FOMC Minutes
A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washington, D.C., on Tuesday, July 26, 1966, at 9:30 a.m.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Hayes, Vice Chairman
Bopp
Brimmer
Clay
Hickman
Irons
Maisel
Mitchell
Robertson
Shepardson
Messrs. Scanlon, Francis, and Swan, Alternate
Members of the Federal Open Market Committee
Messrs. Ellis and Galusha, Presidents of the
Federal Reserve Banks of Boston and
Minneapolis, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Messrs. Eastburn, Green, Koch, Mann, Partee,
and Tow, 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
Mr. Hersey, Adviser, Division of International
Finance, Board of Governors
Mr. Axilrod, Associate Adviser, Division of
Research and Statistics, Board of
Governors
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Miss Eaton, General Assistant, Office of
the Secretary, Board of Governors
Mr. Forrestal, Senior Attorney, Legal
Division, Board of Governors
Messrs. Heflin and Kimbrel, First Vice
Presidents of the Federal Reserve
Banks of Richmond and Atlanta,
respectively
Messrs. Link, Ratchford, Brandt, Baughman,
Jones, and Craven, Vice Presidents of
the Federal Reserve Banks of New York,
Richmond, Atlanta, Chicago, St. Louis,
and San Francisco, respectively
Mr. Geng, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Anderson, Financial Economist,
Federal Reserve Bank of Boston
Mr. Kareken, Consultant, Federal Reserve
Bank of Minneapolis
Upon motion duly made and
seconded, and by unanimous vote,
the minutes of the meetings of the
Federal Open Market Committee held
on June 28 and July 11, 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 June 28 through July 20, 1966, and a supplemental report for
July 21 through 25, 1966.
Copies of these reports have been placed
in the files of the Committee.
In comments supplementing the written reports, Mr. Coombs
said that the Treasury gold stock was being reduced by $100 million
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today in order to replenish the Stabilization Fund.
In June the
French took in nearly $100 million and they were converting all
of it to gold this month.
In addition, the U.S. share of gold
pool losses in July would cost some $25 million.
Pressure had
been extremely heavy on the London gold market, but had tapered
off in the last few days after the announcement of the new British
program.
If the program did not go well, however, the pressure
was likely to resume.
The gold pool had suffered a great deal of attrition so
far this year, Mr. Coombs noted.
The pool's resources were now
down to $94 million from $312 million at the start of the year,
and an effort was currently being made to negotiate agreement on
new contributions of $100 million by the pool members.
It was not
clear, however, whether those negotiations would be successful;
the European members of the pool were becoming extremely discouraged
and restive, and at the next Basle meeting in September there might
be some fairly strong opposition to further calls upon their gold
reserves to maintain a ceiling on the London market price.
More
over, thus far in July the French had taken in $140 million which
they presumably would convert to gold next month.
If there were
other official conversions of dollars to gold as well as heavy
drains on the gold pool over the next few months the gold situation
could rapidly become serious.
As the Committee knew, for some time
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he had felt that the greatest potential threat to the dollar was a
breakout in the London gold price.
On the exchange markets, Mr. Coombs continued, the speculative
attack on sterling witnessed during the past month was more sustained
in intensity than that of November 1964, and in certain respects more
dangerous.
Perhaps he could best summarize the magnitude of the
crisis by noting that, from July 1 through Friday, July 22, the drain
on British reserves amounted to roughly $1.1 billion, and it would
have been increased by $145 million if the New York Reserve Bank had
not undertaken market operations for Treasury and System Account to
support sterling.1/
The sheer magnitude of those figures--which, of course, were
extremely confidential--suggested a remarkably wide swing of the
leads and lags against sterling and the buildup of a huge short
position.
Before the new British program was announced there was
some hope on both the British and U.S. side that strong market
action to push up the sterling rate might force some quick covering
of short positions.
An abrupt swing, such as had occurred last
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material referred to certain
exchange market operations, including operations undertaken by the Bank
of England.
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September, did not seem likely, however.
For one thing, the
deterioration in sentiment this year was considerably greater.
Secondly, last September's announcement concerned a new interna
tional package of assistance for sterling, the significance of
which could be quickly grasped by the market, in contrast to the
announcement now of a complicated new Government program with
much uncertainty remaining as to whether it could be implemented
effectively.
The New York Reserve Bank began market operations in
sterling a few minutes after the program was announced, Mr. Coombs
said.
On Wednesday, Thursday, and Friday of last week it bought
a total of $145 million, in the process pushing the rate up from
$2.7875 to a peak of $2.7912.
Very strong resistance was
encountered as sterling continued to be sold in heavy volume
through the Paris bourse and other European markets.
Although
the pressure receded a little on Friday, the operations clearly
had not yet succeeded in inducing short covering; there was a
general feeling in the market that devaluation of sterling was a
foregone conclusion, and such an attitude was hard to combat.
On
the other hand, both the New York Reserve Bank and the Bank of
England felt that the operations had had a useful stabilizing
effect on expectations during a period of acute uncertainty.
They had also provided concrete evidence of official U.S. support
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for the British program by backing up with money the statement the
Treasury had issued.
In addition, the operations had probably
succeeded in sweeping the market reasonably clean of the last rem
nants of sterling available for sale, thus setting the stage for a
natural recovery of the rate if there was even a minor return of
confidence.
The British had no reserve losses on Monday and so far
today, which might suggest that they were slowly rounding the corner.
If and when a more buoyant tendency appeared in the market, it might
be useful to give an additional push through market operations.
Mr. Coombs remarked that the skepticism of the market
regarding the new British program did not seem to arise out of any
widespread feeling that the program was not sufficiently drastic;
it certainly was that.
Rather, the continuing concern of the market
was based on fears that the Government might be confronted with a
revolt by the trade unions and so be unable to carry through the
most important element of the program--namely, the wage freeze.
That issue now hung in the balance, but by tomorrow there might be
some indication of whether the trade unions would go along or would
rebel.
If trade union support, however grudging, could be secured,
there might be a major turn for the better.
If not, a major chal
lenge to the entire international financial system might eventuate.
As he had mentioned, Mr. Coombs said, the cost of the
intervention by the Bank of England this month had been very heavy
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indeed, and they would face the prospect, in the absence of further
central bank financing, of having to show a reserve loss of roughly
$1 billion for the month of July.
As the Committee knew, the New
York Reserve Bank had strongly urged the Bank of England at the end
of June to minimize their use of the Federal Reserve swap line and
to show a sizable reserve loss so as to point up the cost of the
seamen's strike, and thereby bring home to the British public the
necessity of drastic corrective action.
course.
They chose to follow another
With respect to the end of July reserve problem, however,
the market was in such a speculative mood that he feared a report
of heavy additional reserve losses could trigger a panic which
might quickly get out of control.
He had, accordingly, been urging
the Bank of England to round up central bank financing from all sides,
and it now appeared that they might be able to raise approximately
$500 million from various European sources.
Assuming that they would
wish to show a reserve loss of no more than $100 million, they would
still need another $400 million.
The Treasury might be prepared to
provide $200 million on an overnight basis, and he would be hopeful
that the System could provide the remaining $200 million through the
swap line, also on an overnight basis.
In a situation as dangerous
as the existing one he could see certain advantages in avoiding
three-month commitments until it was clear whether the tide had
begun to turn.
7/26/66
In reply to a question by Mr. Mitchell, Mr. Coombs said that
the Bank of England now had drawings of $250 million outstanding on
its swap line with the System, all on a three-month basis.
As he
indicated, they might wish to draw an additional $200 million at the
month end, and his recommendation was that that drawing be made on
an overnight basis, to be repaid August 1.
Mr. Mitchell then asked whether Mr. Coombs thought the
British would soon be able to make some repayment on their existing
$250 million drawings if developments unfolded as now expected.
Mr. Coombs replied that the main need was for the British to
implement their program effectively--although it was possible that
even if they were forced to give way on the wage-price freeze the
rest of the program would prove sufficiently strong to lead to a
turn in the situation.
In any case, the turn was likely to be slow.
The British were faced with a high degree of disillusionment in
sterling and in the policies of their Government, and once confidence
was lost it was hard to restore.
Mr. Mitchell asked what implications an abandonment of the
gold pool operation would have for the British.
Mr. Coombs said that Britain's share in the pool was
relatively small.
Moreover, since they had used up so many dollars
over the last few months they might have to sell gold in any case,
so an abandonment of the pool operations would have no particular
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implications for them on that score.
Countries in a surplus position,
however, preferred to buy rather than sell gold, and calls by the
pool upon their gold reserves created a difficult problem for them
domestically.
More generally, a break-out of the London gold price
would have ominous speculative implications for all currencies,
including sterling and the dollar.
In answer to another question by Mr. Mitchell, Mr. Coombs
said that in London, the prime market for gold, daily turnover might
be on the order of seven or eight tons, and on occasion as high as
twenty-five tons.
In contrast, other markets--such as Beirut-
typically handled only about one or two tons a day.
All South
African and Russian gold was channeled through London.
There had
been some indications recently that the South Africans were trying
to establish alternative marketing locations, but that effort would
probably be resisted by the European central banks.
The big question
was whether the breakdown in confidence in sterling would ramify
throughout the whole system.
In his judgment that was a clear and
present danger, and if it eventuated the market demand for gold
might reach such proportions as to make the cost of the gold pool
operation prohibitive.
The U.S. share in the pool was 50 per cent,
and if the Europeans pulled out the U.S. would have to carry the full
burden.
The U.S. gold stock was now down to $13.3 billion and market
demands plus official conversions by France and possibly by others
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might result in further heavy losses.
If the pool arrangement was
discontinued because the cost of intervention had become prohibitive
and the price of gold moved up, the situation would be much like
that of late 1960.
In fact, it would be much worse; in 1960 the U.S.
gold stock was over $18 billion and the position of the dollar was
still relatively unchallenged.
In present circumstances a wave of
apprehension might well be set off, with pullbacks of dollar balances
and panicky purchases of gold by smaller countries.
In effect, a
sharp rise in the London price would be regarded as a direct challenge
to the $35 U.S. parity.
Mr. Mitchell then asked whether Mr. Coombs thought the U.S.
should not plan to withdraw from the pool if the Europeans were
planning to do so and if it seemed clear that this country could not
handle the market alone.
Mr. Coombs responded that there had been a good deal of
quiet technical discussion of the gold pool during the past year.
It had been hoped during that interval that the U.S. balance of
payments position would improve and that sterling would strengthen.
Instead, there had been a steady string of unfavorable developments
and increases in pressures.
He had not meant to imply that the
Europeans were going to withdraw from the pool, but rather that they
were becoming discouraged and highly restive.
The U.S. faced a
problem in that area that might require some basic decisions in the
next few weeks.
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Mr. Mitchell asked if the British had the legal authority to
close the London gold market.
Mr. Coombs replied affirmatively, but added that they
probably would strongly resist such a suggestion.
Moreover, he was
not sure that they should be encouraged to close the market.
The
London market would be subject to a measure of responsible control
even if it were on its own.
East or other markets.
Such control was not feasible in Middle
To shift gold trading out of London thus
might contribute to further instability.
Mr. Mitchell then asked whether the London gold market might
not function more effectively if trading there were confined to
Governments and monetary authorities.
Mr. Coombs replied that it was not possible to exclude
private buyers from the gold market.
If they were kept out of London
they would shift their demands to other centers, and the price in,
say, the Middle East would become sufficiently attractive to draw
South African gold there.
Mr. Hayes noted in that connection that a dilemma had existed
since 1960.
On the one hand all central banks, including the Federal
Reserve, were reluctant to see a large proportion of the gold supply
absorbed by private demand.
On the other hand they were acutely
aware of the effect a large rise in the price of gold in London or
elsewhere could have on confidence in the dollar.
He agreed with
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Mr. Coombs that if the London market were closed to private buyers
a large part of new gold production would flow to them through
other markets.
Mr. Coombs recalled that in the late 1940's and early 19 5 0 's
the price of gold in Beirut, Tangiers, and other markets was highon the order of $75 an ounce.
In those days, however, no one
considered such prices to pose a challenge to the dollar.
The
experience in 1960 demonstrated that that assumption no longer held
good, and it was even less valid at present.
He recalled that an
official of a large bank in New York City had made a speech in 1960
in which he suggested that the free market price of gold had little
to do with the position of the dollar.
That official had been sub
jected to a barrage of criticism from financial market participants
who thought otherwise.
There were, however, certain protective
measures that could be taken.
Mr. Mitchell observed that Mr. Coombs' position seemed to
him to be unrealistic.
The series of unfavorable developments to
which Mr. Coombs had referred was quite likely to continue, and he
(Mr. Mitchell) did not see any basis for expecting an easing in the
demand for gold.
If the Europeans were becoming restive it behooved
this country to make positive plans now for dealing with the situation.
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Mr. Coombs said he had made a series of recommendations a
year ago for that purpose.
The problem had not come as a surprise
to him or to the Committee.
Mr. Shepardson said he shared Mr. Mitchell's concern.
The
Committee's whole program of foreign currency operations, as he had
understood it, was geared to operating against foreseeably revers
ible trends, but in his report today Mr. Coombs had indicated
pessimism about the prospects for reversal of present trends.
That
posed a real question as to what actions would be appropriate.
Mr. Hayes asked if Mr. Shepardson was referring to the gold
or the sterling market situation, and Mr. Shepardson replied that
in his judgment the two were related.
Mr. Hayes then commented
that he thought there was a good possibility of reversal with
respect to the sterling situation, although that was by no means
certain.
Mr. Shepardson commented that in view of the press reports
regarding the resistance of British labor to the new program he
questioned whether there was any basis for optimism regarding
sterling.
Mr. Hayes observed that the System had a delicate role to
play in the present situation.
In his view the Committee was
entitled to feel a growing skepticism.
At the same time, he
believed it would be a mistake to conclude that the System should
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now withdraw assistance on the grounds that the whole effort was
futile.
The British might now be rounding the corner, and the
situation might be at a point at which patience would pay large
dividends.
Mr. Coombs concurred in Mr. Mitchell's observation that
decisions with respect to U.S. participation in the gold pool were
the responsibility of the Treasury.
He had mentioned the subject
because any serious difficulties in the gold market would lead to
sizable flows of funds which in turn might necessitate heavy System
drawings on the swap lines.
In reply to a question by Mr. Galusha, Mr. Coombs said that
those who had been closely following developments in the gold market
felt that the basic forces of supply and demand probably were begin
ning to move against the pool.
Whereas in 1963 and 1964 the pool
had accumulated large surpluses, on the order of $650 million a
year, the trend of private buying was rising and South African
production was leveling off.
