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.,
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
on Tuesday, June 7, 1966, at 9:30 a.m.
Martin, Chairman
Brimmer
Clay
Daane¹
Irons
Maisel
Mitchell
Robertson
Shepardson
Scanlon, Alternate for Mr. Hickman
Treiber, Alternate for Mr. Hayes
Wayne, Alternate for Mr. Bopp
Mr. Swan, Alternate Member of the Federal Open
Market Committee
Messrs. Ellis, Patterson, and Galusha, Presidents
of the Federal Reserve Banks of Boston, Atlanta,
and Minneapolis, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Molony, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Brill, Economist
Messrs. Eastburn, Green, Koch, Mann, Partee,
Tow, and Young, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account
Mr. Cardon, Legislative Counsel, Board of Governors
Mr. Fauver, Assistant to the Board, Board of
Governors
Mr. Williams, Adviser, Division of Research and
Statistics, Board of Governors
1/
Left the meeting at the point indicated in these minutes.
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Mr. Reynolds, 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
Mr. Forrestal, Senior Attorney, Legal Division,
Board of Governors
Messrs. Hilkert, MacDonald, and Lewis, First
Vice Presidents of the Federal Reserve Banks
of Philadelphia, Cleveland, and St. Louis,
respectively
Messrs. Eisenmenger, Link, Ratchford, Brandt,
Baughman, Jones, and Craven, Vice Presidents
of the Federal Reserve Banks of Boston,
New York, Richmond, Atlanta, Chicago,
St. Louis, and San Francisco, respectively
Mr. Meek, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Kareken, Consultant, Federal Reserve Bank of
Minneapolis
Upon motion duly made and seconded,
and by unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on May 10, 1966 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 May 10 through June 1, 1966, and a supplemental report
for June 2 through 6, 1966.
Copies of these reports have been placed
in the files of the Committee.
In comments supplementing the written reports, Mr. Coombs
said the Treasury gold stock would remain unchanged this week.
The
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Stabilization Fund had acquired $50 million in gold from Canada,
which increased its holdings to nearly $100 million, but that entire
amount seemed likely to be used up over the next few weeks by a sale
of $75 million to France, plus other miscellaneous sales.
Consequently,
it probably would be necessary to show another reduction in the gold
stock of $75 or $100 million before midyear.
The way things were
going, it would not be surprising if the gold stock declined below
the $13 billion level by year-end.
In fact, recent balance of payments
trends suggested that might occur sooner rather than later.
On the London gold market, Mr. Coombs said, demand had been
restrained by the very tight money market conditions prevailing
throughout world financial markets.
Nevertheless, the resources of
the gold pool had been drawn down by $94 million since the beginning
of the year, and there seemed to be a growing impression that the
Russians might be able to hold off selling until the latter part of
the year.
The situation in that market remained dangerous; serious
speculative pressures could materialize from one day to the next.
During the past two days, for example, there had been a wave of
speculative buying apparently arising out of the British maritime
strike and the devaluation of the Indian rupee.
On the exchanges, Mr. Coombs continued, at the beginning of
May the Bank of England paid off month-end swaps totaling $100 million
with the U.S. Treasury and the German Federal Bank, and in the course
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of the month it paid off another $50 million of short-term central
bank credit to the Bank for International Settlements.
In addition to
such debt repayments of $150 million, the Bank of England suffered
further reserve losses of about $100 million and thus at month-end
was down a total $250 million.
Their published reserve statistics
showed the true loss of $106 million as of the month-end; the
remaining $150 million, reflecting central bank debt repayments, was
refinanced by new borrowings of $50 million from the System under the
standby swap line and $100 million from the U.S. Treasury on a one-day
swap.
May was the third month in succession in which the published
figures had shown Britain's actual reserve loss, with drawings on
credit lines limited to refinancing central bank debt.
The main feature in the sterling market, of course, had been
the effects of the maritime strike, Mr. Coombs commented.
Although
negotiations seemed to be more or less on dead center at the moment,
the market had been sustained by the hope that the British Government
might finally be taking a firm line against a continuation of the
wage-price spiral.
Meanwhile, however, the payments deficit was
deepening as exports were choked off, and the longer the strike
continued the greater the danger of a new speculative outburst.
In
fact, developments of the last few days might reflect the beginnings
of a speculative drive.
The Bank of England had allowed the rate to
drift down in response to selling pressure, and yesterday the rate
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went through the $2.79 level which had been firmly defended last
summer.
This morning it was $2.7884.
On Friday the British lost
$50 million of reserves; on Monday somewhat more than $100 million;
and thus far today about $50 million.
The New York market had been
quiet on Friday and Monday but there was some indication that selling
might now develop--the market had been alerted to the fact that there
was a problem and might react accordingly.
With respect to other markets, Mr. Coombs continued, the
earlier capital outflows from Switzerland had reversed themselves as
the Swiss market had tightened, and the Swiss National Bank had taken
in $135 million during the past few weeks.
That inflow had increased
the Bank's uncovered dollar holdings to a level $70 million in excess
of their usual ceiling, and further large inflows might occur in
connection with window-dressing operations in Switzerland at the end
of June.
Accordingly, it might be necessary for the System to draw
upon the Swiss franc swap line before long.
sizable dollar
Also, he anticipated very
accruals by the Bank of Italy during the summer tourist
season, which might necessitate drawing upon the lira swap line again.
In response to a question by Mr. Mitchell, Mr. Coombs said
that Britain had not received assistance from central banks other
than the Federal Reserve during the past month.
At the end of May
they considered the possibility of attempting to raise some funds
from the Italians, Swiss, and Germans.
They decided against that
course, however, on the grounds that it might muddy the waters at
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a time when agreement on the new sterling balance credit package
appeared close.
Instead, they drew on the System and U.S. Treasury.
If their reserves were still down at the end of June, which seemed
likely, and if the sterling package was approved, the British probably
would draw on the new credit lines, with parallel drawings on the U.S.
equaling 31 per cent of the total.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
May 10 through June 6, 1966, were
approved, ratified, and confirmed.
Mr. Coombs then recommended renewal of a $50 million drawing
on the swap facility with the National Bank of Belgium, which would
mature on June 22.
As the Committee would recall, the arrangement
with the Belgium Bank was unique in that it provided for that
$50
million to be fully drawn at all times, with renewals at six-month
intervals.
There was no use of the swap line at present in the sense
of disbursements from the amount drawn.
In response to questions, Mr. Coombs indicated that while
the drawing in question was for six months, the underlying swap
agreement had a term of twelve months.
He had not been able to
persuade the Belgians to change the terms of the agreement to conform
to those of the System's other swap arrangements, which were wholly
on a standby basis until activated by three-month drawings.
6/7/66
Renewal of the drawing on the swap
arrangement with the National Bank of
Belgium, for a further period of six
months, was noted without objection.
Chairman Martin then noted that on June 3 Mr. Coombs had
distributed a memorandum to the Committee concerning the Basle
negotiations on the British sterling balance credit package as
well as copies of the final draft of the agreement itself, and
he asked Mr. Coombs to comment on the negotiations.1/
Mr. Coombs observed that, as the Committee knew, it had
been hoped for some time that it might be possible for the United
Kingdom to negotiate a swap network similar to the System's which
would assure that other central banks would join the U.S. in
providing support in the event of a sterling crisis, making it
unnecessary to rely on last-inute negotiations.
The Committee
would recall that the November 1964 package of credit assistance
was for a six-month period, and that it was not renewed at the
expiration date.
Thus, in the summer of 1965 the Bank of England
was dependent entirely upon the Federal Reserve and the U.S. Treasury
for any necessary credits.
Efforts had been underway since last fall
to develop a supplementary British network with central banks under
which credits would be made available for any purpose.
1/ Copies of the documents referred to have been placed in
the Committee's files.
6/7/66
The new package that had been negotiated went only part way
toward that objective, Mr. Coombs said.
Partly as a result of the
record of the continuing problems of sterling over the past twenty
months, the attitudes of the European central banks toward sterling
had hardened.
They had taken the line that they would be willing
to make credits available to the Bank of England but only to protect
sterling against drains resulting from its role as a reserve currency-i.e.,
drains occasioned by liquidation of foreign-held sterling
balances.
They were not prepared to offer assured financing for
other purposes.
In effect, they would underwrite the institutional
role of sterling but not Britain's balance of payments deficits.
Staff
at the New York Bank and at the U.S. Treasury thought that those terms
were undesirably restrictive, but they--as well as the Bank of England
people--were persuaded that the choice was between such arrangements
or none at all.
Mr. Coombs saw one advantage to the nature of the arrangements-the link to a long-run problem increased the likelihood that they
would be renewed at maturity.
And whatever restrictions might be
written into the agreement, in the event of a real crisis the
European central banks were likely to permit use of the credits for
more general purposes.
There would be a real advantage in having
the credit lines in being, even if under terms that limited their
use.
The agreement would not exclude other special ad hoc credits
that might be arranged if circumstances justified them.
6/7/66
In conclusion, Mr. Coombs noted that with the latest turn
in the sterling situation the System had a real interest in seeing
the agreement adopted.
The British were likely to have to draw on
credit lines in some volume, and existence of the new arrangements
would substantially reduce the amounts they would have to draw on
the U.S. Treasury and the Federal Reserve.
As he had mentioned,
the U.S. share under the package would be 31 per cent.
At the Basle
meeting next weekend Mr. Hayes presumably would be expected to
indicate whether or not the proposed arrangements were acceptable
to the Federal Reserve, and he
(Mr. Coombs) recommended that the
Committee note them without objection.
Chairman Martin observed that the negotiations in question
had been going on for some time, and he suggested that the Committee
members raise any questions they had concerning the proposed agreement.
Mr. Mitchell asked whether there was any doubt as to whether
the sterling credit package would be approved, and whether the total
amount of credits it provided for, which Mr. Coombs' memorandum
indicated was $1 billion, was likely to prove adequate to the foreseeable need.
Mr. Coombs replied that it was his impression that the
Europeans, as well as the Canadians and Japanese, had decided to go
along with the package, but he could not say whether recent sterling
developments would change their attitudes.
The British might find
themselves subject to a certain amount of questioning when the
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agreement came up for approval at Basle on June 11-12.
As to the
adequacy of the package, it was quite unlikely that the British
would lose $1 billion of reserves in a single month.
It was true
that they had lost $500 million in a few days in November 1964, but
at that time foreign sterling balances were much larger than they
were now.
He would hope they could get through the month of June
with the European credit lines available.
There was no question but
that the attitudes of the Europeans had hardened with respect to
assisting the British, and he was afraid that some of that hardening
also was beginning to be reflected in their attitudes toward the
United States.
In response to questions by Messrs. Brimmer and Ellis, Mr. Coombs
indicated that the duration of the propsed standby arrangements was
nine months, with three-month renewable drawings.
There was a provision
that all swaps would be terminated by mid-June, 1967, to accommodate
drawings made at the end of the term of the standby arrangements.
No
new credit extensions by the U.S. were involved; the $1 billion total
was made up of $75 million from the BIS, $525 million channeled through
the BIS by the participating central banks, and parallel arrangements
involving a new $90 million facility with the Bank of France and an
earmarking of $310 million of the existing U.S. credit lines to the
British for proportionate use along with drawings on the other central
banks.
The U.S. lines, of course, consisted of the $750 million swap
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arrangement with the System, which had been renewed for another
twelve-month term on May 31,
1966, and the $400 million authorized
by the Committee and the U.S. Treasury in September 1965.
The
question of the source of any U.K. reserve loss--and thus the
availability of the new credits as a means of financing the loss-would be left to the judgment of the British but,
of course, at the
following meeting in Basle they would be expected to defend their
judgments with data on changes in sterling balances.
It was his hope
that interpretations in that connection would be reasonably flexible.
Mr. Irons asked whether the earmarked portion of the U.S.
lines would be increased by $90 million if the French decided not
to extend a new facility to the British.
Mr. Coombs replied that he would recommend against such a
procedure.
It would be better to have the total package cut back to
$910 million if the French did not participate.
Of course,
if the
other central banks agreed to increase their contributions the
earmarked part of the U.S.
lines might be increased proportionately.
Mr. Galusha asked whether there were indications that the
British would adopt policies that would effectively restrain their
wage-price spiral.
Mr. Coombs responded that the British authorities obviously
were working on that problem, although he did not know what particular
measures they were considering.
A great deal of pressure was converging
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on them to take effective steps, and conceivably something might
be done by the United States to encourage them further.
It was his
opinion that they were under no illusions with respect to the
seriousness of the situation.
Thereupon, the proposed new
sterling balance credit arrangements
were noted without objection.
Mr. Ellis then remarked that it had been about a year since
the Committee had last discussed the possibility of negotiating
reciprocal currency arrangements with Venezuela and Mexico.
Those
two countries had made substantial progress in improving their
financial positions and he asked whether the Committee should not
consider the question again.
In response to the Chairman's request for comment, Mr. Coombs
said the main development in the area since the Committee's earlier
discussion was that the U.S. Treasury had negotiated swap arrangements
with the central banks of Venezuela and Mexico.
It would be useful to
learn what the Treasury's experience had been under those arrangements,
and whether the Treasury intended to maintain the relationships or
might prefer to have the Federal Reserve share in them.
To his mind,
however, the key question was whether negotiation of swap lines
with the two countries would expose the System to pressures for
similar arrangements with other countries in Latin America that were
in less strong positions.
If there was some basis on which a clear
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line could be drawn separating Venezuela and Mexico from the rest of
Latin America, a good case might be made for having swap lines with
the two countries.
If not, the System might be well advised not to
enter into such arrangements.
In any case, he thought a study would
be useful.
Chairman Martin agreed that such a study should be made.
The Chairman then suggested that the Committee consider further
the proposed new instruments governing foreign currency operations that
had been discussed at the past several meetings.
He asked Mr. Holland
to comment on the memorandum on the subject distributed by the
Secretariat on June 1, 1966.1/
Mr. Holland said that on the basis of the discussion at the
meeting of the Committee on May 10 and subsequent conversations with
Mr. Mitchell, the staff had recommended a revision of paragraph 2(B)
of the proposed new foreign currency directive distributed on April 28,
1966.
In addition, the staff had noted a possible alternative revision
in which the second sentence of paragraph 2(B) would be deleted and a
new paragraph 5 added.
The revision recommended in 2(B) was as follows:
B. To temper and smooth out abrupt changes in spot
exchange rates, and to moderate forward premiums and
discounts judged to be disequilibrating. Whenever supply
or demand persists in influencing exchange rates in one
direction, System transactions shall be modified, OR
1/ A copy of this memorandum has been placed in the Committee's
files.
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curtailed, [DEL:
or eventually discontinued pending a]UNLESS
UPON REVIEW AND reassessment OF THE SITUATION by the
Committee [DEL:
of supply and demand forces]DIRECTS OTHERWISE;
Mr. Treiber remarked that the provisions of paragraph 2(B)
represented a statement of general principles relating to conditions
under which operations in foreign currencies should be undertaken.
In his judgment the language of the paragraph contained in the staff's
April 28 draft was more appropriate than the new language now suggested.
Mr. Daane noted that his view was similar to Mr. Treiber's.
He did not think any useful purpose would be accomplished by the
suggested change and if adopted he would be concerned about the
possibility of adverse reactions when the new language was published.
Mr. Mitchell commented that he felt the proposed revision of
paragraph 2(B) did not involve a substantive change.
He thought that
it did involve an improvement in language, and that the Committee had
nothing to lose by adopting it.
In his judgment, however, the principal
issue concerned the possible new paragraph 5 noted in the Secretariat's
memorandum.
That paragraph read as follows:
5. The System's foreign currency operations are not
designed to counter the effects of basic and persistent
economic forces on flows of international payments or on
movements of exchange rates. Operations undertaken to
deal with forces deemed temporary or transitional shall
be modified or curtailed, unless upon review and reassessment of the situation the Committee directs otherwise, if
the forces persist (a) for six months, or (b) for a lesser
period if the Special Manager concludes that they can no
longer be considered temporary.
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In Mr. Mitchell's opinion that suggested paragraph reflected a
position that the Committee should take publicly, and he recommended
its addition to the directive.
Mr. Daane agreed that the suggestion to add the new paragraph
5 represented the more important issue, but observed that there were
differences in judgment concerning it.
In his opinion, to whatever
degree the paragraph would affect the flexibility of operations it
would work in the wrong direction, and he did not think it should be
adopted.
Mr. Treiber concurred in Mr. Daane's view.
It was highly
difficult, he said, to distinguish between forces that were temporary
and transitional, on the one hand, and those that were basic and
persistent, on the other; the duration of particular forces often
would depend on the actions of the Governments involved.
It had been
the practice of the Committee to review all credit extensions every
three months and to get the judgments of the Special Manager concerning
them at those times.
It seemed to him that the workability of the
present arrangements had been demonstrated and he preferred them to
those that would be called for under the suggested paragraph 5.
Mr. Coombs agreed that the key issue concerned the proposed
paragraph 5; the language revision suggested in paragraph 2(B) was
a subsidiary issue.
