FOMC Minutes
A meeting of the Federal Open Market Committee was held
in the offices of the Board of Governors of the Federal Reserve
System in Washington, D. C.,
on Tuesday, August 23, 1966, at
11:30 a.m.1/
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Hayes, Vice Chairman
Bopp
Brimmer
Clay
Daane
Hickman
Irons
Maisel
Mitchell
Robertson2/
Shepardson
Messrs. Wayne, Scanlon, Francis, and Swan, Alternate
Members of the Federal Open Market Committee
Messrs. Ellis, Patterson, and Galusha, Presidents of
the Federal Reserve Banks of Boston, Atlanta,
and Minneapolis, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Molony, Assistant Secretary
Mr. Hexter, Assistant General Counsel
Mr. Brill, Economist
Messrs. Garvy, Green, Mann, Partee, Tow, and
Young, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account
Mr. Cardon, Legislative Counsel, Board
of Governors
Mr. Fauver, Assistant to the Board of Governors
1/ This meeting was preceded by a joint meeting of the Board and
the Reserve Bank Presidents to discuss certain proposals regarding
discount administration. Copies of the minutes of the joint
meeting have been placed in the Board's files.
2/ Withdrew from meeting at point indicated in minutes.
8/23/66
Mr. Garfield, Adviser, Division of Research
and Statistics, Board of Governors
Mr. Reynolds, Adviser, Division of
International Finance, Board of Governors
Mr. Gramley, Associate Adviser, Division of
Research and Statistics, Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Mr. Bernard, Economist, Government Finance
Section, Division of Research and
Statistics, Board of Governors
Mr. Furth, Consultant, Board of Governors
Mr. Strothman, First Vice President, Federal
Reserve Bank of Minneapolis
Messrs. Taylor, Baughman, Jones, and Craven,
Vice Presidents of the Federal Reserve
Banks of Atlanta, Chicago, St. Louis, and
San Francisco, respectively
Mr. Monhollon, Assistant Vice President,
Federal Reserve Bank of Richmond
Mr. Deming, Manager, Securities Department,
Federal Reserve Bank of New York
Messrs. Arena and Rothwell, Economists, Federal
Reserve Banks of Boston and Philadelphia,
respectively
Upon motion duly made and seconded, and
by unanimous vote, the minutes of the meeting
of the Federal Open Market Committee held on
July 26, 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 July 26 through August 17, 1966, and a
supplemental report for August 18 through 22, 1966.
Copies of
these reports have been placed in the files of the Committee.
8/23/66
In comments supplementing the written reports, Mr. Coombs
said that the gold stock was being reduced by $75 million today
in order to replenish the Stabilization Fund, which had been hit
by a French gold order of $145 million.
On the London gold market,
recurrent buying pressure had now reduced resources of the gold
pool to $76 million, representing a drain of $236 million since
the first of the year.
What he found most ominous was the large
suppressed demand for gold.
Such demand had been suppressed by
the very tight money conditions throughout the world, but it could
break through into the market if there was any serious disruption
in the circle of parities.
At the time of the previous meeting of the Committee,
Mr. Coombs recalled, the fate of sterling was hanging in the
balance. If a collapse had occurred, the System probably would
have been struggling today to halt a speculative onslaught
against the dollar.
However, a number of acute uncertainties
present at the time of the previous meeting--the risk of a
breakdown of the Wilson Cabinet, the risk that Chancellor Callaghan
would fail to support the wage-price freeze, and the risk that the
trade unions would revolt--had all receded, at least for the time
being.
The British program was about as drastic as could have
been expected, and it should soon begin to bite.
Nevertheless,
the general atmosphere in the exchange market remained almost as
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8/23/66
despondent as before; everyone who could stay short of sterling
continued to do so.
In that atmosphere, sterling remained highly
vulnerable to any new setback, and selling pressures had resumed
during the past few days, perhaps reflecting some speculation
associated with the forthcoming Fund-Bank annual meetings.
On
the other hand, if something could be done to trigger a shift in
expectations, and if the enormous short position in sterling that
had been built up over the past few months could be exploited, the
situation might turn around.
During July, Mr. Coombs continued, the British ran a
deficit of $1,120 million, of which $1,050 million was covered by
central bank and other assistance.
They chose at month-end to show
a reserve reduction of only $70 million.
That report was greeted
with derision in the market, but the market also took the report
as a sign that the British apparently still had plenty of credit
resources at their command and sterling actually improved a little
after the figures were announced.
To cover the total deficit the
Bank of England made a three-month drawing of $100 million on the
Federal Reserve swap line; it drew another $100 million on the
Bankfor International Settlements, and $130 million on the sterling
balance credit package negotiated at Basle last June.
In addition
the Federal Reserve and the Treasury supplied $145 million through
purchases of guaranteed sterling.
Finally, at month-end the
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8/23/66
Federal Reserve and the Treasury supplied $400 million of over
night credit, and an additional $175 million of such overnight
credits were obtained from four other central banks.
Of that
total of $1,050 million of credit assistance, the British repaid
$575 million on August 1, so in effect they began the month of
August facing a deficit of $575 million.
So far this month they
had suffered sizable further losses, which by month-end might
easily come to $400 million.
Perhaps half of that amount, i.e.
$200 million, might be covered by further drawings upon the
sterling balance package, and they might want to cover the bulk
of the remaining $200 million by further three-month drawings on
the System swap line, under which $250 million was already
outstanding.
Reverting to the total of $575 million of overnight money
provided at the end of July by the Treasury, the Federal Reserve,
and four foreign central banks, Mr. Coombs said he could see no
alternative but to repeat that operation at the end of August.
He
would hope that the $175 million obtained at the end of July from
four foreign central banks would again be available.
If August 31
fell on any other day but Wednesday, he would also have recommended
at this meeting that the Federal Reserve join with the Treasury in
overnight credits of $200 million from each agency.
But since an
overnight credit extended by the System on a Wednesday would show
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up dollar for dollar in the "other assets" item in the weekly
statement, it had seemed to him preferable to recommend to the
Treasury that they take over the entire $400 million of overnight
money.
The Treasury had agreed to do so.
What was foreseeable,
as far as the System was concerned, between now and the end of the
month was a possible drawing by the British of $100, or even
$150 million, on the Federal Reserve swap line on a 3-month basis.
Mr. Coombs also mentioned that the System Account yesterday
bought $250 million of lire from the Treasury, which had acquired
the lire in a special borrowing from the International Monetary Fund.
Of the amount purchased, $225 million had been used to pay off the
outstanding drawings under the swap line with the Bank of Italy.
In effect, the Treasury had provided the System with a backstop
for swap drawings which, in the case of Italy, were threatening
to run on too long.
He would hope that was a precedent for opera
tions in other currencies.
There was now open access to the Fund,
through the technique developed in the case of lire, and that should
help to relieve the worries Committee members and the Account
Management had felt about getting involved in swap drawings that
might go on too long.
The remaining $25 million of lire obtained
from the Treasury was used to pay down the System's forward commit
ment to the Bank for International Settlements, totaling $40 million,
to deliver lire for sterling.
8/23/66
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
July 26 through August 22, 1966, were
approved, ratified, and confirmed.
Mr. Coombs noted that the $100 million standby swap arrange
ment with the Netherlands Bank, having a term of three months, expired
September 15, 1966.
He recommended renewal for another three-month
period.
Renewal of the standby swap with
the Netherlands Bank was approved.
Mr. Coombs then commented on his memorandum dated August 18,
1966, on sterling and the gold market, a copy of which has been
placed in the Committee's files.
In that memorandum, he recalled,
he had pointed to the risk of a new crisis in either sterling or
the gold market, or both, which could be triggered by speculation
about a devaluation of sterling during the course of the annual
Fund and Bank meetings.
Those meetings often stimulated speculation
about changes in parities, and this year such speculation probably
would focus on sterling.
Since the memorandum was prepared, the
risk had, in his judgment, become more imminent and more menacing.
In fact, he was beginning to think there might be some serious
trouble immediately following the publication on September 2 of
the British reserve figures for August.
Earlier the Bank of England
had been hopeful that through market swaps and similar arrangements
8/23/66
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it might be able to show a small gain for the month and to indicate
simultaneously that no additional recourse to central bank credit
had been made during the month.
They would then have reported a
true figure, and that could have had a useful effect in tilting
the balance of expectations in favor of sterling.
But the way things looked now, Mr. Coombs said, on
September 2 the British would have to announce either a reduction
of reserves, an acknowledgment of further recourse to central bank
credit, or both.
The market reaction to such an announcement,
coming as it would 40 days after the new policy package was
announced on July 20, might well set off a new burst of selling,
which undoubtedly would be aggravated by speculative talk associated
with the Fund and Bank meetings.
As the Committee could see from
the figures he had quoted, the British had been utilizing their
credits at a rapid clip, and it might not take much longer to run
through all of them.
If
a final effort was to be made to defend
not only sterling but, more particularly, the dollar, through
enlarging the swap network, he thought it was necessary to begin
moving right away.
Mr. Coombs said he would like to make one point clear:
it
was quite true that the immediate reason for suggesting a massive
increase in the swap network was the speculative pressure on sterling,
but the basic reason was to avoid the pressure on the dollar that
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would result from a sudden collapse of sterling.
The dollar would
become the target if sterling were to collapse, and the pressure
would be reinforced by the probability of a breakout on the
London gold market.
If sterling did go down, the System would
have already in place the additional borrowing facilities with the
continental central banks that would be indispensable to a success
ful defense of the dollar.
Of course, there was the possibility
of last-minute negotiations, but such negotiations during the past
few years had involved finding the right people on hand at the
time they were needed; the next time they might not be there.
In
summary, whether sterling stood or fell, he saw an urgent need for
swap line increases of the kinds suggested in his memorandum.
There was admittedly a risk, Mr. Coombs added, that such
a major reinforcement of the swap lines might suggest a spirit of
desperation, and thus alarm the market further.
However, that had
not been the market reaction to other recent announcements of
central bank credit arrangements.
Those announcements had invar
iably been received as evidence of the determination of the central
banks to act together in defense against speculative pressures.
At
present the market was aware of the virtual breakdown of the Group
of Ten negotiations looking toward the creation of additional
reserve assets.
It was aware of the pressure on sterling and the
situation with respect to Vietnam.
There was a growing feeling
8/23/66
-10
that the whole system of international financial solidarity was
beginning to come apart.
Announcement of a new large effort
demonstrating to the market that it was not coming apart--in fact
was being strengthened--should do a lot to change that psychology.
The greater risk, Mr. Coombs said, was that a new package
of credit facilities might suggest to the market that the existing
facilities had been virtually exhausted.
But that risk could
readily be averted if all outstanding drawings under the swap
network were reported as of the end of August.
It would be highly
useful, in the event of an increase in the British swap line, for
the British to publish exactly what they owed under it.
That
would make it clear to the market that not only were those credit
facilities being increased but that a large unexpended balance was
available for intervention.
In summary, Mr. Coombs said, he thought there was the clear
danger of a breakdown of the international financial system within
the next month or 6 weeks.
He saw very little that the Group of
Ten could do to stop it; their negotiations had reached an impasse.
The U.S. Treasury was not in a position to do a great deal about
it.
The Stabilization Fund had only limited amounts of money and
the Treasury was set against providing medium-term credit through
the Export-Import Bank.
Open Market Committee.
The burden therefore fell directly on the
8/23/66
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Mr. Hayes, after stressing the highly confidential nature
of the subject, noted that in the past few weeks there had been
discussions by a Governmental committee centering in the Treasury
as to the type of emergency that might develop and the part that
the swap arrangements might play in dealing with it.
Mr. Daane
had attended those meetings, and Mr. Hayes asked him to comment.
Mr. Daane said that the particular group (usually called
the Deming Committee) was set up in response to a directive from
the President in June 1965.
The main concern of the group was the
international monetary reform question and the whole program of
the Group of Ten.
However, the President also requested that this
group keep under surveillance the sterling problem, then clearly
developing, which eventuated in the September assistance package.
At intervals, whenever the British situation seemed to be partic
ularly difficult, the committee had taken a look at the various
possible approaches.
In connection with that, the Secretary of
the Treasury had in the past requested Mr. Coombs and Mr. Hayes to
come down and discuss with the group and with him the question of
various alternatives.
A couple of weeks ago the same request was
made of Mr. Coombs with respect to a question from the Treasury
side as to whether there were ways of preventing or avoiding an
emergency that could, as Mr. Coombs had noted, react upon the
dollar as well.
In response, Mr. Coombs had pointed up the
8/23/66
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possibility of increasing the swap lines, always making clear,
however, that that particular mechanism was the responsibility of
the Open Market Committee.
The interagency group was not entirely
of one mind, but he (Mr. Daane) thought the real differences were
more in terms of timing and technique than substance.
The Treasury
seemed to lean toward Mr. Coombs' suggestion as a most feasible
and desirable approach.
There was some feeling within the group
that it might be preferable to attempt to put together a more
direct package of assistance, but he thought it was fair to say
that the Treasury view, shared by Mr. Coombs and himself, was that
it would be unrealistic to think of that sort of credit in any
major magnitude being arranged under current circumstances.
In
general, the principal difference in views turned on whether one
could better put together a larger swap package, and get the kind
of psychological boost that could come from it, now or after an
emergency had actually developed.
There was some feeling that
perhaps the package could be put together more readily after an
emergency had developed than in advance.
There was also some
feeling that putting together such a package would relieve some of
the continentals from direct assistance to sterling.
That more or
less countered an alternative approach favored by some, which
would be to wait for the emergency, go on unilaterally, and then
turn to the continentals for reciprocity.
In any event, no
8/23/66
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clear-cut Administration view had evolved from those discussions.
As he had said, he thought the differences involved mainly timing
and technique, but it was clear to him that the Treasury was
leaning heavily toward the view that the best way of proceeding
was along the lines suggested in Mr. Coombs' memorandum.
Mr. Daane added there was one further difference of view.
Some of the group felt that the market would get a psychological
boost, but there was some feeling that announcement of an increase
in the swap lines might have a perverse effect, for reasons
Mr. Coombs had discussed.
Mr. Daane stressed that the committee
operated on a confidential basis and that its deliberations should
be held in close confidence.
In response to a question as to his personal view, Mr. Daane
said he felt strongly that Mr. Coombs had outlined the best proce
dure under current and foreseeable circumstances.
He was highly
skeptical, from his contacts with central bankers in the Group of
Ten sessions and otherwise, that it was realistic to expect them
to put up any substantial money directly.
He thought the existence
of this backlog of credit lines would prove reassuring to the
market.
In his judgment, it would be inadvisable to wait for an
emergency to develop and then go hat in hand to the continentals.
If the suggested course was followed, there was a good chance of
forestalling such an emergency.
Aside from simply reassuring the
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market, the System would acquire a right to currencies that could
be useful in dealing with any dollar movements that would constitute
a real threat to the status of the dollar.
Mr. Hayes remarked that it was clear to him that this was
one of the most crucial issues the Committee had had to face in
some time.
It warranted full discussion.
In his own view, there
was no workable alternative to the type of program that had been
set forth unless the Committee wanted to take the risk that all of
the past efforts to preserve sterling parity would come to naught,
with all that could mean for the dollar and the financial structure
that had been built up in the postwar years.
The idea of a direct
multilateral package of assistance was something that he had
discussed informally from time to time with various influential
people on the continent, and he did not think it could be worked
out.
In a discussion last week the Governor of the Bank of England
indicated that he was of the same opinion.
That was an important
factor, because obviously no one would want to seek a multilateral
package unless the British wanted to obtain it.
Mr. Hayes also stressed that the great merit in the scheme
proposed was that it would provide important new protection for
the dollar whatever happened to sterling.
The pressure on the gold
market and the continuing serious U.S. balance of payments problem
made it important to do everything possible to reinforce the
8/23/66
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defense of the dollar.
It went without saying, of course, that
the Committee would not want to pursue the Coombs' proposal, or
anything else of the kind, without the full blessing of the
Treasury.
The Committee had followed that policy since the
inception of its foreign currency operations.
Mr. Hayes also said that he had discussed the matter with
Secretary Fowler and Under Secretary Deming, both of whom were
favorably disposed toward the program, although the Secretary
indicated that he was not in a position at the moment to give a
formal Treasury approval.
Over the weekend he (Mr. Hayes) had
also talked briefly with Chairman Martin about the proposal.