Industrial uses of gold were expanding
rapidly, and with the rise in real incomes throughout the world
private individuals were increasingly attracted to holding gold in
jewelry and other forms.
exceed the new supply.
In due course private demand would probably
The annual report of the Bank for Inter
national Settlements had detailed the supply-demand situation, which
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previously was not widely appreciated, and probably had been an
important contributing factor to recent speculative buying.
Mr. Shepardson asked whether the purpose of the proposed
overnight credit extension to the British was to allow them to
window-dress their reserve statement.
Mr. Coombs replied affirmatively,1/
The market had no
inkling of the actual size of their July reserve loss, and if the
British published figures showing a large loss a panic situation
was likely to result that might lead to either the imposition of
exchange controls or devaluation.
Mr. Robertson asked whether the Treasury had already agreed
to provide a $200 million overnight credit, and Mr. Coombs said he
thought that the decision was fairly solid.
He noted that the
Treasury had extended a $100 million overnight credit at the end of
June.
Mr. Shepardson then asked how long the situation might be
papered over.
In reply, Mr. Coombs noted that the British had not revealed
their actual reserve losses for three months in mid-1965.
They had
then shown true figures, by and large, from September 1965 through
May 1966.
Actual losses had not been disclosed in June, and they
would not be again in July.
If the Government remained in power
1/ Part of a sentence has been deleted at this point for one of
the reasons cited in the preface. The deleted material reported a further
comment by Mr. Coombs on the rationale for the proposed credit.
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and there was no general strike, the new program should begin to
have an effect in the next few months and could bring about a
gradual turn in the situation.
He was not suggesting that the
outlook was hopeless, but rather that there were serious risks
of which the Committee should be aware.
Mr. Shepardson then asked what Mr. Coombs would expect if
the hoped-for turn did not eventuate and there was a break-through
in the sterling situation in August or September.
Mr. Coombs replied that under such circumstances short-term
central bank credits would do no good whatever.
That was why he
had suggested making the additional $200 million swap drawing an
overnight arrangement.
Of course, the British still had about $1
billion in medium-term credits available, including $500 million
in drawing rights on the International Monetary Fund, a $250 million
Export-Import Bank credit, and $250 million in possible credits from
the BIS.
They also had about $500 million in their portfolio of
American securities.
He did not think any problem need be anticipated
in connection with repayment of British drawings already outstanding.1/
Mr. Robertson said that it might be the better part of wisdom
for the British to camouflage their reserve losses.
On the other
1/ A sentence has been deleted at this point for one of the reasons
cited in the preface. The sentence reported a further comment by
Mr. Coombs on British use of the swap arrangement.
7/26/66
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hand, it might very well be that publication of the true reserve
loss was necessary in order to win public acceptance of the wage
price freeze, and that the System would be doing the British a
disservice in helping them to paper it over.
He did not feel he
knew enough about the situation to reach an independent judgment
on the question, but he thought the fact that it had two sides
should be recognized.
Mr. Coombs agreed, but added that, in the judgment of the
Bank of England and the British Treasury, publication of a reserve
loss as large as $200 or $300 million for July might prove disas
trous.
Mr. Hayes noted that in June, during the seamen's strike,
the Federal Reserve Bank of New York had thought it would be
desirable for the British to show most of the loss they incurred
in that month.
The market situation then was not as acute as at
present and there was an advantage seen in bringing home to the
public the seriousness of the strike's effects.
However, in the
judgment of many people the present situation was too dangerous to
take the chance of showing a large loss for July.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions
in foreign currencies during the
period June 28 through July 25, 1966,
were approved, ratified, and confirmed.
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Mr. Coombs recommended renewal of two standby swap arrange
ments that would mature soon:
the $250 million arrangement with the
German Federal Bank, having a term of six months, and maturing
August 9, 1966; and the $100 million arrangement with the Bank of
France, having a term of three months, and maturing August 10, 1966.
Renewals of the two standby
arrangements, as recommended by
Mr. Coombs, were approved.
Mr. Coombs then noted that two three-month, $50 million
drawings by the Bank of England on its swap line with the System
would mature July 29, 1966, and August 31, 1966, respectively.
He
recommended renewal of each for another three-month period if the
Bank of England so requested.
Both would be first renewals.
Renewal of the two drawings
by the Bank of England, as recom
mended by Mr. Coombs, was noted
without objection.
Mr. Coombs reported that a $40 million, three-month swap
with the BIS of guaranteed sterling against lire would mature on
August 25, 1966.
The swap had been renewed once and he would
recommend a second renewal unless the U.S. Treasury executed a
lira drawing on the IMF in time to permit repayment before matu
rity.
In any event, a lira drawing by the Treasury was scheduled
for late summer which would provide lira availabilities for paying
off System debt to the Bank of Italy.
The Committee might recall
that in a memorandum of April 1965 he had recommended that the
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Treasury draw foreign currencies from the Fund when necessary to
enable the System to repay swap drawings that were running on for
unduly long periods.
A number of System drawings were paid off in
that manner last summer, and some technical problems encountered
then had since been resolved.
Thus, a major source of medium-term
financing had been opened up that should enable the Treasury to
backstop any System drawings that did not prove reversible within
six months.
Renewal of the $40 million
swap of sterling against lire, as
recommended by Mr, Coombs, was
noted without objection.
Mr. Coombs said he would conclude with one final observation.
Earlier today he had cited the risks of a crisis in the gold pool
that could result in a challenge to the dollar, and the risks that
lay in the sterling situation.
Unfavorable developments in those
areas or in the U.S. balance of payments might result in a substan
tial buildup of dollar holdings at European central banks, causing
the System to draw heavily on its swap network.
The System already
had drawings outstanding on the swaps with the Swiss, Italians, and
Dutch, and a further large drawing on the Italians might be required
shortly.
The U.S. might well be confronted with an emergency situa
tion requiring drastic action by the System; but unless supporting
measures were taken by the Government, such drastic action by the
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System, acting alone, might backfire, just as the British Bank Rate
increase in November 1964 had done.
He thought strong Government
action in two areas would be desirable under such circumstances.
His first suggestion would be to control, through licensing, direct
U.S. investment in Europe.
Secondly, he thought a strong appeal
should be made to American tourists to stay at home for a year or
so.
Both actions would be welcomed by European central banks,
although there might be some complaints from European business
interests if American tourism was reduced.
Unless some such meas
ures were taken by the Government, the System might find itself
operating in a vacuum.
Mr. Heflin asked how widely the true British position was
known.
Mr. Coombs replied that the recent British reserve figures
were reflected on the books of the Federal Reserve Bank of New York,
but were not known by other central banks; each such bank saw only
a small piece of the whole picture.
Conceivably, the Bank of
England might disclose the figures to a European central bank in an
effort to obtain credits, but otherwise they were not likely to do
so.
Mr. Hayes observed that that fact underscored the confi
dential nature of the figures.
It was extremely important, he said,
that they not be disclosed outside of the meeting room.
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Mr. Shepardson asked whether authorization by the Committee
was required for the proposed overnight accommodation of the British.
Mr. Coombs replied in the negative.
In effect, he had sug
gested that he should take a more restrictive position in his
discussions with the Bank of England than the Committee had approved
generally for swap drawings.
It was possible that the British would
object to that position, and that he would have to consult on the
matter before the next meeting of the Committee with the available
members of the Subcommittee designated for such purposes in the
Committee's foreign currency authorization.
Mr. Shepardson commented that he still did not like the
window-dressing involved but he supposed that it was necessary.
Mr. Robertson remarked that no members liked it, but if it
was necessary a short period presumably was better than a long one.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering open market operations in U.S. Government securities
and bankers' acceptances for the period June 28 through July 20,
1966, and a supplemental report for July 21 through 25, 1966.
of both reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
Copies
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Interest rates have moved sharply higher since the
Committee met on June 28. At the close of business last
night the three-month Treasury bill rate was about 1/2
per cent above its level on the eve of that Committee
meeting. During the interval yields on intermediate-and
long-term Treasury coupon issues moved above their end
of-February highs by 10 to 15 basis points and corporate
and municipal yields rose further. The prime rate was
raised 1/4 per cent early in the period, Federal funds,
bankers' acceptances, finance paper, Government agency
securities, and dealer loan rates all moved into new high
ground, while 30-day negotiable certificates of deposit
became quite generally available at the 5-1/2 per cent
ceiling. There were widespread market expectations of
an increase in the discount rate, and in the absence of
such action most rates have moved lower over the past
week with some sentiment apparently arising again that
this time the peak of rates may have been reached. In
yesterday's Treasury bill auction rates on three- and
six-month bills were established at 4.82 and 4.92 per
cent respectively, 18 basis points lower than the high
rates set in last week's auction.
The conduct of open market operations was affected
by a number of diverse factors, including market appre
hension about the course of interest rates after the
prime rate increase, continuing strong loan demand, the
Fourth of July holiday reserve needs, exceptionally wide
swings in country bank excess reserves, and the airline
strike. The mid-year interest payment period for
savings and loan associations and mutual savings banks
fortunately created no special problems, and with the
higher rates offered by many of these institutions a
rough competitive equilibrium appeared to have been
attained among the major financial intermediaries.
High yields on a variety of marketable securities,
however, continued to attract funds from the financial
intermediaries.
Net borrowed reserves fluctuated widely from week
to week, reflecting the behavior of required reserves
growth, the swing in country bank excess reserves, and
more recently, the $1 billion in extra reserves provided
by the airline strike. Thus, in the week ending July 6,
when required reserves were growing more rapidly than
anticipated, net borrowed reserves were moved up above
$450 million. In the week ending July 13, when required
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reserves were showing less strength than expected,
the country bank build-up of excess reserves was
inhibiting the flow of reserves within the banking
system, and the airline strike was beginning to supply
reserves, net borrowed reserves fell to $95 million.
In the following week, net borrowed reserves moved
back up to $479 million, but in a considerably easier
money market atmosphere as country banks moved their
abnormally large accumulated excess reserves into
the money centers.
In view of the special report submitted to the
Committee, I will not comment in any detail on the
large volume of matched sale-purchase transactions
carried on over the period.1/ I would like, however,
to reiterate that the matched sale-purchase trans
action has proved to be a very valuable instrument
for absorbing reserves in size for temporary periods
with a minimum of market disturbance. It has worked
even better than we had expected, and I believe that
the lively competition between dealers kept the cost
of these transactions to a minimum.
Banks and the market generally feel that money is
tight and that the Federal Reserve is really determined
to keep bank credit expansion within reasonable bounds.
It is somewhat disturbing to hear some leading commercial
bankers talk in terms of a possible money panic, but it
is clear that the financial community is feeling the
pressure of continued loan demand in a period of monetary
restraint. Against this background, and with the stern
reality of high financing costs, Government security
dealers are understandably reluctant to carry any
substantial inventories. As a result we should be
prepared to see a continuation of erratic fluctuations
in interest rates as temporary supply and demand forces
or specific economic, political, or financial devel
opments push the market first one way and then the
other.
1/ A memorandum from Mr. Holmes entitled "Use of Matched
Sale-Purchase Contracts, July 13-20, 1966" was distributed
to the Committee on July 22, 1966. A copy has been placed
in the Committee's files.
7/26/66
-24-
Given the state of the markets and the many
uncertainties involved, we should try to be as flexible
as possible in our approach to open market operations,
so that the routine alternation of the Federal Reserve
as buyer or seller of securities does not unnecessarily
exacerbate interest rate swings. Looking ahead, our
current projections indicate a need to supply something
over $1.5 billion of reserves in the next two weeks,
assuming that the airline strike is settled by the first
of the month. A continuation of the strike would, of
course, supply a major portion of these reserves, while
the reserve outlook is further clouded by the interna
tional financial uncertainties described by Mr. Coombs.
As you will recall, the Committee at its June 28 meeting
amended the continuing authority directive to permit
repurchase agreements to be made against Government
securities of any maturity rather than limiting them
to Government securities maturing in 24 months. The
understanding at that time was that this added degree
of flexibility would remain in effect only until the
next meeting of the Committee when Committee action
would be required to restore the continuing authority
directive to its original form. I would now recommend
that the Committee not take action today to so restore
the directive, thereby continuing to authorize repur
chase agreements against Government securities of any
maturity.
I would like to turn to one vexing question in
connection with any repurchase agreements that may be
made in the period just ahead. I am troubled by the
fact that the discount rate, which is the rate at which
RP's would normally be made, is so far out of line with
other dealer financing costs and is well below the three
month Treasury bill rate. As you know, the Committee
has set no upper limit on RP rates, but there is a
distinct danger that setting a rate above the discount
rate might well be detrimental to the Treasury financing
operation and could possibly set into motion renewed
speculation about an early increase in the discount
rate. At this time, therefore, I see no good alternative
to continuing to make RP's at the discount rate. I
would hope that we would not have to lean too heavily on
RP's during the coming weeks, but we will have to be
guided by events as they develop.
7/26/66
-25-
In addition, in view of the heavy need to supply
reserves indicated by the projections, I recommend that
the Committee increase the leeway for changes in the
System Open Market Account from $1.5 billion to $2
billion. Such an increase would not be needed if the
airline strike continues or if a substantial volume of
repurchase agreements were made, but it would appear a
useful measure to take in order to allow room for neces
sary operations if the reserve need turns out to be
greater than expected.
As you know, the Treasury will be announcing tomorrow
the terms for the refunding of $9.1 billion outstanding
Treasury securities maturing on August 15. With only
$3.2 billion of the outstanding issues held by the public
this should be a routine operation--but there is no such
thing as routine in the markets at the present time.
Market thinking is quite diverse on the appropriate terms
for the issue, with different views as to appropriate
maturity or maturities, as to coupon, and as to whether
there should be a simultaneous prerefunding of November
1966 and February 1967 maturities. All of these issues
will be under discussion with Treasury advisory committees
today and tomorrow, and the decision will not be easy in
the light of recent market gyrations. Dealer underwriting
interest in the refunding has been minimal, but somewhat
more investor interest has developed with the improved
market performance of the past several days. How long
this sentiment will last is problematical, and a rather
difficult even keel period will lie ahead. A definition
of even keel is not easy when extraneous developments
may have more effect on interest rates than minor swings
in reserve aggregates or other factors under Federal
Reserve control. But I believe it is clear that we should
try to be as neutral as possible in our effect on the
money market through the August 15 payment date and perhaps
for some period beyond.
Mr. Hickman, referring to Mr. Holmes' final remark concerning
the Treasury refunding, asked how long an even keel might have to be
maintained to stabilize the after-market.
7/26/66
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Mr. Holmes said it was almost impossible to make a prediction
on that point at a time like the present, when market conditions were
tending to go through wide swings over short periods.
