Squeezing Until It Hurts

In response to Washington's battle against inflation, the cost of borrowing from U.S. banks last week climbed to a historic high. For the third time in six weeks, major banks raised their prime rate, the interest that they charge their best corporate customers for loans. The latest increase, from 6 3/4% to 7%, is in tended to help curb the nation's overexuberant economy by making credit so costly that businessmen will borrow and spend less. Because they operate in directly, such restraints at best take effect only after a time lag of weeks or months. The immediate impact fell on the securities markets, forcing bond yields up and stock prices down.

On the New York Stock Exchange, the Dow-Jones industrial average sank for the fourth straight week. A 26-point loss reduced the average to 925, wiping out all its gains since mid-September. From its early December peak, the Dow has slipped 60 points, or 6%. Brokers generally see little on the economic horizon to provide much cheer.

Costlier for Consumers. The rising cost of credit is beginning to affect consumers as well as businessmen. In California, the giant Bank of America and several savings and loan associations lifted their minimum interest rate on home mortgages from 7 1/4% to 7 1/2%. At week's end Manhattan's First National City Bank increased by one-fourth of 1% its charges for auto, consumer and home-improvement loans. The true annual interest rates on some personal loans rose to more than 13%.

Interest rates have been climbing since early December because the Federal Reserve Board deliberately put banks into a squeeze. The board raised from 5 1/4% to 5 1/2% the rate at which bankers themselves can borrow from the Federal Reserve. But it made no change in the 6 1/4% ceiling on the interest that banks are allowed to pay on large time deposits, which account for about $23 billion in U.S. banks. As money rates in the open market spurted above 6 1/4%, New York City banks alone lost almost $1 billion in such funds as corporate treasurers took advantage of the higher return available on bonds and even U.S. Treasury securities. Some economists expect banks to lose as much as $4 billion more during the first three months of this year.

Aiming at Business. The last time funds drained out of lending institutions at such a rate was just before the crisis that bankers call the "1966 credit crunch." Bond prices crashed, the Dow-Jones average plunged 18%, and mortgage money grew so scarce that housing starts fell to a postwar low. Though some pessimists fear that all this could happen again, the banks have considerably more cash on hand in 1969 than in 1966. The Federal Reserve is also using its monetary weapons with more finesse.

As the board sees it, the fundamental inflationary pressure on the economy lately has come from spending by business. The board has therefore aimed its credit pinch at the chief source of corporate loans: the commercial banks.

Besides raising the cost of money, the Federal Reserve has been acting to constrict the nation's money supply. For much of 1968, the Reserve Board allowed the money stock to grow at an annual rate of 11%. But in the four weeks ended Jan. 1, the money supply rose at a 3.6% annual rate. By any measure, that amounts to a significant--if so far brief--squeeze.

The Federal Reserve is likely to maintain such pressure until it stifles the inflationary psychology that has gripped investors, businessmen and consumers. "We have to knock out the notion that inflation is a built-in way of life," says Daniel H. Brill, senior adviser to the board. The faster businessmen get that message, the less painful the effects of slowing down the economy should be.

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