He would note first that foreign central banks
had primary responsibility for influencing the exchange rates of
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The System could intervene in
their currencies against the dollar.
the exchange markets, but it did so only in rather extreme circumstances.
The only two occasions on which strong actions had been taken to
influence exchange rates were at the times of the Cuban crisis and
of the assassination of President Kennedy.
In sum, he thought the
Committee need not be overly concerned about possible efforts by the
Account Management to influence exchange rates.
Thus, Mr. Coombs continued, the issue to which the proposed
paragraph 5 was essentially directed was the duration of swap
drawings.
He agreed with Mr. Treiber that there was a certain ambiguity
in terms such as "temporary" and "persistent" because the nature of
Governmental policy was decisive in determining whether particular
forces lasted two months or twenty.
At the outset of a particular
development it often would be impossible to predict its duration.
The
real question was how much breathing space should be provided for
effective Governmental actions to deal with the development.
The
general policy of the Committee, which he thought was a proper one,
was to allow a six-month breathing space, and to become progressively
more concerned if drawings stayed on the books for a longer period.
Preparations were made to shift to some other form of financing as
drawings approached a six-month term.
Some 94 per cent of all
drawings had been repaid within six months and none had gone on for
more than a year.
6/7/66
-17Mr. Mitchell remarked that he thought the paragraph in
question said essentially what Mr. Coombs had been saying.
The
Committee should be prepared to defend itself against critics by
indicating in the directive that it was not trying to rig markets
when there were basic forces at work that should be dealt with by
appropriate Government policies.
If, for example,
it appeared that
some foreign country's basic situation was deteriorating, the
responsibility for deciding whether to offer support should lie
with the Committee rather than with the Special Manager.
The
proposed paragraph said, in effect, that the Committee should make
the decision in such cases.
Mr. Shepardson observed that he did not read the proposed
language to call for a determination at the outset that a particular
development was temporary.
Mr. Coombs said that the opening phrase of the second sentence-"Operations undertaken to deal with forces deemed temporary or
transitional"--conveyed such an implication to him.
In a typical case,
however, some central bank in the swap network might take in a
substantial volume of dollars in a short period and suggest that the
System absorb those dollars by a swap drawing, as an alternative to
a gold sale.
It was appropriate, he thought, to make the drawing to
absorb the initial impact of the development and then to study the
situation to determine whether it reflected a temporary phenomenon.
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It was his practice to report to the Committee before renewing
central bank drawings at the end of their three-month terms.
Mr. Mitchell commented that the procedure Mr. Coombs
described was much like that followed when a domestic bank came
to the discount window; the Reserve Bank accommodated the bank
automatically and then studied the situation.
The fact that
Mr. Coombs reported to the Committee on proposed renewals of
drawings seemed to him to have nothing to do with the matter at
issue, which concerned publishing a statement of the principle under
which the Committee operated.
Mr. Robertson indicated that he shared Mr. Mitchell's position.
Mr. Coombs remarked that if the proposed paragraph appeared
in print it could be used against the United States by foreign
countries who might ask, for example, why the U.S. was still employing
short-term credit facilities when its balance of payments deficit had
persisted for nine years.
Borrowing as well as lending by the U.S.
was involved, and he would hope that the Committee could preserve a
reasonable degree of flexibility for dealing with possible developments.
By way of illustration, he recalled that early in 1966 System
credits to the Bank of England were reaching the end of their sixmonth terms.
In the immediately preceding period the System put
considerable pressure on the British to pay off their drawings.
That
was rather difficult for them because it required liquidation of a
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large part of their portfolio of U.S. securities.
Under other
circumstances he could visualize the U.S. having to borrow and--if
the suggested language was adopted and published--being pressed by
foreign central banks to clear up its debt within a certain time
and under certain conditions that could prove to be highly inconvenient.
Hence, he would not recommend hardening the requirement that
credits be kept short and repaid within some specific period such as
six months.
He thought there should be a general understanding within
the Committee to that effect, but if the Committee could avoid printing
such a rule it would be in a better position to deal with possible
emergencies in which some departure from general rules might be
desirable.
Mr. Daane referred to the final clause of the proposed
paragraph, which read, "or for a lesser period if the Special Manager
concludes that they can no longer be considered temporary."
In his
judgment that clause imposed an unreasonable burden on the Special
Manager.
Moreover, the Europeans were extremely sensitive with
respect to the short-term nature of swap drawings, and to adopt the
paragraph would simply give them more ammunition to use against the
United States.
If, as he believed, the Committee had adhered
to
the principle that the swap arrangements were short-term credit
facilities and had maintained proper surveillance over their use,
he saw no reason to change the directive.
would be hurtful rather than helpful.
To do so, in his opinion.
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-20Mr. Mitchell replied that the purpose of the proposed
paragraph was to set forth the practice the Committee had in fact
followed so that the public would be aware of it.
He thought the
point was not adequately stated in the record.
Mr. Ellis said he had found that academicians tended to rely
on the Committee's published instruments for an understanding of the
objectives of its foreign currency operations.
He had some sympathy
for the proposed paragraph because it provided a clearer description
of the nature of the forces with which the Committee was attempting
to deal.
It was true that one could not know at the outset of a
development whether it would prove temporary but whether or not
operations were continued would depend on a subsequent judgment on
that point.
Chairman Martin remarked that he thought the Committee was
dealing largely with questions of intentions and language.
Mr. Mitchell
was correct in noting that the suggested paragraph described the
Committee's general policy, and there was merit in Mr. Ellis' point
regarding academicians.
It was difficult, however, to formulate
such a policy statement in precise terms and he was not persuaded
that it was necessary to incorporate the paragraph.
Mr. Wayne noted that the network of swap arrangements had been
developed originally primarily because of problems with respect to
international payments of the United States, and that the proposed
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paragraph would apply to drawings by the U.S. as well as by the other
parties to the arrangements.
He thought those facts warranted careful
consideration, and he wondered whether the Committee ought to put the
proposed paragraph into the directive.
He personally had been impressed
by the points Mr. Coombs had made today.
Mr. Mitchell remarked that he considered odd the argument
that the Committee should do the right thing in limiting the duration
of swap drawings but at the same time it should avoid saying it was
doing the right thing.
The Committee did in fact extend swap drawings
beyond six months only with great reluctance, and it did look to more
basic policy measures to deal with persistent problems.
The proposed
paragraph specified exactly what the Committee had been doing.
Chairman Martin observed that in view of the differences of
opinion expressed today the Committee probably would not want to change
the substance of the directive unless it was convinced that the change
involved an improvement.
He then suggested that the Committee members
indicate whether or not they favored adding the proposed paragraph.
Messrs. Mitchell, Robertson, and Shepardson noted that they did and
the other members indicated that they did not.
Chairman Martin then asked whether there would be any objection
to incorporating the revisions in paragraph 2(B) recommended by the
staff in its June 1 memorandum, and no objections were heard.
6/7/66
-22The Chairman then observed that, as indicated in the
Secretariat's memorandum of June 6, 1966, Mr. Swan had offered
some suggestions for change in the language of the proposed authorization and the proposed directive.1 /
He invited Mr. Swan to comment.
Mr. Swan said his suggestion for the authorization involved
some small changes in wording in paragraph 1B(2) that he thought were
clarifying, as follows:
other] currencies held spot or
(2) ADDITIONAL[DEL:
purchased forward, up to the amount necessary for
System operations to exert a market influence BUT
[DEL:
and]not exceeding $150 million equivalent; and
His suggestion for the directive was simply to omit from the list of
purposes of System foreign currency operations the statement in
paragraph 1(B), which read "To aid in making the system of international payments more efficient."
The meaning of that statement,
taken by itself, was not clear to him, and unintended implications
might be read into it.
The intended meaning seemed to be covered
adequately by paragraphs 1(C) and 1(D).
Mr. Treiber said he thought the System's operations did
contribute to the efficiency of the international payments system
by making additional sources of credit available.
The statement in
1(B) of the directive had been included in the Committee's existing
authorization for some time and he would prefer to retain it in the
new directive.
1/ A copy of the memorandum referred to has been placed in the
Committee's files.
6/7/66
-23Mr. Daane remarked that the revision in the proposed authoriza-
tion that Mr. Swan had suggested seemed to be an improvement.
He
agreed with Mr. Treiber, however, that it would be desirable to
retain paragraph 1(B) of the directive, noting that the forthcoming
report of the Deputies of the Group of Ten would make a statement
along the same lines.
Chairman Martin proposed that the Committee accept Mr. Swan's
suggested revisions in paragraph 1(B)(2) of the proposed authorization
but not his suggestion for the directive, and no objections were heard.
Thereupon, upon motion duly made
and seconded, and by unanimous vote, the
Committee replaced its previously existing
instruments governing foreign currency
operations, namely, the authorization
regarding open market transactions in
foreign currencies, the guidelines for
System foreign currency operations, and
the continuing authority directive with
respect to foreign currency operations,
with two new instruments, namely, an
authorization for System foreign currency
operations and a foreign currency directive,
reading as follows:
AUTHORIZATION FOR SYSTEM FOREIGN CURRENCY OPERATIONS
1. The Federal Open Market Committee authorizes
and directs the Federal Reserve Bank of New York, for System
Open Market Account, to the extent necessary to carry out
the Committee's foreign currency directive:
A. To purchase and sell the following foreign
currencies in the form of cable transfers through spot
or forward transactions on the open market at home and
abroad, including transactions with the U.S. Stabilization
Fund established by Section 10 of the Gold Reserve Act
of 1934, with foreign monetary authorities, and with the
Bank for International Settlements:
6/7/66
-24Austrian schillings
Belgian francs
Canadian dollars
Pounds sterling
French francs
German marks
Italian lire
Japanese yen
Netherlands guilders
Swedish kronor
Swiss francs
B. To hold foreign currencies listed in
paragraph A above, up to the following limits:
(1) Currencies held spot or purchased
forward, up to the amounts necessary to fulfill
outstanding forward commitments;
(2) Additional currencies held spot
or purchased forward, up to the amount necessary
for System operations to exert a market influence
but not exceeding $150 million equivalent; and
(3) Sterling purchased on a covered
or guaranteed basis in terms of the dollar, under
agreement with the Bank of England, up to $200
million equivalent.
C. To have outstanding forward commitments
undertaken under paragraph A above to deliver foreign
currencies, up to the following limits:
(1) Commitments to deliver to the
Stabilization Fund foreign currencies in which the
United States Treasury has outstanding indebtedness,
up to $200 million equivalent;
(2) Commitments to deliver Italian
lire, under special arrangements with the Bank of
Italy, up to $500 million equivalent; and
(3) Other forward commitments to
deliver foreign currencies, up to $275 million
equivalent.
D. To draw foreign currencies and to permit
foreign banks to draw dollars under the reciprocal currency
arrangements listed in paragraph 2 below, provided that
drawings by either party to any such arrangement shall be
-25-
6/7/66
fully liquidated within 12 months after any amount
outstanding at that time was first drawn, unless the
Committee, because of exceptional circumstances,
specifically authorizes a delay.
2. The Federal Open Market Committee directs the
Federal Reserve Bank of New York to maintain reciprocal
currency arrangements ("swap" arrangements) for System
Open Market Account with the following foreign banks,
which are among those designated by the Board of Governors
of the Federal Reserve System under Section 214.5 of
Regulation N, Relations with Foreign Banks and Bankers,
and with the approval of the Committee to renew such
arrangements on maturity:
Foreign Bank
Austrian National Bank
National Bank of Belgium
Bank of Canada
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Netherlands Bank
Bank of Sweden
Swiss National Bank
Bank for International Settlements
(System drawings in Swiss francs)
Bank for International Settlements
(System drawings in authorized
European currencies other than
Swiss francs)
Amount of
Arrangement
(millions of
dollars
equivalent)
Period of
Arrangement
(months)
50
100
250
750
100
250
450
250
100
50
150
12
12
12
12
3
6
12
12
3
12
6
150
6
150
6
3. All transactions in foreign currencies undertaken
under paragraph 1(A) above shall be at prevailing market rates
and no attempt shall be made to establish rates that appear to
be out of line with underlying market forces. Insofar as is
practicable, foreign currencies shall be purchased through
spot transactions when rates for those currencies are at or
-26-
6/7/66
below par and sold through spot transactions when such
rates are at or above par, except when transactions at
other rates (i) are specifically authorized by the
Committee, (ii) are necessary to acquire currencies to
meet System commitments, or (iii) are necessary to acquire
currencies for the Stabilization Fund, provided that these
currencies are resold forward to the Stabilization Fund
at the same rate.
4. It shall be the practice to arrange with
foreign central banks for the coordination of foreign
currency transactions. In making operating arrangements
with foreign central banks on System holdings of foreign
currencies, the Federal Reserve Bank of New York shall
not commit itself to maintain any specific balance, unless
authorized by the Federal Open Market Committee. Any
agreements or understandings concerning the administration
of the accounts maintained by the Federal Reserve Bank of
New York with the foreign banks designated by the Board of
Governors under Section 214.5 of Regulation N shall be
referred for review and approval to the Committee.
5. Foreign currency holdings shall be invested
insofar as practicable, considering needs for minimum
working balances. Such investments shall be in accordance
with Section 14(e) of the Federal Reserve Act.
6. A Subcommittee consisting of the Chairman and
the Vice Chairman of the Committee and the Vice Chairman of
the Board of Governors (or in the absence of the Chairman
or of the Vice Chairman of the Board of Governors the
members of the Board designated by the Chairman as alternates,
and in the absence of the Vice Chairman of the Committee his
alternate) is authorized to act on behalf of the Committee
when it is necessary to enable the Federal Reserve Bank of
New York to engage in foreign currency operations before
the Committee can be consulted. All actions taken by the
Subcommittee under this paragraph shall be reported promptly
to the Committee.
7.
The Chairman (and in his absence the Vice
Chairman of the Committee, and in the absence of both, the
Vice Chairman of the Board of Governors) is authorized:
6/7/66
-27A. With the approval of the Committee,
to enter into any needed agreement or understanding
with the Secretary of the Treasury about the division
of responsibility for foreign currency operations
between the System and the Secretary;
B. To keep the Secretary of the Treasury
fully advised concerning System foreign currency
operations, and to consult with the Secretary on
such policy matters as may relate to the Secretary's
responsibilities; and
C. From time to time, to transmit
appropriate reports and information to the National
Advisory Council on International Monetary and
Financial Policies.
8. Staff officers of the Committee are authorized
to transmit pertinent information on System foreign currency
operations to appropriate officials of the Treasury Department.
9. All Federal Reserve Banks shall participate
in the foreign currenty operations for System Account in
accordance with paragraph 3 G (1) of the Board of Governors'
Statement of Procedure with Respect to Foreign Relationships
of Federal Reserve Banks dated January 1, 1944.
10.
The Special Manager of the System Open Market
Account for foreign currency operations shall keep the
Committee informed on conditions in foreign exchange markets
and on transactions he has made and shall render such
reports as the Committee may specify.
FOREIGN CURRENCY DIRECTIVE
1. The basic purposes of System operations in
foreign currencies are:
A. To help safeguard the value of the
dollar in international exchange markets;
B. To aid in making the system of
international payments more efficient;
C. To further monetary cooperation
with central banks of other countries having
6/7/66
-28convertible currencies, with the International
Monetary Fund, and with other international
payments institutions;
D. To help insure that market
movements in exchange rates, within the limits
stated in the International Monetary Fund
Agreement or established by central bank
practices, reflect the interaction of underlying economic forces and thus serve as
efficient guides to current financial decisions,
private and public; and
E. To facilitate growth in
international liquidity in accordance with
the needs of an expanding world economy.
2. Unless otherwise expressly authorized by
the Federal Open Market Committee, System operations in
foreign currencies shall be undertaken only when necessary:
A. To cushion or moderate fluctuations
in the flows of international payments, if such
fluctuations (1) are deemed to reflect transitional
market unsettlement or other temporary forces and
therefore are expected to be reversed in the foreseeable future; and (2) are deemed to be disequilibrating
or otherwise to have potentially destabilizing effects
on U.S. or foreign official reserves or on exchange
markets, for example, by occasioning market anxieties,
undesirable speculative activity, or excessive leads
and lags in international payments;
B. To temper and smooth out abrupt changes
in spot exchange rates, and to moderate forward premiums
and discounts judged to be disequilibrating. Whenever
supply or demand persists in influencing exchange rates
in one direction, System transactions should be
modified or curtailed unless upon review and reassessment
of the situation the Committee directs otherwise;
C. To aid in avoiding disorderly conditions
in exchange markets. Special factors that might make
for exchange market instabilities include (1) responses
to short-run increases in international political tension,
6/7/66
-29(2) differences in phasing of international
economic activity that give rise to unusually
large interest rate differentials between major
markets, and (3) market rumors of a character
likely to stimulate speculative transactions.
Whenever exchange market instability threatens
to produce disorderly conditions, System
transactions may be undertaken if the Special
Manager reaches a judgment that they may help
to reestablish supply and demand balance at
a level more consistent with the prevailing
flow of underlying payments.