Mr. Brimmer asked whether the Manager was including the
expected Treasury cash financing among the operations for which he
thought an even keel should be maintained.
Mr. Holmes replied that he was not.
The cash operation,
which probably would involve an offering of tax bills with tax and
loan account privileges, would be announced before August 15, with
payment to be made sometime later in the month.
While it might
present a problem for a short period the problem was not likely to
be sufficiently serious to extend the time for which an even keel
would be required.
Mr. Hickman asked whether the Manager thought that the
refunding would preclude a policy change in the latter part of
August.
Mr. Holmes replied there might be an opening for such a
change in the latter part of August, but at this point it was dif
ficult to make a firm prediction.
Mr. Hayes remarked that in an informal discussion a week
or so ago the Treasury people had shown a willingness to consider
the possibility of the System's not maintaining an even keel after
the refunding.
While they might change their minds, that was at
least a possibility.
7/26/66
-27
Mr. Mitchell referred to the concern Mr. Holmes had expressed
about the spread between the discount rate and dealer financing costs,
and asked why he was reluctant to use a rate higher than the discount
rate on any repurchase agreements he might make.
Mr. Holmes commented that in the midst of a Treasury financ
ing market participants would be unusually sensitive to anything that
suggested a change in System policy, and they might interpret a
higher rate on RP's as foreshadowing a change in the discount rate.
At the moment the market did not expect an immediate change in the
discount rate.
Mr. Mitchell asked whether the rate on System RP's with
dealers had been out of line with dealer loan rates at times in the
past.
Mr. Holmes replied that the rate on RP's had been well below
dealer loan rates for some time now.
The Account Management had con
sidered raising the RP rate, but had decided not to for the reason he
had mentioned--a higher rate might be taken as a signal of an imminent
change in the discount rate.
There also had been periods in the past
when the discount rate was out of line with dealer financing costs.
Mr. Ellis asked whether a rate above the discount rate had
ever been set on RP's by the Desk.
-28
7/26/66
Mr. Holmes replied that that had been done on one or two
occasions, but that in each such case an increase in the discount
rate had been announced a few days later.
In response to a question by Mr. Robertson, Mr. Holmes said
his intention would be to continue to set the rate on repurchase
agreements at the discount rate if any RP's were made during this
period, although he had expressed his concern over the fact that
that rate was out of line with current dealer financing costs.
Mr. Robertson said he shared Mr. Holmes' concern.
He
would recommend that the Desk avoid the use of RP's to the fullest
extent possible, recognizing that some might be necessary.
He did
not think, however, that in present market circumstances a rate on
RP's above the discount rate would necessarily be construed as
signaling a change in the discount rate.
Mr. Mitchell commented that the System could well be
criticized if it made RP's with dealers at so large a differential
below their alternative financing costs.
Mr. Holmes agreed.
At the same time, he said, he would
not like to take any action that could be pointed to, rightly or
wrongly, as having upset a delicate Treasury financing operation.
The Desk had felt constrained in the use of RP's in the recent
past because of the rate differential, but it might have to use
them to some extent in the weeks ahead because, with dealer
7/26/66
-29
inventories small, exclusive reliance on outright purchases could
push the bill rate very low.
Of course, if the airline strike con
tinued and float remained high there would be very little problem,
but the period ahead was a highly uncertain one.
Mr. Brimmer remarked that precisely because of the existing
uncertainties he would keep innovations to a minimum.
If the Manager
felt that he had to make RP's, he (Mr. Brimmer) would favor setting
the rate on them at the discount rate.
Mr. Maisel commented that the Committee's primary concern
was with monetary policy and not with the cost of operations.
Moreover, the cost to the System of outright purchases followed by
sales probably would be greater than that of making RP's at the
discount rate.
It seemed to him, therefore, that if the Manager
concluded that making RP's at the discount rate was desirable for
reasons of monetary policy, he should proceed to make them.
Mr. Mitchell remarked that the question was not one of costs
to the System but rather of profits to the dealers, and Mr. Maisel
rejoined that they were the two sides of the same coin.
Mr. Hayes said that he was struck by two facts.
First, the
System was making funds available at a 4-1/2 per cent rate to banks
through the discount window.
Secondly, the Desk made RP's with
dealers in amounts and for periods of its own choosing, and it
policed them effectively.
He could understand the concern that
7/26/66
-30
had been expressed, but he personally felt that the Treasury financing
was sufficiently delicate to warrant the Committee's living with the
existing situation for a few weeks more.
Recent RP's had been made
at the discount rate, so no change from present practice was involved.
Mr. Shepardson noted that his feeling was similar to
Mr. Mitchell's; the procedure might be necessary but he thought it
was not desirable.
Mr. Hayes summed up by saying that in light of the discussion
the Manager was fully aware of the unfavorable aspects of the
procedure and would try to avoid making RP's to the extent possible.
The Committee's consensus, as he understood it, was that decisions in
the matter should be left to the Manager's judgment, although some
members were reluctant to have RP's made at the discount rate.
Thereupon, upon motion duly
made and seconded, and by unanimous
vote, the open market transactions
in Government securities and bankers'
acceptances during the period June 28
through July 25, 1966, were approved,
ratified, and confirmed.
Mr. Hayes then noted that while the Committee had amended
the continuing authority directive at the previous meeting to remove
the maturity limitation on securities held under repurchase agree
ments on the understanding that the directive would be restored to
its original form at this meeting, the Manager now recommended that
the Committee not take such action today.
He asked whether there
7/26/66
-31-
was any objection to retaining the existing form of the directive,
and none was heard.
Mr. Hayes then asked whether there was any objection to the
Manager's recommendation that the leeway for changes in the System
Account holdings of Government securities between meetings of the
Committee be increased from $1.5 billion to $2.0 billion, and none
was heard.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
paragraph 1(a) of the continuing
authority directive to the Federal
Reserve Bank of New York was amended
to read as follows:
(a) To buy or sell U.S. Government securities in
the open market, from or to Government securities dealers
and foreign and international accounts maintained at the
Federal Reserve Bank of New York, on a cash, regular, or
deferred delivery basis, for the System Open Market
Account at market prices and, for such Account, to
exchange maturing U.S. Government securities with the
Treasury or allow them to mature without replacement;
provided that the aggregate amount of such securities
held in such Account at the close of business on the day
of a meeting of the Committee at which action is taken
with respect to a current economic policy directive shall
not be increased or decreased by more than $2.0 billion
during the period commencing with the opening of business
on the day following such meeting and ending with the
close of business on the day of the next such meeting.
Mr. Hayes called at this point for the staff economic and
financial reports, supplementing the written reports that had been
distributed prior to the meeting, copies of which have been placed
in the files of the Committee.
-32-
7/26/66
Mr. Partee made the following statement on economic
conditions:
A good many business analysts seem recently to have
turned less bullish on the future course of economic
activity. Doubts are heard increasingly about the under
lying strength of private sector demands, and forecasts
of marked slowing or even downturn around year-end or a
little later are now not uncommon.
Weakness in the second-quarter GNP figures, much of
which reflected the substantial setback for the automobile
market and its widespread ramifications for supplier
industries, has helped fuel this concern. But many
analysts view past and present spending levels as exces
sive in other lines as well--for plant and equipment,
business inventories, consumer durable goods generallyand point to the auto setback as a harbinger of things
to come. Concern is also frequently expressed variously
about the effects of tight money, rising costs and prices,
the evident weakness in the stock market, and the balance
of payments situation--all with forebodings for the future.
To the extent that these forebodings are transmitted
to businessmen, investors, and consumers, they will in
themselves tend to bring a moderation in future plans and
actions. But I cannot go along with the view that a
near-term economic reversal is now shaping up. We would
all agree, I think, that imbalances in the economy have
broadened and intensified over the past six months or so.
Plant and equipment expenditures look increasingly
vulnerable, expectations of rising prices have become a
more important part of the picture, and inventory
accumulation may well be proceeding at an unsustainable
rate if the uptrends in new orders and sales continue to
moderate.
But the continued expansion in spending associated
with the war in Vietnam--which appears to have hardened
further over the past month--provides a powerful support
to the economy and a deterrent to cutbacks in private
spending flows. The Federal budgetary position is now
shifting abruptly to a more expansive stance, reflecting
not only higher defense spending, but also the Federal
civilian and military pay raises, the start-up of Medicare,
and the phasing out of tax payment speed-ups, which raised
receipts sharply in the second quarter. We estimate that,
7/26/66
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on the revised national income basis, the Federal Government's
net position will move from surpluses of $2.3 billion in the
first quarter, and $3.6 billion in the second quarter, to
approximate balance in the third quarter and a small deficit in
the fourth.
This shift figures prominently in the Board staff's
projections of third-quarter GNP, which show a rise of $14
billion as against $11 billion and $17 billion in the last
two quarters, respectively. The main feature of the projec
tion is a pick-up in consumer spending, the expansion in
which slowed markedly in the second quarter.
The slowdown last quarter took the form of lower auto
sales and reduced growth in nondurable goods, but it also
reflected a somewhat slower expansion in personal incomes
and a sharp increase in Federal tax payments, as the new
withholding schedules took effect. Conversely, in the
current quarter, personal incomes should rise faster--mainly
because of higher transfer payments and the Federal pay
raise--and the increase in the tax take will be more moderate.
Hence, disposable income will rise sharply faster than in
the second quarter, providing strong support to consumer
spending. Higher retail sales in June and thus far in July,
though tentative, provide some confirmation of the expected
resurgence in consumer demand.
Inventory accumulation accelerated last quarter, on the
other hand, and in this case a slowing in the current quarter
seems almost inevitable. Much of the increase reflected the
dealer build-up in auto stocks, and these should be worked
down in the weeks immediately ahead as output is cut sharply
for model changeovers. But manufacturers' inventories have
also accumulated more rapidly in recent months, and whether
there will be any slowing here is less certain; not much has
been allowed for in the projection.
Another clearly weak spot--and on more than technical
grounds--is in residential construction. Private housing
starts in May and June were at an annual rate 20 per cent
below the peak three-month average last winter, and the
recent figures on building permits have been noticeably
weaker than those for starts. The staff projection allows
for some further decline in residential building expenditures,
but it may still understate the drop in store.
7/26/66
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On balance, it seems to me that the green book 1 /
projection could turn out to be a little high for the
third quarter. But even so, the general impression of
recovery to a somewhat more rapid advance in GNP after
midyear, with much more of it coming in final demands,
seems correct. If so, the existing strong pressures on
resources can be expected to be maintained. Industrial
production rose at a 6 per cent annual rate in the second
quarter, even with the slowdown in output and demand.
And an extraordinary number of teen-agers were absorbed
into the labor force in June with no increase in the
unemployment rate. It would appear from this that there
are substantial backlogs of labor demand, even for
relatively unskilled workers.
Prices also continue under pressure and, with
aggregate demands continuing to mount, no real let-up
is in sight. The June rise in the consumer price index
brought the increase for the first half to 1.7 per cent,
substantially more than in the same period last year.
Much of the increase was accounted for by foods, reflect
ing in part special supply factors, but nonfood commodities
also rose somewhat and the increase in services was the
largest since 1957, paced by higher medical costs.
Wholesale prices of industrial commodities also have
continued upward, at a 3.5 per cent annual rate in the
second quarter. Some sensitive materials prices recently
have shown less strength, but it would take very little
additional increase in other materials and products to
make up the difference in the over-all industrial index.
Under these circumstances--which include the prospect
of a resurgence in consumer spending, continuing strong
pressures on resources, and upward movement in the price
indexes--public policies that will hold in check expansion
in aggregate demand at about the current rate clearly are
still in order-. Monetary policy, for its part, now appears
to be biting, not only in construction but in other lines
affected marginally by the restricted availability and
increased costs of credit. And further effects are likely
to appear with the passage of time, given the time lags
required to influence spending decisions and actual outlays.
1/ The report, "Current Economic and Financial Conditions," prepared
for the Committee by the Board's staff.
7/26/66
-35-
In view of these lags, and taking into account the
apparent recent dampening in business expectations, it
seems to me that a good case can be made for avoiding
further escalation in monetary restraint for the present.
But the situation bears unusually careful watching;
either a breakout of the economy on the upward side or
a spreading of unexpected weaknesses are long-shot pos
sibilities.
Mr. Koch made the following statement concerning financial
developments:
A major uncertainty at the time of our last meeting
was the extent of mid-year liquidity pressures that
savings and loan associations and mutual savings banks
might have to face. Deposit withdrawals have been
substantial for the saving and loans, but fortunately
less than had been widely feared. A factor helping to
limit withdrawals was the increase in interest rates
posted by the nonbank financial institutions, particu
larly in California and New York.
But despite the less intense than feared recent
pressure on major real estate lenders, mortgage financing
and residential construction remain under great strain.
This is indicated by the continuing evidence of sharp
reductions in new commitments of lenders and in new
permits to build. Although it is likely that the near
crisis atmosphere that has been evident in mortgage
markets in recent weeks is dissipating, market conditions
no doubt will remain tight in the months ahead and flows
of mortgage credit will diminish further, mainly
reflecting commitment cutbacks.
Commercial banks have benefited to some extent by
the July withdrawals from competing institutions.
Time and savings deposits at commercial banks are
expected to be up at a seasonally adjusted annual rate
of over 13 per cent this month, as compared with an
average of about 10 per cent in May and June. Savings
deposits, at least at city banks, continue to decline
and growth in large negotiable CD's has been slower, but
small denomination time deposits have increased
substantially further. We have no comprehensive informa
tion as to how banks have reacted to the recent change in
Regulation Q, but the reports we have heard are that many
7/26/66
-36-
banks are converting their time deposits to single-date
maturities and continuing to pay the higher permissible
rates.
Looking at the domestic financial scene more broadly
and over a longer time span, there is growing evidence
that restraint is biting. Total net funds raised in
financial markets by the private sectors of the economy
decreased considerably in the second quarter. Mortgage
financing and corporate security financing showed particu
larly sharp declines, but part of the corporate decline
may have been due to earlier anticipatory borrowing.
Total funds raised is a more meaningful indicator
of over-all restraint than bank credit expansion alone,
for bank credit reflects not only the effects of monetary
restraint but also the changing role of banks as financial
intermediaries for savings. Even the bank portion of
total credit flows has fallen sharply--from about 45 per
cent in the second half of last year to around 25 per
cent in the first half of this year.
The effect of Federal Reserve restraint on the
commercial banking system can also be seen in the recent
course of the aggregate measures. Total reserves, for
example, increased at about a 5 per cent seasonally
adjusted annual rate in the first half of this year, as
compared with 7 per cent in the first half of last year.
