August 23, 1966 FOMC Minutes: Full Text
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. Hayes, Vice Chairman Mr. Bopp Mr. Brimmer Mr. Clay Mr. Daane Mr. Hickman Mr. Irons Mr. Maisel Mr. Mitchell Mr. Robertson 2/ Mr. 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 Sherman, Assistant Secretary Mr. Mr. Kenyon, Assistant Secretary Mr. Molony, Assistant Secretary Hexter, Assistant General Counsel Mr. Mr. Brill, Economist Messrs. Garvy, Green, Mann, Partee, Tow, and Young, Associate Economists System Open Market Account Mr. Holmes, Manager, Manager, System Open Market Mr. Coombs, Special Account Counsel, Board Mr. Cardon, Legislative of Governors Assistant to the Board of Governors Mr. Fauver, meeting of the Board and was preceded by a joint 1/ This meeting Bank Presidents to discuss certain proposals regarding the Reserve Copies of the minutes of the joint discount administration. been placed in the Board's files. meeting have meeting at point indicated in minutes. 2/ Withdrew from
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 Open Market Committee held on of the Federal July 26, 1966, were approved. meeting there had been distributed to the Before this report from the Special Manager of the members of the Committee a foreign exchange market conditions Open Market Account on System and Treasury operations in foreign and on Open Market Account 17, 1966, and a July 26 through August currencies for the period 22, 1966. Copies of report for August 18 through supplemental placed in the files of the Committee. these reports have been
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 meeting--the risk of a at the time of the previous present the risk that Chancellor Callaghan breakdown of the Wilson Cabinet, and the risk that the support the wage-price freeze, would fail to least for the time all receded, at unions would revolt--had trade as could have was about as drastic The British program being. soon begin to bite. Nevertheless, been expected, and it should remained almost as in the exchange market the general atmosphere
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 the British apparently still had plenty of credit as a sign that resources at their command and sterling actually improved a little after the figures were announced. To cover the total deficit the made a three-month drawing of $100 million on the Bank of England another $100 million on the Federal Reserve swap line; it drew Bankfor International Settlements, and $130 million on the sterling package negotiated at Basle last June. In addition balance credit Reserve and the Treasury supplied $145 million through the Federal purchases of guaranteed sterling. Finally, at month-end the
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, Coombs said he could see no four foreign central banks, Mr. and at the end of August. He but to repeat that operation alternative at the end of July from that the $175 million obtained would hope banks would again be available. If August 31 four foreign central he would also have recommended fell on any other day but Wednesday, join with the Treasury in that the Federal Reserve at this meeting each agency. But since an credits of $200 million from overnight extended by the System on a Wednesday would show overnight credit
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 drawings under the swap line with the Bank of Italy. outstanding In effect, the Treasury had provided the System with a backstop for swap drawings which, in the case of Italy, were threatening too long. He would hope that was a precedent for opera to run on currencies. There was now open access to the Fund, tions in other in the case of lire, and that should through the technique developed members and the Account to relieve the worries Committee help in swap drawings that about getting involved Management had felt $25 million of lire obtained might go on too long. The remaining System's forward commit used to pay down the from the Treasury was ment to the Bank for International Settlements, totaling $40 million, lire for sterling. to deliver
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 could be triggered by speculation the gold market, or both, which the course of the annual of sterling during about a devaluation often stimulated speculation and Bank meetings. Those meetings Fund year such speculation probably in parities, and this about changes was prepared, the sterling. Since the memorandum would focus on and more menacing. become more imminent risk had, in his judgment, might be some serious to think there In fact, he was beginning on September 2 of following the publication trouble immediately the Bank of England for August. Earlier British reserve figures the and similar arrangements market swaps hopeful that through had been
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 but, more particularly, the dollar, through not only sterling 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
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 together in defense against speculative pressures. At banks to act present the market was aware of the virtual breakdown of the Group the creation of additional Ten negotiations looking toward of of the pressure on sterling and the reserve assets. It was aware with respect to Vietnam. There was a growing feeling situation
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. The burden therefore fell directly on the Open Market Committee.