In such cases,
the Special Manager shall consult as soon as
practicable with the Committee or, in an
emergency, with the members of the Subcommittee
designated for that purpose in paragraph 6
of the Authorization for System foreign
currency operations; and
D. To adjust System balances within
the limits established in the Authorization for
System foreign currency operations in light of
probable future needs for currencies.
3. System drawings under the swap arrangements
are appropriate when necessary to obtain foreign currencies
for the purposes stated in paragraph 2 above.
4. Unless otherwise expressly authorized by
the Committee, transactions in forward exchange, either
outright or in conjunction with spot transactions, may
be undertaken only (i) to prevent forward premiums or
discounts from giving rise to disequilibrating movements
of short-term funds; (ii) to minimize speculative
disturbances; (iii) to supplement existing market
supplies of forward cover, directly or indirectly, as a
means of encouraging the retention or accumulation of
dollar holdings by private foreign holders; (iv) to
allow greater flexibility in covering System or Treasury
commitments, including commitments under swap arrangements; (v) to facilitate the use of one currency for the
settlement of System or Treasury commitments denominated
in other currencies; and (vi) to provide cover for
System holdings of foreign currencies.
6/7/66
-30Before 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 May 10
through June 1, 1966, and a supplemental report for June 2 through
6, 1966.
Copies of both reports have been placed in the files of
the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
The Committee directive adopted at the last meeting
has, I believe, generated a constructive dialogue within
the System on the nature of staff reserve projections
and their use in helping to shape day-to-day open market
operations. Over the recent period, actual results have
been in line with the staff estimates of a reversal during
May of the sharp increases in aggregate reserves that had
occurred in April. In fact, over most of the period
required reserves tended to fall a bit short of the
estimates, suggesting no need to speed up the process
of attaining gradual reduction in net reserve availability.
Thus, net borrowed reserves and borrowings from the
Reserve Banks each increased by about $50 million in the
weekly averages.
I believe most of the staff would agree that we need
much more work and experience before a judgment can be
reached about the effectiveness of permitting short-run
fluctuations in aggregate reserve measures to influence
the course of open market operations between Committee
meetings. June, for example, may prove a more difficult
month than May because of the uncertainties spelled out
in the blue book.1/
The changed pattern of tax payments,
the problems that face the thrift institutions as they
1/ The report, "Money Market and Reserve Relationships," prepared
for the Committee by the Board's staff.
6/7/66
come into their midyear interest payment period, and
the continued pressure of Government agency financing
are all factors to be reckoned with in coming weeks.
With bank reserve positions under greater pressure,
the Federal funds rate has moved into new high ground.
Last Friday the effective rate reached 5-1/4 per cent,
and offerings at 5-3/8 per cent made their appearance
for the first time. The funds rate continues to be
influenced by CD and other short-term money rates, and
by the desire of many banks to avoid borrowing at the
discount window. The discount rate is exerting little
influence.
Given the taut reserve situation, banks have
tended to manage their positions cautiously, with considerable pressure in the funds market and heavy borrowing
before the weekend a typical, but not exclusive, pattern.
Over the long Memorial Day weekend borrowing from the
Reserve Banks exceeded $1 billion, and very large
excesses were built up, particularly at New York City
banks.
In fact, the New York City banks ended that
statement week with more than $0.5 billion in surplus
reserves, even though country banks took advantage of
the break in the Federal funds rate to accumulate $1.3
billion in excess reserves on Wednesday to carry over
into the final week of their statement period or to
resell on subsequent days to their sophisticated city
cousins at higher rates.
Rates on bankers' acceptances, finance paper,
commercial paper, and short-term agency issues, and
dealer financing rates have all pushed into new high
ground over the period. Treasury bills, on the other
hand, have been on a course of their own despite dealer
financing rates that have touched as high as 5-5/8 per
cent. Strong demand from corporations and public funds,
together with System buying and the investment in bills
by investors seeking a liquidity haven until the course
of long-term rates becomes clearer, has pressed on market
supplies. In yesterday's auction, average rates of 4.57
and 4.74 on three- and six-month bills, respectively,
were established.
At these levels, however, dealers were cautious in
their bidding and there was an unusually wide spread
between the average price bid and the lowest price accepted
by the Treasury.
6/7/66
-32-
A heavy atmosphere pervaded the capital markets for
most of the period as investors were choosy in the light
of the growing calendar, and only very attractively priced
issues were well received. The corporate market was under
particularly heavy pressure, with yields on both new and
outstanding issues pushing into new high ground. Some
improvement in atmosphere occurred late in the period when
a triple-A telephone issue with 5-year call protection
priced to yield 5.45 per cent--nearly 30 basis points
above yields on a comparable issue a month ago--was well
received. The weakness in the corporate market adversely
influenced the market for Treasury notes and bonds, as
did the diminishing expectations of a tax increase and
Secretary Fowler's remarks about the possibility of some
revision of the 4-1/4 interest rate ceiling. Despite
these developments, there was a considerable body of
sentiment in the Government market that the February-March
interest rate peaks might be tested, but that rates might
be in the process of bottoming out. Uncertainties about
the future course of monetary and fiscal policy together
with Congressional and Administration expressions of concern
about the competitive position of the savings and loan
associations and the mutual savings banks have tended to
produce an air of caution but no firm sense of direction
in the Government bond market.
In the meantime, the relentless pressure of new
offerings has created a number of problems in the market
for Government agency issues.
Prices have given ground
and it has become increasingly difficult to place each
succeeding new issue in investors' hands. On Thursday,
FNMA will be pricing an offering of $350 million Small
Business Administration participation certificates maturing
in 1-5 years and $180 million of their own new participation
certificates maturing in 13-15 years. Current market talk
is for a 5.70 - 5.75 rate on the shorter issues, with
underwriters having only moderate success in lining up buyers
even at these rates. For the longer maturities there appears
to be good demand at a 5-3/8 - 5.40 per cent yield range.
The very high rates on shorter agency issues is becoming a
matter of increasing concern to the Administration, but is
the natural outcome of the crowded calendar of issues that
has been forced into the market. Given the continued
pressure on bank reserve positions, the coming weeks--which
include the dividend and tax dates, a substantial calendar of
Government agency, corporate, and municipal offerings,
6/7/66
-33-
possible Congressional action on CD rates, the midyear
interest payment period for savings and loan associations and mutual saving banks, and the current pressure
on sterling mentioned by Mr. Coombs--will provide a
considerable test for both the money and capital markets.
Mr. Swan asked whether the Manager expected the large disparity
between the bill rate and other short-term rates to continue indefinitely or whether he thought bill rates would advance and narrow the
gap.
Mr. Holmes replied that at current levels of other short-term
rates there was an air of caution about the bill rate, as evidenced
in yesterday's auction.
It was hard to forecast bill rates at
present because of uncertainties about the volume of funds seeking
havens in bills.
It was known, for example, that some corporations
were instructing their treasurers to place funds only in bills, and
if that continued it could keep rates depressed for some time.
He
would imagine, however, that with all of the other pressures existing
in short-term markets bill rates would move up sooner or later.
Mr. Mitchell noted that System purchases had contributed to
downward pressures on bill rates, and asked whether the Desk should
not be buying other types of securities.
For example, would it be
desirable for the Committee to authorize purchases of agency issues?
Mr. Holmes agreed that System purchases had contributed to
the recent downward pressure on bill rates, although he thought such
purchases were not the main factor.
As to trading in other securities,
the Desk had bought coupon issues from time to time.
There were a
6/7/66
-34-
number of problems connected with buying agency issues.
First
was the legal question of the System's authority to buy particular
types of issues.
Secondly, there were difficulties relating to the
issues themselves; most were small and were not tradable on any
scale.
Third, what might be called an "even keel" problem existed.
Five or six agency issues might be offered in a single month, as
well as issues of the new participation certificates, and there
was likely to be a serious risk of giving false signals to the market
by trading in them.
Both purchases and sales by the System could
affect rate expectations and operations might have an undesirably
large influence on the market.
Finally, the present period, with
the crowded agency calendar and with the problems being encountered
in pricing some issues, would be a difficult one in which to begin
operations in agencies.
In response to a question by Mr. Mitchell as to whether the
Committee should consider operating in commercial paper,
Mr. Holmes
replied that the System could, of course, trade in any obligations
authorized by law if that served its purposes.
He would not want
to make an off-hand judgment on the desirability of trading in
commercial paper; the question warranted careful study.
Mr. Mitchell then asked what was known about the sources of
funds that were being invested in agency issues.
6/7/66
-35Mr. Holmes replied the dealers handling such issues had made
good progress in broadening the market, although further broadening
would be desirable.
Recent participants included corporations and
financial institutions such as savings banks and commercial banks.
Good strides also had been made in interesting pension and trust
funds as well as other institutional investors, and there had been
some foreign buying.
Mr. Mitchell then referred to the draft directives1/ the staff
had prepared for this meeting, particularly to the phrase in alternative
A for the second paragraph reading "provided, however, that if required
reserves expand sharply more than seasonally expected .
. . ."
He
asked how the Manager would interpret that phrase.
Mr. Holmes said the first problem would be to specify what
was seasonally expected in June.
Seasonal factors based on experience
of prior years would be of only limited usefulness this year because
of the changed pattern of tax payments.
As the blue book indicated,
the Board's staff expected the daily average bank credit proxy to be
about 6-1/2 per cent higher, at an annual rate, in June than in May,
and bank credit to rise about 10 per cent from the end of May to the
end of June.
The New York Bank staff was projecting increases of
7-1/2 and 15 per cent respectively, in the two series.
1/
Appended to these minutes as Attachment A.
Those
-36-
6/7/66
differences reflected the degree of uncertainty in expectations.
Mr. Daane noted that the blue book indicated that a
deepening in net borrowed reserves beyond $400 million could
lead to pressure on the discount rate and Regulation Q ceilings.
He asked whether the Manager thought there was much room left to
reduce net reserve availability further without forcing an
increase in the discount rate.
Mr. Holmes replied that, while it was difficult to judge
how much such room existed, he did not think it was very much in
view of the many pressures in the market.
He was inclined to
agree that net borrowed reserves consistently deeper than $400
million would affect expectations and might lead the market to
conclude that a change in the discount rate was inevitable.
That
was a personal judgment, of course, and one that might be changed
by developments.
Thereupon, upon motion
duly made and seconded, and by
unanimous vote, the open market
transactions in Government securities and bankers' acceptances during
the period May 10 through June 6,
1966, were approved, ratified, and
confirmed.
Chairman Martin called at this point for the staff economic
and financial reports, supplementing the written reports that had
-37-
6/7/66
been distributed prior to the meeting, copies of which have been
placed in the files of the Committee.
Mr. Brill made the following statement on economic
conditions:
My predecessor in this job, Mr. Noyes, was
always a source of sage advice. But the soundest
of his counsel was a parting message to me, warning
against the perennial risk of overstaying a tight
monetary policy.
I have taken this message to heart and searched
each nugget of information for signs of economic
weakening that should trigger a change in policy.
The slowdown in auto sales beginning in April
caused my antennae to quiver, and their vibrations
intensified with news of the drop in new orders,
the further cutbacks in auto production, and the
reports of housing construction grinding to a halt.
They shook violently when the May rise in the
unemployment rate was reported.
What does it add up to? Is the economy
really slowing down? I think the answer to this
is a qualified yes. Is the Fed overstaying its
tightening? I think the answer to this is an
unqualified no.
Let me elaborate on this paradox, first
giving some reasons for qualifying the answer on
the state of the economy. The weak spot in current economic activity is autos. Soon residential
construction will be in this category, but, at the
moment, the slowdown in activity and spending is
largely limited to the auto sector. It's showing
up in a variety of economic indicators, however,
and followers of driblets of economic intelligence
have a tendency to add these fragments, rather than
to question whether they often are multiple reflections of the same phenomenon. For example, autos
account for the April-May drop in retail sales,
the May drop in the workweek, and the second-quarter
slowing in GNP. If one abstracts from autos, retail
sales in May continued to rise as rapidly as earlier,
the workweek stayed at its postwar peak, and the
6/7/66
-38-
second-quarter rise in GNP is proceeding as fast as
that in the first quarter.
One has to be cautious, therefore, to avoid
going overboard about the auto slowdown, particularly
when consumer anticipation surveys suggest the
possibility of some rebound in auto sales later
this year, and particularly because consumers
currently are showing no signs of keeping their
wallets closed with respect to other types of
spending. Appliance and furniture sales have been
very strong, and consumer purchases of nondurable
goods continue to rise steadily.
Buttressing consumer spending plans in the
months ahead is the scheduled introduction of
Medicare payments at midyear, and the likely rise
in Federal civilian and military pay. Even if
auto sales do no better than level off at current
rates--a more pessimistic outlook, indeed, than
that held by most observers--the rise in other
consumer spending should keep businessmen happy
with their plans for new plant and additional
stocks.
On the other hand, the housing dip lies
ahead of us.
Housing activity currently is
being maintained on the basis of financial
commitments made earlier.
Judging from Reserve
Bank reports on new commitment flows, we should
expect the residential construction figures to
slide more rapidly and by autumn to show a
decided reduction.
Some temporary relief may
be afforded by an enlarged FNMA purchase program,
if Congress appropriates the funds, and by
possible actions to limit commercial bank
invasion of savings and loan fund sources.
But short of a major shift in the posture of
policy, or an unexpected decline in other credit
demands, housing will probably turn out to be a
much weaker area of activity over the balance of
this year than our current worry--automobiles.
Now let's turn to some of the bright spots
(depending upon what one construes as a good
The new plant and equipment
omen these days).
survey shows no indication of a cutback in
business capital outlays. True, during booms
we have gotten accustomed to expecting business
6/7/66
spending plans to rise in successive surveys,
and the fact that the two most recent surveys
are not far from the February reading suggests
somewhat less than usual ebullience, cyclically
adjusted. Perhaps monetary restraint is having
some effect--along with Presidential exhortations,
delivery delays, and rising machinery prices and
construction costs. But before chalking up plant
and equipment as another victim of tight money,
let's keep in mind that at close to midyear,
business plans call for plant spending to remain
a driving force for economic expansion over the
next two quarters.
One always hesitates to go out on a limb
about so volatile an area as business inventories,
but at the moment it's hard to see this as a
major drag on the economy. Some involuntary
accumulation of auto stocks at dealers is in
process, but these should be worked off during
the model changeover period. Outside of autos,
inventory-sales ratios continue low and favorable
to maintenance of the recent pace of inventory
investment.
Hovering over all judgments as to the economic
future is the question of defense spending. The
January Budget Message implied a pattern for
defense spending of a fast rise in the first quarter,
a slowing in the second quarter, and an abrupt
leveling off after midyear. Such an abrupt change
in the defense tempo would undoubtedly give private
spending plans a jolt, but it appears unlikely to
develop. Not that we as yet have any definite
clues on the course of military needs. But
piecing together the available information on
new defense orders and on draft calls, it seems
more likely that defense spending will continue
to rise next quarter at least as rapidly as it
has in the current quarter.
Adding this to the prospects for private
spending noted earlier, and abstracting from
the possibility of a financial crisis stemming
from the situation with respect to savings and
loan associations, one comes up with a picture
of a still-strong economy, one in which real
output would be rising less rapidly than in
6/7/66
-40-
the first half of the year, but with resource use
sufficiently intense to maintain pressure on costs
and prices.
Even with capacity continuing to grow,
manufacturing plant would continue to be used
intensively--a 92 per cent rate is our guess for
the third quarter. With unemployment among
experienced workers continuing at rockbottom
levels, wages would likely continue to drift up
and productivity to drift down, and, as a result,
unit labor costs to rise further.
In the context
of continuing strong over-all demand, it would
not be surprising if these cost increases were
passed through into rising prices.
It's hard
for me to see any significant slackening in
the rate of advance in industrial prices over the
summer and fall.
In time, we might expect a deceleration in
defense spending, substantial growth in industrial
capacity, and the training of new workers--all
factors favoring a return to price stability.
Unfortunately, neither the domestic nor the
international situation affords the time to permit
natural forces to work their way through the economy.
Important wage contract negotiations begin this
summer and carry through next year; the price and
profits background surrounding these negotiations
will not be conducive to moderate settlements.
Monetary policy may be a poor tool to use to
ward off a cost-push inflation threat, but in
the absence of more efficient restraints, it
doesn't seem to me that the Fed can abdicate its
responsibilities. Indeed, if it weren't for the
financial market conditions Mr. Axilrod will be
discussing in a moment, I would submit that this
would be an appropriate time to tighten the policy
screw another notch.
Following his presentation Mr. Brill responded to questions
on the consumer savings rate.
Mr. Mitchell then noted that the first sentence of the
staff's draft directive read, "The economic and financial developments reviewed at this meeting indicate that the domestic economy
6/7/66
-41-
is continuing to expand, with industrial prices rising further and
credit demands remaining strong."
He asked whether, in view of
the projection for a lower rate of growth in GNP in the second
quarter, it would not be more accurate to say, " . .
. although the
domestic economy is expanding at a less rapid rate than in the
first quarter, industrial prices are rising further and credit
demands remain strong."