The
Chairman had authorized Mr. Hayes to tell the Committee that,
while he obviously had not had an opportunity to consider all of
the details, he was in sympathy with the basic program objectives
and felt it desirable to make the effort to prevent what could be
a disintegration of the present financial system.
The Treasury
had indicated that it hoped the Committee would have a full discus
sion today and would be prepared to go ahead with the program on
short notice if and when final Administration clearance was obtained,
which might be a matter of weeks, days, or hours.
Mr. Robertson stated that he had talked to the Secretary
this morning about the matter.
The Secretary was inclined to
favor the approach and hoped the Committee would approve the use
8/23/66
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of the particular instrument, subject to action being triggered
by notice from the Secretary to the Chairman or Acting Chairman
of the Board of Governors, so that if it was necessary to move
it would be possible to move fast, without a need to reassemble
the Committee.
Mr. Hickman asked whether there had been any indication
of the attitude of the major European central banks, and Mr. Coombs
expressed the view that the attitude of the Bank of Italy would
probably be favorable.
In the case of the Bundesbank, as the
Committee would recall, several approaches had been made to them
over the past year about the possibility of increasing the swap
line to $500 million.
He had not been able to determine what was
blocking those efforts, but he thought the Group of Ten delibera
tions may have been a factor.1/
Mr. Mitchell asked about the role of the IMF in such a
situation, and Mr. Coombs replied that its main role was that of
a fall-back to provide medium-term credit.
there were two important limitations.
In the present situation
First, so far as the British
were concerned, their drawing rights were pretty well used up.
Mr. Mitchell asked if there was any provision for emergency assist
ance, and Mr. Coombs said he did not believe so; none had been
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material reported further
comments by Mr. Coombs on the subject under discussion.
8/23/66
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granted to date.
The second difficulty about the Fund, he added,
lay in its slow-moving machinery, which in the process of turning
over gave wide advertisement to the problems under consideration.
An advantage of the swap network lay in the ability to move fast.
It could absorb day-to-day pressures, and most important of all
was the impression it gave to the market of central bankers
having a common interest in maintaining the present parity system
and being prepared to put up money to support it.
Mr. Mitchell remarked that from Mr. Coombs' document and
comments he gathered that the contingency involved was the
possible devaluation of sterling; without that contingency there
would be no need to expand the swap network.
Mr. Coombs replied
that nothing, so far as the defense of the dollar was concerned,
worried him more than a breakout in the gold market, which could
be triggered by a devaluation of sterling or by other causes.
Mr. Mitchell suggested that enlarging the swap network on
a crash basis might stir up a great deal more anxiety than would
be desirable.
He wondered whether it might not be better to go
about the process more deliberately, perhaps on occasions when
swap lines came up for renewal, and take the chance that some action
on an emergency basis might be necessary.
Mr. Mitchell noted that a serious domestic crisis might be
impending.
If on top of that a broad effort was undertaken to
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rescue sterling from its present difficult position, the combina
tion of problems might be more than could reasonably be handled.
Mr. Coombs expressed agreement on the domestic side and
said that was the foundation of his suggested approach on the
international side.
A breakdown on the international financial
sphere could not be afforded; and if nothing was done, such a
breakdown was likely to occur.
Mr. Mitchell then raised the question whether the point
had not been reached where "papering-over" operations should be
stopped.
Mr. Hayes replied that that would almost amount to saying
that one was willing to throw the door open to "every man for him
self" in the international financial field.
Mr. Mitchell commented that a large package of credits
for the British already existed.
further.
He was not against enlarging it
However, if the continental central banks did not go
along, other efforts were likely to be ineffectual.
Mr. Coombs noted, in reply, that the lines of credit now
being extended to the U.K. by the continental central banks came
to $1.1 billion, or roughly equivalent to what the U.S. was
putting up.
On the matter of timing, Mr. Hayes said that if the Committee
were in a position to proceed deliberately, that might be well and
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good.
Whether or not that would have a better effect psycholog
ically, he did not know.
He was inclined to think that announcement
of a simultaneous massive increase of the swap lines was more likely
to make a favorable impression, but in any event the time element
did not permit the deliberate approach.
Mr. Daane, stressing the confidentiality of the observation,
said that within the Government there were two assumptions.
The
first was that a likelihood existed of a major crisis in September,
and the second was that in the went of such a crisis the U.S. would
do something with respect to it in terms of providing financial
resources, unilaterally if necessary.
It really came down to the
question of how best to proceed; whether the U.S. would be in a
better position to meet the situation if the enlarged swap network
was put in place now.
Mr. Coombs commented that if he had been in a position to
negotiate gradual increases in the swap network, with periodic
announcements, that might have been the best way.
nity for that had passed.
But the opportu
Even though there was a risk of backfire
from announcement of a package of large swap increases, the
alternative was so bad that he thought it necessary to take a
chance.
Mr. Bopp noted that only a short while ago negotiations
with the Bundesbank for a more modest increase than now envisaged
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had been unsuccessful.
Mr. Coombs commented that the next renewal
of the swap agreement with the Bundesbank would not occur until
February 1967, and that would be too late to attempt to negotiate
an increase.
Mr. Ellis referred to the extremely large short positions
in sterling and the question whether something could be done to
turn the situation around.
He asked whether an announcement of
enlargement of the swap lines would be likely to have an effect
on the short positions.
Mr. Coombs replied that he would hope that it would help
to turn things around.
What the market feared at present was that
the British credit resources were almost gone, and that no more
would be forthcoming.
Mr. Ellis noted that the memorandum also referred to the
possibility of negotiating an enlargement of the gold pool, and
Mr. Coombs replied he had been working on that for the past month
or six weeks.
He believed that the Germans and Italians would
agree to increases in their shares sufficient to expand the pool's
resources by $100 million.
He had not approached anyone else, but
if the Germans and Italians agreed, others probably would go along.
Then it would be possible to continue to intervene for a while
longer in the gold market.
Mr. Ellis inquired whether the possible backlash effect of
a failure to negotiate a simultaneous doubling of several major
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swap lines should not be taken into account, and Mr. Coombs said
he would contemplate negotiating with the Germans first.
If the
Germans were not prepared to go along, he might suggest calling a
halt at that point.
He thought he would know after contacting no
more than one or two central banks whether the plan could be
negotiated or not.
Therefore, the risk of a leak should not be
too great.
Mr. Ellis noted that the memorandum indicated that no
approach to the French was contemplated, and Mr. Coombs said the
swap line with the French was useless.
The only purpose in contin
uing the swap line was to symbolize some continuing link between
the Bank of France and the Federal Reserve, and to avoid an overt
disruption of relationships which might lead to market distrubances.
Mr. Shepardson noted that a memorandum from Mr. Furth dated
August 17, 1966, a copy of which has been placed in the files of
the Committee, contained an alternative suggestion for dealing with
the British situation.
Mr. Coombs' proposal would involve a
straight increase in the swap line, while Mr. Furth had suggested
certain possible offsets to such an increase.
Mr. Coombs expressed the view that the market effect of a
swap-line increase would be negated if any of the other credit
arrangements were to be canceled out.
He added that some of them
were not actually available to the British at the present time,
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for example, the Export-Import Bank line.
As to canceling the
September 1965 package, a considerable amount of money had in fact
already been committed under that authorization.
main objective was to improve confidence.
He thought the
If the market received
the impression that the central banks were standing back of the
British program, it might be hoped that the British would not have
to draw further on the credits available to them.
Otherwise they
might have to draw all that was left, and that would add up to a
tremendous amount of short-term debt.
Mr. Shepardson asked Mr. Daane whether, in the discussions
of the interagency Government group, there was indication of further
effort on the part of the Administration in regard to dealing with
the U.S. balance of payments problem.
Mr. Daane noted that, as Mr. Coombs had pointed out,
consummation of the increased swap lines would put this country
in a stronger position in case there was any speculative ricocheting
against the dollar.
If the outflow of dollars continued, it would
clearly have an implication there also.
But he did not think there
had been any real linkage of the two problems in the discussions.
That did not mean, of course, that the Government was saying there
was no further problem on the U.S. balance of payments.
They were
working, and would be continuing to work, on a program to improve
the balance of payments situation.
8/23/66
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Mr. Coombs commented that it was not known what the
Administration would or would not do on the balance of payments
side if dollars flowed out and it was necessary to draw on the
swap lines to mop them up.
The most the Committee could do was
to make every effort to be sure that the System did not get
locked in on swap drawings.
An avenue had now been opened up for
the Treasury to go to the Fund for help.
If, for example, the
System drew guilders in order to forestall a loss of gold, the
Treasury acquired some responsibility to take the System out if
the drawings went on for too long, by going to the Fund.
Mr. Brimmer commented that he had been participating in
some of the discussions in Washington about the balance of payments
situation.
programs.
Some effort was being made to look beyond ad hoc
However, those possibilities were still under considera
tion at a secondary level.
Some people were raising questions
about the longer-run viability of the Department of Commerce program
on direct investments.
Some people were talking about taxes, but
that had not gotten any blessing one way or another.
There was
also some feeling that the question of tourism should be looked
into, along with the deployment of troops on the European Continent.
Likewise, there had been some discussion of the use of swaps, the
Group of Ten negotiations, and other matters.
Some of the differences
of opinion seemed to reflect variations in the basic interests of
-24
8/23/66
people participating in the discussions and the agencies they
represented.
That helped, he thought, to explain the differing
views on how to deal with the balance of payments problem.
In
any event, no new program had as yet come up to the Cabinet
Committee on the Balance of Payments.
Mr. Clay said it seemed to him that the fundamental dif
ference between the present proposal and other papering-over
operations was that on this occasion the British had taken definite
steps of a fundamental nature to correct their basic problem.
If
their internal political situation permitted them to persevere,
the new program should bring about some correction of the situation.
The papering-over technique was giving them time to achieve results
from the basic steps taken.
As to the papering-over of the U.S.
problem, he thought whoever was talking with Administration
people should emphasize that there must be a fundamental program
for dealing with the balance of payments problem.
a part of the package.
That should be
It should be emphasized that the objective
was not just to save the pound but to give the dollar more time
and to shore up the foundations of the British situation.
Mr. Clay noted that the Coombs' proposal would involve
increasing the swap lines to a maximum aggregate amount of $5.2
billion.
He asked what the System's financial risk would be if
sterling should fall.
8/23/66
-25
Mr. Coombs said that first of all there would be the
financial risk involved in the credits extended to the British
under the swap arrangement.
Last fall there had been some basic
discussions with the Bank of England and the Chancellor of the
Exchequer.
The result was an understanding that a banking
obligation of the Bank of England was involved and that it would
have to be paid off if that took every dollar of their reserves.
They still had more than $3 billion of reserves plus the remainder
of their securities portfolio.
So if sterling went down, and they
owed the System $600 or $700 million, the System should be able to
get its money back.
In event of a devaluation of sterling, Mr. Coombs said,
the French might move quickly to parallel the British action.
Scandinavians and others might also move.
The
So there could be a
crumbling of the parity system around the world.
Talk of an
increase in the price of gold and a new set of parities would
generate a drive against the dollar.
Foreigners might pull money
back from the U.S., including money in the stock market, or
increase their demands on the gold market.
be a direct challenge to the dollar.
Here again there would
The dollar would be under
tremendous pressure if sterling went down, and the best hope was
to work out some clear understandings with the countries that it
was felt could be relied upon to develop a firm defensive network.
8/23/66
-26
Mr. Hayes then remarked that he gathered it would be
appropriate for the Committee, if it so desired, to authorize
Mr. Coombs to commence negotiating enlargement of the swap lines,
but only if and when a formal approval of the program was received
by the Chairman or Acting Chairman of the Board of Governors from
the Treasury.
Mr. Wayne suggested that conceivably the Secretary of the
Treasury might not give a formal approval.
Mr. Hayes said the only thing the Committee had thus far
was an indication of favorable leaning on a personal basis.
The
negotiations should be started only if the Secretary of the
Treasury formally asked the System to undertake the program as a
matter of U.S. policy.
Mr. Daane remarked that no U.S. policy position had yet been
formulated.
The question would have to go to the top level.
Mr. Wayne commented that the matter was too important to go ahead
under a kind of gentlemen's agreement.
Mr. Hayes repeated that he would propose that the program
become operative only if and when formal approval of the Treasury
was received, and Mr. Mitchell raised the question whether "approval"
or "request" was the more appropriate term.
Mr. Mitchell also asked whether it was conceived that the
System would be acting just as an agent of the Treasury, and
8/23/66
-27
Mr. Hayes said he thought it was recognized that the System did
not have to do anything it considered unsound, and the Committee
had never accepted the thesis that it would take any action it
thought was wrong.
That was different from saying that even if
the Committee considered a program sound, it would not undertake
the program unless it was consistent with U.S. international
financial policy as expressed by the Treasury.
He saw little
difference, in that context, between an approval and a request.
It was his recollection that the System's foreign currency
activities had been undertaken from their inception with the full
approval of the Treasury.
Mr. Robertson remarked that the question whether to under
take the program was one for the Committee to decide, but any
action must be triggered by a specific notification from the
Secretary of the Treasury that it was time to act.
Mr. Hayes then suggested that the Committee authorize
negotiations to increase the swap lines with the understanding,
however, that the negotiations would not be activated until there
was specific notification from the Treasury that they wished the
Committee to proceed.
Mr. Scanlon noted that Mr. Coombs had indicated that if
negotiations with either of the key countries failed, the program
probably should be called off.
Suppose the Germans were willing
-28
8/23/66
to go to only $500 or $600 million instead of $750 million?
Would
the proposed Committee action give Mr. Coombs enough leeway?
Mr. Coombs responded that he hoped it would.
If the Germans
agreed to only $500 or $600 million, he would not consider that a
fatal blow to the negotiations.
His memorandum had only referred
to the $5.2 billion aggregate figure as a maximum.
Mr. Hayes then said that all the Committee would be granting,
subject to notification from the Treasury, was authority to
Mr. Coombs to attempt to negotiate the proposed swap-line increases
within the suggested maximum amounts.
He assumed that Mr. Coombs
would furnish the Committee a full report of the results, with a
request for formal ratification of whatever actions seemed feasible
as a result of the negotiations.
Mr. Daane expressed the view that the record should be clear
that the Committee was authorizing the negotiations subject to
notification from the Treasury that such action was fully consistent
with U.S. international financial policy, and that the timing was
appropriate.
Mr. Shepardson asked whether it would seem appropriate, in
further discussion with the Treasury concerning the swap program,
to use the occasion to press for Administration concern on the
total balance of payments problem.
Mr. Hayes said he thought it might be a mistake to try to
tie that in as a quid pro quo.
However, he would not lose any
8/23/66
-29
opportunity to stress informally the need for action on the balance
of payments.
Mr. Daane said that insofar as he, Governor Robertson,
and Governor Brimmer had participated in any Governmental review
of the balance of payments position, they had always stressed the
need for correction through the development of a broad-gauged
program.
He thought it was quite appropriate to continue to press
the matter whenever opportunities presented themselves.
The consensus of further comments was that it would be
inadvisable to tie the proposed program regarding the swap lines
to a request for more vigorous efforts on the balance of payments
problem, but that System representatives should properly use all
appropriate opportunities to stress the need for fundamental
correction.
Mr. Patterson asked whether Mr. Coombs was being authorized
to proceed to negotiate swap arrangements which, however, would
not be put into effect until the Treasury requested, and Mr. Hayes
said Mr. Coombs was not to begin negotiations until word was
received from the Treasury.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
Mr. Coombs was authorized to negotiate
for an enlargement of the swap network
along the lines proposed in his
memorandum of August 18, 1966, subject
to the understanding, however, that
such negotiations were not to be begun
until the Chairman or Acting Chairman
-30-
8/23/66
of the Board of Governors received
specific notification from the
Secretary of the Treasury that the
proposed program was fully consistent
with U.S. international financial
policy and that the timing was
considered appropriate.
At Mr. Hayes' suggestion, Mr. Daane then presented a brief
summary of the Group of Ten meetings held at The Hague, Netherlands,
on July 25-27, 1966.
The first order of business, he said, was a
meeting of the Deputies on the morning of the 25th, at which they
finalized the report that would be made public this Thursday.
He
thought he had given enough of the flavor of that report at
previous Committee meetings to make it unnecessary to go into
detail concerning it.
It did represent a considerable agreement
and consensus on the elements of contingency planning for reserve
creation.