The rate of growth of the bank credit proxy--total member
bank deposits--declined from 10 to 7 per cent, reflecting
mainly a reduced rate of increase in time deposits.
Growth in the narrowly defined money supply, on the other
hand, has remained in the 4 to 5 per cent range that has
prevailed over most of the past two years, but this rate
I think it is fair to
has been below that in the GNP.
say we have been achieving the moderation in the rate of
growth of the "reserve base, bank credit, and the money
supply" sought in recent directives.
Financial conditions have been getting more restric
tive for some time now, but it is only in the last couple
of months that real tightness has developed. This is
shown most clearly by recent changes in the cost and
availability of various types of credit and capital.
I have already commented on the tight situation
prevailing in the mortgage market. The tightness has
spread to the municipal market where interest rates have
risen over 35 basis points since mid-April. Many banks,
particularly the larger ones, are either cutting back on
7/26/66
-37-
their acquisitions of new municipals or are liquidating
some of their existing holdings. Specialized municipal
dealers are finding the going very rough and there have
been postponements and cancellations of new issues.
There is even some evidence of lower municipal spending
on capital projects as a result of the credit squeeze.
Financing of brokers and dealers in both private and
Government securities is more expensive and less readily
available. Consumer credit terms are also more restrain
ing at both banks and sales finance companies.
Business borrowing from banks continues to be the
area where restraint is less evident. The increase in
such borrowing was at a seasonally adjusted annual rate
of about 20 per cent in the second quarter and has
continued brisk in July. One has to be careful, however,
in basing monetary restraint on the course of business
loans, for this type of lending is notoriously sluggish
in its response to restraint.
Small banks also seem to be under less pressure than
large banks. Loan demands on them have been less intense
and their liquidity remains greater. Yet it is difficult
to see how additional pressure can be brought against
these smaller banks without intensifying the already very
tight situation of the large city banks. Discount policy
may be a possibility, but it is a hard one to administer.
As for the immediate future, our policy until the
next meeting seems quite clear, namely, one of an "even
keel." Although the Treasury refunding is relatively
small, it occurs in a highly uncertain market, one in
which even a well-priced, routine, short-term, rights
refunding could result in high attrition and further
upward pressure on longer-term interest rates. In this
situation, it seems to me that the Manager should be
instructed to hold to a steady course, using money market
conditions as his main guide to operations.
Mr. Mitchell said he had been under the impression that
June and July were periods of exceptionally large demands for bank
loans because of corporate tax payments and accelerated payments
of withheld taxes, and that there would be some slack in loan
demand in August.
Mr. Koch's remarks suggested, however, that
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7/26/66
the slack was not likely to materialize.
He (Mr. Mitchell) asked
whether that did not imply that the Committee should increase the
degree of monetary restraint.
Mr. Koch replied that it would be difficult, in his
judgment, to reduce the growth in business loans.
Business loan
demand was continuing strong partly because of the inventory
situation, although the decline in the rate of accumulation of new
car inventories should give some relief.
Mr. Holmes noted that, as the blue book 1 / indicated, the
Board's staff expected the bank credit proxy to rise at an annual
rate between 4 and 6 per cent in August.
That, roughly, was only
half the July rate, although the seasonal adjustment factors used
might be more than ordinarily subject to question.
Moreover, a
good deal of current business borrowing might be anticipatory, as
a safeguard against the possible unavailability of funds later.
He added, however, that the New York Reserve Bank's projections of
bank credit growth in August were higher than those of the Board
staff.
Mr. Hayes commented that the New York Bank staff also
expected loan demands to be somewhat stronger in August than did
the Board staff.
1/ The report, "Money Market and Reserve Relationships," prepared
for the Committee by the Board's staff.
7/26/66
-39
Mr. Mitchell said he thought the Committee would want to
tranquilize strong loan demands.
He was concerned about the
possibility of another surge in bank credit in August if the
Committee adopted a posture of even keel today.
Mr. Maisel remarked that the basic question at issue
concerned the interpretation the Committee intended to place on the
proviso clause of the second paragraph of the directive, assuming
it adopted a directive today along the lines of that proposed by
the staff.1/
A similar question had been raised near the end of
the June 28 meeting but was not completely resolved, and perhaps
it was best to have it raised early in the meeting today.
Mr. Brimmer said he had been concerned about the growth of
business loans.
He was particularly apprehensive about the prospec
tive growth rates in July and August, especially in light of the
New York Reserve Bank projections.
He thought that for several
months the Committee had been led to believe that business loan
growth would moderate, and that it should now discount such
expectations and work on the assumption that the bulge would not
prove to be temporary, for whatever reasons.
Moreover, he felt
that focusing on the expansion of total bank credit might divert
attention from the shift that was occurring toward business loans
at the expense of other categories of bank credit.
1/
Appended to these minutes as Attachment A.
-40-
7/26/66
Mr. Maisel said that it had been his understanding at the
June 28 meeting that the proviso clause of the directive adopted
then would become operative if growth in the bank credit proxy
exceeded an annual rate of about 9 or 10 per cent in July.
The
latest estimates for July suggested that actual growth was a little
higher than that, but not much.
He asked whether it was contemplated
that the proviso in the proposed new directive would become operative
if the credit proxy rose at an annual rate in excess of 4-6 per cent
in August.
Mr. Holmes said that 4-6 per cent represented the Board
staff's expectation; the projection of the New York Bank was close
to 9 per cent.
Mr. Maisel then asked whether there was a similar disparity
in the projections of required reserves.
Mr. Holmes replied that, speaking generally, that was the
case, although one could not directly translate divergencies in
estimates between one series and the other for various reasons,
including differences in the seasonal factors.
Mr. Maisel then noted that the proviso clause of the staff's
suggested directive began, "provided, however, that if required
reserves are stronger than expected.
would interpret that language.
.
."
He asked how Mr. Holmes
-41-
7/26/66
Mr. Holmes replied that he would hope the members would
express their opinions on the appropriate interpretation of the
language in question when they commented on the directive today.
The staff's projections were before the Committee; and if the
members would note whether or not they thought the indicated
growth rates were appropriate he would find it helpful in under
standing the Committee's intent.
Mr. Hayes suggested that the members return to the subject
under discussion in the course of the go-around.
Mr. Hersey then presented the following statement on the
balance of payments:
I find it today more than usually difficult to sum up
the present state of the balance of payments. In the first
place, the figures that have been coming in for increases
in U.S. liquid liabilities in recent months have been
heavily affected by foreign and international acquisitions
of agency securities and time deposits with original maturity
over 1 year. As a result, the preliminary press release at
mid-August will show a second-quarter seasonally adjusted
liquidity deficit greatly reduced from the first quarter's
level. The average rate of deficit in the first half of
1966 will appear to have been less than the average rate in
the second half of 1965, which was $1-3/4 billion. Yet we
know very well that there was a deterioration in the
merchandise export surplus by $1 billion annual rate, and
we think we know that the changes in other parts of the
current account and in the private capital account were
not, on balance, anywhere near favorable enough to offset
this trade deterioration between the second half of last
year and the first half of this.
That is my first difficulty. My second difficulty is
quite different. In the very recent data on changes in U.S.
reserve assets and liquid liabilities--that is, the data
for June and the first two-thirds of July--I sense a hint
7/26/66
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that something of a more favorable kind may have begun to
happen. The usual summer-time bulge in the deficit does
not seem to be developing. Yet, it is much too early to
have corroborative evidence. And the indicators of weekly
and monthly deficits themselves are incomplete and subject
to revision, and they may be affected by any number of
accidental or at least nonregular factors.
One reason for hesitance in taking seriously the hints
of a favorable turn is that perhaps additional large shifts
of foreign official and international funds may have been
made in June and July into long-term time deposits and
agency securities. Our estimate of the total of such move
ments in the second quarter has just been raised from a
little under $500 million to nearly $550 million; the June
figures are still not complete, and there is still a pos
sibility that the shift into non-liquid assets will prove
to have been larger in June than it was in April or May.
However, assuming that the hints of an improvement in
the balance of payments in June and July do not eventually
get explained away in that manner, we may find that the
tight money situation and the slowing of the domestic
economic advance in the second quarter have had measurable
effects. One sector in which improvement could be hoped
for is imports. The June import figure is being released
though it
today. It proves to be moderately encouraging:
is up a little from May, it is no higher than the April
May average. It does leave the second-quarter total about
4 per cent above the first quarter, but the higher level
was reached early in the quarter. If we group the last
four months by pairs, imports in May and June were no
higher than those of March and April.
What I wish to convey is simply the thought that it
is possible that the balance of payments may show a turn
for the better as the overheated economy begins to cool
off. Whether a significant change has already occurred in
the balance of payments is still a moot question, only to
be answered with statistics that are not yet in.
It is also possible that the backlash of the distrust
of sterling may have generated abnormal net payments to
this country on various current transactions or to acquire
assets here other than those that are counted as liquid.
But probably the largest effects of the sterling crisis
are not on the liquidity balance at all, but rather only
on the official reserves transactions balance--on which I
will say a little later.
7/26/66
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But suppose the hypothesis of a July drop in U.S. imports
were to be confirmed. Even then there would be no immediate
implications for policy, in my opinion. Just as the rise
in imports may have ceased for the present with the recent
slowing of the rise in domestic output, income, and expendi
tures, so the new acceleration of domestic expansion that
seems to be in the cards for the third quarter can be
expected to bring a new acceleration in imports, perhaps
with a lag of a month or so. The balance of payments case
for as restrictive a combination of monetary and fiscal
policy as the economy can stand will continue to hold until
the economy is firmly on a track of expansion at a sustain
able rate without appreciable inflation.
I should like to add a footnote on the official reserve
transactions balance, partly to correct a misstatement on
page 5 of the summary part of the green book. We can now
estimate the seasonally adjusted annual rate of this balance
in the second quarter, not "somewhere between $1 billion and
$2 billion," but at about $0.6 billion. The difference
between this relatively small deficit and the liquidity
balance at a rate of about $1 billion, a difference of $0.4
billion, is explained as follows. Because shifts between
liquid and nonliquid assets do not, in general, affect the
official reserve transactions calculation, this balance
would have been very much larger than the liquidity balance,
if it had not been for a still larger factor working in the
other direction. This was an increase in U.S. liquid
liabilities to commercial banks abroad and to other private
holders, amounting to half a billion dollars before seasonal
adjustment and $650 million seasonally adjusted. This was
mainly a reflection of the run on sterling.
Some of the drain on U.K. net reserves from their
over-all deficit on current account, long-term capital, and
short-term capital had its counterpart in reserve gains for
European countries, and had no effect on the U.S. net reserve
position on either of our two styles of calculation--though
it does increase our liabilities to central banks who may be
unwilling dollar holders.
But a very large part of the
flight from sterling was into dollars, and especially into
Euro-dollar deposits. Given the tight money market in the
United States, banks in the Euro-dollar market receiving
these deposits placed in this country much of the dollar
funds they had gained, rather than lending out dollars in
Europe to end up in the holdings of European central banks.
Thus, there was a very large increase in the balances owed
7/26/66
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by banks in the United States to their branches abroad (and
perhaps also to other banks) operating in the Euro-dollar
market. The increase in these balances owed to banks in the
Euro-dollar market would apparently have been even larger
than it was if the Bank of England had not swapped out part
of its spot dollar losses to the market, causing banks
operating in London to put back into sterling, on a covered
basis, some of the dollars that had come to them.
Presumably these processes continued to work during
the first three weeks of July, at a more violent pace. The
whole business illustrates very well the good standing of
the dollar under present conditions as a currency into which
some people are willing to move their funds out of a currency
that is under attack.
Note: Immediately following the meeting,
information was received that the estimate
of the June deficit on the liquidity basis
had been revised downward to correct a
reporting error by a commercial bank. For
the second quarter, the seasonally adjusted
annual rate was changed from about $1 bil
lion to about $0.6 billion. The estimate
for the official reserve transactions
deficit given in Mr. Hersey's statement
($0.6 billion, seasonally adjusted annual
rate) was unaltered. The increase in U.S.
liquid liabilities to commercial banks
abroad and to other private holders was
changed from $650 million to $550 million,
seasonally adjusted quarterly amount.
Mr. Hayes then began the go-around of comments and views on
economic conditions and monetary policy with the following statement:
The business expansion continues to proceed at a less
hectic pace than in the first quarter. It looks, however,
as if the advance in aggregate demand in the third quarter
will be stronger than in the quarter just completed. The
prospective advance is rapid enough to maintain strong
upward pressure on prices. Federal Government expenditures,
particularly on defense, are now clearly the most powerful
force propelling the economy forward, and business outlays
on plant and equipment are another important stimulant.
We look for a renewed acceleration of consumer spending in
the current quarter.
7/26/66
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A most disturbing feature of the second quarter was
the fact that over-all prices recorded the same large
increase as in the first quarter--a 3-1/2 per cent annual
rate--while real GNP rose at a rate of only 2-1/2 per cent.
We see no reason to look for a slowdown in the rate of
price rise, although no acceleration is visible at this
time, Cost-push pressures on prices are likely to increase.
Unemployment continues to be relatively low and is likely
to remain so.
The further deterioration of the balance of payments
in the second quarter, apart from special "cosmetic"
adjustment, is an additional reason for serious concern.
The dominant factor has been a weakening of the trade
account, with a rapid rise in imports and a slowing in the
growth of exports. Rapidly rising aggregate demand in
this country is of course the main source of the import
increase. Rising Government outlays abroad, tourist
expenditures, and direct investment must also share the
responsibility for our poor payments showing. In view
of the prospect of further domestic business expansion,
and considerable restraint on demand in many other
countries, there is little hope of improvement in our
trade balance unless efforts to dampen aggregate demand
in the U.S. are more successful than they have been to
date. It does seem clear that some decisive new program
of action to deal with our payments deficit is badly
needed.
Last week witnessed the most serious of the crises
that have beset sterling over the past couple of years.
It is still too early to know whether the latest crisis
has been surmounted, but there is at least ground for hope
that the immediate danger is past, partly because of
vigorous action by the System and the Bank of England.
Of course Britain's longer-range problem is far from
solved, and the sterling situation will continue to con
tribute to an atmosphere of uncertainty in international
financial markets. However, the Wilson program is an
impressive one, and, if effectively implemented, would
set the stage for a long-run solution. Of course, pressure
on the gold market and concern over our own payments are
enhancing the uneasy international atmosphere.
Bank credit growth seems to have been around an 8
per cent annual rate for the first half of this year, as
compared with about 10 per cent for the full year 1965.