Mr. Brill replied that he would be reluctant to see the
directive cast in terms of projections because they often were
highly uncertain.
Moreover, it appeared likely that GNP growth
would return to the first-quarter pace in the third quarter.
In
view of the apparent slowdown in the second quarter, however,
the staff did suggest dropping the word "vigorously" in describing
the current pace of the expansion.
In response to questions by Mr. Maisel, Mr. Brill said
that the latest survey results on planned business capital outlays implied less of an increase in real investment than the
previous survey because of the rise in machinery prices and
construction costs.
Capital spending was still expected to be
a strong expansive force, however.
The GNP price deflator was
projected to rise substantially in the third quarter, from about
a 3 per cent annual rate of increase to 4.2 per cent.
That was
mainly because of the expected Federal pay raise and the
6/7/66
-42-
inauguration of the Medicare program, which together contributed
significantly to the third-quarter figure.
Mr. Maisel then asked whether growth in real GNP in the
second quarter was less than the staff had projected early in
the year.
Mr. Brill indicated that he was not certain, but
would undertake to determine the facts on the question.
(Note:
Following the meeting Mr. Brill informed Mr. Maisel that the
staff's estimate of second-quarter GNP in current dollar terms
had proved accurate but growth in real GNP had been overestimated;
there had been a larger than expected rise in the price deflator.)
Mr. Axilrod made the following statement concerning
financial developments:
Since around mid-April interest rates on
virtually all securities and financing instruments
outside the Government securities market have
either regained earlier highs or continued their
advance to new highs for the year. Demand pressures
have been a driving force in some markets, but
restraints on supply appear to be more pervasive
than earlier, particularly in the mortgage market.
Yields on U.S. Government securities have
recently lagged behind the rise in other market
rates. Apart from the impact of the 4-1/4 per
cent interest ceiling on Treasury bond yields,
the relatively low level of U.S. Government
security rates can be mostly explained by the
unusually large cash surplus the Federal Government is running in the second quarter--projected
to be about $9 billion, or $4 billion more than a
year ago--and the consequent relatively large
reduction in debt outstanding--some inadvertent, as
in the May refunding--which has been only partially
6/7/66
replaced by new agency issues for cash. Part of
this large surplus is the result of tax speedups and some is the result of a faster growth in
GNP than was anticipated in the January budget
document.
But while tax speed-ups and the more
rapid GNP growth have taken some pressure off
the Government securities market, they have
generated additional private credit demands in
the market and hence a widening of rate spreads
between private and U.S. Government securities.
The general upward movement in the over-all
level of rates has been accompanied by a reshaping
of the yield curve. It now once again shows yields
relatively high at the short end and lower at the
long end.
In the U.S. Government securities
market, this is the result of the rise of yields
in the 1 - 3 year area to new high levels for the
year. That was the end of the market hit hardest
by the recent rash of agency issues and it also
was the area of the May refunding. And at the
very short end of credit markets, while the 3month Treasury bill rate is relatively low,
yields on commercial paper and bankers' acceptances
have risen over 1 percentage point since the
December discount rate increase and are more
representative of pressures in the short-term
sector.
Barring any change in the economic weather
or in the outlook for fiscal policy, I would
suspect that over the next few weeks there will
be a tendency for the yield curve to flatten
out more as a result of an upward rate movement
at the long end rather than a downward movement
at the short- and intermediate-end. Such a
conclusion is consistent with what we know
about the corporate, municipal, and Federal
agency calendar ahead and with the generally
restrained availability of investment funds at
some major financial institutions.
It is also consistent with the view that
the relatively high cost of short-term funds to
banks may impel them, as it did in early winter
(before the prime loan rate was raised), to
make portfolio adjustments or to tighten loan
terms as strong loan demand continues. This,
too, would add to upward pressures on long-term
market rates, not to say on banks' own lending rates.
6/7/66
-44-
The pressure for banks to undertake further
portfolio adjustments and to restrain lending
would become very intense if growth in aggregate
reserves was considerably restrained. The leeway
banks have under Regulation Q ceilings to become
aggressive in competing for short-term funds in
the CD market has been progressively reduced and
the competition of other short-term instruments
is becoming more fierce.
Banks have been offering
the 5-1/2 per cent ceiling rate on shorter
maturities (some reported in the 3 to 4 month
area) and secondary market trading in CD's is
taking place above the ceiling rate in the 3 to
6 month area. Thus, banks are close to becoming
very cramped in their ability to accommodate
loan demand, especially if investors find it
increasingly preferable or necessary to utilize
competing instruments such as Treasury bills
for liquidity purposes.
By combining the picture described above
with uncertainties facing nonbank savings
institutions after midyear interest crediting,
with legislative uncertainties overhanging
banks, with the possibility that credit demands
in June and July will be very large partly for
temporary reasons, with the need for the agency
market to digest a very large supply in a very
short period, and with sizable bank CD maturities,
one is driven to the conclusion that open market
policy should chart an unusually cautious course
in the period immediately ahead--recognizing that
a considerable amount of restraint is already
in the financial system.
It is possible, though, that net borrowed
reserves could be deepened somewhat further--say
closer to $400 million--in the face of a tendency
for reserve aggregates to grow rapidly without
leading to a substantial risk of a short-run
bind in the money markets.
Any significant
further tightening beyond that point threatens
to bring up a whole host of problems very similar
to those the Committee, and monetary policy
generally, faced last December. In principle,
the problem is that the availability of bank
reserves cannot be very much more constrained
6/7/66
without raising very difficult further issues
about the sustainability of time deposit ceilings
and the discount rate--and all the complicated
questions of timing that are involved in the
relationship of such rates to open market policy
and to other actions by the Administration and
the Congress.
I think the problem of relationships between
official and market rates is most dramatically seen
in the Federal funds market, where the trading
level recently has often been 50 basis points or
more above the discount rate as large city banks
have used this market rather than the discount
window to obtain additional reserve funds. If
the flow of nonborrowed reserves to the banking
system is reduced while loan demand stays large,
it is very likely that the availability of Federal
funds will decline. The volume of Federal funds
transactions has shown signs of declining in May
even with the Federal funds rate rising to 5-1/4
per cent at times. Intensification of such a
development would make it more necessary for
large city banks to borrow at the discount window.
Thus, a further tightening of monetary policy
will be accompanied by stronger demands on the
discount window from all classes of member banks
at the same time as market interest rate adjustments are occurring--and time deposits are becoming
harder to buy. It seems clear, therefore, that
open market policy's next significant step toward
restraint will mean that Regulation Q will produce
anguish from banks, as they find their CD's squeezed
into shorter and shorter maturities, as well as from
nonbank savings institutions. And the discount
rate and discount administration will become even
more of a problem than they are now.
Mr. Reynolds then presented the following statement on the
balance of payments:
Last March, Mr. Hersey reported to this Committee that Government technicians foresaw a
payments deficit on the liquidity basis of as much
6/7/66
-46-
as $2-1/2 billion this year--double last year's
deficit--if aggregate demand were allowed to
produce a GNP of $735 billion. At the time, the
$2-1/2 billion figure seemed startling. And such
an outcome still seemed avoidable, provided that
the domestic boom were brought promptly under
control by an appropriate mixture of fiscal and
monetary restraints. But this was not done.
And now we are having to become accustomed to
the $2-1/2 billion figure, and even to brace
ourselves for the possibility of a larger figure.
The liquidity deficit in the first four
months of the year was already at a rate of
about $2-1/2 billion. It would have exceeded
a $3 billion rate if the Treasury had not persuaded some foreign central banks and international institutions to shift from liquid
dollar assets into over-one-year time deposits
and into Federal agency securities--items that
are classified in the statistics as nonliquid.
The alternative measure of the deficit,
based on official reserve transactions, is
not a suitable one for identifying recent
trends, because special influence have caused
it to swing widely from quarter to quarter.
In the fourth quarter of last year, it was the
largest it had been in nearly three years. Not
only were private holders giving up dollars to
shift back into sterling, but there were very
large year-end shifts by foreign commercial
banks out of dollars into their own currencies,
with consequent accretions to central bank
holdings of claims on the United States. In
January-April of this year, the rate of deficit
measured by official reserve transactions was
roughly $1-1/2 billion, but it would have been
higher if there had not been reversals of the
previous year-end shifts.
If the domestic boom should roar ahead in
the second half-year after the current slight
hesitation passes, as projected in the green
book,1/ it would be prudent to expect some further
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.
6/7/66
-47-
increase in the payments deficit, on either basis
of calculation. The only source of improvement
about which one can now feel at all confident is
a decline in new Canadian security issues, following
the January-April bulge. Against that, and probably
outweighing it, further deterioration seems likely
on at least five fronts.
(1) Further shrinkage of the surplus on
merchandise trade is a strong possibility. The
trade surplus was already down to an annual rate
of less than $4 billion in January-April, compared
with more than $5 billion in the fourth quarter of
1965.
(2) Direct investment outflows are thought
to have fallen off to an annual rate of about $2-1/2
billion in the first quarter; they will probably be
larger than that during the rest of the year.
(3) The available evidence points toward a
further expansion of U.S. military expenditures
and economic aid outlays in Asia.
(4) Even with Treasury encouragement, shifts
of foreign funds from liquid to nonliquid assets
will not continue at the April-May rate of some
$200 million a month.
(5) The reflow of U.S. bank credit may not be
sustained at the $1 billion annual rate that has
prevailed since last fall, at least not without a
further substantial tightening of domestic credit
conditions. The recent sharp tightening of credit
in several foreign countries, reported in the green
book, makes a relative tightening in the United
States more difficult to achieve.
If all that were at stake was another one-year
setback in our progress toward payments equilibrium-this time attributable mainly to a war that will
someday end and a boom that is sure to fade--one
might hope to ride it out with equanimity. One
could take comfort in the fact that some other
leading countries have also been experiencing
accelerated inflation. Also, reserves are now
accruing more to the developing countries and less
to the traditional gold-buying countries (although
sometimes developing countries also buy gold).
Further U.S. recourse to the International Monetary
Fund could limit our gold losses for a time, as it
has during the past year, permitting other countries
-48-
6/7/66
to exchange unwanted dollars for claims on the
IMF instead of for gold.
But, unfortunately, much more than a oneyear setback is likely to be at stake.
If, as
seems possible, we are now seeing the beginning
of a domestic price-wage spiral that could gather
momentum right into the next recession, as
happened in the late 1950's, and if some other
leading countries are about to be successful in
slowing down their inflations, also as in the
late 1950's, then we may be risking a ten-year
setback rather than a one-year setback. It is
unlikely that we shall be allowed to repeat the
gradual, one-decade approach to payments adjustment. We would be starting this time from a
much weaker reserve position than in 1957, and
against a long background of doubt and disappointment.
It seems to me that the risk of a lasting
setback on the payments front is very much more
serious than the opposite risk of stepping a
little too hard on the brake.
Chairman Martin reported briefly on the recent meeting of
the American Bankers Association in Madrid, which he had attended
along with Messrs. Bopp, Daane, and Hayes.
ABA's thirteenth Monetary Conference.
The meeting was the
About 125 people had
attended, including about 30--a larger than usual number--from
foreign countries.
There was an underlying note of concern at the meeting of
a kind that he had not seen for some time, the Chairman remarked.
The concern was hinged on the belief that the balance of payments
problem of the U.S. was out of hand.
A number of foreigners had
commented during the course of the meeting about the necessity for
6/7/66
-49-
increasing the gold holdings of their countries and reducing their
dollar holdings.
While it would not be right to say there was any
real distrust of the dollar in Europe as yet, the seeds of such
distrust were there.
And the latest sterling developments might
well have been forecast from the discussions at the meeting.
One competent commentator had remarked, Chairman Martin
said, that America's present problem in Vietnam was analogous
to France's problem in Algeria; despite French claims that the
Algerian hostilities were not a real war, they eventually led to
the devaluation of the franc.
The Chairman did not think the
analogy was necessarily an accurate one, but it pointed up European
apprehensions about the U.S. situation.
Those apprehensions
should be borne in mind because they could lead to serious
consequences unless some means was found for dealing with
inflationary pressures in the U.S.
It was possible that the
crest of the domestic boom had been passed, although he personally
was not ready to pass a judgment on that question.
But the
interesting point was that virtually all of the Europeans who
had been through a similar experience were convinced that whatever
pause was occurring in the economy now was just a prelude to
another strong upswing.
Also to be borne in mind was the
possibility of real financial pressures developing over the next
several months.
6/7/66
-50In response to an inquiry by Chairman Martin, Mr. Daane
said he had nothing to add regarding the Madrid meeting.
He
thought the Chairman's report reflected accurately the feeling of
pessimism in Europe regarding U.S. efforts to resolve its balance
of payments problem.
The Chairman then invited Mr. Daane to comment on the
Rome meeting of the Deputies of the Group of Ten that had been
held prior to the ABA meeting in Madrid.
Mr. Daane noted that the Deputies had met in Rome on
May 17, 18, and 19.
The meeting was held against the background
of a rather sharp exchange of views, which had been reported in
the press, between Chairman Emminger of the Deputies and Mr. Schweitzer
of the International Monetary Fund.
Mr. Schweitzer had charged
publicly that the Group of Ten was dragging its feet on the whole
question of international monetary reform.
Also, he had scathingly
compared the proposal for a set-aside, for the use of countries
outside the Group, of any new reserve assets created to the
outmoded "separate but equal" accommodations treatment of minority
groups in the U.S.
In his reply Chairman Emminger had emphasized
that, because the Deputies were engaged on a long-run task, the
difference of a few months one way or the other in completing
their preparatory work was not of great importance.
With respect
to the "separate but equal" charge, he observed that the ten countries
6/7/66
-51-
of the Group would always have to bear the main responsibility
and financial burden involved in the functioning of the system.
Mr. Daane noted that Chairman Emminger had prepared a
draft report, organized into five chapters, for the consideration
of the Deputies.
The introductory chapter referred to the need
for a better balance of payments adjustment mechanism, the
instability in the present system related to shifts in composition
of reserve assets, and the probable inadequacy of gold for future
reserve needs.
The flavor of the introduction was that there was
no general shortage of international liquidity now but that it
was the consensus of the Group that there was likely to be a
problem in the future.
The introduction also referred to the
role played and the contribution made by short-term credit
facilities, and to their potential for further development.
The second chapter dealt with possible improvements in
the international payments system, Mr. Daane said.
It included
considerable discussion of the need for strengthening the process
of multilateral surveillance to bring about better adjustments,
perhaps even going as far as suggesting review and coordination
of national reserve policies.
Chapter 3 dealt with the elements
of various proposals for the creation of reserve assets.
There
was little discussion of the first three chapters at the Rome
meeting.
6/7/66
-52Chapter 4, Mr. Daane continued, involved an attempt to
get away from a simple cataloguing of views on individual elements
of various proposals and to put forward the most desirable "package
plan" or plans.
Most of the attention at the meeting was centered
on a draft of chapter 4 prepared by the British delegation in an
effort to get the Group to coalesce around a proposal for a
reserve unit for the limited group, setting aside for future
discussion appropriate provision for other members of the IMF.
While the British proposal would retain the principle that an
expansible inner group would have responsibility for insuring
the acceptability of the new reserve units, it would permit
units to be issued to nonparticipating countries.
On the unresolved
issue of acceptability the proposal provided for a compromise
involving upper and lower holding limits.
If a country accumulated
new units above an upper holding limit it could convert them,
100 per cent, into gold.
Transfer of units below the lower limit
would be at a ratio to either gold or dollars.
Thus, the proposal
contained some of the acceptability elements of both the U.S.
proposal and that of Chairman Emminger.
The Group did not coalesce around the British proposal,
Mr. Daane remarked.
The French took their usual position that
there was no need to do anything at present, particularly in view
of the continuing U.S. balance of payments deficit.
The U.S.
6/7/66
-53-
delegates demurred on the grounds that they still preferred their
own "dual" proposal, which included provisions for drawing rights
as well as new reserve units.
The conclusion was that chapter 4
would still leave open the options of going toward drawing rights,
new units, or some combination of the two.
The European view
now involves new units for the limited group and possible
drawing rights for others, while the U.S. proposal involves
drawing rights for everyone.
The issue of universality was
definitely in the minds of the Deputies as well as of the people
at the IMF.
There was some discussion also of the form and content of
chapter 5 on Conclusions and Recommendations, Mr. Daane observed.
An understanding was reached that a new draft of this Conclusions
chapter would be prepared by Chairman Emminger on the basis of
suggestions sent in to him before the next meeting of the Group,
scheduled for Frankiurt, Germany, June 21-24, 1966.
The other question discussed, Mr. Daane reported, was how
and when to move ahead into the second stage.
His personal view
was that the U.S. balance of payments picture might well affect
the willingness of the Europeans to take that step.
The U.S.
had proposed moving into a second stage involving an Advisory
Committee of Ministers and Governors in the Fund, with about 38
Ministers and Governors to cover the whole Fund membership.
He
6/7/66
-54-
understood that in Fund Board discussions subsequent to the
Group of Ten meeting the IMF Executive Directors had resisted
that idea.