But the real meat of the meetings at The Hague was in
the sessions of the Ministers and Governors, which involved a
debate between the U.S. Secretary of the Treasury and the French
Finance Minister on whether or not to go forward into the second
stage of contingency planning and, if so, under what conditions.1/
The communique
issued at The Hague, which would be sent to each Committee member
along with the report of the Deputies, indicated that U.S. interests
were fully protected in getting into the second stage of the
negotiations, which would involve wider participation.
It pointed
1/ A sentence has been deleted at this point for one of the reasons
cited in the preface. The sentence reported a further observation by
Mr. Daane on the subject under discussion.
8/23/66
-31
out that one of the principles involved was that the interest of
all countries in the smooth working of the international monetary
system was recognized.
That was the U.S. position, and had been
all the way through the negotiations.
The communique said that
it was appropriate to look now for a wider framework for considera
tion of questions that would affect the world economy as a whole,
and it recommended a series of joint meetings in which the Deputies
would take part along with the Executive Directors of the Monetary
Fund.
It indicated that a report should be expected no later than
the middle of 1967.
Nine of the countries of the Group of Ten had
agreed to go into the second stage, and the French had been isolated
in their negative position.
The meeting then recessed and reconvened at 1:50 p.m.,
with the same attendance as at the morning session.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering open market operations in U.S. Government securities
and bankers' acceptances for the period July 26 through August 17,
1966, and a supplemental report for August 18 through 22, 1966.
Copies of both reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
Interest rates have moved sharply higher in an
atmosphere of considerable market apprehension since
8/23/66
-32-
the Committee met four weeks ago. The continued weight
of credit demand, including two Treasury financing
operations, further signs of inflationary pressure as
evidenced by the steel price rise and the terms of the
airline strike settlement, the rise in the prime rate,
the cloudy outlook for CD's in the weeks ahead, and the
Board's action to raise reserve requirements combined
to put inexorable pressure on the financial markets. All
sectors of the financial markets and all maturity ranges
were affected. Rates on Federal funds, Treasury bills,
bankers' acceptances, commercial and finance company
paper, dealer loans, Federal Government agency obliga
tions, and corporate and municipal securities all moved
into new high ground, while stock market values declined
about 7 per cent.
With dealer financing costs high and prices eroding,
the underwriting of new issues has become a highly un
certain undertaking, and this in turn has contributed
to the movement of prices and rates. There are many
illustrations of the pressures the market is facing.
(1) On August 9 a $239 million
To cite only a few:
issue of short-term notes--tax-exempt and fully Government
guaranteed--by the Public Housing Authority was placed
at an average cost of 4.61 per cent, up half a per cent
from the rate on a comparable issue a month earlier.
Major underwriters joined forces to enter a single bid
for a major portion of the issues and exacted as much as
(2) On August 16
a 1/2 per cent underwriting spread.
the Urban Renewal Authority was able to place only
$55 million of a $130 million offering, either because
no bids were received or because the rates involved were
in excess of rather flexible legal limitations.
(3) A
relatively new firm selling computer services was forced
into the capital market after having been refused credit
by a number of major banks, and paid up to 8-1/4 per cent
(4) The syndicate handling the
for a 1970 maturity.
$250 million A.T.&T. issue, originally offered on August 3
to yield 5.58 per cent, was terminated with only two
thirds of the issue sold. The issue closed yesterday at
a yield of 5.86 per cent, up a quarter of a per cent in
20 days.
In the Government securities market, rates on three
and six-month Treasury bills reached peaks of 5.10 and
5.49 per cent, respectively, last Friday, 30 and 60 basis
points higher than at the time of the last meeting of the
8/23/66
-33-
Committee. A technical rally Friday afternoon and
yesterday erased only part of this rise. Yields on
intermediate-term Treasury issues rose by as much as
60 basis points, with the 4 per cent note of February
1969 reaching a peak of 5.88 per cent. Long-term
issues were up as much as 15 basis points in yield,
with the "bellwether" 4-1/4 per cent bonds of 1987-92
hitting a peak of 4.97 per cent. In yesterday's
auction, average issuing rates were set at 5.02 and
5.41 per cent on the three- and six-month bills, down
3 and up 9 basis points from the rates set a week
earlier.
Despite alarms and excursions and an underlying
tone of gloom and weakness, the markets continued to
perform. Securities were traded and funds were raised
at the successively higher yield levels reached. At
each higher level, rates have proved irresistible to
some investors; there has been some short covering by
professionals, and there are always a few optimists
who become convinced--at least temporarily--that a
turning point is at least in sight. While the markets
have functioned, the performance has been a shaky one.
There remains a substantial risk that some unexpected
development or the cumulative pressure of demand on
the supply of funds could set off a series of disruptive
events in the market that would be hard to control,
particularly if psychology got out of hand. Caution,
fortunately, is the order of the day in the markets,
but we should be alert to the potential dangers in the
current situation.
Against this negative background, the Treasury had
to carry out a refunding of issues maturing August 15
(to which holders of November maturities were eligible
to join) and then raise $3 billion in cash in an auction
The initial
of March and April tax bills on August 18.
reactions to the Treasury's offer of a 5-1/4 per cent
note and a 5-1/4 per cent certificate were quite favorable,
with Government securities dealers generally adopting a
more constructive attitude than in recent Treasury opera
But as time went on the atmosphere soured, and
tions.
when the books closed on August 3 both new issues were
quoted at par bid, down 5/64 from their peaks. They have
since declined almost uninterruptedly. At last night's
close, a week after payment date, the new Treasury note
was offered at 99 to yield 5.49 per cent. Those dealers
8/23/66
-34-
who stood up to their function of underwriting Treasury
financing operations have suffered substantial losses
as a result of their participation.
Last week's auction of $2 billion March and
$1 billion April tax bills was preceded by a rise in
the prime rate to 6 per cent and the Board's reserve
requirement action. Despite the eagerness of banks
to acquire the tax and loan deposit that comes with
successful bidding, there was considerable caution in
the bidding, with some banks withdrawing altogether and
others cutting back their participation. While both
issues were covered, bidding was lighter than in any
similar auction in recent history, the range of bids
was wide, and some underwriting bids were entered at
rates of 6 per cent or more. Average rates of 5.34
per cent and 5.43 per cent were set for the March and
April issues, respectively. Secondary market trading
started at rates well above the market for outstanding
bills and after some decline they closed yesterday at
5.58 and 5.60 per cent. The Treasury's experience with
its latest financing raises some fundamental questions
about the possibility of carrying out an effective debt
management policy in a period when rates are constantly
on the rise and the market's ability and willingness
to perform an underwriting function are weak. Further
tests will be supplied now that Congress has given the
go-ahead signal for the issuance of new Federal agency
participation certificates, expected to total $4.2
billion in the current fiscal year. The first instal
ment should be forthcoming soon after Labor Day.
Even keel was, of course, an important consideration
during much of the period since the Committee last met.
It was fortunate, perhaps, that required reserves and the
credit proxy consistently fell below the levels desired
by the Committee at the last meeting. If these aggregates
had been running strong, there would have been a clear
cut conflict between even keel and the Committee's
desire to keep a tight rein on bank credit expansion--a
conflict that would have made the conduct of open market
operations even more difficult than it was. In the event,
estimated required reserves appear to have declined in
August somewhat more than was envisioned at the time of
the last meeting, and the credit proxy has also been
running below expectations even after allowing for the
effect of the rise in bank liabilities to their foreign
8/23/66
-35-
branches (mentioned in the blue book)1/ which are not
now, but should undoubtedly be, reflected in the credit
proxy.
Net borrowed reserves in the three weeks ended
August 17 averaged in the lower end of the range that
most Committee members mentioned at the last meeting,
and in the week ended August 10 the figure turned out
after revisions to be $301 million, well below that
range, although we had no means of knowing this at the
time. At the same time, other money market conditions
were tighter than they had been. The effective rate
on Federal funds reached 5-3/4 per cent in the week the
books on the Treasury financing were open, and moved to
5-7/8 per cent with some trading at 6 per cent in the
week ending August 10 when net borrowed reserves were
low.
Interest rates rose steadily during the period,
as noted earlier. Banks apparently were managing their
reserve positions cautiously, and borrowing averaged
close to $800 million. There appeared to be a tendency
to overborrow at the discount window over the weekends,
with some easing in the Federal funds rate at the end
of statement weeks as banks found they had more reserves
than they needed. This short-lived easing in the funds
market had no effect on dealer loan rates at New York
City banks, which remained at peak levels throughout
the period except for a modest volume of loans against
rights to the Treasury financing made by one of the
New York banks at a rate just under 6 per cent.
In general, the somewhat lower level of net
borrowed reserves--in the over-all context of rate
developments--did not mislead anyone into thinking that
Federal Reserve policy had relaxed, nor did the repurchase
agreements made by the Desk against rights at the discount
rate encourage dealers to go overboard in subscribing to
the new issues. On the other hand, any attempt to maintain
interest rates steady during the even-keel period would
have required a massive outpouring of reserves in the face
of developments during the period and of the market's
conviction that Federal Reserve policy was not only tight
but bound to get tighter after the refunding was out of
the way.
1/
The report, "Money Market and Reserve Relationships," prepared
for the Committee by the Board's staff.
8/23/66
-36-
At the moment the market is anticipating that the
Federal Reserve will be a large buyer of securities to
offset the reserve impact of the settlement of the
airline strike, pre-Labor Day holiday reserve needs,
and at least part of the reserves to be absorbed later
on by the Board's action raising reserve requirements.
In light of this, there was some rally in the Government
bond market on Friday afternoon and yesterday and Treasury
bill rates receded from their recent peaks. Today the
bond market is again off; prices that had been moving
up are back down again. Corporate rates are tending to
affect the Government bond market as well. As we move
into September the expected pressure on bank CD positions
at a time of expanding seasonal loan demands should lead
to growing pressure on financial markets generally. In
order to maintain pressure on the ability of banks to
expand credit without disrupting the Government securities
market, we shall have to be as flexible as possible in
the conduct of open market operations. During the period
since the Committee last met, we made use twice of
matched sale-purchase contracts to absorb reserves on a
temporary basis--the operation last Tuesday being con
ducted at the lowest gross return to the dealers that
we have seen. Today, with net borrowed reserves falling
below what we thought the Committee intended, the Desk
has made some further matched sale-purchase contracts.
In my view, this instrument has proved its value as a
tool of open market operations.
In supplying reserves
in the weeks immediately ahead, we would plan to rely
first on outright purchases of Treasury bills and other
securities to the extent that they are available, but
will try to minimize any major impact on rates in a
market where the ready supply of all issues is fairly
small.
Should repurchase agreements become a useful
tool I would plan to make them at a rate above the
present discount rate, although the precise rate would
have to depend on market conditions at the time the
contracts were undertaken. In view of the need for
flexibility I recommend that the Committee not take
action today to restore the continuing authority
directive to limit RP's against Government securities
to securities maturing in less than 24 months.
Similarly,
I believe it would be advisable to retain the $2 billion
leeway on purchases and sales--authorized by the Committee
at the last meeting--between now and the next Committee
meeting.
8/23/66
-37
In response to a question, Mr. Holmes verified that if
repurchase agreements were made at rates above the present
discount rate, it would be the first time that that had been
done recently.
Probably the rate would be linked to the three
month bill rate, but the precise rate would depend on market
conditions at the particular time.
He felt that it would be
desirable to get away from the discount rate, and he did not
think that that would shock the dealers unduly at this juncture.
Asked for his view as to where the net borrowed reserve
figure would come out for the current statement week, Mr. Holmes
said that last night the Desk had been looking at a figure of
roughly $470 million.
Today it was found from the country bank
sample that required reserves were about $50 million lower than
anticipated, and with this and other revisions the Desk was
looking at a figure of around $390 million this morning.
As a
result of the matched sale-purchase contracts made today, he
would expect a figure around the $470 million level, but tomorrow
there might be trouble again.
Mr. Hickman commented on the fact that required reserves
were again falling below the target, and Mr. Holmes replied that
recently that had been the case consistently.
When he last checked,
the credit proxy showed about a 2 or 3 per cent growth in August,
compared with the 4-6 per cent growth estimated at the time of the
8/23/66
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last Committee meeting.
Required reserve figures were still
coming in lower than anticipated, which would mean that, if
anything, the credit proxy would be revised further downward.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
during the period July 26 through August
22, 1966, were approved, ratified and
confirmed.
Mr. Hayes inquired whether any members of the Committee
disagreed with the Manager's recommendation that no change be
made at this meeting in the continuing authority directive, and
no objections were heard.
Mr. Hayes then called for the staff economic and financial
reports, supplementing the written reports that had been distrib
uted prior to the meeting, copies of which have been placed in
the files of the Committee.
Mr. Brill made the following statement on economic conditions:
At this time, when the System is in the process
of making a quantum jump in the intensity of monetary
restraint, it is reasonable to want to assess carefully
any dangers that may be inherent in such a policy course.
This afternoon, Mr. Partee will be discussing the
possible ramifications of recent policy changes on
financial markets and institutions. For my part, I am
making the assumption that policy can be implemented
effectively without creating financial crisis, and will
address myself to two questions: first, whether this
policy is what the economy needs, and, second, how much
of it is needed and how long the economy can stand it.
8/23/66
-39-
The proposition that the economy needs more
restraint is neither as simple nor as self-evident
as might seem on first blush. Current wage and
price developments that tend to excite us are not
necessarily leading indicators; very often these are
lagged responses to economic sins committed earlier,
or responses to essentially temporary supply and
demand phenomena. The question that has to be answered
is whether general economic circumstances will likely
be such that current wage and price trends will persist,
or perhaps accelerate.
In this connection, I would remind the Committee
that the staff projection of GNP incorporated in the
green book1/ has real GNP expanding at less than a
4 per cent annual rate in the third and fourth quarters
of this year, down from the 5-1/2 per cent rate during
the first half of the year and the almost 7 per cent
rise in the second half of 1965. Moreover, even this
projection might turn out to be over-optimistic in two
respects. First, it was completed before the July
housing starts figures were in, showing a sharp drop
to levels we didn't anticipate till year-end.
If
starts fail to bounce back--this is a volatile series,
but the drop in permits and the continued strain in
mortgage markets do not look encouraging--this could
pare three-quarters of a billion or so from the $14
billion rise in GNP projected for the third quarter
and perhaps twice that from the fourth quarter.
The second area of possible over-optimism is
consumption, projected as rebounding to a pace double
that of the slow second quarter. This isn't an
unreasonable expectation, since the reduced pace of
total consumer spending in the spring seems to have
been associated mainly with the slackening in disposable
income plus, in some measure, the auto safety hassle.
But while most attention has been focused on lagging
auto sales, other consumer outlays have held up
relatively well; over all, there doesn't seem to have
been much change in consumers' propensity to spend.
Disposable income is now slated to rise more rapidly
1/ The report, "Current Economic and Financial Conditions," prepared
for the Committee by the Board's staff.
8/23/66
-40-
than earlier--at least there is no big tax bite
scheduled--and with June and July retail sales
looking good, the green book projection is
persuasive.
My reservations about this consumption out
look are based more on hunch than hard evidence.
Consumers have generally behaved rationally in the
postwar period; when prices have risen significantly,
more often than not they have decided to hold back
on buying. This rational approach, along with
tightened consumer credit standards, may operate
to confound Detroit in a month or so, when the new
models arrive in the showroom.
But, whatever reservations one may have about
consumers' contribution to inflationary pressures
in the months ahead, large increases in Federal and
business spending are in prospect. The course of
defense orders and order backlogs, and enlarged
draft calls, continue to suggest a further rise in
defense outlays in the months ahead. Quantifying
this remains necessarily arbitrary, but the number
we are using--an increase of $2-1/2 billion this
quarter and the same next quarter--is not regarded
as outlandish by other (equally blind) forecasters
in town.
Federal nondefense spending is rising, too,
and Medicare payments, after a slow start, may
accelerate. Thus, we would expect total Federal
outlays--defense, nondefense, and transfer paymentsto rise more rapidly than tax receipts, and on a
national income accounts basis the Government's net
contribution to the economy to move from a $4 billion
surplus in the second quarter to about a billion
dollar deficit in the fourth quarter, hardly a fiscal
policy appropriate to the times.
The other major expansionary force--business
investment spending--seems ordained to rise over the
balance of the year, and perhaps even to accelerate,
since the spending increase was held down somewhat
earlier this year by construction strikes and delivery
delays. Shortly there will be a new reading on
current and future business capital spending plans.