7/26/66
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Thus we have perhaps made a beginning toward our objective
of slowing the pace of credit growth. In New York, at
least, the demand for bank loans has remained very strong
in July, despite the passing of the June tax and dividend
dates. Although the banks' liquidity has reached a very
low level, New York bankers feel that the quality of a
great many borrowers whose requests are received is so
high, and competitive factors so strong, that substantial
loan increases are bound to continue short of considerably
more severe reserve stringency than they have experienced
so far. On the other hand, there is some fear that any
sudden intensification of the pressure could lead to very
serious problems, such as possible inability to honor
commitments, or rapid forced liquidation of investments.
The savings institutions appear to have weathered the
mid-year interest period without any serious difficulties.
The mutual savings banks were losing funds more rapidly in
early July than in early April but have since recouped and
at the moment seem to be gaining deposits at a better rate
than in July of last year. The savings and loan associa
tions are also said to be gaining funds again. In both
cases increases in rates have helped reverse earlier losses.
Current efforts in Government circles to roll back rates
paid on various types of certificates of deposit seem to
me to overlook completely the fact that savings institutions
and commercial banks together are already tending to lose
out, in the competition for savings funds, to direct
investment in securities on the part of the public.
The need for a continued general policy of restraint
seems clear in view of the still excessive rate of credit
growth, the continuing inflationary danger, and the parlous
state of our balance of payments. With no assist from
higher taxes in prospect for the near term, I think we
should seek an even firmer monetary policy were it not for
current even-keel considerations. Under the circumstances,
with the refunding likely to be especially delicate and
perhaps quite difficult, we can do no more than maintain
about the same degree of restraint prevailing in recent
weeks. It seems to me, incidentally, that the new technique
discussed at our special telephone meeting proved to be
extremely useful in enabling us to prevent any undue easing
as a result of the airline strike; and we might well consider
whether this should not be a permanent addition to our kit
of tools. In the coming three weeks we might have in mind
a range of free reserves of $450-$500 million, but I think
7/26/66
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the Manager should be given ample leeway to depart from
this range in the light of apparent credit trends and of
the Treasury's financing problems.
Perhaps a word is in order at this point on the
subject of the discount rate. In spite of the Board's
position as stated in their letter of July 16, I am still
convinced that the 1/2 per cent increase in the discount
rate voted by our directors on July 14 was the right
action under all the circumstances; and I was glad to see
five other Reserve Banks take similar action. In regard
to the point in the Board's letter that 1/2 per cent
might not be enough to calm existing uncertainties, I
think this doubt was far outweighed by the fact that a
1 per cent rise would very probably have set off a renewed
sharp spiral of interest rates, which in turn would have
been undesirable both from the Treasury financing stand
point and in the light of current Administration and
Congressional efforts to check the escalation of rates.
The basic economic and financial reasons, both domestic
and international, for the July 14 action are, I think,
fairly obvious; and I believe there would have been a
real advantage in narrowing the wide spread between the
discount rate and market rates before the even-keel period
was upon us. The sterling problem was not yet so acute
on July 14 that this constituted a sufficient reason for
holding our hand, whereas a week later the inflamed and
delicate sterling market position did argue strongly
against any discount rate action; and for this reason,
and this reason alone, our directors voted last Thursday
to re-establish the existing rate. I would hope that
some opportunity might be found after completion of the
refunding to carry out an increase in the discount rate
with the Board's blessing. A couple of weeks ago Treasury
officials indicated that this might be feasible, and I
hope that this possibility will receive careful study
during the coming weeks.
I find the draft directive quite satisfactory, except
for the wording at two points in the first paragraph. I
would substitute "appears to be" for "is" in the first
sentence statement regarding over-all domestic activity;
and I would change the reference to the balance of payments
to read, "The balance of payments situation continues to
reflect a heavy underlying deficit."
7/26/66
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Mr. Ellis reported that the New England economy continued
to roll along in high gear.
Each month saw new production, employ
ment, and income records posted with such monotonous regularity
that one tended to overlook their real significance.
For example,
during the week ending June 18 insured unemployment was the lowest
in tabulated records going back over 20 years.
In many ways that
statistic had greater long-range significance than the more widely
publicized fact that not all students found jobs for the summer
and the unemployment rate rose slightly.
Rising employment, longer
hours of work, and expanding incomes were translating into rising
consumer spending--except for automobiles.
Rising sales, in turn,
were generating optimistic sales expectations in the minds of New
England manufacturers.
The Reserve Bank's regular quarterly survey,
covering firms with one-eighth of the region's employment, found
them expecting their seasonally adjusted sales level to rise by 1.3
per cent from the second to the third quarter, having declined by
that much between the first and second quarters.
In the financial arenas, Mr. Ellis continued, both commercial
banks and mutual savings banks were breathing easier now that the
July dividend dates had passed.
No savings banks had had to draw
on lines at the commercial banks to meet deposit losses.
In fact,
it was estimated that, in the aggregate, the mutuals would gain
deposits in July.
They were still making a substantial volume of
7/26/66
-49
mortgage loans but were buying fewer out-of-State mortgages.
While
the large commercial banks were determined to meet their loan com
mitments to the mutuals, they were somewhat concerned about having
the funds to do so.
For all weekly reporting banks in the District,
liquid assets as a per cent of total deposits adjusted fell to 4.8
per cent on July 13, roughly half of the national figure of 8.9 per
cent, and loan-deposit ratios reached 77.9 per cent, compared with
a national ratio of 73.7 per cent.
touched 84 per cent.
For Boston banks, the ratio
It was quite clear that First District banks
were less liquid and were under stronger pressures than was suggested
by data reflecting the national scene.
District banks, particularly the larger ones, reported they
were rationing their established customers and rejecting prospective
new ones they would be delighted to accommodate in normal times,
Mr. Ellis remarked.
In fact, several had arrived at a point of
urging that some guidelines--by total and by type of loan--be
formally established to give them more backbone in reaching tough
decisions.
It was not at all surprising, therefore, to find that
District banks were very active participants in the Federal funds
market and also showed up frequently at the discount window.
During
the second quarter as many as 41 per cent of the country member banks
borrowed at some time or other and their borrowings averaged 7 per
cent of their required reserves, substantially more than in any other
7/26/66
-50
District.
In contrast, among country banks, continuous borrowers
of six periods or longer borrowed a larger portion of their required
reserves in six other Districts than they did in New England.
Apparently, while First District banks in general borrowed more
heavily and more frequently, the extent of borrowing by the so
called continuous borrowers was below average.
After considering those and related economic facts, Mr. Ellis
said, directors of the Boston Federal Reserve Bank voted on July 18
to raise the discount rate by 1/2 per cent.
They viewed the move as
a desirable step in continuation of a gradual tightening of monetary
policy.
Realizing that the longer a rate remained out of pattern
the greater the distortion it caused and the greater the inertia
that had to be overcome, they sought to reduce uncertainty in a
market when such action had been fully discounted.
In addition,
they thought that such a move would reduce, marginally, the rate
incentives to borrow from the Federal Reserve; that it would provide
another signal to other nations that the United States was determined
to pursue monetary restraint; and that it would reserve for later
use the possibility of still another discount rate increase if market
trends prevailed.
The directors considered a possible increase of
a full percentage point, but rejected it for two reasons.
First,
the abruptness of such an action, which would completely close the
present gap between discount rate and the Regulation Q ceiling,
7/26/66
-51
could be viewed as a divergence from the recognized policy of gradual
shifts toward tightness; it could well be described as slamming on
the brakes.
Secondly, the competitive balance between commercial
banks and other financial institutions--Mr. Holmes had used the term
"competitive equilibrium"--would be shaken more severely than desir
able just as it showed some signs of settling down.
Quite obviously, Mr. Ellis continued, the Treasury financing
schedule now blocked action on the discount rate until the last half
of August, when it might possibly be fitted in around the expected
issue of tax bills.
It might be desirable at that time for the Desk
to innovate with respect to the rate on repurchase agreements,
setting a rate closer to the bill rate.
Meanwhile, Mr. Ellis remarked, the critical issue of policy
settled down to a meaningful definition of even keel in the context
of present conditions and expectations in the market.
The staff
memoranda had outlined markets that were expected to fluctuate
substantially under the influence of special float factors, changes
in tax payment schedules, and other forces.
In general, the
Committee's objective, in his judgment, should continue to be
retention of an atmosphere in which commercial banks felt under
considerable sustained pressure to slow their rate of aggregate
credit creation.
The 10 per cent rate of credit expansion projected
7/26/66
-52
for July suggested that banks still had a considerable leeway for
expansion, so the basic position of policy should be to continue
gradual tightening whenever possible.
The proposed directive apparently was intended to express
such an objective, Mr. Ellis said.
He thought Mr. Hayes' proposed
wording changes in the first paragraph were appropriate.
In
addition, because the wording of the proviso clause in the second
paragraph of the staff draft seemed unnecessarily clumsy, he would
urge the Committee to consider some alternative wording such as
"provided, however, that if required reserves expand more rapidly
than expected and if conditions associated with the Treasury financ
ing permit, ...
." As he considered the directive, it instructed
the Manager to hold to a posture of tightness insofar as the Treasury
financing permitted, and to stiffen restraining pressures if reserve
growth tended to accelerate.
He would define tightness in the terms
of the staff memoranda, with net borrowed reserves in the $400-$500
million range, borrowings around $800 million, the Federal funds
rate at 5-1/2 per cent or higher, and dealer loan rates above 6 per
cent, as recently.
He realized that the three-month bill rate
probably would fluctuate rather widely, but he hoped it would
fluctuate up--to the neighborhood of 5 per cent--more frequently
than down.
In general, he thought the Committee had not achieved
the retardation of growth in bank credit that it had intended, and
7/26/66
-53
he would like to see occasional months in which there was no
growth in reserves to offset the months in which reserve growth
was unusually high.
Mr. Mitchell asked Mr. Holland what particular expectations
the staff had in view in suggesting that the proviso clause of the
directive begin ". .
if required reserves are stronger than
expected."
Mr. Holland replied that the staff started with the projec
tions contained in the blue book but recognized, of course, that
the Committee might conclude that some different objectives were
appropriate.
Specifically, the staff had in mind the blue book
projections for August of a 4-6 per cent annual growth rate in the
bank credit proxy and of "small growth"--by which was meant
practically no increase--in required reserves.
Mr. Shepardson noted that Mr. Holmes had reported earlier
that the New York Bank staff projected an annual rate of growth in
the bank credit proxy of 9 per cent.
Mr. Irons reported that economic activity in the Eleventh
District was at a high level and continuing to move up, although
it was not surging.
expansion.
Most recent indicators reflected further
Department store sales were strong and automobile sales,
although not as high as earlier, were generally regarded as very
good.
The year-to-year increase in employment was 5 per cent and
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7/26/66
unemployment recently had been running at about 3 per cent of the
labor force.
July.
Manufacturing employment was expected to rise in
Construction contract awards were up from May to June and,
unlike the situation in other Districts, residential construction
continued to rise in the Eleventh District.
In June, the latest
month for which figures were available, residential construction
was 22 per cent higher than in May.
According to the Reserve
Bank's index, District industrial production was up 2.6 per cent
in June and was running 8-1/2 per cent over a year ago.
Agricultural
conditions were difficult to assess at this time, although it
appeared the cotton acreage this year would be about 25 per cent
lower than last year.
In the financial area, Mr. Irons said, total loans at
Deposits
District banks declined slightly in the last few weeks.
were up, with demand deposits rising quite substantially.
The
unfavorable developments that had been feared at savings and loan
associations around the mid-year interest-crediting date had not
materialized; he had heard of no cases of real hardship.
In the
last month large negotiable CD's of District banks had increased
about $44 million to a total somewhat over $1 billion.
Bankers
reported that loan demand continued very strong and that they were
rationing credit.
Perhaps the rationing was not as severe as
might be desirable, but the fact remained they were turning down
7/26/66
-55
loans they would have made under other circumstances.
Bank liquidity
was somewhat less than it had been in earlier months.
Banks were
active purchasers of Federal funds, averaging net purchases of about
$500 million in the latest week.
The total dollar amount of Reserve
Bank discounts outstanding had increased in the last three or four
weeks but that could not be described as reflecting a trend; the
volume of discounting often rose sharply for a short period if one
or two large banks came to the window.
The proportion of banks bor
rowing was not large, although some very small country banks that
had not borrowed in long periods were being referred to the Reserve
Bank by their city correspondents.
Mr. Irons said that he had thought he had a clear understand
ing on how to operate the discount window, but was no longer sure
that he did after receiving the Board's recent letter on the subject.
The Bank was continuing to operate as it had been earlier, while
trying to blend in the suggestions made.
The problem rested largely
on the question of the appropriate definition of "continuous"
borrowing.
He assumed that that question was being examined in the
current fundamental reappraisal of the discount mechanism.
With respect to the national economy, Mr. Irons observed
that the rate of expansion had been high during the second quarter
and thus far in the third quarter.
In light of the staff's projec
tion for a $14 billion increase in GNP in the third quarter, with
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7/26/66
considerable increases in consumer, business, and defense spending,
he did not see any let-up in sight.
Pressures on prices were strong,
interest rates had moved up substantially, and money market conditions
were very firm.
There had been some moderation in bank credit growth
recently, but demands for bank credit continued strong.
In Mr. Irons' judgment the Desk had handled the float problem
created by the airlines strike extremely well, and he approved the
technique that had been used of matched sale-purchase contracts.
The
Eleventh District had been fortunate in not experiencing a large rise
in float; the airlines that were not struck had got the mail through,
and the float increase was smaller than had been anticipated.
That
situation was not likely to continue, however, if the strike extended
to another major airline.
There was no question but that the recent firmness of monetary
policy was biting, Mr. Irons said.
While bankers perhaps were trying
to find ways to work around the current tightness, they were not
expecting conditions to ease.
At present, the forthcoming Treasury
refunding called for maintaining the status quo.
would have to try to avoid binds in the market.
Also, the Desk
It had been success
ful in doing so in the period since the preceeding meeting, although
he thought that additional firmness had developed in that period.
He
would like to have the present degree of firmness maintained without
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7/26/66
a deliberate attempt to tighten further.
Net borrowed reserves in
the $400-$500 million range would be satisfactory to him, with the
structure of interest rates about as at present.
The directors of
the Dallas Reserve Bank had not considered an increase in the discount
rate at their latest meeting, and he had not recommended that they
take such action.
Mr. Irons concluded by saying that he could accept the
draft directive.
He would prefer, however, to omit the proviso
clause, as he had noted at another recent meeting.
He was inclined
in that direction partly because he did not have much confidence in
the projections.