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
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 boost that could come from it, now or after an of psychological There was some feeling that emergency had actually developed. could be put together more readily after an perhaps the package developed than in advance. There was also some emergency had putting together such a package would relieve some of feeling that from direct assistance to sterling. That more or the continentals an alternative approach favored by some, which less countered would be to wait for the emergency, go on unilaterally, and then turn to the continentals for reciprocity. In any event, no
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. to a question as to his personal view, Mr. Daane In response that Mr. Coombs had outlined the best proce said he felt strongly foreseeable circumstances. He was highly dure under current and bankers in the Group of from his contacts with central skeptical, realistic to expect them otherwise, that it was Ten sessions and He thought the existence money directly. to put up any substantial lines would prove reassuring to the of this backlog of credit inadvisable to wait for an his judgment, it would be market. In go hat in hand to the continentals. to develop and then emergency there was a good chance of If the suggested course was followed, from simply reassuring the such an emergency. Aside forestalling
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, all that could mean for the dollar and the financial structure with that had been built up in the postwar years. The idea of a direct of assistance was something that he had multilateral package discussed informally from time to time with various influential the continent, and he did not think it could be worked people on the Governor of the Bank of England out. In a discussion last week that he was of the same opinion. That was an important indicated factor, because obviously no one would want to seek a multilateral package unless the British wanted to obtain it. that the great merit in the scheme Mr. Hayes also stressed proposed was that it would provide important new protection for to sterling. The pressure on the gold the dollar whatever happened serious U.S. balance of payments problem market and the continuing made it important to do everything possible to reinforce the
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 and would be prepared to go ahead with the program on sion today short notice if and when final Administration clearance was obtained, might be a matter of weeks, days, or hours. which that he had talked to the Secretary Mr. Robertson stated The Secretary was inclined to this morning about the matter. would approve the use approach and hoped the Committee favor the
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 deliberations may have been a factor. He hoped the Germans would accept a swap-line increase. If they did, the rest probably would fall in line rather quickly. 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. In the present situation there were two important limitations. 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 assistance, and Mr. Coombs said he did not believe so; none had been
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 deal more anxiety than would a crash basis might stir up a great whether it might not be better to go be desirable. He wondered perhaps on occasions when about the process more deliberately, and take the chance that some action swap lines came up for renewal, basis might be necessary. on an emergency a serious domestic crisis might be Mr. Mitchell noted that a broad effort was undertaken to impending. If on top of that
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 where "papering-over" operations should be had not been reached stopped. Mr. Hayes replied that that would almost amount to saying willing to throw the door open to "every man for him that one was in the international financial field. self" that a large package of credits Mr. Mitchell commented already existed. He was not against enlarging it for the British central banks did not go further. However, if the continental were likely to be ineffectual. along, other efforts 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
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 if necessary. It really came down to the resources, unilaterally to proceed; whether the U.S. would be in a question of how best position to meet the situation if the enlarged swap network better was put in place now. that if he had been in a position to Mr. Coombs commented in the swap network, with periodic negotiate gradual increases best way. But the opportu that might have been the announcements, was a risk of backfire Even though there nity for that had passed. swap increases, the a package of large from announcement of necessary to take a that he thought it alternative was so bad chance. a short while ago negotiations Bopp noted that only Mr. for a more modest increase than now envisaged with the Bundesbank
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
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 France and the Federal Reserve, and to avoid an overt the Bank of disruption of relationships which might lead to market distrubances. noted that a memorandum from Mr. Furth dated Mr. Shepardson a copy of which has been placed in the files of August 17, 1966, contained an alternative suggestion for dealing with the Committee, Mr. Coombs' proposal would involve a the British situation. the swap line, while Mr. Furth had suggested straight increase in certain possible offsets to such an increase. that the market effect of a Mr. Coombs expressed the view if any of the other credit increase would be negated swap-line added that some of them be canceled out. He arrangements were to were not actually available to the British at the present time,
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. He thought the main objective was to improve confidence. 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 an implication there also. But he did not think there clearly have any real linkage of the two problems in the discussions. had been 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.
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 discussions in Washington about the balance of payments some of the effort was being made to look beyond ad hoc situation. Some those possibilities were still under considera programs. However, at a secondary level. Some people were raising questions tion viability of the Department of Commerce program about the longer-run Some people were talking about taxes, but on direct investments. one way or another. There was that had not gotten any blessing of tourism should be looked some feeling that the question also troops on the European Continent. with the deployment of into, along discussion of the use of swaps, the Likewise, there had been some matters. Some of the differences of Ten negotiations, and other Group in the basic interests of seemed to reflect variations of opinion
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. That should be a part of the package. It should be emphasized that the objective just to save the pound but to give the dollar more time was not foundations of the British situation. and to shore up the Mr. Clay noted that the Coombs' proposal would involve the swap lines to a maximum aggregate amount of $5.2 increasing billion. He asked what the System's financial risk would be if sterling should fall.