Until then all we can say is that most of the relevant
factors--the high rate of capacity utilization, the
still high profit margins, the prospects of accelerating
8/23/66
-41-
wages, and the backlogs of machinery orders--appear
to be pointing to continued rapid expansion in
business spending for plant and equipment, if the
funds can be found.
Business inventory accumulation could also add
to the pressure on resources. Businesses have
tended to accelerate buying in anticipation of price
rises, and one might argue that the staff GNP projec
tion is too conservative in expecting some moderation
in inventory demands. Protective buying and stock
piling could provide a more powerful thrust to the
economy than is allowed for in the projection.
Balancing the probabilities attaching to the
various components of activity, I think it's a fair
assessment that, over the next several months, gains
in real output will be slower than the peak rates
reached last winter, in part because of labor and
plant capacity limitations in some key areas such
as machinery, but in part also because of slackening
in some demands. Nevertheless, it doesn't seem
likely that activity will be slowing fast enough to
head off mounting inflationary pressures. Even if
our projection is shaded down a bit, it would still
imply, for the balance of this year, industrial
production rising rapidly enough to keep manufacturing
capacity as fully utilized as ever, and unemployment
still below 4 per cent.
For some time ahead, then, the greater danger
is that we'll be staying in the zone of plant
utilization and labor shortages where wage and price
escalation is possible. Thus, the July rise in the
consumer price index--four-tenths of a per cent--will
bring wage increases of 2 cents an hour to over a
million workers, including the auto workers, and this
along with the rise in steel prices will likely provide
the arguments for higher price tags on the new model
cars. In turn, this will make it more difficult to
argue for moderation in other wage contracts to be
negotiated this fall. In the context of a still strong
economy, price rise engenders price rise. Given the
dim fiscal outlook, it doesn't seem to me that the
System has much option now but to move aggressively
toward curtailing expansion in demands, particularly
in the business sector. At the same time, we will have
to redouble our efforts to detect signs of any spreading
-42-
8/23/66
weakness in demands, in order to avoid carrying
such a policy stance too far or too long.
Mr. Partee made the following statement concerning financial
developments:
Events have moved so swiftly since the last
meeting of the Committee that it is difficult to
frame an appraisal of the situation. Interest rates
have adjusted sharply upward, so that past relation
ships and funds flows may have little relevance for
the new configurations beginning to emerge. The
stock market has declined markedly further, certainly
due in part to the pull of high interest rates and
concern among investors about "tight money", but the
financial implications are by no means clear. Un
certainty and apprehension have come to dominate
the mood of both lenders and borrowers, and changes
in portfolio policies and financing plans doubtless
are now in process. Such is the price of escalating
financial tautness in an increasingly inflationary
economic environment.
The biggest question mark currently, of course,
is the possible extent of a CD runoff at the major
banks. These banks already are paying the ceiling
rate on large-denomination CDs of most or all
permissible maturities. Even so, the rise in
outstandings has slowed, with banks in New York
and Chicago showing no net increase since mid-year
and other weekly reporters an expansion of less
than $200 million. The recent further sharp rise
in yields on alternative money market instruments
puts the banks at a clear competitive disadvantage.
Therefore, in view of the heavy schedule of CD
maturities, and assuming that Regulation Q is not
changed, some runoff of outstandings seems certain.
Even a fractional runoff of maturing CDs, which
in September will probably total close to $5 billion,
could readily involve a funds outflow of $1 to $2
billion. But there really are no past guides to
provide the basis for a prediction. Perhaps the bulk
of the funds will remain with the banks, even at a
concession in yields, because customers will wish to
remain in good standing for other purposes. This seems
8/23/66
-43-
to have been the experience of outlying banks, at
least when yield differentials were moderate. Any
substantial diversion of funds into other markets,
moreover, will tend to hold down yields on the
alternative instruments, though the prospects for
this do not seem especially promising. Offsetting
upward rate pressures in the market will probably
be coming simultaneously from increased supply, bank
selling, declining corporate liquidity, and investor
apprehension.
Bank deposit growth generally has not been
especially large over the summer. Taking daily
average figures for the three months through August,
we estimate that private demand deposits will show
virtually no change while Government deposits will
have dropped $800 million. Total time deposits will
have increased by $4.8 billion, an annual growth rate
of 12.5 per cent versus 16 per cent in 1965. Time
deposit expansion has occurred mainly outside the
money centers, however, since the big banks have not
done well with their negotiable CDs and have had
continuing savings deposit losses partly offsetting
growth in consumer CDs.
Meanwhile, loan demand has continued very strong.
Total loans at all commercial banks, on a last Wednesday
basis, rose at annual rates approaching 20 per cent in
both June and July, and business loans showed an almost
unbelievable 30 per cent growth rate over the two-month
period. Loan expansion appears to have slowed thus far
in August, reflecting liquidation of both security and
finance company borrowings and a marked slowing in
business loan growth. But the latter development is
probably temporary; the speedup in corporate payments
of withheld taxes has substantially reduced August
cash needs, after greatly boosting them--and probably
borrowing too--in July and June.
That most big banks are expecting a strong fall
loan demand emerges clearly from Federal Reserve Bank
reports on their recent interviews with selected large
banks. And this prospect is suggested also by the
aggregate figures on corporate sources and uses of
funds. We estimate that corporate investment expen
ditues--for plant, equipment, and inventory--in the
second quarter exceeded internally generated funds by
$13 billion, at annual rates, up from $10.5 billion in
8/23/66
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the first quarter and $4.7 billion in calendar
1965. With capital expenditures continuing to rise
and earnings recently leveling out, it is hard to
see any appreciable diminution in this gap in the
months ahead. Additional funds are being raised
in the capital markets, and the new issue calendar
may well rise even further in the fall, but a sizable
residual demand on the banks seems certain to remain.
Assuming continued substantial business loan
demand, and a sizable runoff in CDs, what can the
banks do to adjust? There is a limit to continued
liquidation of Government securities--especially for
the large banks--because of minimum liquidity needs
and pledged asset requirements. Municipal security
portfolios, which had continued to expand overall
until recently, provide an obvious source of funds,
but at substantial cost to the banks and to market
stability. Security loans and loans to finance
companies can be pushed out, as seems to be going on
at some large banks, but efforts by these borrowers
to obtain funds elsewhere may further limit banks'
ability to sell CDs.
On the liability side, a few of the largest
banks have obtained substantial funds recently from
their foreign branches, although prospects for
maintaining inflows in that magnitude for very long
seem doubtful. And almost all the big banks still
have room under the rate ceilings to compete more
aggressively for consumer CDs; I would not be
surprised to see some do so as the September
dividend-crediting date approaches.
In the end, however, it seems likely that more
banks--including major money market banks hard pressed
by CD losses and prime customer credit demands--will
have to come to the Federal Reserve for assistance.
Increased borrowing, whether on a regular basis or
under a special assistance program, will pose problems
for open market operations and for interpreting money
market statistics. Greater accommodation of the major
banks at the window will not necessarily be offset by
lesser borrowing by the smaller banks, given the
pattern of reserve distribution, but it will provide
the base for increased credit expansion by the banking
system as a whole. Hence, it will be important for
open market operations to mop up any excess reserves
8/23/66
-45-
provided to the system through assistance operations
involving individual banks. Such excesses are
likely to show up initially in the very short-term
money markets, and to be reflected in such things as
Federal funds rates and flows, availability and rates
on dealer loans, and yields on the shortest-dated
Treasury bills.
It is for these reasons that the draft directive
language provided by the staff 1/ places more emphasis
than usual on money market rates and conditions and
less on net borrowed reserves. We feel that close
attention to the money market will provide a better
indication of any developing ease than will net
borrowed reserves, which may become a less meaningfuland perhaps even a perverse--indicator of pressures
on aggregate reserves in the period ahead.
The "no change" directive specifies that money
market rates and conditions be held about where they
are today, which should be accompanied by some CD
runoff in the weeks ahead. In this event, member
bank deposits in September should increase less than
the 8 per cent we would have projected in the absence
of the developing CD problem; perhaps a figure around
6 per cent would be a reasonable expectation. The
"tightening" directive specifies a gradual firming
in money market rates and conditions. This should
result in a sizable and growing CD runoff, and
consequently in only a modest growth in the bank
credit proxy for September--perhaps 2 or 3 per cent.
In either alternative, we feel that the Account
Manager will need an unusually large degree of
discretion to deal with potentially destabilizing
developments; the possibility that such may occur is
greater now than it has been for a long time past.
Asked whether the projection for increase in member bank
deposits in September was seasonally adjusted, Mr. Partee said
that it was, although he warned that there was a certain amount
of variation in the seasonal adjustment.
He went on to say that
the projections were very speculative and that they were included
1/ Appended to these minutes as Attachment A.
8/23/66
-46
for purposes of illustration as much as anything else.
It was
quite early to be having any firm view of September projections.
A principal factor, however, was the delivery of $3 billion of
tax bills late in August, which would give a large impetus to
average bank credit for the month of September.
The 8 per cent
projection included substantial demand deposit expansion, in
recognition of what had occurred in every last-of-quarter month
for the past several quarters.
It also allowed for a lesser
rise in time deposits than had been occurring recently, including
nothing but a seasonal change in CD's.
The 6 per cent projection
assumed a modest CD runoff; credit growth would be lower--perhaps
in the 3 per cent range--in the event of a large CD runoff.
Mr. Hayes said he understood that the 6 per cent figure
was a rough estimate in event of the kind of CD runoff that might
be expected from the maintenance of existing credit conditions,
and Mr. Partee agreed, emphasizing that it was a very rough
estimate.
Mr. Brimmer noted that the inflow of funds to certain
U.S. banks from their foreign branches did not show up in member
bank deposits (the credit proxy).
Therefore, if the inflow
continued, there could be some credit expansion beyond that
indicated by the credit proxy.
Mr. Partee agreed, but added that
the current inflow might well be less than the high figure of
8/23/66
-47
around $700 million in July.
If that rate of inflow continued,
he estimated that it would represent the equivalent of an increase
in the credit proxy figure by two or three points for the month,
on an annual rate basis.
For the year as a whole, the influence
would not be so great because the inflow was not too significant
during the first half of the year.
Mr. Hayes agreed that the
inflow was not likely to continue at the high July rate.
Mr. Hickman asked Mr. Partee about the degree of confidence
he attached to the projection of an easing of short-term money
market rates.
It would seem that the pressure of strong loan
demands would tend to mop up available funds.
If the System
maintained the current state of conditions in the money market,
would it not, in effect, be supplying more reserves than needed?
Mr. Partee replied that in the blue book the staff had
projected perhaps a moderate easing of short-term rates.
The
System would be buying a considerable amount of securities and
current changes in private investors' portfolio composition should
favor short-term instruments against intermediate- and long-term
securities.
There could be more easing if, in fact, a considerable
amount of credit was provided through the discount window.
For
the period immediately ahead, maintaining money market rates about
where they were would probably not mean easing but absorbing any
sloppiness that might develop.
8/23/66
-48Mr. Hickman said he was wondering if one could not get to
the same place by maintaining required reserves about where they
were.
He did not like to place reliance on money market conditions
if there was some better policy guide.
Mr. Partee replied that the staff was very reluctant to
specify the reserve aggregates at this time because the relation
ships were so uncertain in view of the deposit shifts that were
taking place.
Mr. Reynolds then presented the following statement on the
balance of payments:
As Charlie Walker observed recently, the "mix"
between Federal monetary and fiscal restraint today "is
very much like an extra dry martini--about 6 parts monetary
to only one part fiscal."
Mr. Brill has suggested that the
mixture is now becoming even drier than that.
It has sometimes been argued that this sort of recipe
ought to be well suited to the U.S. balance of payments
situation, because monetary restraint particularly restrains
capital outflows. But the 1966 experience to date exposes
the flaws in this line of analysis. The sharp tightening
of credit conditions has indeed reduced net outflows of
capital significantly. But because monetary restraint
has so far operated very selectively on domestic demand,
it has not prevented excessive aggregate demand pressures
from sharply worsening the external balance on goods and
services.
The effect of tight credit on capital flows is clearly
visible for flows of U.S. bank credit and of foreign liquid
funds.
In July there was a reflow of about $140 million of
bank credit covered by the VFCR reports; only about one
third of this was seasonal. In view of the developing
squeeze on large U.S. banks, it now seems reasonable to
take the July movement as a portent for the near-term
future, and to regard the second-quarter outflows as
only a temporary interruption of the reflow that had
8/23/66
-49-
developed earlier. Japanese and Italian borrowers in
particular have been repaying debt to U.S. banks, and the
Japanese would be repaying even faster if the authorities
there were not trying to slow them down.
The second capital flow that clearly reflects tight
money and high interest rates in this country also comes
through U.S. banks. I refer to the inflow of foreign
private liquid funds through the foreign branches of U.S.
banks. Such inflows were exceptionally large in July
and early August, totalling about $900 million, and were
also sizable--about $1/2 billion--during the first half
year. The huge surge in July was related to the run on
sterling and should be viewed as temporary. But funds
are also being attracted out of other currencies by the
very high Euro-dollar rates that U.S. bank branches are
now prepared to pay.
Other capital flows have been less clearly affected.
It may be that the falling off in new Canadian security
issues in this country since April owes something to the
high cost and relative scarcity of U.S. funds. We know
very little so far about this year's direct investments.
Against the known improvements on private capital
account must be set a disturbingly large deterioration on
current account. From the fourth quarter of 1965 to
the second quarter of 1966, the annual rate of current
account surplus declined by about $1-1/2 billion.
Merchandise imports increased as rapidly as before,
despite large releases from domestic stockpiles, while
merchandise exports leveled off. The balance on military
transactions plus services apparently did not change much
over this particular period, but has worsened by comparison
with the year 1965 as a whole.
The net result of all these changes, and of others
that we cannot yet measure, has been to widen the payments
deficit on the liquidity basis of calculation to an
annual rate of roughly $3 billion in July and early
August.
The alternative payments measure, based on official
reserve transactions, has developed very differently, and
shows a seasonally adjusted surplus during July and early
August. The difference results mainly from that fact
that the huge inflows of foreign private liquid funds
in that period improve this balance but do not affect the
liquidity calculation. Since a large part of the
exceptional July inflows should be regarded as temporary,
we should expect to see a renewed deficit on the official
8/23/66
-50-
settlements basis later in the year, although that deficit
might be held well below the liquidity deficit by some
continuing inflow of foreign liquid funds.
To answer more broadly the questions of where we
now stand and where we are heading, one needs to take
account of longer-run trends and of likely business cycle
swings. I would be prepared to concede that we may not
yet have seen much trend deterioration in the payments
position this year. The increase in the liquidity
deficit from a rate of $2 billion a year in 1964-65 to
$3 billion now may be largely explainable in terms of
temporarily or cyclically excessive demand pressures
whose adverse effects have outweighed the cyclically
favorable effects of unusually tight credit. Similarly,
the official settlements deficit might still have been at
about the $1-1/2 billion rate of 1964-65 if it had not been
for cyclical boom developments here and the recent run on
sterling. These rough impressions of trend cannot, of
course, be closely appraised until long after the event.
The worrisome thing is that the earlier trend of
slow improvement in the balance of payments appears to
have been stopped in its tracks. Moreover, it is in danger
of being reversed if, as the green book suggests, the
upward pressure of rising labor costs is now to be added
to the existing pull of demand on prices of manufactured
materials and products. It seems to me that the fiscal
monetary policy martini that we have concocted this year
is likely to produce a much worse hangover in the balance
of payments (and also in the domestic economy) than would
a mixture containing a forthright dose of general fiscal
restraint. The tightening of credit that has helped our
capital account can be reversed a lot more quickly in
some future recession than can a price-cost spiral that
will have impaired our international competitiveness.
My remarks are in no way intended to question the
recent trend of monetary policy--quite the contrary.
The point is that unless restraint of some kind can be
pushed to the point where it significantly dampens
aggregate demand and heads off the inflationary spiral,
the long-run prognosis for the balance of payments is
very bleak.
Mr. Hayes suggested that, since Mr. Robertson might have to
leave before the meeting was finished, he start the go-around of
comments and views on economic conditions and monetary policy.
8/23/66
-51Mr. Robertson said that first he would like to suggest, in
view of the discussion earlier today, that the staff be asked to
update last year's contingency planning on how to handle the
securities market in the event of a sterling crisis.
It was agreed that that should be done.
