Quoted below is the

text of the letter sent by Chairman

Martin under date of November 8, 1965:

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11/2/65

This is in further reference to your letter of September

21, 1965, in which you asked for certain information concern

ing the System Open Market Account.

At its November 2 meeting, the Federal Open Market Com

mittee directed its staff to prepare and assemble the following

data, records, and other information relating to the questions

raised in your letter:

Dollar Value of Portfolio

1. System Account holdings as of the end of

each month, December 31, 1963 through June 30, 1965

broken down between Treasury bills, notes and bonds

and showing par value, accrued interest, premium,

discount and net book value.

2. Sample photostat copies of the actual System

Account books for the above dates showing total par

value, accrued interest, premium and discount with

distributions among the twelve Federal Reserve Banks

and by issues.

Trading since January 1, 1964

1. Summary transactions from 1964 and 1965

through June 30, 1965.

2. Copies of System Account books for the

same period showing individual daily transactions

by issue, amount

(par value),

and price but after

deletion code number for the dealer with whom the

transaction was carried out.

Income of System Open Market Account

1. Annual income and profit and loss for the

year 1964 and 1965 through June 30, broken down

between income from interest-bearing securities

and Treasury bills.

2. Sample photostat copies of actual System

Account books for the end of each month December 31,

1963 through June 30, 1965 showing daily net income

accumulations distributed among the twelve Federal

Reserve Banks.

Other Material

Memorandum describing procedures for handling

income of Open Market Account and for participation

of Reserve Banks in that income.

Preparation of the material should be completed in roughly

two weeks; it will be delivered to you as soon as it is ready.

Chairman Martin also noted that a list of dates for prospective

meetings of the Cuommittee during the year 1966 had been distributed.

11/2/65

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He asked whether there were any comments, or suggestions for changes

in the schedule, and the comments heard were favorable.

It was agreed that the next meeting of the Committee would

be held on Tuesday, November 23, 1965, at 9:30 a.m.

Thereupon the meeting adjourned.

Secretary