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. The and others might also move. So there could be a Scandinavians parity system around the world. Talk of an crumbling of the gold and a new set of parities would increase in the price of dollar. Foreigners might pull money generate a drive against the in the stock market, or from the U.S., including money back Here again there would demands on the gold market. increase their The dollar would be under a direct challenge to the dollar. be down, and the best hope was pressure if sterling went tremendous with the countries that it to work out some clear understandings develop a firm defensive network. could be relied upon to was felt
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
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 was one for the Committee to decide, but any take the program 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, that the negotiations would not be activated until there however, Treasury that they wished the specific notification from the was Committee to proceed. Coombs had indicated that if Mr. Scanlon noted that Mr. of the key countries failed, the program negotiations with either off. Suppose the Germans were willing probably should be called
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. asked whether it would seem appropriate, in Mr. Shepardson further discussion with the Treasury concerning the swap program, to press for Administration concern on the to use the occasion 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
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 tie the proposed program regarding the swap lines inadvisable to to a request for more vigorous efforts on the balance of payments but that System representatives should properly use all problem, stress the need for fundamental opportunities to appropriate correction. Patterson asked whether Mr. Coombs was being authorized Mr. which, however, would to proceed to negotiate swap arrangements until the Treasury requested, and Mr. Hayes not be put into effect until word was Coombs was not to begin negotiations said Mr. received from the Treasury. upon motion duly made Thereupon, and by unanimous vote, and seconded, authorized to negotiate Mr. Coombs was of the swap network for an enlargement proposed in his along the lines of August 18, 1966, subject memorandum understanding, however, that to the negotiations were not to be begun such until the Chairman or Acting Chairman
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 report that would be made public this Thursday. He finalized the thought he had given enough of the flavor of that report at meetings to make it unnecessary to go into previous Committee 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 of the Ministers and Governors, which involved a the sessions between the U.S. Secretary of the Treasury and the French debate Finance Minister on whether or not to go forward into the second stage of contingency planning and, if so, under what conditions. The Secretary clearly came off best in the debate. 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 protected in getting into the second stage of the were fully negotiations, which would involve wider participation. It pointed
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 from the Manager of the System Open Market of the Committee a report open market operations in U.S. Government securities Account covering and bankers' acceptances for the period July 26 through August 17, August 18 through 22, 1966. a supplemental report for 1966, and files of the Committee. placed in the reports have been Copies of both Mr. Holmes the written reports, of In supplementation commented as follows: higher in an have moved sharply Interest rates apprehension since considerable market atmosphere of
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 agency obliga loans, Federal Government paper, dealer 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. To cite only a few: (1) On August 9 a $239 million 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 a 1/2 per cent underwriting spread. (2) On August 16 the Urban Renewal Authority was able to place only of a $130 million offering, either because $55 million no bids were received or because the rates involved were in excess of rather flexible legal limitations. (3) A new firm selling computer services was forced relatively capital market after having been refused credit into the by a number of major banks, and paid up to 8-1/4 per cent for a 1970 maturity. (4) The syndicate handling the A.T.&T. issue, originally offered on August 3 $250 million 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 bills reached peaks of 5.10 and and six-month Treasury cent, respectively, last Friday, 30 and 60 basis 5.49 per points higher than at the time of the last meeting of the
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 threeand 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 and then raise $3 billion in cash in an auction to join) of March and April tax bills on August 18. The initial the Treasury's offer of a 5-1/4 per cent reactions to and a 5-1/4 per cent certificate were quite favorable, note securities dealers generally adopting a with Government more constructive attitude than in recent Treasury opera on the atmosphere soured, and tions. But as time went 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 a week after payment date, the new Treasury note close, was offered at 99 to yield 5.49 per cent. Those dealers
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
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 not mislead anyone into thinking that developments--did Federal Reserve policy had relaxed, nor did the repurchase made by the Desk against rights at the discount agreements rate encourage dealers to go overboard in subscribing to issues. On the other hand, any attempt to maintain the new during the even-keel period would interest rates steady of reserves in the face have required a massive outpouring during the period and of the market's of developments that Federal Reserve policy was not only tight conviction tighter after the refunding was out of but bound to get the way. "Money Market and Reserve Relationships," prepared 1/ The report, the Committee by the Board's staff. for
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.
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 and with this and other revisions the Desk was anticipated, looking at a figure of around $390 million this morning. As a contracts made today, he result of the matched sale-purchase $470 million level, but tomorrow would expect a figure around the might be trouble again. there fact that required reserves commented on the Mr. Hickman and Mr. Holmes replied that were again falling below the target, case consistently. When he last checked, recently that had been the or 3 per cent growth in August, proxy showed about a 2 the credit at the time of the 4-6 per cent growth estimated compared with the
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 the meeting, copies of which have been placed in uted prior to 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.