Mr. Robertson then made the following statement:
Beyond question, the current economic situation is
so fraught with inflationary pressures that we need to
be applying all the restraint upon the availability of
credit that we can reasonably bring to bear. The main
issue that should concern us today is how best to achieve
that policy posture (with perhaps a secondary issue being:
"How can we recognize that position when we get there?").
Already there is a good deal of monetary restraint
present in our financial system. Interest rates have been
rising sharply, securities markets are tight, and both
bank and nonbank credit extensions to private borrowers
as a group seem to have slowed somewhat.
Even so, when we see the kinds of excess demand still
apparent in most markets, the accelerated rates of advance
in prices and wages that are taking place, and the overlay
of inflationary expectations apparent in many quarters,
we simply cannot sit back and assume that monetary policy
has done enough.
There is one major problem that we must take account
of, of course, in contemplating any further firming by
monetary action. That is the subject--already discussed
this morning--of the highly uneven impact of the credit
restraint already achieved, and the likelihood that still
more uneven effects could follow from further credit
tightening action. These uneven credit effects need to
concern us--not just because they are inequitable, or
because they give rise to political hostility, but because
the kinds of credit being least affected are those financing
some of the most inflationary and unsustainable types of
private expenditures, most particularly business plant,
equipment, and inventory spending.
8/23/66
-52-
The kind of discount administration program we have
talked about this morning seems to me to offer us one
possibility of doing something--not everything, but
something--to redress this lack of balance in credit
restraint. In my judgment, some such program--adjusted
and qualified as seems wise in the light of the best
thought of everyone in the System--has to be an essential
part of our future monetary policy. To fall short on
this score will be to stop monetary policy from making
its fullest contribution to the very difficult task
of economic stabilization that this country faces today.
I am going to assume, therefore, that we will take
steps in the direction outlined that will make further
tightening via open market operations feasible and
desirable. To be specific, I would like to see net
borrowed reserves running deeper by at least $100
million--one-fourth of the reserve effect of the reserve
requirement increase--by the time that action becomes
effective in early September. Beyond that, I recognize
that member bank borrowings might mount considerably higher
as banks seek discount window assistance in meeting the
September squeeze. I would urge the Manager not to engage
in open market purchases to reduce such borrowing, but to
instead be prepared to conduct operations to keep such
injections of borrowed reserves from in any way easing
the climate of firmer money market conditions that I
hope we will have achieved by then.
Finally, let me say a few words about the desirability
of keeping the "proviso" clause in the directive. It is
important in our instructions to the Manager to keep in
mind the need for providing him with sufficient flexibility
to moderate unexpected and undesired surges or contractions
in credit demand. Generally, he should be able to make
the net position of banks and the money market less
comfortable if credit demands prove very strong and more
comfortable if such demands become weak. As strong demands
converge on banks, the Manager in his operations should
force the banks to meet some part of their resulting
reserve needs through the discount window; in that way,
the discipline of the window can be added to the discipline
of the market place. On the other hand, if demands prove
weak, it would not be amiss if banks as a whole were in a
position to reduce some of their indebtedness to us.
However, in as inflationary a situation as we face
today, we should be more wary of letting the indebtedness
8/23/66
-53-
of banks to the Federal Reserve become too low than about
forcing it to high levels. In the current circumstances,
this means that the Manager should see to it that net
borrowed reserves deepen further, and more rapidly if
credit demands prove strong and threaten to bring about
a rapid aggregate reserve expansion. Only if it is
crystal clear that demands are weakening, or if in the
unlikely event that financial markets become patently
disorderly, should he let up in any significant way on
the pressure on banks.
I believe the following wording for the second
paragraph of the directive would accomplish the objectives
I have in mind:
To implement this policy, while taking account
of possible unusual liquidity pressures on banks,
System open market operations until the next
meeting of the Committee shall be conducted with a
view to attaining further firming of money market
and reserve conditions, with the firming to be
greater if bank credit tends to expand more than
expected.
Mr. Hayes then made the following statement:
The pace of the business expansion appears to be
increasing in the current quarter, and there are signs
that inflationary pressures in the economy are accelerating.
As has been true for many months, the outlook is for
continuing strength in the economy over the remainder of
the year and well into 1967. Price developments in July
were very discouraging, as wholesale food and farm
prices once again rose sharply; and earlier hopes for
lower prices in this area later in the year seem to have
vanished. Consumer prices continue to rise at a rate of
about 3.5 per cent. The airline wage settlement seems
likely to set an excessive wage pattern for upcoming
contract demands; and emergence of cost-push pressures
is further indicated by the recent steel price increase.
There is no basis for encouragement as to our
balance of payments position, despite some recent official
and press comments in that direction. A preliminary
deficit figure of $437 million for July is very unfavorable
even after allowance for seasonal factors. For several
months we have observed a serious deterioration in our
trade surplus, and apart from special transactions our
liquidity deficit would have increased from a $2.0
8/23/66
-54-
billion rate in the first quarter to a $2.5 billion
rate in the second quarter. For the time being, pressure
on the dollar in foreign exchange markets has been
significantly reduced by heavy borrowings in the Euro
dollar market by overseas branches of American banks.
Incidentally, this was not reflected in the required
reserves of the banks involved and has provided a
partial alternative to enlarged Federal fund purchases
and borrowings at the discount window.
Bank credit statistics are as usual highly confusing,
but the growth so far in 1966 has been only a little
below last year's excessive rate. There has been some
uncertain indication of a more significant slowing in
the last few weeks, even after allowance for the estimated
growth of U.S. bank liabilities to overseas branches.
However, New York bankers are projecting a further
substantial loan increase for the third quarter and are
again tightening their lending policies. The prime rate
boost was of course intended to facilitate this process
of rationing. Current loan demand is no doubt swollen
by fears that credit may become still harder to obtain
some months from now. Meanwhile the big city banks are
faced with the prospect of a considerable loss of negotiable
CDs over the coming weeks and months, in the light of
the recent sharp upward movement of nearly all market
interest rates.
Coming to matters of policy, I am impressed anew
by the urgent need for development of a concerted System
approach in view of the very difficult economic and
financial conditions we face and the lack of clear
understanding of these problems in many quarters outside
the System. In the first place, the need for general
Governmental policies of restraint seems to be obvious;
yet there is still no evidence of a likely near-term
assist from fiscal policy in the form of a tax rise.
With the burden on monetary policy therefore excessively
heavy, we must be even more than usually alert to the
risk of causing undue financial strains or disorderly
markets, without losing sight of our basic goal of
slowing the rate of bank credit growth.
In connection with recent increases in reserve
requirements, I think it worth emphasizing the inevitably
intimate connection between reserve requirement changes
and open market operations. Inasmuch as open market
operations are inherently capable of supporting,
reinforcing, or nullifying the reserve effect of a
8/23/66
-55-
requirement change, it would have been useful to have a
prior general discussion of possible future reserve
requirement changes at a meeting of the Committee, just
as it has been our general practice to use this forum
for a general exchange of views on the desirability of
a discount rate change.
My second observation on the latest change in
requirements has to do with my concern that the System
may be playing into the hand of those who maintain that
a very sharp distinction may be made between cost of
credit and its availability. More concretely, it seems
illusory, for example, to refrain from approving a
discount rate rise on the ground that it may lead to an
escalation of market rates, while raising reserve require
ments in the hope that this may lead to slower credit
expansion without appreciable rate effects. There seems
to be little doubt that the two recent increases in
reserve requirements have been a significant contributing
cause of the sharp upward move in market rates. I might
add that our directors wish to be associated with these
comments on the necessarily close tie between cost and
availability of credit.
Turning to open market policy, I would hope we can
maintain a firm rein on bank credit expansion. Further
tightening should be closely geared to the pace of growth
of bank credit as that can best be measured in the short
run. In this connection, it is worth noting that the
bank credit proxy for August, after allowing for re-lending
of funds obtained from foreign branches, appears to be
running at or below the lower end of the 4-6 per cent range
mentioned at our last meeting. I will be pleased if this
is the way the August figures finally come out. Looking
ahead, I would continue to feel that a rise in the proxy
at a rate significantly above 6 per cent would be reason
for greater restraint, provided that market conditions
permit such action by the Manager. In general, I believe
we should be paying close attention to the uncertainty
that has prevailed in financial markets. In terms of net
borrowed reserves, I have in mind a level of around $500
million, with higher levels if credit expansion is exces
sive.
A higher net borrowed reserve figure of course implies
forcing the banks to acquire more of their reserves through
the discount window; and this in turn would automatically
give the System additional leverage over the banks' credit
8/23/66
-56-
policies. As I said earlier, all of this can be accom
plished in the period immediately ahead without any
essential change in the method of administering the
Reserve Banks' discount windows. I think all of us
agree that we should try to force more banks into the
window; but, as I have already suggested, this is the
automatic effect of any tightening through our tested
instrument of open market operations.
The discount rate is even more glaringly out of line
with market rates than it was about six weeks ago, when
the directors of a number of Reserve Banks voted to
Our own directors feel quite strongly that
increase it.
the rate should be raised now that the Treasury financing
is out of the way. I very much hope that the Board of
Governors will see fit to go along with an increase some
time in the next two weeks or so, as I think it would be
most unfortunate if the impression were to gain ground
that the rate is "frozen" at its present level until the
banks become much tighter than they are now. The discount
rate has traditionally been a "member of the team" of
credit policy instruments. At the very least it has been
moved from time to time to bring it in line with the
realities of market conditions, even when it was not used
as a dramatic advance signal. It is so far behind the
parade now that it may cause unnecessary public confusion
as to our basic policy objectives, besides rendering
administration of the window more difficult than it would
otherwise be. I am not sure in my own mind whether the
rise at this time should be by 1/2 per cent or by 1 per
cent.
As far as the first paragraph of the directive is
concerned, I would suggest adding to the phrase "and
interest rates have risen substantially" the words "in
an atmosphere of great uncertainty."
Alternative A of
the second paragraph would best express my policy conclu
sions, but with all the provisos involved I would not
object to alternative B if the majority prefers it.
Mr. Francis observed that there were some similarities between
the economic problems of the British for the past three or four years
and the economic problems of the United States during the past year.
In both cases public policies had fostered excessive total demand
8/23/66
-57
for goods and services resulting in inflation.
Total demand in
excess of ability to produce leads not only to current price infla
tion but also to bottlenecks and other inefficiencies of production,
which, as time passes, may cause the margin between demand and
available supply to become even larger.
The British might have had
greater real production in the recent past if they had not followed
excessive total demand policies which led to inflationary wage
settlements and "hoarding" of labor.
In the United States, Mr. Francis said, prices had been
rising during the past year, and output was not being hampered by
shortages of key items.
Current wage demands, the breakdown of
the administration's price guidelines, and talk of wage and price
controls pointed up the seriousness of the problem of excessive
total demand.
The problems of wage negotiations and of commodity
pricing would be greatly simplified if there were public confidence
that total spending was being kept within limits which would foster
general price stability.
The longer total demand outpaced real
output the greater the economic problem became, as evidenced by
the British situation.
But the economy continued to operate under the pressures
of excessive total demand, Mr. Francis remarked.
Although total
spending slowed in the second quarter, the last half of the year
apparently would resume a rapid pace similar to that which spending
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had followed since the end of 1964.
It was highly unlikely that
the productive capacity of the economy could accommodate that
level of demand without further and sharper price increases, and
as one looked towards next year's wage bargaining, the inflationary
prospects seemed even more dismal.
It became increasingly clear, Mr. Francis said, that fiscal
policy had been far too expansionary and had been the primary
contributor to excessive total demand during the past twelve months.
Moreover it would apparently continue in the same direction over the
last half of this year.
But he did not think a withholding of
appropriate monetary measures was justified because of lack of a
more enlightened fiscal policy.
Rather, the Committee should view
fiscal policy as part of the given total demand picture and adapt
monetary policies accordingly.
During the past year financial intermediaries had been slow
to increase their rates on both loans and savings, Mr. Francis noted.
That reluctance to adjust to market conditions had resulted from
their own conservatism and short-run profit considerations, pressures
from the administration and the supervisory agencies, and restrictive
laws and regulations.
As a result, the flows of funds through banks,
savings and loan associations, and other financial intermediaries
had declined, and, surprisingly, the smaller flows had been char
acterized as a rate war for funds among financial institutions.
The
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reduced role of the financial intermediaries had been induced by an
expansion of direct lending and borrowing in the capital and money
markets and by an intensified use by corporations of their own liquid
funds.
Most funds raised in the open market went to governments and
the larger well-known businesses.
Small borrowers who relied chiefly
on financial intermediaries for credit were those mainly affected by
these changing credit flows.
It had been suggested, Mr. Francis added, that supervisory
agencies should further limit rates paid by financial intermediaries
at a time when most other rates had been working up.
him that that would be the wrong thing to do.
It seemed to
To the extent that
the limitation held back adjustments in particular areas, it mis
allocated resources.
Such actions would tend to reduce further the
role of financial intermediaries and would make it still more dif
ficult for those small borrowers that relied on financial institutions
to get an appropriate share of the credit.
Also, there was a risk
that diverting funds from banks and other intermediaries might be
interpreted as monetary restraint (i.e., a slower growth in deposits,
bank credit, and measurable liquid assets) when in fact total liquid
assets might continue to rise unabated via other avenues.
It was
becoming increasingly evident that over the past four months the
firmer stance of the Committee had brought about a leveling off in
the rate of growth of total reserves and money.
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While the rate of growth of productive capacity might be
a reasonable first approximation of a norm for the growth of the
money supply, Mr. Francis remarked, there were times when a lesser
rate was appropriate, just as there were times when growth should
be more rapid than normal.
In this period of easy fiscal policy
and higher interest rates, when the rate of growth of demand for
money holdings was exceptionally low and there was an excessive
total demand, now, if ever, was the time when the money stock
should not be increased so rapidly as the demand.
The recent moderation of monetary expansion was most
encouraging, and he would like to see restraint applied with
increasing pressure until there was evidence that spending plans
and inflationary expectations had been moderated.
He thought that
maintaining the same degree, or somewhat less, of total reserve
availability than had prevailed over the past few months was in
order.
Shortly, he would expect that the banking system would be
increasingly unable to accommodate further spectacular increases
in business lending such as had occurred since April.
There had been some talk of an autumn "liquidity crisis"
both for banks and for nonfinancial corporations, Mr. Francis
noted; but that should not deter the Committee from its quest for
long-run stability.
If anything like a liquidity crisis should
show itself, it seemed to him that the necessary short-run adjust
ments could and should be made through the discount window.
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The discount rate continued to be increasingly out of
step with market realities and almost any economic reasoning
argued for its realignment, Mr. Francis said.
He was aware, how
ever, that other telling arguments existed for continuing the rate
without change.
So long as those arguments remained dominant, he
was confident that borrowing could be controlled by proper discount
window administration as a tighter over-all policy was pursued.
Mr. Patterson reported that the Sixth District economy
continued to be exuberant.
About the only soft spots were in
southern Florida, where the airline strike seriously cut the summer
tourist business, and in some agricultural areas where production
of cotton and corn was expected to be down because of drought and
reduced planted acreage.
Construction employment held at very high
levels in most areas of the District, and construction contracts
through June remained strong despite disruption in the mortgage
markets.
There was a strong advance in manufacturing employment
in June that helped pull up total nonfarm employment, although the
July figure would probably show less strength because of strikes.
However, the strongest growth industry was Government employment,
which had experienced a seasonally adjusted increase of 8.7 per
cent since the first of the year.
Sixth District bankers, especially those in the larger
cities, continued to complain about difficulties in meeting the
8/23/66
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credit demands stemming from the exuberant behavior of the economy
even though many of the District banks had apparently experienced
less pressure than banks in other parts of the country.
Many
District banks had been able to hold on to their investments
despite the loan expansion.
tightest positions.
The larger city banks were in the
In Mississippi, where the seasonal loan peak
generally came in August and September, some banks had been hard
put to meet loan demands and, judging from the applications at the
discount window from an increasing number of small country banks,
the pressures were extending outward from the larger cities.
For
the District as a whole, the major seasonal pressures were yet to
come although the normal seasonal increase from now to December of
about 2.5 per cent was small compared with the current seasonally
adjusted growth in loans of 1 per cent a month.
Pressures were
greatest at the Atlanta banks, and last Wednesday all the Atlanta
banks raised their prime rates to 6 per cent.
