Making the Dollar Worth More

THE TIGHT MONEY POLICY

A Federal Reserve Board official once wryly remarked: "Only a handful of men really understand the credit system." Nevertheless, it is in the field of credit that the Eisenhower Administration has made its swiftest and boldest decisions.

Secretary of the Treasury Humphrey and the Federal Reserve Board had to move swiftly because, in an economy freed of direct controls, the burden of curbing inflation fell upon indirect fiscal controls, chiefly the restriction of credit. Though Eisenhower's moneymen have moved with seeming sureness, even they know that they are sailing, uncharted fiscal waters. For the first time, the U.S. is trying a great experiment: control of the ups and downs of a semi-war economy by fiscal and credit means alone.

The chief burden of the job falls on the FRB (called the "Fed" by bankers), which was created in 1913 as an independent, self-governing agency. Among its functions: to maintain an "orderly market" for Government securities, regulate private and public credit in the U.S. To do this, it has three major weapons:

P: "Entering into open market operations," i.e., the buying or selling of Government securities. This has a tendency to raise or lower the market price for the bonds.

P: Setting "reserve requirements," i.e., the proportion of cash reserves a bank is required to hold against its total deposits. The Fed can set reserves as low as 10%, on the average, which means banks can lend $10 for each $1 on deposit. Or it can hike them to 20%, on the average, which means that banks can lend only $5 for each $1 on deposit.

P: Fixing the "discount rate," i.e., the interest which the twelve regional Federal Reserve banks charge their member banks on loans. By raising the discount rate, the FRB makes borrowing more expensive--and thus harder.

In the Depression, when the New Deal wanted "cheap money" (i.e., low interest rate) the FRB lost much of its independence. To help the Treasury float each new issue of low interest bonds to finance mounting deficits, the Fed had to support the prices of all bonds by buying enough to keep them above par.

In World War II, the FRB also had to peg bond prices to enable the Treasury to float the tremendous additional debt ($226,500,000,000) to finance the war. The issues were so huge that only banks, rather than individuals, could absorb most of them. This "monetized" the debt, for banks did not pay for the bonds outright. They simply created a deposit for the Government to draw checks against it. Receivers of these checks deposited them in their own bank accounts. From these increased deposits, the banks could lend about $5 for each $1 received. Thus credit, and inflation, increased, and the dollar bought less and less.

When World War II ended, so did the biggest justification for the cheap money policy. The Truman Administration wanted to continue it, however, because cheap money held down the interest payments on the debt. But as postwar inflation mounted, cheap money added more to all costs through inflation than it saved in interest.

In 1951, the FRB broke away from Treasury's domination and stopped supporting Government bonds at a fixed level. Without pegs, bonds fell, and their yields (i.e., interest) automatically rose, causing a gradual rise in all interest rates. This was the first real tightening of money, but it only used half of the available tools, for the Treasury continued to float bonds at low interest.

Now both Treasury and FRB are working together with a common goal: to stop inflation by trimming the expansion of credit, and thus increase the buying power of the dollar.

With the U.S. still running a deficit, one way to make each dollar worth more is to reduce the supply of money (now $130 billion). Restricting credit has that effect. But the FRB could not raise reserve rates; in general they were already at the maximum. It could, and did, raise the discount rate (from 1 3/4% to 2%). Then, in order to get a large part of the debt away from banks which would use it to expand credit, the Treasury offered $1 billion worth of 30-year bonds, with an interest rate (3 1/4%) high enough to make insurance companies and ordinary individuals want to buy them and tuck them away. In its wake came additional rises in general interest on loans, mortgages, etc. There are already loud complaints that money is too tight. Actually, credit is still rising. However, the credit base is not expanding enough to let everyone borrow all he wants.

Secretary Humphrey, who feels that inflation is still a danger, wants to work credit fat off the economy in a full-employment period when it will not be missed. Then, if a recession threatens, the Treasury and the FRB will be able to loosen up on credit and avert, or at least ease, it. Without such a tightening now, the weapon of credit would be useless and the nation would have foolishly thrown away one of its best weapons to fight a recession.

This file is automatically generated by a robot program, so reader's discretion is required.