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 book 1/ 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 associated mainly with the slackening in disposable been in some measure, the auto safety hassle. income plus, But while most attention has been focused on lagging auto sales, other consumer outlays have held up well; over all, there doesn't seem to have relatively change in consumers' propensity to spend. been much is now slated to rise more rapidly Disposable income 1/ The report, "Current Economic and Financial Conditions," prepared the Committee by the Board's staff. for
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 are in prospect. The course of business spending 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 and the same next quarter--is not regarded quarter 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 nondefense, and transfer paymentsoutlays--defense, rapidly than tax receipts, and on a to rise more 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 spending--seems ordained to rise over the investment 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 there will be a new reading on delays. Shortly current and future business capital spending plans. all we can say is that most of the relevant Until then factors--the high rate of capacity utilization, the still high profit margins, the prospects of accelerating
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 is shaded down a bit, it would still our projection for the balance of this year, industrial imply, rising rapidly enough to keep manufacturing production capacity as fully utilized as ever, and unemployment still below 4 per cent. then, the greater danger For some time ahead, is that we'll be staying in the zone of plant and labor shortages where wage and price utilization possible. Thus, the July rise in the escalation is of a per cent--will consumer price index--four-tenths 2 cents an hour to over a bring wage increases of the auto workers, and this million workers, including will likely provide rise in steel prices along with the on the new model higher price tags the arguments for it more difficult to turn, this will make cars. In wage contracts to be for moderation in other argue of a still strong this fall. In the context negotiated rise. Given the rise engenders price economy, price seem to me that the outlook, it doesn't dim fiscal now but to move aggressively System has much option in demands, particularly toward curtailing expansion same time, we will have sector. At the in the business to detect signs of any spreading to redouble our efforts
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 Chicago showing no net increase since mid-year and 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 and assuming that Regulation Q is not maturities, changed, some runoff of outstandings seems certain. Even a fractional runoff of maturing CDs, which in September will probably total close to $5 billion, involve a funds outflow of $1 to $2 could readily billion. But there really are no past guides to for a prediction. Perhaps the bulk provide the basis 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
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 this prospect is suggested also by the banks. And sources and uses of figures on corporate aggregate We estimate that corporate investment expen funds. and inventory--in the ditues--for plant, equipment, second quarter exceeded internally generated funds by $13 billion, at annual rates, up from $10.5 billion in
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 major money market banks hard pressed banks--including 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 operations and for interpreting money for open market market statistics. Greater accommodation of the major window will not necessarily be offset by banks at the the smaller banks, given the lesser borrowing by 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
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 the possibility that such may occur is developments; greater now than it has been for a long time past. for increase in member bank Asked whether the projection seasonally adjusted, Mr. Partee said deposits in September was that it was, although he warned that there was a certain amount of variation in the seasonal adjustment. He went on to say that and that they were included the projections were very speculative Attachment A. minutes as to these 1/ Appended
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 their foreign branches did not show up in member U.S. banks from deposits (the credit proxy). Therefore, if the inflow bank be some credit expansion beyond that continued, there could indicated by the credit proxy. Mr. Partee agreed, but added that the current inflow might well be less than the high figure of
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 be buying a considerable amount of securities and System would portfolio composition should current changes in private investors' intermediate- and long-term short-term instruments against favor be more easing if, in fact, a considerable securities. There could the discount window. For of credit was provided through amount money market rates about immediately ahead, maintaining the period were would probably not mean easing but absorbing any where they sloppiness that might develop.
Mr. 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
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, releases from domestic stockpiles, while despite large leveled off. The balance on military merchandise exports transactions plus services apparently did not change much this particular period, but has worsened by comparison over the year 1965 as a whole. with of all these changes, and of others The net result cannot yet measure, has been to widen the payments that we basis of calculation to an deficit on the liquidity rate of roughly $3 billion in July and early annual August. payments measure, based on official The alternative has developed very differently, and reserve transactions, adjusted surplus during July and early shows a seasonally results mainly from that fact August. The difference of foreign private liquid funds that the huge inflows improve this balance but do not affect the in that period calculation. Since a large part of the liquidity exceptional July inflows should be regarded as temporary, to see a renewed deficit on the official we should expect
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 policy martini that we have concocted this year monetary 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.
Mr. 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.