Mr. Patterson said that, after looking at economic
conditions in his own area and concluding that they were fairly
typical of what was going on throughout the nation, it would be
easy to fall into the temptation of considering that the policy
the Committee had been following had had no effect at all on
slowing down the pace of the economy.
that was so.
However, he did not think
Undoubtedly, expansion would have been much greater
8/23/66
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had policy provided a higher reserve base for the growth of bank
credit.
More importantly, the way rates were behaving and funds
were being sought out suggested that the economy was tightening
itself and that that tightening was going to have an increasing
effect on limiting total demand.
One of the men at the Atlanta Bank had suggested that
this was the time for the System to punt.
Although he was not
an expert quarterback, Mr. Patterson believed a football team
decided to punt when it was in such a position that an offensive
act was too risky to make and giving the ball back to the other
team might eventually create a better offensive position.
On the basis of similar reasoning, Mr. Patterson
concluded that an increase in the discount rate now seemed to be
too risky a move to make.
He feared that the psychological impact
would not result in merely a technical adjustment of catching up
with market rates but rather in pushing the whole rate structure
up, intensifying the illiquidity of the banks, and ultimately
forcing the System into supplying large quantities of reserves in
order to avoid a liquidity crisis.
Under those circumstances, it seemed to Mr. Patterson
that the banking system and the financial markets should be allowed
to handle the ball for a while with the System maintaining a strong
defense.
In other words, it should allow market adjustments with
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minimum interference.
The recent rise in the prime rate suggested
that that was already occurring.
A strong defense implied that
the System should not prevent further market adjustements by
raising permissible rates under Regulation Q nor offset the effects
of the Board's recent action raising reserve requirements against
time deposits.
If, as a result, more banks were forced to resort
temporarily to the discount window, a gradual deepening in the net
borrowed reserve figure should be allowed.
He favored alternative A
of the draft directives, with the change suggested by Mr. Hayes.
Mr. Bopp remarked that with the business advance showing
clear signs of accelerating in the current quarter, financial
markets had continued under considerable strain.
Bankers in the
Third District expected more intense loan demand in the fall, with
seasonal growth added to the cyclical thrust responsible for the
intensity expected.
The demand for business loans had been
especially strong since midyear.
Though old customers and large
borrowers continued to be accommodated, new borrowers had in many
cases been turned down.
All of the Philadelphia reserve city
banks followed the increase in the prime rate.
There had been
few changes in terms of mortgage loans in the past several weeks.
Most Philadelphia banks were making mortgage loans only in excep
tional cases and to fulfill previous commitments.
Only a minority
of the banks, however, had attempted to cut back instalment loans.
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As for sources of funds to meet the anticipated fall loan
demand, Mr. Bopp said that two Philadelphia banks expected consumer
type savings certificates to provide the bulk of the funds needed.
Two other banks thought they could attract some CD funds in the near
term; however, all expected CD's to decline in the fall.
Two large
Philadelphia banks believed they might be forced to reduce loans in
the fall as a result of shortages of funds.
In the nation as a whole, Mr. Bopp continued, it also seemed
likely that the banking system would come under increasing strain in
coming months as loan demand intensified under seasonal pressures and
as banks found it more difficult to replace maturing CD's.
Indeed,
$7.7 billion (about 43 per cent) of the negotiable CD's of $100,000
and over outstanding July 27 would mature in August and September.
That raised the question of market reaction to a runoff, possibly
one of sizable proportions.
Since a market confronted with the
unexpected was more likely to be buffeted by severe pressures, the
Philadelphia Bank had tried to get some further idea this past week
of bank expectations regarding the Regulation Q ceiling.
The question
had been discussed with high-ranking officers at each of the five
major Philadelphia banks.
Those individuals expected no change in
the Q ceiling, and all expected some pressures to develop from CD
runoffs as rates on other instruments rose.
Two respondents cited
public statements by System officials as the basis for their belief.
8/23/66
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One banker believed political considerations prevented any change
in Regulation Q.
Another said that the Federal Reserve System had
performed two "operations of relief" in behalf of banks previously,
and that he felt bankers were on their own this time.
He also
stated that he believed "monetary policy has done all it can do."
Turning to policy, it seemed to Mr. Bopp that the proper
course was to allow pressures to build slowly and to exert further
restraint on growth rates in reserves and bank credit.
Accordingly,
he would coordinate open market operations with the Board's action
on reserve requirements to achieve a gradual move toward further
restraint.
He would use the discount window if necessary to ease
severe pressures on individual banks.
In view of the intense
pressures currently prevailing in money and capital markets, however,
he suggested that any move toward further restraint should be gradual
and should be implemented with great caution.
On economic grounds,
he still favored an increase in the discount rate.
On balance, he
favored alternative B for the directive, but he did not feel strongly.
Mr. Hickman expressed the view that business activity should
continue to move forward for the rest of the year, sparked by increas
ing demands for equipment and materials.
Defense spending had already
far exceeded expectations and, as pointed out in the green book,
"there appears to be no abatement in the pace of the increase."
and equipment spending was exceptionally strong.
Plant
As an illustration,
8/23/66
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one of the Cleveland Reserve Bank directors, the chief executive
officer of a leading machine tool producer, stated at the last
Board meeting that present order backlogs were sufficient to maintain
production at full capacity for the next 14 months, even without any
new orders, although he warned that some of the backlog would be
cancelled in the event of a business recession.
Production of 1967
autos would soon be moving into full swing and, as now planned, the
auto component would provide more than seasonal stimulus to the produc
tion index in coming months.
However, with expected end-of-August
inventories of approximately 1.1 million cars, equivalent to a 48-day
supply, planned production might be too optimistic.
Steel output turned up in July on a seasonally adjusted basis,
Mr. Hickman noted, but it was expected to decline in August and should
contribute little to the production index, plus or minus, for the
balance of the year.
Steel companies reporting to the Cleveland Bank
on a confidential basis indicated that new orders in August were not
rising as much as usual, and that defense orders thus far had been
easily absorbed by the industry.
On the price front, Mr. Hickman said, the public seemed to
be catching up with the fact that inflation was a clear and present
danger.
Actual price behavior, however, had been mixed, with prices
of sensitive industrial materials declining recently.
While that
might imply a temporary lessening of inflationary pressures on
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industrial prices, the resumption of rising farm and food prices and
disquieting wage negotiations--both present and future--left little
room for complacency.
Nor could one be complacent about the financial situation,
Mr. Hickman continued, in view of the serious stringencies devel
oping in financial markets.
The depressed states of the mortgage
and stock markets were well known.
Beyond that, more selective
lending policies of banks were pushing corporations increasingly into
the capital market.
Private placements were drying up as a source of
funds; insurance companies were overcommitted and were themselves
contemplating use of the capital market.
In the municipal market,
lower prices and rising yields, in part caused by bank selling, had
resulted in cancellations of new municipal financings.
Thus, intended
policy effects had apparently been achieved throughout all sectors of
the money and capital markets.
Moreover, mounting evidence suggested that further pressures
would build up in the weeks immediately ahead, as strong demands for
credit pressed on a growing scarcity of funds.
Although prediction
in that area was always hazardous, Mr. Hickman believed the Committee
could look for sharply higher yields in the corporate and municipal
markets in the next few months, caused by further bank liquidation
of municipals, the drying up of CD's, and the withdrawal of insurance
companies from the mortgage and capital markets.
All that had led
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and would lead to a desired reduction in aggregate demand.
The
problem was to achieve just the amount of reduction that was needed
to relieve price pressures without destabilizing the economy.
His
own view was that the Committee should wait to see how the economy
responded to the steps already taken.
Mr. Hickman therefore recommended that policy be kept about
the same until the next meeting, with bank reserves provided only
to satisfy seasonal needs.
If bank credit increased more than
projected, under the moderate CD runoff assumption, net borrowed
reserves should be allowed to rise perhaps to as high as $600
million.
On the other hand, if bank credit increased less than
projected, then net borrowed reserves might be allowed to remain
about where they were, that is, around $400 million.
Mr. Hickman said he had been on the call since the last
meeting, and would like to commend the Manager for his handling of
a very difficult situation.
The refunding was touch-and-go all the
way, with considerable attrition, and with the new issues drifting
off in the after-market.
The Manager was hampered during and after
the refunding by major revisions in the reserve statistics, partic
ularly by a shortfall in required reserves below expectations.
That caused net borrowed reserves for one week to fall below $400
million.
On the other hand, smaller net borrowed reserves were
accompanied by lower total reserves, nonborrowed reserves, and bank
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credit (proxy) than had been adjudged appropriate by the Committee.
Yet the money market was extremely tight and uncertain.
In the words
of one observer, the market was characterized by "solid erosion."
Despite all of that, the Desk was able to steer a middle course that
avoided the extremes of tightness and ease.
Mr. Hickman repeated that he favored keeping policy about the
same until the next meeting.
He found the first paragraph of the
draft directives acceptable, with Mr. Hayes' suggested amendment.
He would suggest a second paragraph reading "To implement this policy,
while taking account of potential liquidity pressures within the bank
ing system, 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; provided, however, that if
required reserves expand more rapidly than expected, operations shall
be conducted with a view to requiring greater reliance on borrowed
reserves."1/
Mr. Brimmer pointed out that there was a minor inconsistency
between objectives with respect to the balance of payments and on the
domestic side.
While the inflow of funds from foreign branches of
U.S. banks apparently was helpful from the balance of payments
standpoint, it undercut to some extent the efforts of the Committee
to achieve further gradual credit restraint at home.
That was
1/ Later during the go-around, Mr. Hickman indicated that a
directive along the lines suggested by Mr. Mitchell would be
acceptable to him.
8/23/66
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particularly important because so few U.S. banks had foreign
branches and benefited from the inflow.
He hoped that before too
long the Board would review the situation and reach a judgment
about the appropriate steps to take, if any, with regard to the
inflow.
With respect to the domestic scene, Mr. Brimmer commented
that the question was being raised increasingly whether the System
had gone far enough with monetary policy.
That was enhanced because
of the uncertainty and doubts on the part of some observers about
the differential impact of credit restraint.
that the System had not gone far enough.
His own feeling was
Despite the lack of
additional assistance from the fiscal side--and today's paper quoted
a high official as giving assurance that there would be no tax
increase at this time--he thought it was vital that the System push
on with the use of monetary instruments.
The recent informal survey
of current lending practices, conducted by the Reserve Banks at the
request of the Board, provided mixed evidence.
The responses describ
ing the activities of some of the banks were less comforting than he
had hoped.
While there were substantial variations, even within
Districts, on balance the evidence indicated that the banks were in
fact rather close to being prisoners of their large customers.
While he would not say that in public--only within the Committee--he
thought he detected such a high degree of value on customer relations
8/23/66
-72
that the banks, in fact, had difficulty in saying "no."
He repeated
that he thought the System should push on.
During the past couple of weeks, Mr. Brimmer said, he became
concerned about the way the Desk was carrying out the directive of
the Committee.
He agreed with Mr. Hickman that it was a difficult
period, complicated by the Treasury financing and the serious problem
of how to maintain an even keel, but he had asked a staff member to
review the operations of the Desk during this period because it was
possible to see some slippage and he wanted to know why that had
occurred.
The staff appraisal was shared with the Manager, who
thought it was worthwhile to undertake a review of that kind from
time to time.
The evidence suggested that the Manager had decided
to accept net borrowed reserves in the lower part of the indicated
range.
The reasons for that decision were convincing to the Manager
and were accepted by him (Mr. Brimmer).
That meant, however, that
the Committee was starting off with net borrowed reserves not quite
as it
had hoped they would be when the Committee met a month ago.
How to quantify that was difficult, but he felt that the Committee
was slightly behind and that it
should make up some lost ground.
As a minimum, he hoped that the effect of the Board's reserve require
ment action would not be completely offset.
Roughly one-fourth could
be passed through to net borrowed reserves, in his opinion.
8/23/66
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In summary, Mr. Brimmer thought the Committee ought to come
out with net borrowed reserves somewhat higher than at present.
The Manager had suggested a figure in the high $400 millions, but
he (Mr. Brimmer) was hopeful they would end up in the high $500
millions.
On the discount rate, he would say simply that he had
heard the comments around the table this morning.
All of this suggested to him, Mr. Brimmer said, that the
Committee ought to come out with alternative B, phrased as suggested
by Mr. Robertson, because it would permit the Committee to make up
some of the ground that had been lost.
Mr. Maisel said that from all the documents received for
this meeting it seemed to him that two critical facts stood out.
First, it appeared that aggregate demand was going to expand less
than aggregate supply for the next half year.
Second, the credit
variables, with the exception of business loans, had finally reached
the point where they were expanding less than normally.
Most had
now reached a level of expansion only about one-half to two-thirds
of the expansion rate of last year.
Those were the two critical
bases against which the Committee was going to have to operate.
Accordingly, Mr. Maisel said, it seemed to him the Committee
had now reached the point where it must consider what impact monetary
policy was expected to have on the situation with respect to aggregage
supply and demand.
How would the monetary variables react, and would
the reactions be desirable for the economy?
As to action the System
-74
8/23/66
was taking now, when would it be expected to be effective?
He did
not think the answers to those questions were critical at this
meeting, but he believed they would grow increasingly important over
the next few months, and he would hope the Committee could have
specific estimates of the expected impact and the lags involved.
Mr. Maisel disagreed with the view that there had been any
undue slippage.
Rather, he would want to hold the credit proxy at
an annual expansion rate close to the average thus far this year.
It seemed to him that the Committee should start allowing the market
to react against a rather constant growth rate rather than to
determine the market, with one basic exception.
Business loan
expansion was far out of line with all other credit variables, and
he would favor a policy of trying to indicate to the banks, through
the discount window, that a substitution of business loans for
securities was not aiding monetary policy in the fight against infla
tion.
It should be made clear that if credit was going to be curtailed,
the place where the curtailment would do the most good was in business
loans.
With those provisos, Mr. Maisel said, he would favor contin
uing to follow a credit proxy variable as a basis for Desk operations.
He would be well satisfied with a 6 per cent expansion rate in the
credit proxy, and he would support alternative A for the directive
on the assumption that that was its goal.
He would not be concerned
8/23/66
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if net borrowed reserves fell below current levels, or if money
market conditions relaxed somewhat or tightened, provided the
credit variables continued to expand at about the rates that had
prevailed recently.
Mr. Daane made the following statement:
At the outset Mr. Chairman, I would like to address
myself to the Board's action of last Wednesday, not in a
spirit of recrimination or of crying over spilled milk
but rather because, as indicated in your statement as well,
I think the considerations surrounding that action are
highly revelant to the problems and decisions we confront
today. Perhaps I can most simply summarize my views with
respect to that action and where it leaves us and leads
us by reading into the record my memorandum to the Board
of August 11, 1966. That memorandum read as follows:
I have reviewed carefully Governor Robertson's
memorandum of August 9, 1966, proposing a further
increase in reserve requirements on large holdings
of time deposits, and the related staff memoranda.
I have also discussed the possible market impact
with the Manager of the System Open Market Account.
On the basis of this review and discussion, and
despite my feeling that the System should, in the
absence of sufficient fiscal restraint, move
further in the direction of credit tightening, I
am strongly opposed to the suggested reserve
requirement action at this time for the following
reasons:
(1) The announcement effect, in the present
market, would in my judgment have severe
repercussions, going well beyond what would be
desired and well beyond the repercussions of
a modest discount rate change. If it resulted,
as it well might, in a substantial forced sale
of assets by one or more of the largest banks
this could bring us close to a disorderly market
and necessitate Account operations and resultant
reserve expansion contrary to present System
objectives. Present market sensitivity is amply
demonstrated in the reception accorded this
8/23/66
-76week's issue of Public Housing Authority notes
and in the current behavior of the new 5-1/4s,
which are selling below par despite substantial
Treasury purchases during the past two days.
(2) The action would intensify the problem
the banks face in September of replacing existing
CDs without, in my judgment, achieving the
differential impact on bank credit expansion
intended and desired. As I review the staff
documents, and from my own discussions with
several bankers whose judgment I respect, it
seems to me that the real problem confronting
us is one of avoiding too abrupt a runoff of
CDs rather than aggravating a squeeze by our
actions. And I am skeptical, as apparently so
is staff, that the desired differential effects
would ensue. I think banks would simply cut back
further in the credit areas where they are now
cutting--hitting much harder on other loan and
investment areas than on business loans, and
least of all on the demands from their best
business loan customers.