He might note one other point, Mr. Daane said, that might
have partly reflected the effects of the current U.S. balance of
payments position.
When the Deputies turned to chapter 3, dealing
with elements of reserve asset creation, the discussion brought
out clearly the considerable interest on the part of the continental
Europeans in establishing preconditions, both procedural and
substantive, that would prevent early or excessive activation of
machinery set up to create reserves.
In that respect they were
moving in the direction of the French position.
Among the sug-
gestions made for preconditions for activation were a rule of
unanimity, an initial date not earlier than 1970, or a two-year
period in which there were no
net additions to world gold stocks.
In addition, the Europeans talked about setting up some qualitative
criteria that would very rigidly limit the amount of reserves
created.
The restrictive flavor of the discussion of activation
was similar to that evident in the questioning of the desirability
of moving into the second stage and in the repeated emphasis on
the need for tighter multilateral surveillance.
Chairman Martin then called for the go-around of comments
and views on economic conditions and monetary policy, beginning with
Mr. Treiber, who made the following statement:
6/7/66
-55-
Business activity continues strong. The
demand for autos is less intense than earlier, but
it is too soon to say whether this is more than a
temporary dip. More striking are the indications
that capital spending plans continue to be very
strong--despite moral suasion, tighter credit,
shortages of labor, and slower deliveries. A
rapidly growing aggregate demand for goods and services
continues to press on the limitations imposed by more
slowly growing capacity.
The most recent survey of consumers' buying
intentions shows no significant change; while
consumers have reduced their automobile buying
plans from the very high level of the previous
survey, their buying plans still are at the high
level of a year ago. On the price front, nonfood
prices--at both wholesale and retail--moved sharply
higher in April. The highly tentative May figures
indicate that industrial wholesale prices have held
about constant. There has perhaps been some reduction
in inflationary psychology, but the inflationary
pressure of demand on resources continues to be
present.
The balance of payments outlook is unsatisfactory, and the prospects are gloomy. The annual
rate of the deficit for the first quarter of 1966
was much greater than the deficit for the year 1965.
The trade balance has deteriorated and could deteriorate
a good deal more unless inflationary forces at home
are checked. There appears to be little prospect of
any significant reduction in direct investment outflows,
and the tourist gap is likely to widen. The Vietnam
conflict promises to be a continuing drain. It seems
probable that there will be a substantial increase in
the balance of payments deficit for 1966 as compared
with 1965. Success in the Treasury's effort to induce
a further shift of foreign official and international
funds out of liquid dollar instruments into nonliquid
assets will serve merely to improve the balance of
payments statistics. The worsening of our balance
of payments could undermine foreign confidence in
the ability and determination of the United States
to rectify its balance of payments problem; and
attempts at window-dressing are not likely to help
the situation.
6/7/66
-56-
Bank credit growth slowed in May. The rise
so far this year is still very substantial, though
less so than in 1965. In April the loss of funds
at thrift institutions was large. The mortgage
market is very tight. But so far the effects on
residential construction activity have not been
great. Bank liquidity has dropped further as banks
have continued to liquidate U.S. Government securities. The demand for business loans continues
strong. There is concern about financial strains
that may occur at the June tax payment date and at
the end of the first half of the year when thrift
institutions will be crediting interest on savings
accounts.
The present situation calls for coordinated
restraint by fiscal policy and monetary policy.
Monetary policy has been working. The big policy
issue, it seems to me, continues to be fiscal
policy. The Federal Government is still providing
a considerable fiscal stimulus in a setting marked
by excess demand.
It seems to me that the prompt
announcement and enactment of a program for a
simple increase in Federal individual and corporate
income taxes would help to reduce the inflationary
pressures and to promote the maintenance of an
orderly and balanced economy now, thus contributing
over the long run to sustainable economic growth
and the expansion of employment. More fiscal
restraint would, of course, lessen the need to
place too great an anti-inflationary burden on
monetary policy, and would reduce the inevitable
pressure on interest rates.
Continuing monetary restraint is called for.
With interest rates on time deposits pressing
closer to Regulation Q ceilings, with the recent
advance in several money market interest rates,
and with a generally taut tone in the money market,
there is not much room for increasing the pressure
on bank reserve positions without endangering the
current viability of the discount rate and Regu-
lation Q ceilings.
It seems to me that it would
be desirable to maintain as much restraint as is
feasible without creating strong expectations of
a change in the discount rate. Such a course
would involve continued firm conditions in the
6/7/66
money
-5-market
positions, with
and
continued pressure
net
borrowed reserves
on bank
perhaps
reserve
in the
$350-$400 million range.
Alternative A of the draft directives prepared
by the staff with the proviso clause would seem to
fit
the prescription I have in mind.
The proviso
clause constitutes a fitting reminder in the directive
of the basic thrust of policy.
Under the proviso, we
should
move toward lesser
reserve
availability
Land
firmer money market conditions if bank credit expands
more rapidly than expected.
Yet the Manager should
not be expected to react automatically to purely
statistical short-range changes in required reserves.
With the stresses of the tax date and the approaching
interest payment date for thrift institutions, a
further increase in restraint under the proviso clause
should be approached with caution.
I will now comment on member bank borrowing in
the Second Federal Reserve District.1/
As regards borrowing by country banks, the System's
program of monetary restraint is now finally reaching
down into the country banks, and beginning to bite.
The country banks, like the reserve city banks, are
faced with a continuing heavy demand for loans, which
the have met and are continuing to meet through
whatever means are available. Traditionally, country
banks have maintained an excess of reserves over
Lorroings or a net free reserve position. Since the
middle of March, however, country banks have been
showing a net borrowed reserve position.
Since large
correspondent banks are no longer in a position to meet
the needs of the country banks, the country banks are
relying more and more on the discount window to avoid
1/ In transmitting the agenda for this meeting the
Secretary of the Committee had indicated that "interest has been
expressed in hearing any comments the Presidents might care to
make concerning the factors underlying the recent substantial
increase in country bank borrowing at the Federal Reserve Banks,
and whether any banks borrowing at the discount window were
al-o selling Federal funds to others during the same period."
6/7/66
-58-
liquidating securities, in the face of continuing high
loan demand.
As our discount window policy begins to
be applied to these borrowings, a restrictive
effect
upon expansion of credit by country member banks should
follow.
As regards banks borrowing at the discount window
and selling Federal funds to others, we have taken the
position that the large correspondent banks who are
acting as dealers in Federal funds should not borrow
from the discount window during any reserve period
in which they are net sellers of Federal funds.
Recognizing the fact that in order to maintain a
market in Federal funds these banks must be sellers
of Federal funds as well as purchasers, we have not
considered borrowing inappropriate as long as the
bank was a net purchaser of Federal funds. On only
three occasions (one country bank and two city banks)
were banks borrowers at the discount window and net
sellers of Federal funds in the same reserve period.
We satisfied ourselves in each instance by direct
contact that the situation was inadvertent and not
for the purpose of obtaining a rate differential. In
none of the three cases has the practice been repeated.
We have seen no instance of a net sale of Federal
funds by a bank which has borrowed from us with the
objective of gaining the benefit of a rate differential.
There is still another matter in which I think
the Committee would be interested. It concerns the
problem of possible withdrawals from savings banks
at midyear.
Yesterday the President of the Savings Banks Trust
Company, which serves as a kind of central bank for
the mutual savings banks of New York State, and the
Presidents of three of the large New York City savings
banks called at the Federal Reserve Bank of New York
to discuss a possible savings bank crisis in July.
At the end of the first quarter of 1966 the savings
banks of New York State experienced rather large
withdrawals; they fear even larger withdrawals at
midyear. The savings banks are comparatively illiquid,
with limited access to commercial bank credit and the
capital markets. Emergency sales of their holdings
of U.S. Government securities and agency securities
would not only bring them substantial losses but
could disrupt the U.S. Government securities market.
6/7/66
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While they do not predict a crisis, they think
that a crisis is possible unless there are alternative
means for prompt relief, possibly through the Federal
Reserve System, in the event of the withdrawal from
the savings banks of several hundred million dollars
in a couple of days. A crisis for the savings banks
would, of course, have adverse repercussions on the
entire banking and financial system.
There was a discussion of the possibility of
setting up a mechanism whereby the Federal Reserve
System could provide relief, if needed, to avoid a
crisis.
For example, to the extent that the larger
savings banks in New York City have available for
pledge direct obligations of the United States, such
banks might, after exhausting their normal borrowing
facilities, borrow from the Federal Reserve Bank of
New York on the security of those obligations, pursuant
to the thirteenth paragraph of Section 13 of the
Federal Reserve Act. If additional borrowings from
the Federal Reserve Bank become necessary on the part
of those banks or any other New York State savings
banks whose needs cannot be satisfied by the Savings
Banks Trust Company, an arrangement might be made
whereby a member bank in New York City could act as
a medium or agent for the Savings Banks Trust Company
in borrowing from the Federal Reserve Bank of New York,
it being contemplated that the collateral would not
qualify for use in connection with advances under
Section 13, but rather under Section 10(b), of the
Federal Reserve Act. Permission of the Board of
Governors would, of course, be necessary for such a
borrowing under the ninth paragraph of Section 19
of the Federal Reserve Act and Section 201.5 of
Regulation A.
The savings bank representatives agreed to
furnish us promptly with a memorandum outlining the
problem and possible solutions, to the end that
another meeting be held and further discussions had
within the next ten days. Stress was placed on the
desirability of setting up the machinery for handling
the problem as far in advance as possible, and also
of having the operating rules clearly understood by
all, as soon as the way is open.
We indicated a
generally sympathetic attitude toward the savings
6/7/66
-60-
banks' problem, and will be working closely with them
and the Superintendent of Banks of New York. As soon
as we receive the memorandum we will be discussing
the subject further with the Board of Governors.
Last week we met with the President of the
Federal Home Loan Bank of New York. He was not
alarmed about the savings and loan situation in his
district. The Federal Home Loan Bank of New York is
prepared to provide financial assistance to associations to help them meet any unusual withdrawals that
may arise at midyear. From the supervisor's
viewpoint he saw much to be gained in the current
experience; higher standards of lending and operations
are being promoted.
Mr. Ellis reported that the basic posture of the First
District economy continued to be one of firm pressure against
available resources.
With factory output rising, with capital
expenditures rising, with construction activity rising and
jobs seeking workers, more attention was being directed toward
the financial reflection of such pressures and their immediate
outlook.
In construction, Mr. Ellis said, new contracts during
the first four months of this year were 43 per cent above
year-ago levels.
Nonresidential building contracts in April
registered a 45 per cent year-to-year gain.
Residential
contracts posted a 47 per cent gain, mostly due to a sharp
rise in apartment buildings.
In partial reflection of those
trends, real estate loans of the District's weekly reporting
member banks stood 12 per cent higher than a year ago, and in
late May were increasing at a 10 per cent annual rate.
It
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seemed fair to conclude that financing had been available in
New England.
There was some evidence, Mr. Ellis continued, that the
first quarter brought a rush of loan commitments that would
require a period of digestion.
At least one insurance company
reported that during the first quarter it committed all the
funds it expected to have available during 1966.
reduced loan commitments also faced the mutual
considered as a group.
A period of
savings banks--
While some individual banks still had
funds to invest out of State at net yields of 6 per cent or
better, others found their slight dip in deposits during April
brought their loan-deposit ratios up to or even above the
85 per cent legal loan limit in Massachusetts.
If presently
scheduled deposit withdrawal notifications for July materialized
in historical patterns, several more of the mutuals would be
pushed above their loan ceilings, and would be under the same
kind of pressure as Mr. Treiber had indicated was possible in
New York.
The mutuals had been "refreshing" their loan
commitments for member banks.
Mr. Ellis went on to say that the Boston Reserve Bank's
May 11 survey of time deposits at New England member banks
provided evidence of continued efforts to attract time and
savings deposits.
One-quarter of the member banks now issued
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non-negotiable CD's, and their outstanding volume had increased
15 per cent since December.
A full third issued negotiable
CD's in denominations of less than $100,000 and had lifted the
outstanding level by 25 per cent since December.
Along with their 23 per cent year-to-year gain in
total savings deposits (and 2 per cent gain in demand deposits),
weekly reporting member banks in New England had found
increasing difficulty in meeting their reserve requirements.
the three statement weeks ending last Wednesday (June 1), the
banks were borrowing on average four times more than a year
ago.
The green book indicated that "the factors occasioning
the recent sharp increase in borrowing by country banks . . .
are not completely clear."
In the First District's case, the
number of country banks borrowing had doubled in the past
three weeks.
As the large correspondent banks drew near the
acceptable limits of their borrowing at the Federal Reserve
Bank they had curtailed their willingness to provide Federal
funds on call of their small correspondent banks, who in turn
showed up at the discount window.
The Boston Bank had reviewed the borrowing and Federal
funds activities of those banks making daily reports to it,
Mr. Ellis said.
Having regard to the fact that the funds
sales and Reserve Bank borrowings occurred at different times
In
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in a reserve period, no convincing evidence was found of banks
making a deliberate policy of borrowing at the discount window to
sell Federal funds.
Borrowing seemed directly related to the
basic factors of peak seasonal deposit and loan pressures superimposed on cyclical conditions of strong loan demand and
tightening monetary policy.
About the same words came to his mind, Mr. Ellis said, in
appraising the national scene.
Concern seemed greatest in the
financial reflections of a surging economy.
Capital investment
was surging ahead in spite of the Presidential plea.
Vietnam
impacts were showing up ever more broadly as the effects of defense
spending were imposed on top of business and consumer demands.
However slight its real effect on release of the pressures on
resources, he was inclined to regard the cutback in auto production
as a welcome relief from a prevalence of excesses.
Starting with the premise that the strong upward thrust of
the economy was continuing, as he did, Mr. Ellis continued, it
remained a critical but still unresolved issue as to whether a
tax increase might be forthcoming.
Facing that uncertainty, the
major alternatives of monetary policy lay in holding the present
degree of tightness or continuing to move gradually in firming
further.
While reluctant to lose momentum, he was persuaded that
it was time for a pause in the tightening process.
Three factors
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predominated in his conclusion:
first, the projected tightness in
money markets in June and early July as corporations had to meet
accelerated tax payments out of reduced liquidity; second, the
exposed position of savings institutions having deposit losses and
July dividend payments while the Government enlarged its enticements
for savers' funds by issue of attractively priced participations;
and third, recent moves in policy that added another degree of
tightness in a market increasingly affected by cumulative effects
of past tightening.
Those factors persuaded him, Mr. Ellis said, to urge a pause
in which further tightening would be foregone to allow the markets
to work their way through present difficulties and to allow the
Committee another assessment of what it could accomplish by
further moves.
Those views led him to select alternative A of
the second paragraph of the draft directive, with the proviso
clause included in order to forestall loss of ground.
As to the
first paragraph, he would prefer to substitute the word "the" for
"our" in the references to the U.S. foreign trade surplus and the
deficit in international payments.
Mr. Irons reported that conditions in the Eleventh District
continued strong.
There was, perhaps, some slight moderation as
a result of developments in housing and automobiles, as was the
case nationally.
On the other hand, employment, production, and
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distribution (as reflected by department store sales) had continued
to show steady increases, with indications of further moderate
increases in the months ahead.
Employment had been rising at a rate
of about one per cent a month.
The advance was rather general and
the total had reached a new record.
Production in the District
was up about 0.8 per cent in the past month, with increases
outnumbering declines in about a two-to-one ratio.
Construction
contracts were down; cumulatively, for the year to date, they were
about 6 per cent below the same period a year ago.
Department
store sales were running seven to eight per cent over a year ago
and were continuing to show strength.
For the first time in a
long while, however, there had been a slight decline in new car
registrations.
The agricultural situation was quite favorable.
Moisture conditions were generally good, although there were some
spotty areas, and the livestock conditions were good.
Cash farm
receipts in the first quarter were 22 per cent above a year ago,
with livestock accounting for about 30 per cent of the rise and
crops the remainder.
In the financial area, Mr. Irons continued, bankers
continued to talk about the lack of liquidity and the strength
of loan demand, although loans in total and in most individual
categories declined in the period and were running below the same
period a year ago.
Investments showed a slight decrease as
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holdings of Governments were reduced and other securities were
acquired at a low rate.
As in the preceding period both time and
demand deposits declined, but negotiable CD's advanced to a
record level for the District.
Federal funds purchases were
down a bit but still exceeded sales.
Both the number of member banks borrowing at the discount
window and the amount of borrowings had shown increases, Mr. Irons
said.
In reviewing recent discount window activity he had found
that two reserve city banks borrowing from the Reserve Bank sold
Federal funds in the same period.
That was not a regular
practice, however; the banks in question happened to be caught
with surplus funds at the end of the period.
He believed that some
of the District's small country banks, although not a great many
as yet, probably were coming to the discount window because their
city correspondents were suggesting that conditions were tighter.
Three or four of the banks that had come to the window in the
last few weeks had not borrowed from the Reserve Bank for several
years, and he suspected that they were giving their correspondents
a breathing spell.