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 if credit demands prove very strong and more comfortable comfortable if such demands become weak. As strong demands converge on banks, the Manager in his operations should the banks to meet some part of their resulting force reserve needs through the discount window; in that way, of the window can be added to the discipline the discipline market place. On the other hand, if demands prove of the 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 we should be more wary of letting the indebtedness today,
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 further indicated by the recent steel price increase. is 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
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 that credit may become still harder to obtain by fears 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 of these problems in many quarters outside understanding the System. In the first place, the need for general policies of restraint seems to be obvious; Governmental yet there is still no evidence of a likely near-term fiscal policy in the form of a tax rise. assist from the burden on monetary policy therefore excessively With 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
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 connection, it is worth noting that the run. In this 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 significantly above 6 per cent would be reason at a rate restraint, provided that market conditions for greater permit such action by the Manager. In general, I believe be paying close attention to the uncertainty we should in financial markets. In terms of net that has prevailed borrowed reserves, I have in mind a level of around $500 with higher levels if credit expansion is exces million, 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
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 increase it. Our own directors feel quite strongly that 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 our basic policy objectives, besides rendering as to administration of the window more difficult than it would be. I am not sure in my own mind whether the otherwise time should be by 1/2 per cent or by 1 per rise at this cent. As far as the first paragraph of the directive is concerned, I would suggest adding to the phrase "and have risen substantially" the words "in interest rates of great uncertainty." Alternative A of an atmosphere the second paragraph would best express my policy conclu sions, but with all the provisos involved I would not B if the majority prefers it. object to alternative observed that there were some similarities between Mr. Francis British for the past three or four years the economic problems of the problems of the United States during the past year. and the economic public policies had fostered excessive total demand In both cases
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
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
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. It seemed to him that that would be the wrong thing to do. 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 those small borrowers that relied on financial institutions ficult for to get an appropriate share of the credit. Also, there was a risk funds from banks and other intermediaries might be that diverting (i.e., a slower growth in deposits, interpreted as monetary restraint liquid assets) when in fact total liquid bank credit, and measurable via other avenues. It was might continue to rise unabated assets past four months the evident that over the becoming increasingly about a leveling off in of the Committee had brought firmer stance of growth of total reserves and money. the rate
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 and he would like to see restraint applied with encouraging, 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 unable to accommodate further spectacular increases increasingly as had occurred since April. in business lending such been some talk of an autumn "liquidity crisis" There had and for nonfinancial corporations, Mr. Francis both for banks the Committee from its quest for noted; but that should not deter stability. If anything like a liquidity crisis should long-run show itself, it seemed to him that the necessary short-run adjust through the discount window. ments could and should be made
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 most areas of the District, and construction contracts levels in through June remained strong despite disruption in the mortgage There was a strong advance in manufacturing employment markets. employment, although the helped pull up total nonfarm in June that show less strength because of strikes. July figure would probably industry was Government employment, However, the strongest growth seasonally adjusted increase of 8.7 per which had experienced a since the first of the year. cent bankers, especially those in the larger Sixth District difficulties in meeting the continued to complain about cities,
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. The larger city banks were in the tightest positions. 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, were extending outward from the larger cities. For the pressures 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. said that, after looking at economic Mr. Patterson and concluding that they were fairly conditions in his own area on throughout the nation, it would be typical of what was going fall into the temptation of considering that the policy easy to had had no effect at all on the Committee had been following of the economy. However, he did not think slowing down the pace that was so. Undoubtedly, expansion would have been much greater
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 an increase in the discount rate now seemed to be concluded that 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 the illiquidity of the banks, and ultimately up, intensifying System into supplying large quantities of reserves in forcing the order to avoid a liquidity crisis. it seemed to Mr. Patterson Under those circumstances, financial markets should be allowed that the banking system and the with the System maintaining a strong to handle the ball for a while allow market adjustments with defense. In other words, it should
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.
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 as loan demand intensified under seasonal pressures and coming months as banks found it more difficult to replace maturing CD's. Indeed, per cent) of the negotiable CD's of $100,000 $7.7 billion (about 43 outstanding July 27 would mature in August and September. and over reaction to a runoff, possibly raised the question of market That a market confronted with the one of sizable proportions. Since by severe pressures, the was more likely to be buffeted unexpected idea this past week to get some further Bank had tried Philadelphia Q ceiling. The question regarding the Regulation of bank expectations at each of the five with high-ranking officers had been discussed expected no change in banks. Those individuals major Philadelphia develop from CD some pressures to and all expected the Q ceiling, respondents cited rose. Two on other instruments runoffs as rates for their belief. as the basis by System officials public statements
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 use the discount window if necessary to ease restraint. He would 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, in the discount rate. On balance, he he still favored an increase but he did not feel strongly. favored alternative B for the directive, view that business activity should Mr. Hickman expressed the for the rest of the year, sparked by increas continue to move forward 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." Plant and equipment spending was exceptionally strong. As an illustration,