(3) The action most assuredly will be used
by the banks as the peg upon which to hang a
further increase in the prime rate. This
unnecessarily exposes the System to the escalation
of interest rates attack and I would not be at all
surprised to see some of this come from administra
tion as well as Congressional sources. On the
other hand, it would expose us to attack from the
larger banks--and one difficult to gainsay--to
raise Q ceilings, once more in order to avoid a
drastic blockage of fund flows.
(4) Cushioning operations at a time when
we are normally supplying reserves will necessitate
much larger open market operations and there would
be technical difficulties involved in such an
action.
In summary, I think the timing of the action
would be unwise in the light of current market
developments, of an impending prime rate increase
(and without an FOMC meeting providing a forum
for full discussion of the integration of our
I question whether the desired
instruments).
differential effect will be accomplished and think
8/23/66
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there is a real risk that it will necessitate
System action either to expand reserves or to
raise Q ceilings to avoid undue blockage. And,
finally, it seems to me that further credit
tightening could better be achieved with a
further gradual tightening of open market
operations, subject to a full review by the
FOMC on August 23, 1966.
Subsequent to my memorandum the Board rejected the
proposal to increase reserve requirements, the prime rate
was then raised, Secretary Fowler publicly rebuked the
banks, and the Board majority then went ahead with an
increase in reserve requirements--an action which I did
not share and would not have shared had I been present.
Following last Wednesday's action we have, of course,
had, as I see it, the worst of all possible worlds--a
resultant sharp runup in interest rates, with serious
talk of another prime rate increase, and weakness in the
pound sterling also not unrelated to our recent action.
In evaluating where all of these developments leave
us and lead us today, I am impressed by the views expressed
by members of the Dillon Committee at their meeting last
Friday. This committee, comprising some of the top minds
in the country on international and national financial
matters, did not discuss the Federal Reserve's latest
action in their joint session with Government officials
which I attended. Apparently, however, they did review
it thoroughly in their own deliberations prior to meeting
with Government officials. And one member of the Dillon
Committee told me that they were all extremely critical
of the action, using fairly strong language in the process.
Only one member of the group (which, of course, includes
Messrs. Dillon, Heller, Gordon, Rockefeller, Roosa,
Kindleberger, Mayer, Wilde, and Bernstein) defended the
action and then only if it was aimed solely at raising
slightly the cost of CD money and assuming the reserve
impact would be completely offset by open market opera
tions. Some of the reasoning of those critical of the
Fed's move did appear in the joint discussions and I
think is worth noting. The view generally seemed to be
that we were closer to precipitating a financial crisis
than anyone in Washington realized; that while monetary
policy should not "lose its nerve" it was indeed biting
and biting hard--now--even on business loans; that if it
had been left alone the market and credit situation would
8/23/66
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have tightened itself more than sufficiently; but that
the further stress induced by our action could serve
to provoke a crisis or, at best, be self-defeating
because of our efforts to prevent such a crisis. There
was an unequivocal statement of the Dillon Committee
addressed to the Secretary of the Treasury that what
was lacking on the Washington side was a clear voice
and sense of purposeful direction and guidance. I
might mention also that one of the factors cited as
contributing to the over-taut market situation was the
continuing stream of agency issues and question was
raised as to whether there might be any way to defer
agency efforts to raise new money.
As I have thought about all of these matters in
terms of today's decisions, I am convinced that we
can allow very little, if any, of the increased
reserve requirement at this juncture to find its way
into the net borrowed reserve target. Absent that
Board action, I think we might very well have directed
the Manager of the Account to permit the credit markets
to further tighten themselves somewhat, or even to
probe cautiously toward a further reduction of avail
ability as market conditions permitted, against the
background of a slower pace of loan expansion, even
of business loans as indicated by weekly reporting
banks, of the inroads on bank liquid asset portfolios
that have taken place, of the significant volume of
CDs maturing soon--all leading to existing strong
pressures and even stronger pressures in September.
Next month's likely larger CD attritions can only
serve to add to the pressures on banks facing heavy
loan demands with reduced liquidity.
Thus, I now
conclude that we cannot utilize the most recent action
to produce further tightening but must instead think
about whether we should try to accelerate our seasonal
provision of reserves through open market operations
and similarly provide more of a cushion through the
discount window than is contemplated in the draft
memorandum on discount administration. Otherwise, I
think there is the danger of really disruptive interest
rate developments--disruptive to the financial markets
and the economy--and that risk is too great to run.
Unlike Mr. Robertson's view, expressed this morning,
that he is not bothered by interest rates, I am bothered,
and especially by their implications in terms of market
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pressures. Last Friday in our regular Board staff
discussion of these matters, I raised the question
of the possibility of a financial crisis. Privately
a staff member slipped me a not altogether facetious
note that the probability was ranked by one staff
member at 25 per cent, one member at 33-1/3 per cent,
and one member at 49.9 per cent (almost a 50-50 chance).
While I myself do not see the percentages really that
high, the fact that they exist at all in the judgment
of informed observers should, I think, give us cause
for concern. Frankly I still do not believe that the
kind of further interest rate escalation we see
emerging--escalation that held the Board back from
approving a discount rate change, yet was an inevitable
result of last week's action--should be welcomed by
us or by the administration. I am puzzled by the
seeming naivete of the view that cost and availability
of credit can be neatly separated and central bank
credit so channeled as to determine which loan demands
will be satisfied, all without putting severe pressure
on interest rates. All of whatever experience I have
myself had with financial markets suggests that this
cannot be done. To the extent that banks do not meet
commitments or satisfy borrowers' demands and these
demands turn elsewhere, the price of money inevitably
will go on up. The prime rate change undoubtedly
reflected the fact that large corporate issues required
more than 5-3/4 per cent and, without the prime rate
increase, bank corporate customers would have come in
for their total lines.
All I am saying is that monetary policy may have
produced about as tight a credit situation as we use
fully can. While it is important not to let up on the
restraint we have achieved, I think that we have
pushed about as far as we can at the moment, without
the buttress of adequate fiscal restraint, and are
now achieving all that we can hope for from monetary
policy alone. In saying, as we all have said, I
believe, at one time or another, that monetary policy
cannot do it all alone, I am anxious that we now not
try to disprove ourselves and bring about a financial
disorder either at home or abroad. I would not attempt
a firming of market conditions as per alternative B
and would perhaps provide reserves more willingly than
indicated in alternative A. I would eliminate the
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reference to supplying minimum reserves and suggest simply
maintaining about the current state of money market
conditions--accepting the Partee definition meaning no
relaxation--giving full flexibility to the Manager of the
Account and, as I have already indicated, relying on the
continuing good sense and efforts of our discount officers
without elaborate new rules and arrangements. I am not as
confidently certain as Mr. Robertson that there is no case
now for some realignment of the discount rate.
Mr. Mitchell said that if he understood Mr. Maisel correctly,
the latter was implying that the time might be close for a turn around.
As he (Mr. Mitchell) looked at the pertinent table in the green book,
it showed total loans and investments rising in July at an annual rate
of 10.9 per cent with increases of 8.7 per cent in June, 10.2 per cent
in 1965, and 8.7 per cent for 1966 to date.
While the rate of increase
was down in August, that was just like touching down an airplane that
might bounce and take off again.
There had not been nearly so much
of a touching down as to accomplish the objectives the Committee had
been striving for for a long time.
It seemed to him the rate of
expansion had to be down to the hoped-for August level for a while
before the Committee had achieved its goals.
He thought monetary
policy was biting, and had been, but he thought it could bite a little
more.
That was why he thought some further tightening was desirable.
Mr. Mitchell preferred alternative B of the draft directives,
although he could live with alternative A.
However, he had a change
to propose, recognizing that it would give the Manager a considerable
amount of leeway, probably more than he could use.
His suggestion
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was that the second paragraph of the directive read:
"To implement
this policy, System open market operations until the next meeting
of the Committee shall be conducted with a view to supplying the
minimum amount of reserves consistent with maintaining orderly
money market conditions and the moderation of unusual liquidity
pressures within the banking system; provided, however, that if
bank credit expands more rapidly than expected, operations shall
be conducted with a view to requiring still greater reliance on
borrowed reserves."
It would then be up to the Manager to judge
what it took to maintain orderly money market conditions and what
it took to moderate unusual liquidity pressures.
He thought the
Manager actually had been operating close to that standard for the
past couple of weeks.
He regarded it as an adequate standard and
thought it indicated where the Committee should stand in the next
few weeks.
Mr. Shepardson noted that several comments had been made
about the naive idea that credit availability could be affected
without a rate effect.
He did not know of anyone who had that idea.
The thing he was concerned about was that at times there had been
more emphasis on rate than availability.
was on reducing credit availability.
The emphasis needed now
While recognizing that there
would be a rate effect, he would look for the guideline at avail
ability, rather than rate.
He thought there had been rate
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adjustments in recent weeks and months that were not entirely
compatible with the amount of reduction in availability that had
been achieved.
He did not believe anyone at the table failed to
recognize that the degree of credit availability had an effect
on the rate, but the question was one of where the emphasis should
be placed in the economy of today.
Mr. Shepardson aligned himself with those who felt the
Committee should be pushing for some further gradual tightening.
He would accept alternative B as originally proposed, since the
philosophy embodied in that language reflected his thinking.
Mr. Wayne reported that although economic activity continued
strong in the Fifth District, the latest business survey of the
Richmond Reserve Bank contained a few indications of a slowing
trend.
In addition to a weaker trend in residential construction,
a variety of nondurable goods manufacturers now reported some
decline in new orders and backlogs.
Unemployment remained at very
low levels, however, and wages were continuing upward.
Nationally, Mr. Wayne added, the dominant question was
whether the economy was regaining in the third quarter some of the
momentum lost in the second.
The incomplete data now available
for July and early August were not sufficient, in his view, to provide
a conclusive answer.
In the policy area, it seemed to Mr. Wayne that a combina
tion of pronouncements and actions by the System was conveying to
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the banks and the financial markets the message of restraint.
If
high interest rates could be effective in curbing excess demand,
the present general level of rates should do the job, given time.
The critical factor now was to impose a firm restraint on the
availability of credit.
If that should produce still higher
interest rates, they would have to be accepted.
There was no
question as to the need for continuing restraint; the only question
was how it should be applied.
An increase in the discount rate
would be felt mainly through its announcement effects and would
probably drive up interest rates with little effect on reserve
availability.
It was true that the discount rate was far out of
line, but the market seemed to be accepting the new relationship.
Through firm administration of the discount window, borrowing had
been held to moderate levels and it was doubtful that any feasible
increase in the discount rate would change the demand for discounts
greatly.
Consequently, he believed an increase in the discount
rate would produce several undesirable effects without accomplishing
anything constructive.
In the current delicate situation, a sudden
move of the wrong kind could cause real trouble.
Mr. Wayne favored keeping the pressure about as it was and
as it had been for the past month, which meant that reserves would
have to be supplied, either through the discount window or in the
open market, to offset most of the additional reserves that would
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be required next month.
Alternative A of the draft directives
expressed his views adequately.
Mr. Clay commented that the basic problem with which the
national economy was faced continued to be one of overexuberance,
despite the variation among sectors of the economy.
Accordingly,
appropriate public policy required further measures of restraint,
including further restraint through monetary policy.
The Board of
Governors recently had taken a step in that direction through an
increase in reserve requirements on time deposits effective in
September.
Open market operations should be coordinated with that
action so that the added restraint involved in the reserve require
ment increase was made effective.
The Committee was faced with a number of uncertainties
that would have to be taken into account in implementing monetary
policy through open market operations, Mr. Clay pointed out.
Those included the various impacts upon the commercial banks and
the financial markets deriving from the demand for loans, tax and
dividend payments, CD liquidation, and the higher member bank
reserve requirements.
Recognition had to be given to the conver
gence of a number of those important financial developments as
mid-September approached and the unknown magnitude of their impact
upon the financial system.
Consequently, allowance had to be
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provided in the implementation of monetary policy to meet those
potentialities.
Alternative B of the draft directives appeared
satisfactory to him.
Mr. Scanlon reported that the trend of economic activity
in the Seventh District remained essentially unchanged in July
and early August.
With the exception of the automobile industry,
there had been no moderation of production gains by District
manufacturing firms.
Upward price pressures remained strong.
While unemployment increases had occurred in automobile centers,
other major District areas reported strong labor demand and
continuation of labor shortages.
Help-wanted advertising in
Chicago area newspapers in July increased 16 per cent, signif
icantly more than the 3 per cent gain posted last year.
According to a representative of a local steel firm,
Mr. Scanlon said, customers did not react adversely to the recent
steel price increase.
Although notice of the price hike was given
several days prior to the effective date of the increase, customers
did not take advantage of the opportunity to obtain supplies then
available at the lower prices.
As a result of unfavorable weather during July, crop
prospects in the Seventh District had been revised downward.
Corn
production was now expected to be below last year's level in
Illinois and Indiana.
Farmers might defer the marketing of 1966
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grain crops since the outlook was for strong prices.
Bankers had
noted that the seasonal deposit increase related to the harvest
might be somewhat less than originally expected.
Mortgage terms had continued to firm in the Seventh
District.
Bank loan figures continued to reflect heavy credit
demands by business, and bankers' statements in connection with
the recent prime rate boost indicated that they anticipated even
stronger demands through the fall.
Since midyear the growth in
business loans had been well above the experience in other recent
years, with the Seventh District relatively stronger than the nation
as a whole.
The major Chicago banks reported that they were following
restrictive loan policies; few commitments for term loans were
being made.
To a considerable extent, the higher volume of business
loans had been offset by liquidation of other types of loans,
probably reflecting tighter loan policies.
In addition, there had
been a marked decline in holdings of both U.S. and municipal secu
rities in the past few weeks.
While those developments had reduced
the rate of growth in over-all bank credit, they had also reduced
liquidity further.
The major Chicago banks showed an improved basic reserve
position compared with a month ago.
That was partly due to sales
of securities but also reflected their acquisition of a sizable
amount of CD money earlier this month and an even larger increase
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in other borrowings.
Nevertheless, those funds were short-term
and there was considerable apprehension as to how the banks would
meet CD maturities as well as meet the customer loan demand they
expected.
Mr. Scanlon noted that preliminary estimates indicated
some recent slowing in the growth of most monetary and credit
measures after sharp increases in July.
It appeared to him that
it would be appropriate to maintain the more moderate rate of
monetary and credit expansion in coming weeks.
The settling of
the airline strike and the increase in reserve requirements
effective mid-September should help to curb any tendency for more
than seasonal expansion in adjusted required reserves.
If those
conditions could be achieved within the existing degree of reserve
pressure, he would recommend such a course.
However, if continued
slower reserve expansion required greater reserve pressure, he
would favor moves to bring about that condition.
Mr. Scanlon felt that for economic reasons the discount
rate should be raised.
If the discount rate were brought more in
line with market rates, the System would be in a position to obtain
the announcement effect of large and prompt rate reductions if and
when they should prove desirable.
saw a downturn--quite the opposite.
That did not mean that he fore
He believed the longer one
operated with a rate disparity and the wider it developed, the
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more difficult it would become to find the "right time" for a
change.
He favored alternative B of the draft directives.
Mr. Galusha submitted the following statement for inclusion
in the record:
Ninth District conditions fairly well parallel those
set forth in the green book, with these exceptions:
In the main, the District's experience in the second
quarter, and continuing into the third, is somewhat more
bullish than that of the nation. Retail sales, for
example, rose strongly in the District during the second
quarter, while there was a distinct slow-down at the
national level.
Data for June and July indicate a strong comeback in
the industrial sector from the April-May pause. Impressive
gains were recorded in the mining industry, including metal
mining and petroleum, and continued expansion of taconite
production. Of the 15,950,000 gross tons of annual taconite
capacity under construction on June 21, all but 750,000 tons
were located in the Ninth District, primarily in Minnesota,
with one large development in the Upper Peninsula of
Michigan.
Agricultural conditions continue generally good in the
District, with the exception of southwestern Montana, which
is suffering from a severe drought, and areas of North
Dakota which are suffering from too much rain during the
critical period of wheat harvest. There is little expecta
tion that livestock prices will depart from 1965 levels to
any greater extent than presently prevail. Grain marketings
are uncertain at this point, partly for the reason mentioned
earlier, and partly because of an indicated tendency on the
part of farmers to hold grain for continued strengthening
of price. Because of this strengthening of price, however,
there is reason for the banking community to expect pressure
if there is a reversal of current farmer attitudes, whether
caused by a change in market expectations or crop damage,
which would affect its storage ability.