It would be better, he thought, for the Committee
simply to call for maintaining existing conditions, and to plan on
deciding at the next meeting whether any change was required.
But
he did not feel sufficiently strongly on the matter to make a major
issue of it.
Mr. Swan said that total employment rose only slightly in
the Pacific Coast States in June, despite an unexpectedly large
increase in employment reported by aerospace firms.
With the labor
force rising somewhat faster, the rate of unemployment increased by
one-tenth of one per cent for the second successive month.
Housing
starts in the western States, as in the rest of the country, declined
in June and in the second quarter were 7 per cent below the first
quarter.
The extent to which the decline in housing starts of the
7/26/66
-58
past few years had been concentrated in the west, particularly
California, was evident from the figures.
From 1963 to the second
quarter of 1966, starts in the western States dropped more than 40
per cent, compared with a decline of between 5 and 10 per cent in
the rest of the country.
recent crosscurrents.
Within the area there had been some
In the Northwest--the States of Washington,
Oregon, and Idaho--residential construction contract awards in the
first five months of 1966 were higher than in the same period of
any of the previous four years.
Washington, in particular, had
experienced a sharp increase in residential building from a low
point in early 1965.
The other component of total construction-
nonresidential construction--was continuing at relatively high
levels.
While resources were not completely transferable between
the two kinds of construction, obviously there was some transfer
ability.
California chartered savings and loan associations did much
better in the first eleven days of July than in the corresponding
period in April, Mr, Swan said, and much better than they had
feared.
While exact figures were not available, their share
accounts apparently declined by about $100 million in the first
third of July, compared with over $300 million in that part of
April, and there were some indications of an increase in subsequent
days of July, although data were not yet available.
The California
7/26/66
-59
experience differed from that elsewhere;
in the country as a whole
the decline in association share accounts in early July was con
siderably larger than in April.
The regional Federal Home Loan
Bank had indicated that it had been able to make some loans
recently to provide for an expansion in mortgage lending activity,
rather than simply to help associations meet withdrawals.
The
relative improvement at California associations apparently was
related to the higher rates they were now paying.
By the first
of July the typical rate on passbook accounts had risen to 5-1/4
per cent, and on bonus accounts to 5-3/4 per cent.
Like banks,
savings and loan associations had found that advertising higher
rates on bonus accounts led to a substantial shift to such accounts
from passbook accounts.
He suspected that most of the associations'
customers did not realize that the 5-3/4 per cent rate was not
guaranteed, but that rates would be established quarter by quarter;
any reduction in the rate probably would come as a surprise to them.
In any case, Mr. Swan continued, the California associations
were no longer worried, as they had been some weeks ago, about the
possibility of an immediate massive outflow of funds.
Their concern
had now shifted to the longer-run problem of the profitability of
operations at the existing rate levels.
A few noninsured savings
and loan associations in Idaho and Utah had experienced difficulties
recently; one had closed and at least two others had invoked the
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30-day withdrawal notice provision of State law.
Those events,
however, apparently had not had any significant secondary effects.
In the two weeks ending July 13, Mr. Swan continued, the
District's weekly reporting banks gained considerably more IPC
time deposits than they lost in passbook savings deposits, but
the net increase was offset to a considerable degree by a decline
in public deposits.
As elsewhere, indications were that loan
demands continued strong.
He suspected, however, that some of
that demand reflected anticipations of higher interest rates and
lessened credit availability rather than current needs for funds.
The District's major banks continued to be net buyers of Federal
funds.
Borrowings from the Reserve Bank had been quite moderate
for some time and were negligible in the week ending July 13.
As
Mr. Irons had indicated was the case in the Eleventh District, the
borrowing figures for the Twelfth District fluctuated sharply in
the short-run depending on whether a large bank or two came to the
window.
As far as policy was concerned, Mr. Swan said, the Committee
was faced with the Treasury refunding, and there did not appear to
be grounds for any course other than maintaining an even keel.
Like others who had already expressed their views, he favored net
borrowed reserves in the $400-$500 million area.
He would hope
that the kind of increase in the bank credit proxy that was
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projected by the staff would be realized.
Given the uncertainties
associated with the Treasury financing, however, he thought the
Committee would have to rely on the Manager's judgment to some
degree.
With respect to the proviso clause of the draft directive,
while he agreed with those who favored some specific indication in
terms of the change in required reserves, he felt that the second
condition mentioned--relating to the Treasury financing--was the
significant one, and that it rendered the condition with respect
to required reserves less important.
With that qualification, he
would note that the phrase, "if required reserves are stronger
than expected" struck him as unclear.
Instead, he would suggest
the wording, "if required reserves increase measurably and con
ditions associated with the Treasury financing permit. ..
."
Such language would appear appropriate in light of the blue book
projection for virtually no increase, and at the same time it would
avoid the use of a specific figure.
Mr. Galusha said he would first make a few brief observa
tions about the Ninth District economy.
Appearances were that the
economy's growth also moderated somewhat in the second quarter; but
he would hastily add that second-quarter gains in production and
employment were still impressive.
He was unable at this time to
say whether the District economy's growth accelerated again in
June, but from his travels about the area he could report that the
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dominant mood was one of ebullience.
rural areas.
That was particularly so in
And, all things considered, perhaps that mood was
fitting for an economy with a relatively important agricultural
sector.
The economic implications of the philosophic revolution
now taking place in the U.S. Department of Agriculture were only
dimly perceived, but they were enormous and far-reaching for the
District economy.
In any event, if he had to predict national
economic activity on the basis of the soundings he had taken about
the District, he would have to join with the authors of the green
book and say that the recent slowing up was not to be taken very
seriously.
Mr. Galusha remarked that he, too, could be ebullientor nearly so, since he found the mood a hard one to manage under
the best of circumstances--if it were not for the country bankers,
some of whom persisted in a dim view of System membership.
threat of withdrawal continued very real in the District.
The
And a
change in the structure of reserve requirements, therefore, con
tinued as something very much to be desired.
Before turning from District developments, Mr. Galusha
said, he would respond to the Board's letter of July 19, 1966,
and comment briefly on country bank borrowing.
On trend, it had
been increasing--largely, he suspected, because monetary restraint
had been increasing.
This year, however, country bank borrowing
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in the District had increased a little less in relative importance
than one would have expected on the basis of seasonal forces.
The
normal seasonal pattern was for an increase in the relative impor
tance of country bank borrowing through July.
But, in June, before
the airlines strike, it was a bit under the seasonal expectation.
Naturally, that pleased him.
It confirmed what he had been told-
that administration of the Reserve Bank's discount window had not
changed.
As to open market policy, the present seemed to Mr. Galusha
to be a time for temporizing and, he thought, it would be so even
if there were no announcement of Treasury refunding terms in the
immediate offing.
As recent events had made clear and coming
events would, he believed, make clearer, a considerable increase
in monetary restraint had already been affected.
Moreover, the
quarterly increases in GNP projected by the Board's staff did not
greatly exceed those which would likely be consistent with near
stability in important components of over-all price indexes.
And
one could not be sure that the projections captured the full
effect of what had already been done by the Committee and the
Board.
In light of the relatively weak quarter just past, the
Committee would therefore do well to wait for additional confirma
tion of a return to more rapid growth before tightening further.
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He, for one, fully expected that that additional confirmation would
be rather quick in coming, but he still would prefer to temporize
now.
Mr. Galusha concurred in Mr. Irons' statement on the
directive proviso.
In introducing just one of the additional factors
to which the Desk might have to respond in order to maintain a
quality of credit stringency the Committee members were all agreed
was essential, there might be a danger of limiting the Desk's
response to other factors in the present time of uncertainty.
Like
Mr. Swan, he was bothered by the word "stronger" in the staff's
draft.
He supposed it was meant qualitatively as well as quantita
tively, but some clarification would be helpful.
He said he would
prefer deleting the whole proviso.
Mr. Scanlon reported that the economic picture in the
Seventh District in July did not differ appreciably from that of
June.
New housing starts had been reduced sharply and unemployment
had increased temporarily in auto centers.
No general improvement
in the availability.of experienced labor had occurred, however, and
upward price pressures continued dominant in markets for industrial
goods.
The principal concern of District bankers and businessmen-
other than international uncertainties--was the extent of labor
demands in negotiations later this year and in 1967.
Labor costs
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were widely expected to rise appreciably, thereby tending to erode
profit margins and push prices up further.
Delivery times on steel and aluminum products had eased in
the past month, Mr. Scanlon noted, and current and prospective
meat supplies had risen.
Some building materials were more readily
available, and freight car shortages had eased.
Those factors,
together with new industrial facilities coming into production,
were helping to restrain inflation but were not sufficient to
warrant complacency.
Despite the influx of students to the labor
force, labor shortages continued.
Over 60 per cent of Chicago
employers reported that their production was limited by their
inability to obtain an adequate labor force.
District savings and loan associations appeared to have
weathered the crucial midyear period with much less loss of funds
than had been feared, Mr. Scanlon continued.
Since April many of
those associations had been building liquidity and arranging credits
with commercial banks.
Although many associations were forced to
reduce liquid asset holdings substantially to satisfy net with
drawals of funds in July, there was relatively little need to resort
to borrowing.
Some associations that had been "out of the mortgage
market" since April were beginning to take an active interest in
new loan requests.
During the second quarter housing permits in
the Chicago area were 10 per cent below the same period a year
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earlier, in contrast to a rise of 40 per cent in the first quarter.
Average interest rates on new mortgages had continued to increase
throughout the District.
The banking statistics, coupled with further upward movements
in interest rates, indicated that credit demands remained very
strong, Mr. Scanlon said.
Loans had declined less than seasonally
this month following the unusually large expansion that occurred in
June, despite higher interest rates and more restrictive loan
policies.
Loan patterns at District banks had been similar to those
for the U.S. for the June-July period, with substantial increases in
loans to business and finance companies accompanied by a reduced
pace of real estate and consumer lending.
Major Chicago banks
reached a near-record basic deficit position in the second week of
July, but had since become somewhat more comfortable, with borrow
ings at the discount window sharply reduced.
Their outstanding
CD's had increased over the past month but by less than the tax
period outflow.
Mr. Scanlon commented that estimates through the first half
of July indicated continued rapid growth of bank credit and total
reserves.
The concurrent sharp rise in interest rates indicated
continued strong demand for credit.
The increase in interest rates,
coupled with the rise in net borrowed reserves, was consistent with
the policy directive adopted at the Committee's June 28 meeting,
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which called for reductions in net reserve availability if required
reserves expanded more than expected.
It appeared, however, that
credit demands were so strong that the recent policy posture had
not been sufficiently restrictive to slow reserve growth significantly.
He would like to see further pressure on reserve availability and
money market conditions in an effort to achieve some further slowing
in growth of required reserves.
The Reserve Bank directors continued
to feel an increase in the discount rate would be helpful in that
respect.
Their only question now was whether any increase should
be more than 1/2 per cent.
Mr. Scanlon concluded by saying that he realized that, for
the present, Treasury financing dictated no change in policy.
The
draft directive was acceptable to him with some of the amendments
that had been suggested.
He had interpreted the clause in the
second paragraph reading "if required reserves are stronger than
expected" to refer to the statement in the blue book that the
expectation was for no growth or only a very small growth in
required reserves.
Mr. Clay observed that for the period ahead Treasury financ
ing had to be taken into account in formulating and executing
monetary policy, thus leading to the desirability of an even keel
policy.
Apart from Treasury financing considerations, a further
effort to gradually reduce reserve availability would appear to be
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in order.
Developments and prospects in the domestic economy gave
continuing evidence of pressure on resources and upward movement of
prices.
That was a matter of concern in terms of both the domestic
economy and the international balance of payments.
The goal was not
one of increasing interest rates, but further action to reduce
reserve availability presumably would have such an impact on interest
rates.
One rate change that was needed was an increase in the
Federal Reserve discount rate, Mr. Clay said.
There were under
standable reasons for not raising the discount rate in early July,
and forthcoming Treasury financing activity was an additional factor
that would seem to prevent such action in the next few weeks.
Unless
economic and financial developments led to a substantial reversal in
money and capital markets, he thought that serious consideration
should be given to an increase in the discount rate following the
Treasury financing.
The present situation put a large premium on
borrowing at the Federal Reserve Banks and placed too much reliance
on discount window administration.
The draft economic policy direc
tive was acceptable to Mr. Clay.
Mr. Heflin said there had been no really significant changes
in the Fifth District except for a number of developments that
underscored the difficulties of projecting Government expenditures.
The textile industry continued under pressure from military demands
7/26/66
-69
for a wide range of goods, and the tobacco industry apparently was
receiving a significant stimulus from military demands for cigarettes
for shipment to forces overseas.
It was highly unlikely, however,
that the pressures on textiles and tobacco would continue at present
levels; in both industries there was a feeling that, because of the
heavy recent buying, future Government purchases would not be as
large as had been thought.
More generally, Mr. Heflin continued, economic activity
continued at a high level in the District.
The Reserve Bank's
latest business survey showed further employment gains in both the
manufacturing and nonmanufacturing sectors.
In early June insured
unemployment was at or near record lows throughout the District.
Dealers at the recent Southern Furniture Market were reported to be
bullish regarding the fall sales outlook, and the lumber industry
was currently enjoying prosperity, but both were concerned about
the probable effects on them of the slowdown in housing starts.
Loan demand was heavy and growing, Mr. Heflin remarked.
However, there had been practically no pressure at the discount
window except on the part of a few banks that had tended to borrow
heavily in the past.
The Reserve Bank had discussed the situation
with a number of those banks recently, as it had had to on previous
occasions.
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7/26/66
At the national level, it seemed to Mr. Heflin that the
moderating trend that had started in April was continuing.
That
conclusion differed from the one reached by the Board's staff in
the green book, perhaps because the staff at the Richmond Bank
emphasized past performance while the Board's staff emphasized
future prospects.
That made it appear that two different periods
were under consideration, as, to some extent, there were.
To him,
there was real significance in the second-quarter drop-offs in
growth rates of GNP by a third, industrial production by a half,
and payroll employment by somewhat more than half.
The production
and sale of automobiles had continued down except for a modest
rise in June, and housing starts and expenditures for new construc
tion continued to fall.
New orders for durable goods had registered
small declines in two of the past three months and, while unfilled
orders continued to grow, the rate of growth in the second quarter
was appreciably below that of the first quarter.
On the other side of the picture, Mr. Heflin continued,
there were only a few major series which showed an accelerating
upward trend.
erratically.
Inventories seemed to be moving up, if somewhat
Outlays for Medicare would be large and rising and
the recent increases in military and civil service pay scales
would add to purchasing power.