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 as usual, and that defense orders thus far had been rising as much easily absorbed by the industry. front, Mr. Hickman said, the public seemed to On the price up with the fact that inflation was a clear and present be catching however, had been mixed, with prices danger. Actual price behavior, materials declining recently. While that of sensitive industrial lessening of inflationary pressures on might imply a temporary
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 markets were well known. Beyond that, more selective and stock lending policies of banks were pushing corporations increasingly into market. Private placements were drying up as a source of the capital funds; insurance companies were overcommitted and were themselves contemplating use of the capital market. In the municipal market, caused by bank selling, had and rising yields, in part lower prices financings. Thus, intended in cancellations of new municipal resulted throughout all sectors of effects had apparently been achieved policy the money and capital markets. suggested that further pressures Moreover, mounting evidence as strong demands for weeks immediately ahead, would build up in the of funds. Although prediction pressed on a growing scarcity credit Hickman believed the Committee was always hazardous, Mr. in that area in the corporate and municipal for sharply higher yields could look by further bank liquidation next few months, caused markets in the up of CD's, and the withdrawal of insurance of municipals, the drying All that had led and capital markets. from the mortgage companies
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 like to commend the Manager for his handling of meeting, and would refunding was touch-and-go all the a very difficult situation. The attrition, and with the new issues drifting way, with considerable hampered during and after after-market. The Manager was off in the the refunding by major revisions in the reserve statistics, partic in required reserves below expectations. ularly by a shortfall reserves for one week to fall below $400 That caused net borrowed net borrowed reserves were On the other hand, smaller million. nonborrowed reserves, and bank accompanied by lower total reserves,
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 open market operations until the next meeting of ing system, System the Committee shall be conducted with a view to maintaining about the net reserve availability; provided, however, that if current state of expand more rapidly than expected, operations shall required reserves to requiring greater reliance on borrowed be conducted with a view reserves."1/ out that there was a minor inconsistency Mr. Brimmer pointed with respect to the balance of payments and on the between objectives funds from foreign branches of side. While the inflow of domestic was helpful from the balance of payments U.S. banks apparently to some extent the efforts of the Committee standpoint, it undercut credit restraint at home. That was to achieve further gradual indicated that a the go-around, Mr. Hickman 1/ Later during suggested by Mr. Mitchell would be directive along the lines to him. acceptable
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. His own feeling was that the System had not gone far enough. 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 this time--he thought it was vital that the System push increase at on with the use of monetary instruments. The recent informal survey of current lending practices, conducted by the Reserve Banks at the the Board, provided mixed evidence. The responses describ request of of some of the banks were less comforting than he ing the activities had hoped. While there were substantial variations, even within evidence indicated that the banks were in Districts, on balance the prisoners of their large customers. fact rather close to being not say that in public--only within the Committee--he While he would he detected such a high degree of value on customer relations thought
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.
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. appeared that aggregate demand was going to expand less First, it next half year. Second, the credit than aggregate supply for the of business loans, had finally reached variables, with the exception less than normally. Most had the point where they were expanding only about one-half to two-thirds now reached a level of expansion year. Those were the two critical of the expansion rate of last was going to have to operate. bases against which the Committee said, it seemed to him the Committee Accordingly, Mr. Maisel it must consider what impact monetary had now reached the point where have on the situation with respect to aggregage policy was expected to variables react, and would demand. How would the monetary supply and As to action the System be desirable for the economy? the reactions
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. him that the Committee should start allowing the market It seemed to a rather constant growth rate rather than to to react against determine the market, with one basic exception. Business loan with all other credit variables, and expansion was far out of line a policy of trying to indicate to the banks, through he would favor that a substitution of business loans for the discount window, was not aiding monetary policy in the fight against infla securities tion. It should be made clear that if credit was going to be curtailed, the curtailment would do the most good was in business the place where loans. Maisel said, he would favor contin With those provisos, Mr. proxy variable as a basis for Desk operations. uing to follow a credit be well satisfied with a 6 per cent expansion rate in the He would alternative A for the directive proxy, and he would support credit assumption that that was its goal. He would not be concerned on the
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: The announcement effect, in the present (1) would in my judgment have severe market, well beyond what would be repercussions, going the repercussions of desired and well beyond a modest discount rate change. If it resulted, in a substantial forced sale as it well might, by one or more of the largest banks of assets close to a disorderly market this could bring us operations and resultant and necessitate Account reserve expansion contrary to present System market sensitivity is amply objectives. Present in the reception accorded this demonstrated
week'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. The action most assuredly will be used (3) 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 blockage of fund flows. drastic operations at a time when (4) Cushioning we are normally supplying reserves will necessitate larger open market operations and there would much 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 instruments). I question whether the desired differential effect will be accomplished and think
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 the cost of CD money and assuming the reserve slightly would be completely offset by open market opera impact tions. Some of the reasoning of those critical of the Fed's move did appear in the joint discussions and I noting. The view generally seemed to be think is worth closer to precipitating a financial crisis that we were in Washington realized; that while monetary than anyone policy should not "lose its nerve" it was indeed biting on business loans; that if it and biting hard--now--even had been left alone the market and credit situation would