Still, the number of banks borrowing and the
total volume of borrowings in the District were not large; in the
week ending June 1, 17 country banks and one reserve city bank were
at the window for a total of $18 million.
6/7/66
-67In trying to trace the reasons for country bank borrowings,
Mr. Irons continued, he found that seasonal agricultural demands
were a contributing factor, and were likely to continue to be so.
There was no evidence that the small banks were dealing in Federal
funds one way or the other.
He did not find the increase in
discounting activity to pose a particularly difficult problem,
and in some respects it was desirable for a few more banks that
had not borrowed in some time to come to the window.
The present
level of discounting reflected a combination of seasonal, cyclical,
and money market considerations, and he saw no evidence of efforts
to arbitrage interest rate differentials.
Mr. Irons commented that the national economic situation
had already been discussed fully, and all members were aware of
the balance of payments problem.
With respect to policy, his posi-
tion was quite close to that taken by Mr. Ellis.
The next three
or four weeks would be a period of rather intense uncertainties
and severe pressures in the money market.
The Committee had
made reserves less readily available and had contributed to the
rise in market interest rates.
It was not possible to say what
lay ahead, but the Committee had achieved a considerable bite
with its recent policy actions.
would be prudent.
At this time, he thought, caution
He would like to see net reserve availability
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not deepened further but held at about its recent level.
He did
not believe that the Committee could strain the existing position
much further without giving rise to pressures for action with
respect to the discount rate and Regulation Q ceilings.
He
agreed that coordination of fiscal and monetary policies would be
desirable to relieve financial pressures, but he saw no indications
that fiscal policy action would be taken.
Mr. Irons favored alternative A of the draft directives
which, he noted, called for maintaining net reserve availability
and related money market conditions in about their recent ranges.
He would interpret that language to call for net borrowed reserves
of around $350 million.
While he did not feel strongly on the
matter, he would prefer to omit the parenthetical clause in the
staff's draft.
Mr. Daane left the meeting during the course of Mr. Irons'
remarks.
Mr. Swan reported that in April the unemployment rate in
the Twelfth District had declined again, to 4.3 from 4.5 per cent,
to a considerable extent as a result of another substantial increase
in aerospace employment.
Retail sales continued to do less well
than in the rest of the country and, of course, residential
construction was weak.
Lumber prices declined in mid-May following
a further decline in orders; Government purchases were off and it
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had become evident that new labor contracts would be negotiated
without strikes.
District agriculture seemed to be in good
shape, although the annual question of the availability of labor
for the summer and fall was again being raised.
The first
authorization for Mexican labor, issued in May, called for 1,000
workers to be brought in for the strawberry harvest.
In that
connection, it was interesting to note that strawberry plantings
wereup sharply in Mexico this year.
During the first
quarter of
1966 imports of fresh strawberries from Mexico were double those
of a year ago and frozen strawberry imports were up about
one-third.
Mr. Swan said he would not take the time to review recent
developments with respect to the mortgage market and nonbank
savings institutions in
the District because they had been covered
in his Bank's report on the recent special
survey.1/
He would add
only that the figures the Reserve Bank had obtained for the first
ten days of May indicated a further loss in the share accounts
of California State-chartered savings and loan associations,
accounted for about 70 per cent of total share accounts in
which
the
A report entitled "Current Mortgage Market Conditions as
1/
quoted
in Special Surveys by the Federal Reserve Banks" had
I
been distributed to the Committee prior to this meeting in the
form of a special supplemental appendix to the report, "Current
Economic and Financial Conditions."
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6/7/66
State.
The decrease amounted to $28 million, much less than the
loss in the corresponding period in April.
While the decline was
far from welcome and there still was a good deal of concern about
what might happen in early July, there was some feeling of relief
that it was not larger.
Mr. Swan went on to say that the Home Loan Bank Board's
recent ruling raised to 5 per cent the rate that California savings
and loan associations could pay on share accounts without having
their borrowing privileges at the Bank restricted.
That ruling
was followed by widespread announcements by the associations not
already paying 5 per cent that they would begin doing so on
July 1.
The associations that had gone to 5 per cent in April came
out much better in terms of changes in their share accounts than
others, although it was not clear whether their experience
reflected the higher rate or their greater strength.
There naturally
was some hope on the part of other associations that 5 per cent
would prove to be a viable rate.
Savings deposits at weekly reporting member banks continued
to decline in May, Mr. Swan said, although the decrease in that case
also was much less than in April.
Other time deposits of individuals,
partnerships, and corporations rose substantially more than savings
accounts declined.
The net growth in total time and savings
deposits in May was somewhat greater than in April, although both
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gross amounts were considerably smaller.
The District's larger
banks finally appeared as net interbank purchasers of Federal funds
for two weeks in May, although the amounts involved were not large.
In the other weeks of the month they were net sellers, as they had
been previously, but in relatively small amounts.
In checking on the questions that had been raised regarding
borrowing banks, Mr. Swan continued, he had not learned of any such
banks in the District that also were net sellers of Federal funds
in the same period.
Some borrowers had operated on both sides
of the funds market, but that was not a concern as long as they
were not net sellers.
Borrowings by country banks were somewhat
higher in May than in April, and they also were higher in the two
weeks ending June 1 than in the first half of May; but the total
still was not large.
The week ending June 1 saw a larger number
of country banks borrowing than any other recent week, but that
number
was only five, and those country banks accounted for only
20 per cent of total borrowings from the Reserve Bank in the week.
It was difficult to find any common thread in their reasons for
borrowing.
In the past month there had been two cases resulting
from agricultural developments, such as delays in harvesting, and
one or two cases reflecting unexpected losses of public deposits.
Two of the five country banks were large institutions whose
positions were not markedly different from those of the large
reserve city banks.
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Turning to monetary policy, Mr. Swan said that national
developments since the last meeting of the Committee seemed to
be about in line with what had been anticipated.
He gathered
from Mr. Holmes' remarks that despite problems of measurement
operations had worked out rather well under a directive that
referred to aggregate reserves as well as to net reserve availability.
He found it was not easy to reach a conclusion regarding
policy for the period ahead.
The balance of payments situation
was serious; indeed, if that were the only consideration before
the Committee it probably would call not for gradual tightening
but rather for overt action that would affect attitudes abroad.
However, in light of the domestic situation--the uncertainties
in credit markets, the seasonal needs, the problems facing savings
institutions, and so forth--he came out about about where
Mr. Irons had, with the feeling that the Committee should avoid
any further tightening, at least until its next meeting.
He
would accept alternative A of the draft directives and would
definitely include the parenthetical phrase.
He thought the
Committee should continue to recognize the aggregate reserve
question even though there was some problem of measurement, and
that it should refer to the seasonally expected change despite
the problem of definition.
He agreed with Mr. Treiber on the need
for caution in applying more restraint under the proviso clause,
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and he would favor a rather liberal interpretation of seasonal
changes.
It was necessary, he thought, to meet the additional
demands that were expected in the next few weeks.
Mr. Galusha said that except for developments in the Ninth
District mortgage market, on which a report had been distributed,
there were no District developments of such interest as to require
being reported at this time.
As to country bank borrowing, Mr. Galusha said there
appeared to be nothing unusual going on in the District.
The volume
of such borrowing was considerably higher in May of this year than
in May of last year, and quite a bit higher than in April.
But
the increase from April to May was just about what the established
seasonal pattern would have led one to expect.
If anything, Ninth
District country bank borrowing was surprisingly low in May, for
the loss in total deposits was much greater than seasonal.
Nor
had any evidence been found that during May District country banks,
whether in debt to the Reserve Bank or not, entered the funds
market on the selling side.
The country banks had not yet become
generally active in the funds market.
Mr. Galusha mentioned that the Reserve Bank's recent effort
to dissuade a few of the city banks from using the discount window
as much as they had been was crowned with considerable success.
Those banks which were, by the Reserve Bank's standards, being a
bit too free with discount credit had stopped being so.
6/7/66
-74Turning to open market policy, Mr. Galusha said it appeared
to him that the Committee could do no better for the present than
to aim at maintaining the status quo in money and credit markets.
In his judgment, the objective from now until the next meeting
should be to hold short-term rates about where they had been lately,
on average, and not pay too much attention to the level of the bill
rate, to net borrowed reserves, or, for that matter, to aggregate
reserves or bank credit.
Fortunately, a holding action against
pronounced changes in the complex of short-term rates should not
involve sharp deviations from recent average values for the bill
rate or the level of net borrowed reserves.
Medium- and long-term
rates could well move somewhat higher, but that would not seem to
be an implication from which the Committee ought to shrink.
Mr. Galusha noted the concern about the upcoming tax date
and, more important, the implications of generally and markedly
higher interest rates for nonbank intermediaries and the residential
construction industry.
In his opinion, the need for further
monetary restraint, as measured by purely economic criteria, had
not lessened.
GNP, as valued in current prices, would undoubtedly
increase a good deal less this quarter than it had in the last two,
but at the moment the expectation must be for a return, whether
in the next quarter or in the fourth quarter, to unsustainably
large increases.
Even if the likelihood of a rebound in auto sales
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were to decrease and the likelihood of the worst fears about
residential construction being realized were to increase, there
would still be the twin problems of a clearly unsustainable
pattern of investment demand and sectoral inflation.
He observed,
in that connection, that the upcoming Governmental sale of
financial assets could hardly be thought of as making the Committee's
task easier.
For unsustainably high investment demand, greater monetary
restraint was an obvious solution, Mr. Galusha continued.
It
could not be an inviting one, however, nor even a realistic one,
until ways of lessening the effects on nonbank intermediaries and
the residential construction industry were found.
The System could
therefore do worse than to lead the search for such ways.
He did
not know what answers there might be, but there was a legitimacy
and urgency in the questioning.
Mr. Galusha favored alternative A of the draft directives.
But in opting for that alternative, he was assuming that the
emphasis over the period until the Committee's next meeting would
be on money market conditions.
He objected to the proviso because
it presented, it seemed to him, an unreasonable restraint on the
Desk because so many things could happen that would have effects
on required reserves.
6/7/66
-76Mr. Scanlon reported that with the exception of passenger
cars, output of all major Seventh District industries either
increased further in May or held at the high levels of earlier
months.
While fears of accelerating inflation appeared to have
been dampened somewhat in recent weeks, no significant apprehension
was detected among observers in the Seventh District concerning a
possible early end to the current boom.
Automobile people were
projecting auto assemblies for the calendar year 1966 at 8.7
million, 7 per cent less than in 1965 but substantially more than
in any previous year.
They pointed out that the figure was close
to projections made last fall shortly after the 1966 models were
introduced.
Truck production was still pressed to capacity, and
June output was expected to reach a new high of 175,000 units.
Promised delivery times on most types of flat-rolled steel
products had been reduced sharply, Mr. Scanlon noted, mainly
because of curtailed requirements of auto firms.
As yet, there
was no indication of reduced shipments of steel to other users.
For the year as a whole, local steel experts estimated total ingot
tonnage at a record 134 million tons, with output in the four
quarters as follows: 33, 35, 32, and 35 million tons.
Additional
finishing capacity should ease supply schedules further by year-end,
assuming that sufficient workers were available.
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Labor markets in the Seventh District evidently tightened
further in the second quarter, and it was apparent that heavy
demands for labor were strengthening the hands of unions in
negotiations with management.
It was said that fear of a wage
freeze was often given as one reason for the higher labor demands.
In the construction trades, recent three-year contracts called
for 30 to 40 cents per hour additional each year in wages and
fringe benefits, and some contracts were for even longer terms,
with annual wage increments.
The Chicago Reserve Bank's recent survey, Mr. Scanlon said,
indicated sharp cutbacks in most areas in new commitments for
mortgages on both residential and nonresidential properties, as
was the case in other Districts.
However, demand for construction
in the Seventh District was very strong.
While housing permits were
off sharply in April in the north central region, that was caused,
in part at least, by strikes and unusually heavy rainfall.
The
availability of labor and of materials such as copper and brass
conduits and fittings, plywood, and some aluminum products, as well
is the availability and cost of funds, would largely determine the
Level of construction activity in the Seventh District this summer.
Several of the major savings and loan associations in the Chicago
area had boosted loan rates, effective this week, with the
"standard" single family mortgage now limited to 20 years, with a
25 per cent downpayment and a contract interest rate of 6-1/4 per cent.
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In that connection, Mr. Scanlon commented that while
savings and loan associations in the Chicago area had generally
indicated sharp cutbacks in forward commitments for mortgage funds,
the reason for the cutbacks was not illiquidity in all cases.
For example, the head of one of the largest associations in the
middle west said that while his association had funds to lend to
qualified borrowers it had cut back forward commitments more than
25 per cent because, with all the talk and press comment about
what was going to happen July 1, he wanted to build up substantial
liquidity so he could operate on his own resources under the most
severe conditions foreseeable at this time.
The savings and loan
executive mentioned particularly that he could not be certain what
help would be forthcoming from the Federal Home Loan Bank, so he
wanted to play it safe.
Turning to weekly reporting banks, Mr. Scanlon reported
that loans to manufacturing firms had been rising strongly while
new loans to trade establishments and finance companies had not
kept pace with repayments.
He found no evidence to date of
significant slowing in either real estate or consumer loans.
The
weekly reporting banks continued to liquidate Governments during
most of May, though at a moderate pace, but they acquired a
relatively large amount of other securities, probably agencies.
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Through mid-May, Mr. Scanlon continued, the smaller banks
in the District continued to show more rapid loan growth and
faster liquidation of Governments than the weekly reporters.
Borrowing at the discount window in recent weeks had been largely
by country banks, and the number of such banks seeking accommodation had risen to a new high.
It was understood that some country
member banks were being encouraged by their city correspondents
to use the discount window in preference to their correspondent.
The Reserve Bank knew of one correspondent bank that loaned to
nonmembers at the discount rate but charged the prime rate to member
banks.
It was not aware of any unusual amount of downstream
participation of loans.
The recent survey of time deposits had confirmed the longstanding practice of many small banks in the Seventh District to
use time certificates of deposit as well as passbook savings as
vehicles for acquiring deposits.
In Iowa, for example, 44 per cent
of total time deposits were in certificates, and only a negligible
amount ($3 million) were negotiable certificates of $100,000 or more.
Aggressive postures on interest rates were revealed by
relatively few banks, Mr. Scanlon said.
Only 38 per cent of
District member banks paid as much as 4 per cent on savings
deposits, only 11 per cent paid in excess of 4-1/2 per cent on
time certificates of deposit and open account time deposits, only
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4 per cent paid in excess of 4-1/2 per cent on savings certificates,
and only 2 per cent paid in excess of 4-1/2 per cent on other
nonnegotiable certificates.
Excluding negotiable CD's of $100,000
or more, only 8 per cent of the District member banks paid more
than 4-1/2 per cent on any type of time deposit.
Slightly more
than half the member banks--532--paid 4-1/2 per cent on some kind
of time deposit, excluding large negotiable CD's.
Reserve positions of the money market banks in the Seventh
District still
were not showing strong pressure, although they
were less easy than a month ago.
in June was smaller than in March.
The amount of their CD's maturing
Judging by past experience, those
banks appeared in a position to meet any reasonable volume of credit
demands in the period just ahead.
As to policy, it appeared desirable to Mr. Scanlon to limit
monetary and credit expansion to not much more than normal seasonal
growth.
If such expansion became inconsistent with the existing
rate of net reserve availability, he would like to see some
further reduction in the latter.
He realized that the Committee
did not have a great deal of elbow room, and he certainly would not
want to move overtly, but he believed, if staff projections were
correct, that the Committee must continue gradually to exercise
more restraint.
While he could accept alternative A, with the
proviso, he believed alternative B of the draft directives best
suited the objectives for which he would strive.
6/7/66
-81Mr. Clay commented that some sectors of the economy,
principally automobiles and housing, had slackened their pace
somewhat.
At the same time, the over-all level of economic
activity was increasing at such a rate that the growth in aggregate
demand for goods and services pressed hard on the economy's
resources and capacity to produce.
As a reflection of those
developments, nonagricultural prices continued their upward
movement at the more rapid rate of recent months.
The future pattern of economic activity could not be known
with certainty, Mr. Clay observed, particularly without full knowledge of the course of defense expenditures.
What was known about
probable economic developments, however, suggested that the pressure
of demand on resources and capacity would continue and that price
inflation would also remain a problem.
Under the circumstances,
monetary policy should continue to apply pressure on the commercial
banks and the financial markets.
Developments in reserve aggregates and monetary variables
during May had placed those measures in a more satisfactory
position relative to monetary policy objectives for recent months,
Mr. Clay continued.
Staff projections indicated a substantial
expansion in aggregate financial measures in June.
However,
forthcoming developments surrounded the period with considerable
uncertainty as to financial pressures in view of the large volume
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of scheduled private and public financing, the tax and dividend
requirements in the period, and the problem of the pattern of
savings flows in the economy.
The uncertainty probably would be
intensified if Congress should pass restrictive legislation with
respect to time deposits.
Draft directive A appeared to Mr. Clay appropriate for the
period ahead, provided a less emphatic word such as "considerably"
was substituted for the word "sharply" in the provisional clause.