The general picture is one of high cash farm receipts,
which in turn will mean a continued high level of consumer
demand.
The need for an increase in monetary restraint continues
on balance. Wage settlements being made this summer, and
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the outcome of negotiations which will continue through
the next twelve months, are of a pattern. What evidence
of easing has occurred in some areas of the economy is
at least offset by continued exuberance in other parts.
The Vietnam requirements are certain to continue to
accelerate, particularly in the light of the most recent
developments in China. It might be argued that while
monetary policy has not been particularly effective in
curbing the present inflation--the current issue of the
Economist having likened it in terms of influence to
sun spots--it still is the only weapon being used.
Protestations of the banking industry notwithstanding,
one is left with a feeling that banks are meeting most
reasonable credit requests, and the term "reasonable"
is liberally construed.
The most compelling reason for a further increase
in monetary restraint, including an increase in the
discount rate in the near future, would be to free the
System from the position of technical imbalance with
market rates.
These arguments have been advanced with full
knowledge that there are political constraints which
may be thought persuasive against such an action now,
plus the industry pressure that would result from a
further increase in open market rates if Requlation Q
is not changed. There is the further argument advanced
by one of my colleagues that the current degree of
monetary restraint is so far from the average experience
of the last decade and a half that our quantitative
estimates of its impact may be quite poor. It may be
that under these circumstances the rate of inflation,
which at present is still of a modest order by world
standards, is a price that may have to be paid. However,
I am not persuaded that the case for greater monetary
restraint has been adequately defeated.
Mr. Galusha said he could accept either of the alternative
draft directives.
This was a period when flexibility of operations
would be needed, but at least the present degree of tautness should
be preserved.
It seemed to him the discount rate was in a ridiculous
position and there would have to be a technical adjustment.
There
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was little reason to believe that market rates were going to come
down very fast, and the longer the disparity existed the more
difficult it was going to be to change the discount rate.
Mr. Swan commented that although Twelfth District aero
space firms reported vigorous expansion in employment for the
second month in a row, total nonagricultural employment in the
Pacific Coast States remained about the same in July as in June.
With a decline in farm employment, the rate of unemployment rose
in July to 4.8 per cent, from 4.6 per cent in June.
On the financial side, Mr. Swan said that in the four weeks
ended August 10, total credit at weekly reporting banks declined
more than a year earlier, but by about the same relative amount as
elsewhere.
The decline in business loans was much greater than a
year earlier, and contrasted with an increase in the same period
this year at weekly reporting banks elsewhere in the U.S.
Large
negotiable CD's rose 6 per cent in the period, in contrast to a
decline of .6 per cent at weekly reporting banks outside the
District.
However, time deposits of States and political subdivi
sions declined; that was the one area where there was considerable
feeling at major banks that rate increases would be necessary to
hold the deposits.
The prime competition was from the Treasury
bill market rather than agency obligations.
There was still room
to raise the rates on that sort of time deposits, and presumably
that would be done.
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Looking back over the last four weeks, Mr. Swan was struck
by the fact that the Committee's directive a month ago referred
to "maintaining about the current state of net reserve availability
and related money market conditions."
Maybe net reserve avail
ability was at the lower end of the range in subsequent weeks, but
certainly not related money market conditions.
From the August
figures, it appeared that the changes in total reserves, required
reserves, and bank credit were somewhat less liberal than had been
expected.
In view of those developments, the substantially increased
rate structure, and the market uncertainties that existed, it seemed
to him the Committee should not take further action to tighten
irrespective of market forces.
Instead, he would consider it
desirable to maintain about the present market conditions, recog
nizing that they were tighter now than a month ago.
If credit
demands were stronger than expected, which he translated into the
6 per cent figure mentioned by Mr. Partee, then the Committee should
permit further tightening.
tighten.
Otherwise, he would neither ease nor
In trying to find some measure to relate that to, he had
somewhat the same feeling he assumed was in the minds of the staff
when they dropped the reference to net reserve availability; namely,
that the latter could not be used very well in view of the prospect
of substantially increased borrowing.
If this occurred, he would
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8/23/66
expect some increase in net borrowed reserves, but that would be
hard to interpret in terms of money market conditions.
While he had been thinking in terms of alternative A of
the draft directives, Mr. Swan welcomed Mr. Mitchell's language.
He thought it was an improvement over either of the draft
alternatives, so he would support that sort of directive if the
reference to bank credit expanding more rapidly than expected
tied into the 6 per cent projection.
He believed that a decision
on the question of a discount rate increase could not be delayed
much longer.
He would hope it would not be necessary to wait
until substantial borrowings were already on the books.
The
executive committee of the Board of Directors of the San Francisco
Bank took no action to increase the rate at its last meeting, but
expressed much the same kind of concern that had been mentioned
by Mr. Hayes.
Mr. Irons said conditions in the Eleventh District were
very strong, probably reflecting some of the same factors being
reflected nationally.
Nationally the situation was one of strong
inflationary pressures, in his judgment, and called for no lessening
in the degree of restraint that the Committee had been attempting
to achieve.
It seemed to him that monetary policy had been
effective recently in influencing the attitude of banks.
As to
the uncertainties associated with the anticipated mid-September
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runoff of CD's, that might be something like the situation that
was feared with respect to savings deposits a month or so ago;
the situation might turn out to be not as bad as expected, even
though significant strains might affect banks and markets.
In view of the illiquidity of banks and the effect of
the change in reserve requirements, Mr. Irons felt that a reason
was indicated for trying to maintain for a time about the same
degree of tightness that had been experienced in the market up to
this point.
He had had in mind that he would favor alternative A
of the draft directives for the period ahead, but he liked the
modification offered by Mr. Mitchell because it seemed to reflect
what the Committee was really trying to do.
The Committee was
trying to get all the restraint it could in the market, but at
the same time to maintain orderly conditions.
modification pointed that up clearly.
Mr. Mitchell's
If what the Committee was
trying to achieve could be achieved, well and good.
If not, then
the Committee should not force matters, with money market conditions
as they were and with the uncertainties that loomed ahead around
mid-September.
Mr. Robertson withdrew from the meeting at this point.
Mr. Ellis said that within the framework of generally high
and rising economic activity in New England, three aspects might
be highlighted.
First, District mutual savings banks reported
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downward changes in July deposit balances for the first time in
many years.
Even though new July deposits were up 24 per cent
and interest credits were up 19 per cent compared with July 1965,
withdrawals were up an even greater 47 per cent.
was a .06 per cent decline.
The net change
Second, the District's member banks
continued to gain savings and other time deposits at rates
substantially above the national average.
Third, the region was
not experiencing a slow-down in construction, not even residential
construction.
New England total construction contracts in June
rose 45 per cent above June 1965.
For the first six months the
total stood 34 per cent above the same six months in 1965.
Residential contracts in June exceeded June 1965 by 6 per cent,
and the first six months showed a 9 per cent year-to-year gain.
June building permits in Massachusetts were up 20 per cent from
last year, for a six-month cumulative gain of 19 per cent.
Turning to monetary policy, Mr. Ellis said it was fairly
evident that the economy remained tilted toward inflation.
Demand
pressures of Government expenditures, capital outlays, and probable
expansion in consumer spending indicated the likelihood of a further
trend in that direction in the fall.
To the cost pressures of wage
settlements in excess of productivity gains were added the escalation
of wages to match cost of living increases.
Credit creation continued
excessive, especially after the long period of expansion.
The
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-95
objective as long ago as last December was to slow credit creation,
but the record showed acceleration in business loans, total loans,
total credit, and reserves.
There had been three weeks now in
which the rate of growth seemed less than expected, but, as
Mr. Mitchell had said, one touchdown does not make a safe landing.
He expected that demands ahead in the fall were going to produce
another take-off in the loan category.
Mr. Ellis agreed with Mr. Brimmer's analysis that the
Committee's posture should be one of gradual tightening.
It was
simply a question of the next step, and his answer to that question
rested on two convictions.
First, he felt that the September
"crisis" would turn out to be quite manageable without special
programs to soften the impact of expected developments.
He recalled
the special efforts to soften the July "crisis" that was supposed
to occur at savings and loan associations and mutual savings banks.
Actually, the period passed without great strain.
foresee and plan ahead, they did so.
When banks could
The principal potential
problems were faced by large sophisticated banks.
CD deposits were
not going to disappear altogether, although they might shift in
form and location.
The existing mechanism of the discount window
would provide whatever cushion was needed.
His second conviction
was that the Committee should continue to focus its attention on
aggregate reserve availability, and its cost, rather than attempt
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to tailor a program that sought to allocate credit by categories,
at some risk of lessened attention to changes in the aggregates.
Mr. Ellis said those convictions led him to suggest, as
a first point, that the Committee should tighten the net borrowed
reserve target another notch, by perhaps $50 or $100 million.
Net borrowed reserves had averaged $400 million the past three
weeks, and he would suggest that the target be moved to $500
million, plus or minus $50 million.
He suggested this target
knowing that the Committee would meet again only a few business
days after the effective date of the reserve requirement change.
It could well postpone until that time an appraisal of how much
the effect on reserves should be offset.
If borrowings at the
discount window rose substantially above the $800 million average
of the past several periods, he would add the excess to the net
borrowed reserve target.
That would provide a cushioning reserve
to those banks that needed it, while not losing the effect of
some general tightening on other banks.
Banks had already been
advised that the window would be available for distress cases.
If that course were followed, Mr. Ellis said, he would
expect market rates to rise if credit demands turned out to be
as excessive as projected by bankers to whom he had talked.
Having permitted the rate of bank credit expansion that it had
since December, the Committee could hardly expect to accelerate
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credit growth enough to forestall further rate increases this fall
if the demand continued to expand as much as he had been told it
was going to expand.
Even the 6 per cent projected rate of credit
growth associated with the "no change" alternative directive would
not insure rate stability.
If action such as he had described were taken, Mr. Ellis
continued, he would reinforce it by lifting the discount rate
from 4-1/2 per cent to 5-1/2 per cent when practicable.
Inter
nationally, that would confirm the System's intention to fight
inflation, and it would confirm that the discount rate was still
a tool of monetary policy.
It would buttress reliance on the
window without attracting less urgent borrowing seeking to take
advantage of the present bargain rate.
It would clear the air
of uncertainty as to whether or when the discount rate would be
changed.
Further, the longer the System waited to move the more
difficult it would be to change the rate.
Mr. Ellis said he welcomed the Manager's advice that he
proposed to make repurchase agreements at rates above the discount
rate.
The Manager knew, of course, that the nonbank dealers were
going to protest and charge discrimination.
As to the directive, Mr. Ellis said that alternative B was
his choice.
While he could support Mr. Mitchell's intent, he
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rejected his language as really constituting a "no change" directive.
He preferred a directive that called for gradual firming.
Mr. Hayes said it was his impression that the differences
expressed in the go-around were not enormous.
While he would not
want to minimize them too much, they appeared to represent primarily
differences in shading, both in interpreting where things had been
going on the credit side recently and in interpreting the degree
of danger that might be faced in financial markets and the risk for
the near-term of rising rates.
But the differences seemed rather
marginal, as exemplified by the fact that several persons had said
that either of the alternative draft directives was acceptable to
them.
It appeared to him from his tally that the preferences were
very close, with possibly a little shading toward alternative B.
Perhaps, however, Mr. Mitchell's proposal represented a compromise
solution that would be generally satisfactory.
Mr. Sherman said Mr. Robertson had stated before he left
the meeting that Mr. Mitchell's proposed language would be acceptable
to him.
After the Secretary had read Mr. Mitchell's proposed language,
Mr. Hayes said he was not quite clear as to what the proviso clause
meant in view of the preceding language to the effect that a minimum
of reserves was to be provided consistent with maintaining orderly
conditions and avoiding unusual liquidity pressures.
8/23/66
-99Mr. Mitchell said it was his thinking that the Manager
would be expected to "skate close to the edge" if the credit proxy
seemed to be going up faster than expected.
He thought that in
the light of today's discussion the Manager knew that the Committee
wanted to achieve a little firming if it could do so.
Mr. Holmes said he assumed that what was wanted was as
much restraint as could be achieved without leading to a financial
crisis.
It was his understanding that a 6 per cent rate of growth
in the credit proxy would be acceptable to those at the table.
That
was what was presently expected for September, but it might turn out
to be far different.
If it did turn out different and the expansion
was greater than 6 per cent, then he would move toward deeper net
borrowed reserves and tighter money market conditions, to the extent,
however, that there were no liquidity pressures such as to require
attention.
Mr. Hayes commented that the Manager evidently felt that
the proviso clause would not prevent his paying adequate attention
to orderly market conditions and Mr. Holmes replied that he thought
it would not.
As he understood it, the reference to liquidity
pressures carried through the whole flavor of the directive.
He
added that he would "skate a little closer to the edge" if credit
expansion rose sharply.
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Mr. Ellis said he did not want it on record that everyone
around the table accepted a 6 per cent rate of credit growth for
September.
Such a rate was not acceptable to him.
Mr. Shepardson
agreed.
Mr. Hayes said he felt sure there were differences of
opinion on the exact figure, but something on that order was what
he thought people had in mind as the consensus.
Mr. Bopp suggested that the policy record entry for today's
meeting should make clear that that did not mean that the Committee
was prepared to tolerate disorderly conditions if bank credit expanded
more than anticipated.
Mr. Brimmer recalled that he had expressed a rather strong
preference for alternative B.
He hesitated to dissent from the
consensus, but he would like the record to show that he was not
happy about the prospect of a 6 per cent increase.
If the increase
fell short of that figure, he would feel better, and he would
encourage the Manager to "skate a little closer to the edge."
He
was unhappy that the word "firming" had been lost from the directive.
Mr. Daane said he preferred alternative A to alternative B,
even in the amended version, but he would not record a dissent from
the directive.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Federal Reserve Bank of New York was
authorized and directed, until otherwise
8/23/66
-101directed by the
transactions in
accordance with
economic policy
Committee, to execute
the System Account in
the following current
directive:
The economic and financial developments reviewed
at this meeting indicate that over-all domestic economic
activity is expanding more rapidly than in the second
quarter, despite further weakening in residential con
struction. Recent wage and price developments suggest
that inflationary pressures are becoming more intense.
Credit demands continue strong, financial markets have
tightened further, and interest rates have risen sub
stantially in an atmosphere of great uncertainty. The
balance of payments continues to reflect a sizable under
lying 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, System open market
operations until the next meeting of the Committee shall
be conducted with a view to supplying the minimum amount
of reserves consistent with the maintenance of orderly
money market conditions and the moderation of unusual
liquidity pressures; provided, however, that if bank
credit expands more rapidly than expected, operations
shall be conducted with a view to seeking still greater
reliance on borrowed reserves.
It was agreed that the next meeting of the Committee would be
held on Tuesday, September 13, 1966, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
August 22, 1966.
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on August 23, 1966.
First paragraph
The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is
expanding more rapidly than in the second quarter, despite further
weakening in residential construction. Recent wage and price
developments suggest that inflationary pressures are becoming more
intense. Credit demands continue strong, financial markets have
tightened further, and interest rates have risen substantially.
The balance of payments continues to reflect a sizable underlying
deficit. In this situation, it is the Federal Open Market Com
mittee's policy to resist inflationary pressures and to strengthen
efforts to restore reasonable equilibrium in the country's balance
of payments, by restricting the growth in the reserve base, bank
credit, and the money supply.
Second paragraph
Alternative A (no change, with qualification)
To implement this policy, while taking account of potential
liquidity pressures within the banking system, System open market
operations until the next meeting of the Committee shallbe conducted
with a view to supplying the minimum amount of reserves consistent
with maintenance of the current state of money market conditions;
provided, however, that if bank credit expands more rapidly than
expected, operations shall be conducted with a view to requiring
greater reliance on borrowed reserves.
Alternative B (firming, with qualification)
To implement this policy, System open market operations
the
next meeting of the Committee shall be conducted with a
until
the minimum amount of reserves consistent with
to
supplying
view
gradual
firming of money market conditions, except as
a
attaining
changes may be needed to moderate unusual liquidity pressures
within the banking system; provided, however, that if bank credit
expands more rapidly than expected, operations shall be conducted
with a view to requiring still greater reliance on borrowed
reserves.
Cite this document
Federal Reserve (1966, August 22). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19660823
@misc{wtfs_fomc_minutes_19660823,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {Aug},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19660823},
note = {Retrieved via When the Fed Speaks corpus}
}