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 further tightening but must instead think to produce 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 than is contemplated in the draft discount window on discount administration. Otherwise, I memorandum there is the danger of really disruptive interest think to the financial markets rate developments--disruptive and the economy--and that risk is too great to run. view, expressed this morning, Unlike Mr. Robertson's is not bothered by interest rates, I am bothered, that he and especially by their implications in terms of market
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 of the view that cost and availability seeming naivete 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 had with financial markets suggests that this myself cannot be done. To the extent that banks do not meet commitments or satisfy borrowers' demands and these turn elsewhere, the price of money inevitably demands go on up. The prime rate change undoubtedly will that large corporate issues required reflected the fact per cent and, without the prime rate more than 5-3/4 customers would have come in increase, bank corporate for their total lines. monetary policy may have All I am saying is that situation as we use about as tight a credit produced fully can. While it is important not to let up on the we have achieved, I think that we have restraint we can at the moment, without pushed about as far as the buttress of adequate fiscal restraint, and are achieving all that we can hope for from monetary now policy alone. In saying, as we all have said, I at one time or another, that monetary policy believe, cannot do it all alone, I am anxious that we now not disprove ourselves and bring about a financial try to either at home or abroad. I would not attempt disorder a firming of market conditions as per alternative B reserves more willingly than and would perhaps provide A. I would eliminate the indicated in alternative
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, live with alternative A. However, he had a change although he could to propose, recognizing that it would give the Manager a considerable amount of leeway, probably more than he could use. His suggestion
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 of weeks. He regarded it as an adequate standard and past couple the Committee should stand in the next thought it indicated where few weeks. noted that several comments had been made Mr. Shepardson availability could be affected the naive idea that credit about not know of anyone who had that idea. without a rate effect. He did at times there had been was concerned about was that The thing he The emphasis needed now emphasis on rate than availability. more that there While recognizing reducing credit availability. was on the guideline at avail he would look for would be a rate effect, there had been rate than rate. He thought ability, rather
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, nondurable goods manufacturers now reported some a variety of new orders and backlogs. Unemployment remained at very decline in low levels, however, and wages were continuing upward. Nationally, Mr. Wayne added, the dominant question was economy was regaining in the third quarter some of the whether 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
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 seemed to be accepting the new relationship. line, but the market 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 Consequently, he believed an increase in the discount greatly. undesirable effects without accomplishing rate would produce several the current delicate situation, a sudden anything constructive. In kind could cause real trouble. move of the wrong pressure about as it was and Mr. Wayne favored keeping the meant that reserves would been for the past month, which as it had the discount window or in the to be supplied, either through have reserves that would to offset most of the additional open market,
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. the various impacts upon the commercial banks and Those included markets deriving from the demand for loans, tax and the financial CD liquidation, and the higher member bank dividend payments, reserve requirements. Recognition had to be given to the conver of those important financial developments as gence of a number mid-September approached and the unknown magnitude of their impact system. Consequently, allowance had to be upon the financial
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 days prior to the effective date of the increase, customers several the opportunity to obtain supplies then did not take advantage of available at the lower prices. As a result of unfavorable weather during July, crop District had been revised downward. Corn prospects in the Seventh to be below last year's level in production was now expected might defer the marketing of 1966 Illinois and Indiana. Farmers
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, tighter loan policies. In addition, there had probably reflecting been a marked decline in holdings of both U.S. and municipal secu in the past few weeks. While those developments had reduced rities the rate of growth in over-all bank credit, they had also reduced liquidity further. The major Chicago banks showed an improved basic reserve with a month ago. That was partly due to sales position compared of securities but also reflected their acquisition of a sizable CD money earlier this month and an even larger increase amount of
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 could be achieved within the existing degree of reserve conditions pressure, he would recommend such a course. However, if continued slower reserve expansion required greater reserve pressure, he favor moves to bring about that condition. would economic reasons the discount Mr. Scanlon felt that for rate were brought more in should be raised. If the discount rate be in a position to obtain market rates, the System would line with rate reductions if and effect of large and prompt the announcement not mean that he fore That did should prove desirable. when they the longer one opposite. He believed the saw a downturn--quite wider it developed, the a rate disparity and the operated with
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 are suffering from too much rain during the Dakota which 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 partly because of an indicated tendency on the earlier, and part of farmers to hold grain for continued strengthening of price. Because of this strengthening of price, however, reason for the banking community to expect pressure there is is a reversal of current farmer attitudes, whether if there 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, turn will mean a continued high level of consumer which in demand. The need for an increase in monetary restraint continues on balance. Wage settlements being made this summer, and
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 This was a period when flexibility of operations draft directives. 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
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 decline in business loans was much greater than a elsewhere. The increase in the same period and contrasted with an year earlier, at weekly reporting banks elsewhere in the U.S. Large this year rose 6 per cent in the period, in contrast to a negotiable CD's reporting banks outside the decline of .6 per cent at weekly of States and political subdivi District. However, time deposits that was the one area where there was considerable sions declined; increases would be necessary to feeling at major banks that rate prime competition was from the Treasury hold the deposits. The than agency obligations. There was still room bill market rather sort of time deposits, and presumably to raise the rates on that that would be done.