There also was the ever-present
possibility of sharply higher defense expenditures because of
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escalation in Vietnam.
But, while the picture was not clear, on
balance the areas that showed declines or slower rates of growth
seemed to outweigh those that showed strength.
With respect to policy, Mr. Heflin remarked that money
conditions now were the tightest in a generation.
Two months ago
the Committee had adopted essentially a holding policy, waiting to
see if the emerging trends toward moderation would continue and
grow.
It seemed to him that those trends had continued and had
not been offset by accelerating inflationary trends elsewhere.
With interest rates and credit availability at their present
levels, monetary policy would seem to be doing about all it could
to restrain inflation without taking undue risks of precipitating
a collapse.
The forthcoming Treasury financing and the new austerity
program recently inaugurated by the British Government also argued
against further tightening.
Mr. Heflin said he would associate himself with Mr. Irons'
position that it would be desirable to eliminate the proviso clause
in the draft directive.
Mr. Shepardson said that, notwithstanding the lower rates
of expansion in some areas that had been mentioned, it seemed to
him that the over-all pressures in the economy were continuing and
that the prospects were for further expansion at an excessive rate.
Were it not for the constraint imposed by the Treasury financing he
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would consider it entirely in order to press for a reduction in
credit availability.
Given that constraint, however, he thought the
proviso clause of the draft directive was appropriate.
He would
interpret the directive in terms of figures similar to those men
tioned by Mr. Ellis.
He thought it important, to the extent the
Treasury financing permitted, for the Desk to avoid slippages such
as had occurred from time to time in the past when the Committee
had been seeking to maintain reduced reserve availability.
Mr. Mitchell remarked that he did not have quite as much
confidence as the staff did in the projections.
Nevertheless, like
Mr. Shepardson he thought a little more firming of conditions would
be desirable.
Mr. Hayes' amendments to the first paragraph of the
draft directive were acceptable to him.
In the second paragraph he
(Mr. Mitchell) would replace the language after the semicolon with
the following:
"however, if conditions associated with the Treasury
financing permit, operations shall be conducted with a view to
attaining some further gradual reduction in net reserve availability,
some further firming of money market conditions, and a lesser growth
in money supply and required reserves than projected."
He had some
question about the desirability of accepting a projection as a policy
goal.
Also, he believed that there was real danger of some slippage
in August, and he would like to avoid it.
7/26/66
-73On the question of the discount rate, Mr. Mitchell said, he
was not in town when the Board acted on the increases voted by the
directors of several Reserve Banks, and he had not yet had an oppor
tunity to review the Board's reasons for not approving those increases.
He could say, however, that in his view a discount rate increase of
1/2 per cent would not make much sense at this time and he doubted
whether a I per cent increase would make sense as of today.
But,
if there were to be an increase, he would consider a rise of 1 per
cent to be far more appropriate than one of 1/2 per cent.
Mr. Maisel said that the period since the June 28 meeting
had been more favorable with respect to credit expansion than the
Committee had feared.
While in his view the expansion was slightly
larger than that contemplated in the proviso implementation clause,
the Desk was to be congratulated particularly because of the
emergency conditions under which it had to work.
The Committee was
rapidly approaching a point where its major monetary variables would
be on the proper growth path.
If the projected changes shown in
the blue book for required reserves and the bank credit proxy were
held to from now until the next meeting, the Committee would have
come close to that path.
From then on, a normal growth in those
variables should be maintained.
to stabilize.
That might allow the credit markets
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In the current situation, Mr. Maisel continued, variables
such as total deposits at all institutions and liquid assets were
already below a desirable growth path.
The staff had made clear
that there had also been a slowdown in growth in total credit.
The main difficulties were in business loans, where the rate of
increase was still far above a normal and satisfactory level.
In considering a possible discount rate change, Mr. Maisel
said, it was necessary to be certain that the decision was made in
the light of the total economy and not primarily for technical
market or monetary reasons.
What seemed reasonable on technical
grounds might be drastic in terms of the economy.
The past two
weeks had shown that the market could adjust technically to the
System's action or lack of action.
As the Manager had made clear,
the problems of the market were not primarily that of the discount
rate.
Since there was no way of estimating, even roughly, what the
announcement effects of a change would be, the utmost efforts should
be made to avoid having to run the danger of a move concerning whose
impact the System was basically ignorant.
The increased flexibility
of Desk operations and market moves gained in this period should be
extremely advantageous for the future.
The Committee should not be concerned even if the rate of
borrowing at the discount window doubled, Mr. Maisel continued, nor
about the fact that the discount rate might be advantageous for
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borrowers.
The Committee's concern was clearly with the economy.
It
should not place undue importance on minor costs or profit factors in
comparison to the whole market.
Larger borrowings would give the
opportunity to each of the banks in the System to stress the need for
more careful rationing of business loans and other loans that had a
major inflationary impact at the moment.
In concluding, Mr. Maisel said that the total impact on both
the economy and monetary policy of maintaining the present posture
should be advantageous in comparison to a change.
Mr. Brimmer said he would like to second Mr. Hayes' expres
sion of concern regarding the balance of payments.
In fact, he would
suggest that the directive show that the Committee had taken explicit
note of the extent to which the U.S. balance of payments figures were
being window-dressed.
There had been considerable discussion of
British window-dressing today, and it would be desirable to recognize
that the U.S. was doing the same.
For that purpose he suggested
revising the balance of payments sentence in the first paragraph of
the draft directive to read as follows:
"Despite the apparent
statistical improvement resulting from special official transactions,
the balance of payments situation continues to reflect a heavy under
lying deficit."
Statistics apart, Mr. Brimmer continued, he agreed that the
underlying balance of payments situation was serious and the need for
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progress was as real as ever.
But he did not necessarily agree with
Mr. Coombs that U.S. direct investment abroad and the tourism gap
were the most important areas for attack.
In his judgment there were
some other areas that would have to be considered if the present
serious situation was to be combatted, but he would not take time to
catalogue them now.
Mr. Brimmer indicated that he, too, thought the Desk's recent
performance had been admirable--especially the manner in which the
technique of matched sales-purchase contracts had been used to deal
with the rise in float.
He thought the Committee had made the right
decision in approving use of that technique at its July 11 telephone
conference, and that it should take note of how well the operation
had been carried out.
He had suggested that the Desk keep close
track of the costs of the operation, and he was pleased to note from
Mr. Holmes' memorandum of July 22 that the costs were quite small.
Mr. Brimmer remarked that he had gone to some lengths
recently to make public in specific fashion his views on what should
be done about growth in bank loans.
He felt as strongly now as he
had a week ago that the Committee should not simply focus on over-all
bank credit--although he thought that was growing too rapidly--but
should consider its composition, to ensure that restraint did not
bear unduly heavily on any one sector.
It also was important to
note the extent to which monetary policy was carrying the burden of
7/26/66
-77
restraint.
While he did not expect a tax increase nor elimination
of the investment tax credit in the immediate future, he felt that
sight should not be lost of their desirability.
With respect to policy, Mr. Brimmer thought it was necessary
to look beyond the coming four weeks; indeed, he hoped the Committee's
procedures would evolve in the direction of planning ahead for two
or three policy periods rather than for the single period until the
next meeting.
Thus, while he recognized the need for even keel
during the Treasury financing, he thought that further restraint
would be required after the financing.
Because any slippage in the
coming period would make subsequent firming more difficult, he urged
the Manager to keep slippage to a minimum.
A very modest increase
in required reserves would be good, and no increase at all would be
better. Net borrowed reserves should be at the deeper end of the
$400-$500 million range.
In sum, he would hold to as much firmness
as possible during the financing and plan on proceeding with further
gradual and orderly tightening afterward.
Mr. Brimmer said he would not go into the subject of the
discount rate today except to note that he personally did not con
sider it obsolete as an instrument of monetary policy.
In his
judgment it should continue to be used along with the other policy
instruments, and it would be appropriate for the System to again
consider the desirability of an increase when the time was propitious.
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Finally, Mr. Brimmer said, the Committee should take into
account the current discussions in Congress of possible means to
moderate rate competition among financial institutions.
While bills
currently under discussion would not necessarily be enacted in their
present form, it was quite likely that some expression of a Congres
sional intent to moderate competition would be forthcoming soon,
perhaps before the Committee met next.
Mr. Hickman commented that although business activity
moderated in the second quarter, June was decidedly stronger than
April and May, and the latest readings indicated a fast pace for
July.
While average second-quarter performance might be acceptable
if it could be maintained, danger signals continued to predominate
in major sectors.
Defense spending and business spending were point
ing sharply upward and indications were that GNP advances in the
third and fourth quarters would accelerate.
Price developments continued to be disquieting, Mr. Hickman
said.
The 0.9 per cent increase in the GNP deflator during each of
the past two quarters was well above tolerable limits.
Price rises
had accounted for increasingly larger shares of recent quarterly
gains in GNP, from 20 per cent of the gain in the fourth quarter of
last year to 40 per cent in the first quarter, and to 60 per cent in
the second quarter.
The share of the GNP gain in the second quarter
accounted for by price changes was the largest since the first
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quarter of 1961, except for the abnormal fourth quarter of 1964.
Prices of producers' equipment, in particular, continued to rise
at an uncomfortably high rate and prices of consumer services were
increasing steadily.
With the labor market tight and with a large
number of wage contracts to be renegotiated in the months ahead,
the country could easily drift into cost-push inflation in 1967.
Given that environment, Mr. Hickman thought it was fortunate
that some economic series were declining and others were showing
little further advance.
Signs of moderation were evident in such
areas as construction spending, housing starts, length of the
average workweek, new orders for durable goods, and retail sales.
The airline strike, now in its third week, was bullish on float but
had provided some fortuitous assistance in cooling off the economic
advance.
With the Treasury refunding operation in August scheduled
felt that no change in
to be announced later this week, Mr. Hikkman [sic]
monetary policy was indicated for the next few weeks.
Nonetheless,
the July projections for reserves and bank credit were very strong,
and everything possible should be done to prevent the System from
losing ground.
Once the Treasury refunding was out of the way, the
directors of the Cleveland Reserve Bank would probably vote once
again to increase the discount rate by one-half per cent to help
restrain excessive use of the discount window, which was occurring
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in some Districts.
No further change in Regulation Q was indicated.
The present ceiling, in combination with higher money rates--induced
by the higher discount rate, if and when it was approved by the Board
of Governors--would serve as a check on bank lending, particularly
in the money centers, where it had been too buoyant.
In addition, Mr. Hickman continued, some sort of fiscal
policy action was needed, as Mr. Brimmer had suggested, to help
maintain balanced growth in the period ahead.
His own preference
would be for an across-the-board increase in income taxes, both
personal and corporate.
The great danger now facing the U.S.
economy was another surge of demand such as had been experienced in
the fourth quarter of 1965 and the first quarter of 1966.
The
deterioration in the U.S. trade account was an additional reason
why prompt action should be taken now to prevent the economy from
further inflationary overheating.
Mr. Hickman said he favored the staff's draft directive,
including the proviso, with the hope that the credit proxy would be
held in August to an annual rate of increase of no more than 4 or 6
per cent.
Mr. Bopp remarked that despite continued evidences of some
slowing--particularly in autos and housing--no significant relief
from pressures at work in the national economy had yet appeared.
A month ago there were signs that some sectors of the Third District
7/26/66
-81
economy might be slackening, but latest information suggested they
were a false alarm.
In that kind of atmosphere, perhaps the best
kind of news that could be expected was failure of fears to materi
alize.
That seemed to have been the case with savings flows in July.
In the Philadelphia area, commercial banks gained substantially,
mutual savings banks lost fairly heavy amounts, and savings and loan
associations lost still more.
But all of the mutuals held off from
raising rates from the level of 4-1/4 per cent which now had pre
vailed for a considerable time, and a few savings and loan
associations also held their rates at that level.
The general
feeling of savings institutions in the area was that, given their
relatively low rates, they had passed through the period with no
dire results.
Having been on the conference call since the last meeting
of the Committee, Mr. Bopp said, he had worried along with the Manager
during the airline strike and had shared his relief at the way things
had worked out to date.
The innovation of matched sale-purchase
contracts looked like a useful addition to the tool kit.
When it came to the outlook for the flow of money and credit,
Mr. Bopp wished he could see equally favorable outcomes.
Although
the money supply certainly looked better for July, bank credit was
probably a more meaningful measure at this time.
As nearly as he
could determine, demands for bank credit were still very strong and
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were likely to remain so.
To get some quantitative idea of what
might lie ahead, the Reserve Bank had asked the Philadelphia commer
cial banks for their forecasts of loan volume.
The state of their
forecasting art was rather rudimentary, so the results had to be
interpreted with allowance for considerable error.
They indicated,
however, that loan volume was expected to rise further in the third
quarter but at a slower rate than in the second quarter.
That was
partly seasonal, but it also reflected management policy of restraint
and confirmed what the Reserve Bank had learned from the survey of
lending practices.
Given the stubbornness of credit flows in responding to
restrictive policy to date, Mr. Bopp said, it was perhaps question
able whether the current degree of pressure on marginal reserve
positions would achieve a more reasonable rate of growth of credit
in the future.
But net borrowed reserves had, after all, been
increased to the highest level since 1959, and if the Committee
simply maintained its present posture increasing credit demands
would force still greater tightness.
Rising rates would press
harder on Regulation Q ceilings and force more banks to the discount
window.
On the other hand, if bank credit and required reserves
continued to increase rapidly, it might be necessary to push some
what further in reducing marginal reserve availability.
On that
reasoning, and in consideration of the forthcoming Treasury
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financing, he accepted the staff's draft directive, as modified by
Messrs. Hayes, Mitchell, and Brimmer.
Mr. Bopp thought that an increase in the discount rate of
1/2 per cent would be desirable at the earliest feasible time.
He
noted that the directors of the Philadelphia Reserve Bank had voted
for such an increase on July 21.
Mr. Kimbrel observed that four weeks ago he had reported
that expansionary forces in the Sixth District had diminished in
intensity.
The signposts now seen still did not indicate a return
to the ebullient growth of last winter.
Yet, it was also evident
that business activity had advanced more swiftly in June than in
early spring.
Employment gains had become larger, and automobile
sales increased 7 per cent to just a shade below last year's level.
Looking ahead, the auto sales picture was clouded by heavy dealer
inventories, which for some major makes were equivalent to a two
months' supply.
A definitely distressing factor was the airlines
strike, which already had had noticeable effects on Florida's
tourist industry.
Should that walkout be settled on terms greatly
in excess of the guidelines, its impact, of course, could become
far more serious than it was now.