Whether or not specified in the directive itself, it also seemed
to him that there should be an interest rate or money market
constraint to avoid monetary policy actions that would precipitate
a discount rate increase at this time.
Mr. Clay said the Kansas City Reserve Bank did not have
evidence that borrowers at the discount window were net sellers of
Federal funds.
The factor underlying the recent substantial
increase in country bank borrowing appeared to be the high demand
for agricultural and business credit during a period of tight
money.
The country banks felt the bite in that situation because
(1) they lacked equal access to the CD market, and (2) city correspondent banks were limiting borrowing by their country
correspondents and were referring them to the Reserve Bank.
A
total of 172 banks had borrowed from the Kansas City Bank this
year compared to 120 last year.
Forty-two of those did not borrow
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at any time during 1965, and several had never borrowed before
from the Federal Reserve.
That might be proving that there was
some real advantage to System membership.
Mr. Wayne said that the latest information contained rather
definite evidence of slower growth in some sectors of Fifth District
business.
Building permits, curbed by a dwindling supply of
mortgage money, dropped in April to the lowest level in nearly a
year.
In
the Richmond Reserve Bank's latest survey,
manufacturers'
new orders showed virtually no increase for the first time since
last July, and the rise in factory shipments was considerably smaller
than earlier this year.
Backlogs continued high, however, and
factory employment, hours, and wages showed further gains.
Upward
pressure on prices also continued.
Mr. Wayne reported that there had been some rise in country
bank borrowings in the Fifth District,
remained relatively small.
although the total thus far
A number of banks had been contacted,
but regardless of the reasons they advanced for borrowing it seemed
to him that the general pattern of borrowings was one that should
be expected in a period of tight money with limited opportunities
for obtaining funds.
No evidence had been found of banks selling
Federal funds during a period in which they were borrowing.
With respect to the comments that had been made regarding
savings banks, Mr. Wayne noted that there were a few large savings
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banks in the Fifth District, in the Baltimore area.
Several of
them had expressed some concern about possible developments in
the period ahead, but thus far none had raised the question of
obtaining relief through the Reserve Bank.
In the policy area, Mr. Wayne said, the Committee probably
was now in the critical phase of the difficult and delicate task
of slowing the present boom to a sustainable pace without reversing
the direction of the economy.
For that difficult period, he
suggested a policy of holding about the present level of reserve
availability but with a safeguard to insure against inadvertent
increases in reserves, bank credit, and the money supply.
He would
do that by again gearing the directive to required reserves.
Mr. Wayne noted that excess demand continued to show itself
in several places.
Unfilled orders for durable goods continued
their steady and strong rise.
Plans for business investment showed
some signs of leveling off but still were too high to be sustained.
Those and other inflationary factors should not be discounted, but
perhaps with a little more time they would yield to a continuation
of present monetary pressures.
Mr. Wayne commented that the directive adopted last time
seemed to have worked well, perhaps with the aid of favorable market
conditions and good projections.
He would like to keep that format
and maintain about the same level of reserve availability unless
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required reserves should rise appreciably.
If the latter should
happen, a move should be made toward larger net borrowed reserves.
Alternative A of the draft directives, with the parenthetical
phrase included, expressed a position that seemed appropriate,
but he would like to see some reference in the first paragraph
to the situation in the mortgage market and its implications for
housing.
Without some such reference, the first paragraph seemed
to support alternative B for the second paragraph rather than A.
Mr. Shepardson commented that while there were indications
of a slowdown in some sectors of the economy the general level
of activity was still advancing, with heavy pressure of demands
against resources, a tight labor market, scarcity of skilled labor
in many areas, and a continuing rise in prices.
At the same time
there were pressures ahead around the tax and dividend dates,
concern about the mortgage market, and concern about the effects
of a possible excessive shifting of funds among financial
intermediaries.
indications.
Those factors presented somewhat conflicting
Mr. Reynolds' report on the balance of payments
situation seemed highly significant.
Current price developments
would have implications for subsequent wage negotiations, and any
further deterioration in the price and wage situation could have
serious effects on the competitive position of the U.S., on the
trade balance, and on the total balance of payments.
6/7/66
-86Mr. Shepardson thought that those considerations, on ba
warranted pursuing a policy of further restraint while avoiding
overt action.
As he understood the discussion, the Committee st
had some leeway available to move toward the $400 million level
net borrowed reserves.
Mr. Treiber had mentioned moving toward
that level within the framework of alternative A of the draft
directives.
However, it seemed to him (Mr. Shepardson) that such
a policy was better described in alternative B, and he preferred
that alternative.
Mr. Mitchell said he would make just one remark about
borrowings before turning to the language of the directive.
It
seemed to him that the System was not using the discount rate as
a restraint; at present levels of the Federal funds rate the discount
rate would have to be raised to 5-1/2 or 6 per cent to offer
important restraint, and no one advocated such an increase.
Thus,
it was up to the Reserve Banks to exercise as much restraint as
possible by persuading member banks to turn borrowers away.
Denying
discounting facilities to banks that were selling Federal funds was
one means of doing so.
He hoped the Reserve Banks would continue
their efforts to restrain member bank lending and perhaps
intensify them, because such efforts might be the only way to
avoid an increase in the discount rate, which could prove
catastrophic.
6/7/66
-87Mr. Mitchell agreed with much of what Mr. Wayne had said
about the directive.
He thought it was important to guard against
a repetition of the banking developments of March and April, and
he would favor some further reduction in net reserve availability
if required reserves expanded significantly more than seasonally
expected.
Unless that happened, however, he would go along with-
out much further change in net borrowed reserves.
He still
favored the revision in the first sentence of the directive that he
had suggested earlier today, and he agreed that it would be
advisable to include a statement about the mortgage market.
Mr. Maisel reported that Mr. Daane, who had withdrawn from
the meeting earlier to keep another engagement, had indicated
before leaving that he favored alternative A of the draft directives.
On the savings bank matter referred to earlier by
Mr. Treiber, Mr. Maisel said he hoped there could be a System
approach to the problem, which was an important one.
As to the directive, it seemed to Mr. Maisel that banking
developments were now on the right path, and he interpreted
alternative A as calling for guarding against leaving that path.
Therefore he preferred A.
Conditions now with respect to the major
monetary variables were just about what the Committee had expected.
Over the next month or two the Committee would have to face up to
the question of what goals it expected monetary policy to achieve.
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In his opinion the goals that some people were setting up were not
properly goals of monetary policy; the country could not be run
through monetary policy alone.
Mr. Brimmer said he favored alternative A of the drafts for
the second paragraph of the directive and would leave open for the
time being the question of whether to include the proviso.
Regarding the balance of payments, Mr. Brimmer thought the
problems involved were for the most part beyond the reach of
monetary policy.
Of the five problem areas noted by Mr. Reynolds,
there was only one about which the Committee could do much in the
near future--it might be able to induce commercial banks to lend
less abroad.
He detected nothing in the Administration's attitude
to indicate that it regarded the previously announced balance of
payments target as serious.
On the contrary, recent speeches by
officials suggested that the Administration had decided to run
the risk of further losses of gold in preference to calling for
corrective but unpopular measures.
He would prefer not to see
the Committee try to make up for the lack of Administration
responsiveness to the balance of payments problem.
Thus, unlike
Mr. Shepardson, he thought that the deterioration in the U.S.
balance of payments position was not a good reason for a further
tightening of policy.
6/7/66
-89With respect to the domestic scene, Mr. Brimmer expressed
particular interest in Mr. Brill's opening remark reporting
Mr. Noyes' advice not to let the Committee overstay a tight policy.
The present was a particularly troublesome time for forecasters.
The evidence was mixed, and while he personally believed that the
economy was in for another upswing, he was not certain of his
judgment.
Given the lags in the available data, the Committee
might fail to recognize quickly a weakening in the underpinnings
of the economy.
Accordingly, he would want to be a little cautious.
There were various other reasons for caution, including conditions
in the mortgage market, concerning which he had a sentence to
propose for inclusion in the directive.
The financial problems
ahead might be more serious than any that had been faced by the
present generation, and the Committee should keep in mind its
responsibility for the financial system as a whole and not just
the commercial banks.
In that connection, he was impressed by
the imagination shown in New York, and perhaps elsewhere, in
looking into the steps that might be taken to deal with the savings
bank problem.
He agreed with Mr. Maisel that a System-wide
approach to that problem would be desirable.
Turning to the directive, Mr. Brimmer suggested retaining
the opening sentence of the first paragraph as drafted by the staff,
and following it with a new sentence reading, "There is also much
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uncertainty about the mortgage market and the liquidity of nonbank
financial institutions."
As he had indicated, he preferred
alternative A for the second paragraph and he thought the Manager
might focus on $350 million as his target for net borrowed reserve
He had not taken a position with respect to the proviso because he
was inclined to suggest that the Manager be given substantial
leeway to depart from the net borrowed reserve target if unusual
circumstances developed in financial markets, letting them fall
away from the $350 million figure if necessary.
He doubted that the
seasonal factors available were adequate for dealing with the
situation that lay ahead.
Mr. MacDonald observed that the flow of business news
suggested that the economic expansion was proceeding, momentarily,
at a less frenetic pace than in the first quarter.
Confirmation
could be found in the recent behavior of such series as retail
sales, new orders and shipments of durable goods, industrial
production, construction, industrial prices, and personal income.
Nevertheless, those series were erratic--one swallow did not make
a summer and one month did not make a trend.
To the extent that
there had been moderation, it had been helped by the slide in auto
sales and cutbacks in car production, which were likely to have
further effects as they spread into ancillary industries such as
steel, rubber, and glass.
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Whether it would be possible to recapture the balance in
the economy that prevailed earlier in the business expansion
remained to be seen, Mr. MacDonald noted.
In any event, there
seemed to be less inflationary pressure at the moment than earlier
this year.
He was glad to see that the restrained performance of
monetary measures in May largely counteracted the inflationary
April showing, and that projections for June indicated figures
reasonably close to the Committee's objective.
The desired degree
of monetary restraint might thus have been reached, at least for
the time being.
Mr. MacDonald reported that most economic developments in
the Fourth District had been consistent with the national pattern,
although the regional measures had by no means behaved uniformly.
On the side of moderation, gains in manufacturing activity appeared
to have slackened recently in several major District centers.
District steel production had remained high, but new orders
received by the reporting steel producers declined slightly in May,
on a seasonally adjusted basis.
Auto sales and department store
sales in the District had slipped thus far in the second quarter,
and construction contracts, after climbing through February,
turned down in succeeding months.
On a stronger note, Mr. MacDonald added, insured unemployment in major labor markets of the Fourth District had continued
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to edge down, reaching the low figure of 1.1 per cent; in 5 of the
14 major labor markets the rate was less than 1 per cent.
The
Reserve Bank's spring survey of capital spending plans in Cleveland
and Cincinnati found that business firms had upgraded their
estimates of spending for 1966 since the fall survey.
The change in
part reflected a carryover of capital outlays from 1965 into this
year.
Mr. MacDonald reported that banking statistics for January
through April showed that credit expansion in the District had
been considerably larger at banks outside major cities than at
weekly reporting banks, which suggested that, as of April, the full
effects of tighter monetary policy were still to be felt by
country banks.
With reference to the borrowing of country banks at the
discount window, Mr. MacDonald said that during the first five months
of 1966 such borrowing was up 40 per cent from the year-earlier
period--about the same as in the nation.
Daily average borrowings
of the District's country banks had more than doubled since March,
but still accounted for only about 1 per cent of total country bank
borrowing.
Ten of the banks that borrowed this year had not
borrowed from the Reserve Bank in the past three years.
In
several cases the borrowing reportedly was caused by increased
loan demand stemming from use of credit lines by branches of
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national corporations that had been unable to obtain sufficient
funds in money market centers.
Recent data provided no evidence of a significant shift in
the pattern of banks' use of the discount window and transactions
in Federal funds.
Occasionally, large banks found themselves over-
sold on Federal funds and turned to the discount window.
No
country banks had been found that simultaneously borrowed from the
Reserve Bank and sold Federal funds.
As for monetary policy during the next three weeks,
Mr. MacDonald expressed a preference for alternative A, as drafted
by the staff, for reasons already given by others.
Mr. Hilkert reported that several indicators pointed to
some slackening of pressures on economic resources in the Third
District.
Although the labor force in the District was more fully
employed than at any time since the Korean War, gains in manufacturing employment had lessened and demand for labor (reflected in
help-wanted indexes) had ceased to expand.
Also, nonresidential
construction in the District had lagged so far this year, and
auto registrations for the year to date were under 1965 totals.
Superimposed upon those factors in the real economy,
pressures in the mortgage market had been building rapidly in
intensity.
Inasmuch as the Philadelphia Reserve Bank made a survey
of mortgage conditions four weeks ago and just recently updated it,
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it had been able to observe that build-up.
The surveys indicated
the same kind of cuts in new mortgage commitments that had already
been reported for most other Districts.
One difference observed
in the Bank's two surveys, however, was in the reasons given for
the abrupt change in policy with respect to mortgages.
Around
May 1, savings and loan officials blamed CD's, nearly exclusively,
for the net savings outflow.
But since then few had found
convincing evidence that the money did go to the commercial
banks.
Almost all interviewed admitted frankly they did not know
where the money was going.
with mortgage rates.
Another difference was in connection
FHA average mortgage discounts were 2 points
in March, 3 in April, and 4-1/2 near the end of May.
When
mortgage lenders were surveyed around May 1, FHA did not expect
an average 4-1/2 point discount until midsummer.
During the past week the Philadelphia Reserve Bank also had
been in touch with several banks and finance companies to inquire
about automobile financing, Mr. Hilkert added.
The banks and larger
finance companies reported a volume of business roughly similar to
last year's, or perhaps a bit higher, though borrowers were being
screened more carefully.
The medium and smaller-sized finance
companies, on the other hand, reported business off considerably,
partly because of slipping demand but more importantly because
money was harder to get.
If those findings accurately reflected
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developments throughout the nation, further complaints might soon
be expressed--this time in the area of consumer financing--about
intense competition from the commercial banks.
On the banking front in the Third District, country banks
had experienced slower growth in loans and investments so far this
year than in 1965, with little pressure on the deposit side of
the ledger.
That was one reason, together with heavy participation
in the Federal funds market, why there had not been the bulge in
borrowing at the discount window that had characterized some other
Reserve Banks.
The number of country banks borrowing in recent
weeks had not been out of line with comparable periods of the past
two years, and though there had been some pickup in amounts borrowed
the increase had not been substantial.
The banks that had been borrowing at the window appeared to
have done so for a variety of reasons, Mr. Hilkert said.
For
example, a few larger country banks had experienced a rising loan
demand from large firms that formerly borrowed in the money centers
but now were finding conditions there relatively tight.
Also, the
substantial increase in the Federal funds rate (and at times reduced
availability of such funds) had encouraged several banks to seek
discount accommodation.
It had been possible, Mr. Hilkert said, to keep close track
of borrowing at the discount window in relation to activity in
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Federal funds and other borrowing because the Reserve Bank had
been getting daily figures since February from all country banks
on Federal funds transactions and other borrowing.
Among country banks during the last four bi-weekly reserve
periods, some sold Federal funds during the same reserve period
in which they were borrowing at the discount window, and a few
sold small amounts on days when they were borrowing.
However,
there was no evidence of that being a regular practice by any
country bank.
Two of the six city banks that made a market in
Federal funds for correspondents had borrowed during the past
eight weekly reserve periods.
Each bank sold Federal funds during
those periods, and on days during which they were borrowing.
Typically, city banks reduced their sales of Federal funds when
they borrowed at the window.
Although no pattern had emerged, Mr. Hilkert added, the
Reserve Bank had noticed some factors responsible on occasion
for simultaneous Federal funds sales and borrowing from the
Federal Reserve by country banks.
There had been a case in which
the country bank had an agreement with its correspondent to sell
Federal funds daily; then, when a need arose, it borrowed from
the Reserve Bank instead of cutting back Federal funds sales.
A second case was one in which the country bank used an inflow of
funds to sell Federal funds instead of paying off an existing
note at the Reserve Bank.
6/7/66
-97Mr. Hilkert observed that the Reserve Bank would be in a
position to see whether or not those practices increased as it
obtained more experience with the Federal funds and other
borrowing figures on a daily reporting basis.
No doubt questions
would arise as to proper administration of the discount window.
It seemed obvious, however, that uniformity in policing those
practices would be desirable.
Mr. Patterson submitted the following statement for the
record:
In the Sixth District we note the same moderating
influences evident in the rest of the country. These
have extended to a variety of economic and financial
series. Declines have shown up not only in retail
sales and construction contracts, but also in employment. It may be that some of the employment gains in
the early part of the year borrowed from the most
recent period. Of course, we still find a considerable
shortage of labor, especially skilled help. Nevertheless,
it seems to us that the pressures, even for labor, have
abated somewhat.
Having said this, I don't want to attach undue
importance to the declines that have occurred. The
dip in auto sales has not been large. And even in
the case of construction the drop has been small,
although our survey would indicate that the worst is
yet to come.