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. Otherwise, he would neither ease nor tighten. 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 increased borrowing. If this occurred, he would of substantially
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 to bank credit expanding more rapidly than expected reference the 6 per cent projection. He believed that a decision tied into of a discount rate increase could not be delayed on the question He would hope it would not be necessary to wait much longer. already on the books. The until substantial borrowings were the Board of Directors of the San Francisco executive committee of at its last meeting, but action to increase the rate Bank took no concern that had been mentioned much the same kind of expressed by Mr. Hayes. in the Eleventh District were Mr. Irons said conditions some of the same factors being very strong, probably reflecting the situation was one of strong reflected nationally. Nationally judgment, and called for no lessening inflationary pressures, in his the Committee had been attempting the degree of restraint that in monetary policy had been It seemed to him that to achieve. the attitude of banks. As to effective recently in influencing with the anticipated mid-September the uncertainties associated
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 offered by Mr. Mitchell because it seemed to reflect modification was really trying to do. The Committee was what the Committee it could in the market, but at trying to get all the restraint orderly conditions. Mr. Mitchell's the same time to maintain If what the Committee was pointed that up clearly. modification be achieved, well and good. If not, then trying to achieve could matters, with money market conditions the Committee should not force that loomed ahead around as they were and with the uncertainties mid-September. withdrew from the meeting at this point. Mr. Robertson within the framework of generally high Mr. Ellis said that England, three aspects might economic activity in New and rising savings banks reported First, District mutual be highlighted.
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. The net change was a .06 per cent decline. 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 experiencing a slow-down in construction, not even residential not construction. New England total construction contracts in June 1965. For the first six months the rose 45 per cent above June per cent above the same six months in 1965. total stood 34 in June exceeded June 1965 by 6 per cent, Residential contracts six months showed a 9 per cent year-to-year gain. and the first in Massachusetts were up 20 per cent from June building permits cumulative gain of 19 per cent. last year, for a six-month Mr. Ellis said it was fairly Turning to monetary policy, toward inflation. Demand the economy remained tilted evident that capital outlays, and probable pressures of Government expenditures, the likelihood of a further in consumer spending indicated expansion the cost pressures of wage direction in the fall. To trend in that gains were added the escalation in excess of productivity settlements increases. Credit creation continued of wages to match cost of living of expansion. The after the long period excessive, especially
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. the period passed without great strain. When banks could Actually, and plan ahead, they did so. The principal potential foresee problems were faced by large sophisticated banks. CD deposits were altogether, although they might shift in not going to disappear The existing mechanism of the discount window form and location. would provide whatever cushion was needed. His second conviction continue to focus its attention on was that the Committee should and its cost, rather than attempt aggregate reserve availability,
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 rose substantially above the $800 million average discount window several periods, he would add the excess to the net of the past provide a cushioning reserve reserve target. That would borrowed that needed it, while not losing the effect of to those banks banks. Banks had already been some general tightening on other would be available for distress cases. advised that the window If that course were followed, Mr. Ellis said, he would to rise if credit demands turned out to be expect market rates by bankers to whom he had talked. as excessive as projected Having permitted the rate of bank credit expansion that it had since December, the Committee could hardly expect to accelerate
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 attracting less urgent borrowing seeking to take window without rate. It would clear the air advantage of the present bargain or when the discount rate would be of uncertainty as to whether the System waited to move the more changed. Further, the longer be to change the rate. difficult it would Manager's advice that he Ellis said he welcomed the Mr. at rates above the discount to make repurchase agreements proposed the nonbank dealers were knew, of course, that rate. The Manager and charge discrimination. going to protest alternative B was Mr. Ellis said that As to the directive, Mitchell's intent, he While he could support Mr. his choice.
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 of the preceding language to the effect that a minimum meant in view consistent with maintaining orderly of reserves was to be provided and avoiding unusual liquidity pressures. conditions
Mr. 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 and tighter money market conditions, to the extent, borrowed reserves pressures such as to require that there were no liquidity however, attention. Manager evidently felt that Hayes commented that the Mr. paying adequate attention would not prevent his the proviso clause Holmes replied that he thought market conditions and Mr. to orderly it, the reference to liquidity it would not. As he understood directive. He whole flavor of the carried through the pressures closer to the edge" if credit he would "skate a little added that expansion rose sharply.
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
directed by the Committee, to execute transactions in the System Account in accordance with the following current economic policy directive: The economic and financial developments reviewed at this 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 until the next meeting of the Committee shall be conducted with a view to supplying the minimum amount of reserves consistent with gradual firming of money market conditions, except as attaining a changes may be needed to moderate unusual liquidity pressures within the banking system; provided, however, that if bank credit more rapidly than expected, operations shall be conducted expands with a view to requiring still greater reliance on borrowed reserves.
Also: Record of Policy Actions