Mr. Kimbrel said that bright expectations in residential
housing were hard to find.
Significant cutbacks had occurred in
many places, especially in New Orleans, Nashville, and Huntsville.
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Except in Atlanta, the chief depressants had been overbuilding in the
past and reduced demand due to location shifts in defense and space
activity.
factor.
Only in Atlanta had tight mortgage money been a critical
On conventional mortgages of savings and loan associations,
the most frequently reported rate in Atlanta was now 6-3/4 per cent,
while for some associations the minimum lending rate was 7 per cent.
Fierce competition between banks and savings and loan associations
had subsided somewhat.
And because of the issuance of new 5 per
cent certificates, most savings and loan associations managed to
get by the June 30 dividend period with smaller savings losses than
last quarter.
Construction volume, as indicated by housing starts,
however, did not yet fully reflect the lagging effects of stringency
in the mortgage market.
Mr. Kimbrel indicated that the banking data were difficult
to interpret because of revisions in coverage, but there was some
indication that loan growth at the larger banks slowed down in the
first half of July, as some banks had difficulty in retaining their
negotiable CD's.
On the other hand, smaller banks were still
experiencing very strong loan expansion, and their time deposit
growth continued without letup.
Although credit tightening affected
the smaller banks last, it would appear that they should soon begin
to feel those pressures to an increasing extent even without more
credit restraint.
Greater prevalence of those conditions in the
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District would perhaps suggest that the greatest concern should be
with maintaining the present momentum rather than with intensifying
restraint.
Mr. Francis noted that total demand for goods and services
had risen about 9 per cent in the past year.
That sharp rise in
demand had been excessive in view of the limited amount of idle
capacity and the growth rates in labor, capital, and technology.
As a result the economy had suffered many inefficiencies due to the
strain on its resources, the nation's balance of payments with other
countries had deteriorated, and prices had been rising at an
accelerating rate.
During 1965, each 1 per cent annual rate of
increase in real output had been accompanied by a 0.2 per cent
rise in prices; from the fourth quarter of last year to the first
quarter of this year each 1 per cent gain had been accompanied by
a 0.6 per cent rise in prices; from the first quarter to the third
quarter figures projected by the staff, each 1 per cent rise in real
product would be accompanied by a 1.1 per cent rise in prices.
The strong rise in total demand had been in part the result
of very stimulative fiscal actions flowing chiefly from the Vietnam
conflict, Mr. Francis said.
The high employment budget, which
apparently was the best measure of the influence of Government
actions on total demand, ran at about a $7 billion surplus in the
first half of 1965 and had since been at about a $1 billion surplus
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level.
Also, considered after the fact, it was possible that in the
absence of appropriate fiscal restraint monetary actions could have
prevented so great a rise of total demand.
Bank reserves, bank
credit, and the money supply had all risen very rapidly during the
past year.
Although market interest rates had gone up, the rise had
not been reflected in the real price of borrowed funds to the lender
and the real return to the saver since the effect of the higher rate
of inflation on the value of money had more than offset the rise in
interest rates.
Now the use of resources was becoming still more strained,
Mr. Francis continued.
Investment plans of business were unabated,
and it appeared that the Federal budget stance was becoming increas
ingly stimulative.
He noted that the staff estimate for
current-dollar GNP in the third quarter was an annual rate of $746
billion, up at an 8 per cent annual rate.
It seemed to him that,
unless Government policy was altered, the prospects were for greater
surges of total demand.
He feared that with the more stimulative
Federal budget and acceleration of personal income, consumer
spending, and business fixed investment, total demand would push
forward more rapidly than at any time in the past few years, while
the available resources for expansion of real product would be less
than at any other recent time.
Also, the prospects were for continued
deterioration of the U.S. international payments situation.
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Accordingly, Mr. Francis remarked, there was even greater
need for fiscal restraint, and pending that, for monetary management
to do whatever it could to restrain total demand.
It was necessary
to keep total demand from rising at an 8 or 9 per cent rate when
potentialities for increasing real product were expanding at only a
4 per cent rate.
It would seem appropriate for bank reserves, bank
credit, and money to rise at much slower rates than they had over
the past year.
Recently there appeared to have been some moderation
in the growth rate in money, but the slowdown might have been only
the temporary result of an unusually high Treasury balance.
He
thought that slower growth in money was desirable and that the Com
mittee needed to consider the desirability of keeping down the
growth rate as Treasury balances were again reduced.
Mr. Francis observed that the St. Louis Reserve Bank's
board of directors, as expressed by their action on July 14 in
raising the discount rate by one-half on one per cent, viewed the
current situation about as expressed by Messrs. Hayes and Ellis on
behalf of their directors.
He noted that he had already responded
to the Board's letter with reference to discounts and would not
comment further on that subject.
No problems had developed at
Eighth District savings and loan associations during the recent
period.
7/26/66
-88Mr. Robertson then made the following statement:
Clearly, open market operations between now and the
next meeting of the Committee are going to have to be
governed by "even keel" considerations. Just how long
and how severely restraining those considerations will
be cannot be predicted as yet, for we do not even know
the Treasury's proposed refinancing terms for certain,
let alone the question of market response thereto.
Basically, therefore, we shall have to rely on the Man
ager's judgment of the severity of the "even keel"
limitations as events unfold.
However, the developments I see taking place in the
economy at large make me want to urge the Manager to
maintain as tight a money and credit tone as he can with
in that "even keel" constraint. The resurgence in
business activity following the second quarter slowdown,
the continuing substantial rise in prices, and the
evident labor market pressures all argue for a policy
of monetary tightness. Looking at the financial system,
one sees a good many signs of tightness already presentenough so that I would not want to add substantially to
those pressures just now--but I certainly favor keeping
up the pressure on reserve positions to guard against
any backsliding in the posture of monetary restraint.
In fact, if expansion in bank credit and aggregate
reserves threatens to get out of hand, I would not
hesitate to deepen net borrowed reserves to $500 million
or even a shade beyond. I would not want to countenance
any more than a very short run expansion in reserves at
a time of a Treasury financing, for cash or otherwise.
Neither domestic economic activity, price movements, nor
the balance of payments gives any reason for lessening
our concern over the pace of aggregate reserve expansion.
Since our instructions to the Manager are often cast
in nautical terms, let me say that I am prepared to have
us maintain an "even keel" during this period, but I also
very much want us to keep a "taut ship" as well. In
landlubber language, this means that I favor the draft
directive as presented by the staff, including the proviso.
Now for a word concerning the proviso. What we
should be aiming at, in our deliberations, is the way in
which to reduce or absorb some of the excess demand in the
economy. We should seek to do this by curbing the expan
sion of bank credit--not just by helping to shove interest
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rates higher. Since December, our record in this regard
(i.e., contracting the expansion of credit) has not been
too good. But it has been better since we began using
the proviso--since we began focusing attention on the rate
of expansion of bank credit as evidenced by increases in
required reserves.
As I understand the proviso, what we are trying to
do is to build into the directive some protection against
an unduly large expansion in bank reserves. At other
times, it might be protection against an unduly small
expansion. Under current circumstances, all we are doing
is saying to the Manager that if required reserves look as
though they are growing faster than some rate, he should
deepen net borrowed reserves in order to discourage faster
growth. Our ability to do this obviously does not depend
on whether staff projections turn out to be right or
wrong. While current projections provide a starting point
for our decision, the rate of growth in required reserves
that is of concern to the Manager is evidently the rate
the Committee chooses.
For my part, I would be willing to tolerate whatever
small growth in "required" is consistent with 4 to 6 per
cent bank credit growth--which happens to be the expecta
tion of our staff. With such growth over the next few
weeks, I would not make special efforts to deepen net
borrowed reserves beyond the $400-$500 million range.
But if growth in required reserves and bank credit became
more rapid, I would not hesitate to deepen beyond $500
million, bearing only in mind the limitations necessitated
by the Treasury financing operation.
Mr. Robertson added that since a number of comments had
been made on the discount rate he thought he should comment also.
In his judgment every board of directors should make whatever
decision it thought was right.
So long as he was in his present
position--in the absence of Chairman Martin--he would never tell
any Reserve Bank President what his Bank should do with respect to
discount rates.
On the other hand, the Board itself had to make
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decisions in the light of the picture as it saw it, and the decision
of the Board might differ from that of the Banks.
That should not
create any animosity between the Board and the Banks.
The Board's
decision could not be based solely on whether the discount rate
was out of line with market rates; the problem was much deeper than
that.
It was necessary to recognize that there was sentiment in the
Administration against escalation of interest rates, and a tendency
to view discount rate increases as contributing to such escalation.
The System had to have a strong case before risking any enlargement
of that feeling.
If the case was good, the risk should be taken;
otherwise, it should not be.
The discount rate obviously was out
of line with market rates, but no one had made a case persuasive to
him that additional price action was needed to operate the discount
window effectively.
The volume of borrowing had not been unusually
large for a period such as the present; it was not nearly as large
as it had been in 1959, for example.
It was his personal view that
the System would have much more control over lending by member banks
if they were borrowing in larger amounts and open market operations
were being relied on less to supply reserves.
Of course, in saying
that the price mechanism was not needed now to operate the discount
window effectively he was assuming that the situation was still as
reported by the Presidents recently--namely, that the smaller banks,
which were doing much of the borrowing, were not borrowing and con
currently selling Federal funds to the large city banks,
And he
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assumed that the discount windows were being watched with that
possibility in mind.
The next time the discount rate came up for consideration,
Mr. Robertson said, the Reserve Banks should make their own
decisions.
The Board would do the same in light of what action it
thought, from its own vantage point, would be in the best interests
of the country.
While there might be differences of opinion reflect
ing differences in points of view, he would hope that there would
be no resulting animosity.
The whole Administration was involved in the effort to
stop the escalation of interest rates, Mr. Robertson continued,
and recently he had attended many meetings on the subject with
representatives of various parts of the Government.
The general
feeling was that the "rate race"--if one might call it that--had
to be stopped, because if it were not nonbank financial institutions
would find themselves in great difficulty perhaps 6 months or a year
hence, and ultimately irreparable harm would be done to the whole
financial system, including banks.
It also was thought that the
impact of restrictive monetary policy was being felt too much in
one area.
In sum, the view was that the rate race had to stop.
As the Committee knew, the Board had taken action with respect to
multiple maturity time deposits, and it also had recommended
legislation that would give the Federal Reserve, the Federal
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Deposit Insurance Corporation, and the Federal Home Loan Bank Board
discretionary authority to set ceiling rates on any reasonable basis
they deemed appropriate.
Mr. Robertson then summarized recent discussions with the
Administration, and between the Administration and members of
Congress, regarding alternative forms of possible legislation on
deposit interest rates.
Mr. Hayes commented that there were a number of reasons for
profound concern at present, including the uncomfortable interna
tional position of the dollar, the absence of tax action, and the
lonely position of monetary policy.
He was happy that Mr. Robertson
had said what he had about the discount rate, and he (Mr. Hayes) was
sure that there was no animosity on the part of the Reserve Banks as
a result of the Board's recent decision.
The Committee's consensus on policy today seemed relatively
clear, Mr. Hayes said.
There was a general wish to keep a tight
rein on credit expansion, and a general awareness that the Committee's
ability to act in that area was considerably restricted by the Treasury
financing and the consequent need to maintain an even keel.
He thought
it would not prove too difficult to develop language for the directive
that would meet the wishes of a majority of the Committee.
A discussion of the wording of the first paragraph of the
directive followed, in the course of which it was agreed to accept
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Mr. Hayes' suggestion for the first sentence and a modified version
of Mr. Brimmer's suggestion for the sentence referring to the balance
of payments.
Mr. Hayes then noted that a number of changes had been sug
gested in the staff's draft of the second paragraph of the directive,
most of which were primarily matters of wording.
However, Mr.
Mitchell had suggested a more substantive change, calling for further
firming to the extent that the Treasury financing permitted.
As he
understood the views expressed, a majority wanted to make any further
firming contingent on developments with respect to required reserves
as well as on conditions associated with the financing.
Mr. Mitchell said that he would be prepared to accept a
second paragraph along the lines of the staff draft if it was clear
that a majority did not favor language such as he had proposed.
He
suggested that an expression of views be called for with respect to
his proposed language.
Mr. Shepardson also spoke in favor of a poll of the Committee
on the question.
At Mr. Hayes' request, the Secretary then polled the Commit
tee.
Messrs. Bopp, Brimmer, Mitchell, and Shepardson indicated that
they would prefer the language Mr. Mitchell had proposed, and the
other six members indicated that they would not.
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7/26/66
The Committee then agreed upon a second paragraph consisting
of the staff draft with wording changes of the kind suggested by
Mr. Ellis.
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 Sys
tem Account in accordance with the
following current economic policy
directive:
The economic and financial developments reviewed at
this meeting indicate that over-all domestic economic
activity appears to be expanding somewhat more rapidly
than in the second quarter despite weakness in residen
tial construction, with industrial prices rising further.
Total credit demands continue strong and financial markets,
particularly for mortgages, remain tight. Despite the
statistical improvement resulting largely from special
transactions, the balance of payments situation continues
to reflect a sizable underlying deficit. 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, while taking into account
the forthcoming Treasury financing, System open market
operations until the next meeting of the Committee shall
be conducted with a view to maintaining about the current
state of net reserve availability and related money market
conditions; provided, however, that if required reserves
expand more rapidly than expected and if conditions
associated with the Treasury financing permit, operations
shall be conducted with a view to attaining some further
gradual reduction in net reserve availability and firming
of money market conditions.
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It was agreed that the next meeting of the Committee would
be held on Tuesday, August 23, 1966, at 9:30 a.m.
Thereupon the meeting adjourned.
ATTACHMENT A
CONFIDENTIAL (FR)
July 25, 1966
Draft of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on July 26, 1966.
The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is expand
ing somewhat more rapidly than in the second quarter despite weakness
in residential construction, with industrial prices rising further.
Total credit demands continue strong and financial markets, particu
larly for mortgages, remain tight. The balance of payments continues
in deficit. In this situation, it is the Federal Open Market Commit
tee'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, while taking into account the
forthcoming Treasury financing, System open market operations until
the next meeting of the Committee shall be conducted with a view to
maintaining about the current state of net reserve availability and
related money market conditions; provided, however, that if required
reserves are stronger than expected and conditions associated with
the Treasury financing permit, operations shall be conducted with a
view to attaining some further gradual reduction in net reserve
availability and firming of money market conditions.
Cite this document
Federal Reserve (1966, July 25). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19660726
@misc{wtfs_fomc_minutes_19660726,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {Jul},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19660726},
note = {Retrieved via When the Fed Speaks corpus}
}