That there has been a decided change in underlying
District developments is quite clear, however. It shows
up, for instance, in a reduction in the willingness of
consumers to borrow, not only for autos but for other
purposes as well. In our large cities there has been
a slowing down in the over-all loan expansion. It is
hard to tell to what degree that is traceable to a
softening in credit demands. It may well be partly
self-imposed, and it may also reflect the impact of
our own policy actions.
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It is always difficult to see the effects of credit
restraint when first applied. But as we all know, those
become cumulative and eventually show sizable results.
We are now seeing some evidence of this in the national
housing sector, although the root of the problem there
seems to be also partly a matter of bank competition
and a decline in the demand for housing per se.
Rather than feeling uncomfortable that there has
been a slowing up in theeconomy, I would think that this
is what we hoped would happen, especially since no tax
increase seems to be in the offing. If the economy had
not responded, I would have been very much disappointed.
Therefore, I think it would be a distinct mistake if we
were to ease our policy now.
On the other hand, I wonder if housing is not feeling
more of an impact than we anticipated and bargained for.
This consideration, plus the fact that theeconomy seems
less overheated than it has been, suggests that this is
not the time for additional credit restraint. I am
further persuaded in this conclusion by the agencies'
marketing problems, the mid-June money market pressures,
and the Treasury's prospective borrowing requirements.
My feeling is that while caution is the watchword
today, some difficult decisions on the discount rate and
Regulation Q lie ahead. The number of banks paying
5 per cent on savings certificates seems to have increased
sharply, in our District at least, and in some cases
banks have gone to 5-1/2 per cent. We, too, have found
an increasing number of country banks using the discount
window. This increase--only partly seasonal--seems to
reflect a certain amount of unwillingness to take capital
losses on securities in the face of still relatively
strong loan demands and moderating deposit increases.
There is little evidence that banks are trying to borrow
at the discount window and are also selling Federal
funds, but policing may become a problem. For this
reason, discount rate action may well become a necessity.
On the matter of open market policy, Mr. Patterson said
that in general he favored the approach taken in the directive at
the last meeting.
Today, however, he would not resist the increase
in required reserves for June projected by the staff, unless that
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increase turned out much greater than presently anticipated.
He
would go along with alternative A of the draft directives.
Mr. Lewis reported that economic activity in the Eighth
District continued to show great strength.
Personal income had
risen at about a 10 per cent annual rate since last fall, and
spending, as measured by the flow of check payments, had increased
at a 7-1/2 per cent rate.
The greater demand for goods and
services was straining production and credit facilities and placing
upward pressure on prices.
Real output, as estimated from indus-
trial use of electric power, had increased at about a 5 per cent
annual rate since late last year, and total employment had risen
at a very sharp 7 per cent rate.
Particularly rapid gains
occurred in manufacturing employment at St. Louis and Memphis.
Unemployment, which averaged about 3.4 per cent of the District
labor force in late 1965, had been down to about 3.1 per cent
since March.
Total credit at Eighth District weekly reporting banks
had expanded at an 11 per cent annual rate since December, compared
with an 8 per cent rate in the nation.
Loans had risen at a
15 per cent rate and bank investments had increased slightly.
Business
loans in the District had advanced at an unusually large
25 per cent annual rate since December,
in St. Louis.
with an especially strong growth
Firms in most industrial categories were large net
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borrowers.
Bank deposits had expanded at a 6 per cent rate since
December, with much of the growth in demand deposits.
An exception
to the strong growth in bank deposits and loans had occurred in
the Memphis area.
Deposits in
Memphis had shown only a slight
rise over the past two years, evidently because those banks had
been less competitive in rates paid on time deposits due to a
4 per cent Tennessee limitation.
With a lack of growth in funds
available, outstanding business loans at Memphis banks had changed
little on balance in nearly two years.
Mr. Lewis reported that 25 country banks had borrowed in
the first five months of 1966.
That was three and one-half times
the number that borrowed in the first five months of 1965.
The
amount borrowed in the past three months had averaged about double
the average of last winter.
Reasons given for the greater borrowing
included strong loan demands and increased difficulty of getting
accommodation from correspondent banks.
One bank reported that
it had lost some deposits because competitors were offering higher
rates on time accounts.
Only one country bank had sold Federal
funds in the same period in which it borrowed; that bank sold on
the last two days of the reserve period but then paid out.
Several
reserve city banks had sold Federal funds during periods in which
they borrowed, but were heavy net buyers rather than net sellers.
6/7/66
-101Upward pressure continued on prices, Mr.
Lewis noted.
For
example, in the St. Louis area there had been marked increases in
wages of construction workers, the cost of building materials had
risen sharply, and the delivery period on certain key items had
lengthened considerably.
As a result, builders reported that the
cost of constructing a residence was 5 to 10 per cent higher than
just a few months ago.
Over-all consumer prices in the St.
Louis
area had risen at a 4 per cent annual rate since last September.
In summary, Mr. Lewis said, demands for goods and services
had been unusually strong, probably excessive,
in the Eighth
District, as in the rest of the nation.
Mr.
Robertson submitted the following statement for the
record after presenting a brief oral summary:
It seems to me we are in a continuing strong basic
economic situation, but one in which monetary restraint
can finally be said to be having some real bite on
demands for resources. This is obviously true in the
construction field; it may also turn out to be one of
the contributing factors to the lower level of automobile
sales; and in numerous other areas of spending we hear
at least an occasional story of some spending decision
altered by the money situation.
As a matter of fact, there is an increased outcry
from some of these areas that tight money is biting too
A good part of this is special pleading, of
much.
course, but some of the results of restraint--particularly
in housing--may be drastic enough to deserve some attention.
I, myself, would prefer any remedial action on this front
to come through appropriate amendment of Regulation Q,
rather than any easing of our general policy of restraint.
But I think such developments do suggest that we might
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have carried our progressive tightening about far enough
at this juncture, and that a policy of holding firm
about where we are might be the best decision for us to
reach today.
I am reinforced in this view by the behavior of
the banking aggregates during May, when we finally
managed to achieve some wiping out of the big MarchApril bulge.
I hope our present degree of tightness
will suffice to keep any June bulge smaller in size and
more temporary in duration. To guard against any new
wave of outsize expansion in bank credit, however, I
would again like to tell the Manager to be guided in
part by the strength of over-all bank expansion. To be
more explicit, thinking of his general operating target
as net borrowed reserves in the neighborhood of
$350 million, I would have him run net borrowed reserves
up to $100 million deeper than that if required reserves
should expand substantially more than seasonally
expected; and, by the same token, I would be ready to
see him work net borrowed reserves down to as little
as $250 million if required reserves should be so much
weaker than expectations as to produce a seasonally
adjusted decline.
I should add that I recognize the month of June
may also bring some special money market pressures-from such things as tax date borrowing needs and
Federal agency financings--that will complicate the
Manager's job. As I said last time, I am sure no one
here wants to be recommending actions that would
disrupt the markets, and the Manager may have to
occasionally take this possibility into account in
shaping his operations. But I think this kind of
instruction is and always has been implicit in the
Committee's directive, and needs no spelling out.
Indeed, it would be a very complex job even to try to
express its scope and limitations in black and white,
and it would be misleading if we tried to subsume all
such complexities in the shorthand of a pet phrase
like "taking account of money market conditions."
Therefore, I would not favor inserting an explicit
reference to "money market conditions" in the directive.
I think we are better advised in this area to rely upon
the Manager's discretion, meanwhile keeping our formal
directive aimed consistently at the target of reserve
availability.
6/7/66
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All things considered, I would favor alternative A
of the directive drafts presented to us by the staff,
but I would want to see the phrases referring to money
market conditions stricken on the grounds that they
either imply too much or are not necessary, depending
on which of their two possible meanings one might want
to stress. I would, of course, want to see included
the parenthetical reference to adjusting operations in
the light of the movement of required reserves.
Mr. Robertson added that he shared the view that some
reference be made in the first sentence of the directive to
factors that would argue for holding the present degree of firmness
at this juncture rather than tightening further.
He would suggest
language such as "the mortgage market is tight, automobile sales
have fallen off, and concern exists about the liquidity of nonbank
financial institutions."
Chairman Martin noted that a majority of the Committee had
expressed a preference for alternative A for the second paragraph
of the directive and that, on the whole, the members did not
appear to be far apart in their views on policy.
He proposed that
the Committee proceed by considering the various suggestions that
had been made for revising the draft directive.
A discussion of
wording of the directive ensued.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Federal Reserve Bank of New York
was authorized and directed, until
otherwise directed by the Committee,
to execute transactions in the System
Account in accordance with the following current economic policy directive:
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6/7/66
The economic and financial developments reviewed at
this meeting indicate that, while the mortgage market is
tight, automobile sales have fallen off, and some concern
exists about the liquidity of nonbank financial institutions, the domestic economy is continuing to expand,
with industrial prices rising further and credit demands
remaining strong. The foreign trade surplus has declined
and the international payments deficit has increased.
In this situation, it is the Federal Open Market Committee's
policy to resist inflationary pressures and to strengthen
efforts to restore reasonable equilibrium in the country's
balance of payments, by restricting the growth in the
reserve base, bank credit, and the money supply.
To implement this policy, System open market
operations until the next meeting of the Committee shall
be conducted with a view to maintaing net reserve availability and related money market conditions in about
their recent ranges; provided, however, that if required
reserves expand considerably more than seasonally expected,
operations shall be conducted with a view to attaining
some further gradual reduction in net reserve availability
and firming of money market conditions.
Chairman Martin then observed that the members of the Board
of Governors were to appear before the Committee on Banking and
Currency of the House of Representatives tomorrow (June 8) regarding
legislative proposals affecting financial institutions.
A letter
dated June 6 had been received from Chairman Wright Patman of the
Committee asking for an expression of views on a four-part proposal,
one part of which had to do with permitting open market purchases
by the Federal Reserve System of any obligation which was a direct
obligation of, or fully guaranteed as to principal and interest
by, any Federal Home Loan Bank.
The Chairman thought that matter
should be discussed today since it related to the Committee's
responsibilities.
6/7/66
-105Mr. Treiber inquired about the present eligibility for
purchase by the System of Federal Home Loan Bank obilgations.
Mr. Hackley replied that under section 14(b) of the Federal
Reserve Act the Reserve Banks could operate only in direct or
fully guaranteed obligations of the U.S.
Since there was a specific
statutory provision that Federal Home Loan Bank obligations were
not obligations of, and were not guaranteed by, the U.S. they were
not eligible.
Mr. Maisel remarked that if the Board was to comment
favorably on any legislation in the area he would hope that it
would urge including a broader list of agency issues than simply
FHLB obligations.
Chairman Martin said he thought everyone would agree on
that point, and Mr. Treiber indicated that his initial reaction
also was against a piece-meal approach to the question.
Mr. Cardon noted that in testimony before the House
Committee today Under Secretary of the Treasury Barr had submitted
a list of agency obligations that were not eligible for purchase
by the Federal Reserve Banks.
Mr. Barr had expressed the view
that it would be consistent to make FHLB obligations eligible and
had indicated that the Administration would have no objection to
such legislation.
In reply to a question by Chairman Martin, Mr. Hackley
6/7/66
-106-
categorically how many agency issues were now eligible.
Mr.
Forrestal
of the Board's Legal Division had prepared a memorandum for the
Board on April 13,
1966,
listing a number of obligations believed
to be eligible either because of specific statutory provisions for
full guarantee by the U.S.
or because they fell
within a 1961
opinion by the Attorney General concerning obligations guaranteed
by Government agencies.
(Note:
Subsequent to the meeting copies
of Mr. Forrestal's memorandum were distributed to the Committee
and a copy was placed in the Committee's files.)
Mr. Maisel commented that while the list
was long, it
of eligible issues
consisted mainly of obligations of minor agencies
accounting for a relatively small percentage of all agency issues.
Mr. Swan agreed that the question should be approached in
terms of all agency issues rather than FHLB obligations alone.
However,
in view of the importance of the subject and the like-
lihood that heavy reliance on agency issues in lieu of direct
Treasury obligations would not prove to be a temporary procedure,
he thought the Committee should give very careful consideration
to the desirability of making all agency issues eligible, and of
conducting open market operations in them along with operations
in direct obligations of the Treasury.
Mr.
Treiber remarked that the Federal Home Loan Banks had
authority to borrow directly from the Treasury, and presumably
6/7/66
-107-
would do so if they were unable to raise needed funds in the market.
The System probably would be less subject to pressures if it
confined its operations to Treasury securities.
Of course, if
purchases of FHLB obligations were begun the Committee could still
maintain its desired credit policy by not acquiring an equivalent
amount of Treasury securities.
Mr. Swan noted that there was a statutory limit of $1 billion
on Home Loan Bank borrowing from the Treasury.
Mr. Robertson said that it was difficult to oppose making
all agency issues eligible for System purchase on grounds of
principle.
He agreed, however, that if they were made eligible
the System was likely to be subject to a good deal of continuing
pressure to buy them.
Mr. Mitchell referred to Mr. Holmes' earlier comment
regarding problems in operating in small issues, and asked whether
it would not be desirable to have some lower limit on the size of
issues that would be made eligible.
Mr. Holmes said that, as he had indicated, there would be
many problems in operating in agency issues, including that which
he had referred to as the problem of "even keel."
He questioned
whether the System should be used to enable agencies to avoid
paying the rates necessary to float their issues in the market.
6/7/66
-108Mr. Maisel noted that even if the law was changed the
Committee would still have to revise its Regulation and its
continuing authority directive before the Account Management would
be authorized to operate in agency issues.
In the process of
formulating those revisions the Committee would have an opportunity to carefully consider the various kinds of operating problems.
Mr. Brimmer commented that the matter of agency issues had
been under discussion for some time and he asked if Mr. Holmes had
given thought to possible procedures.
Mr. Holmes replied that it probably would be desirable for
the System to have standing authority to buy agency issues, and
that it was hard to justify having some issues eligible and some
not.
If the agency market continued to develop it was quite
possible that transactions in agency issues would prove workable
as long as it was understood that they would be kept moderate in
size and that they would be supplemental to operations in Treasury
securities.
A study might show that it would be easier to arrange
repurchase agreements against such securities than to deal in them
on an outright basis.
The use of RP's would give some support to
underwriters carrying enlarged positions, and from a technical
standpoint it would be much easier to relate RP's to reserve
objectives than would be the case with outright transactions.
6/7/66
-109Mr. Wayne said he understood that the System could not
engage in repurchase agreements involving particular types of
securities unless it had the authority to buy such securities outright.
The alternatives would appear to be engaging in RP's against
agency issues or operating through the discount window, and of the
two he would prefer the former.
Accordingly, he did not think the
System should oppose the legislation in question.
Chairman Martin remarked that he had considerable trepidation
about the proposal because the System dealt in high-powered money.
He would expect pressures for the System to operate in a wide range
of agency issues regardless of possible consequences for the money
markets.
He doubted that that would be a wise course to follow
if it could be avoided.
In any case, the question had to be thought
through carefully.
Mr. Swan commented that the suggestion that the legislative
authority should cover all agency issues rather than the specific
issues of Federal Home Loan Banks left open the major question of
the moment, as to what might be done if those Banks exhausted their
$1 billion authority to borrow directly from the Treasury.
Mr. Maisel noted in response that another alternative was
available; the Treasury had legal authority to deposit funds in
the Home Loan Banks.
6/7/66
-110Mr. Brimmer suggested that it would be helpful if
the
Manager prepared a memorandum on the general subject of operations
in agency issues for the Committee's use.
It was agreed that such
a memorandum would be desirable.
It
was agreed the next meeting of the Committee would be
held on Tuesday, June 28, 1966, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
June 6, 1966
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on June 7, 1966.
First paragraph
The economic and financial developments reviewed at this
meeting indicate that the domestic economy is continuing to expand,
with industrial prices rising further and credit demands remaining
strong. Our foreign trade surplus has declined and the deficit in
our international payments has increased. In this situation, it is
the Federal Open Market Committee's policy to resist inflationary
pressures and to strengthen efforts to restore reasonable equilibrium
in the country's balance of payments, by restricting the growth in
the reserve base, bank credit, and the money supply.
Second paragraph
Alternative A (preserving current firmness,
tion
with possible qualifica-
To implement this policy, System open market operations
until the next meeting of the Committee shall be conducted with
a view to maintaining net reserve availability and related money
market conditions in about their recent ranges (; provided,
however, that if required reserves expand sharply more than
seasonally expected, operations shall be conducted with a view
to attaining some further gradual reduction in net reserve
availability and firming of money market conditions).
Alternative B (continued firming, with degree conditioned by
movement in required reserves)
To implement this policy, System open market operations
until the next meeting of the Committee shall be conducted with a
view to attaining some further gradual reduction in net reserve
availability and attendant firming of money market conditions, and
to attaining somewhat greater restraint if required reserves expand
sharply more than seasonally expected.
Cite this document
Federal Reserve (1966, June 6). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19660607
@misc{wtfs_fomc_minutes_19660607,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {Jun},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19660607},
note = {Retrieved via When the Fed Speaks corpus}
}