A History of the Federal Reserve, Volume 2 (37 page)

The March 3, 1959, meeting did not discuss the staff memo. We do not know if members objected to the staff’s description, to the emphasis given to money, or to the obvious discrepancy between the factors emphasized in the memo and those emphasized in the regular staff reports at FOMC meetings. Instead, the FOMC turned to its usual business. After the annual ritual of reelecting officers, rotating members and renewing authorizations,
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the committee took up the decision about the discount rate. Hayes had less enthusiasm for an increase than earlier. He preferred to wait until mid-April, after the next Treasury offering. Others favored an increase for technical reasons—to raise the discount rate above the Treasury bill rate. Mills wanted a higher rate to attract foreign deposits and gold. Martin, concerned about renewed inflation, urged the increase. Recognizing Hayes’s reluctance to act, he challenged him directly. Usually the System could rely on New York to lead the increase, he said. Now that was no longer true. “The System either must face up to its responsibilities or take the position that monetary policy could not work in an environment like the present” (FOMC Minutes, March 3, 1959, 56). The Treasury would return to the market in a few weeks. He urged the presidents to act at once, so the higher discount rate would be in effect for two weeks. Addressing Hayes directly, he asked him “to express his [Martin’s] personal judgment to the New York Board of Directors” (ibid., 58).

Hayes replied that credit demand had been more modest than he expected. There was no evidence of inflation. He did not think an increase
was urgent. He preferred to wait until April. If he had to act sooner he would rather vote on March 12 than on March 5.
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230. Hayes again voted no on bills-only. He asked again to change “solely” to “primarily” bills, but no one joined him. The FOMC also continued the formula for allocating securities to the reserve banks that had been in effect since June 1953. Each reserve bank received a share based on its share of total assets in the year ending February 28, 1959. Reallocation became effective on April 1. Another of the continuing resolutions provided for succession on the FOMC in the event of war or defense emergency.

Martin prevailed. On March 6, New York, Chicago, Philadelphia, and Dallas raised their rates to 3 percent. All others followed within a week.
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The volume of discounts and the federal funds rate rose immediately, but bill rates remained in the range that had held since January, suggesting anticipation of the change.

The rest of the March 3 meeting was a delayed response to the leaks from FOMC meetings that had precipitated Vardaman’s resignation. The number of participants expanded after Martin abolished the Executive Committee and increased the influence of the reserve banks. Members had a lengthy discussion of a proposal to limit the number of observers at FOMC meetings and the number of people who had access to the minutes. Public criticism of leaks from the meeting or the minutes brought the issue to the fore. Malcolm Bryan (Atlanta) argued for a return to the procedures used during the 1930s, a strict following of the statute. Only those who had to vote and their alternates would be present. Staff would be kept to a minimum.

Martin spoke last. He defended the current arrangement. It provided training and developed useful information. He did not want to go back to the System he had inherited, when some presidents did not discuss open market policy with anyone in their bank. The committee deferred a decision to a later meeting.

Treasury operations from mid-March through April kept the Federal Reserve committed to maintaining the same degree of restraint. The manager had considerable discretion. Table 2.4 shows the weekly average federal funds rate, the volume of borrowing, Treasury bill and long-term bond rates for this period. Both controlled and open market rates rose. The data suggest that the manager let the federal funds rate rise to the level of the
discount rate. When the Treasury bill rate remained below the (3 percent) discount rate, discounts fell; when the bill rate rose above the discount rate, discounting increased.

231. Martin’s response suggested that he wanted to increase the discount rate right away, but the Treasury had “experienced in its refunding what was widely regarded as a failure” (FOMC Minutes, March 3, 1959, 62). Martin’s conviction had been strengthened by the response of the Federal Advisory Council (FAC) to a question about the inevitability of further inflation. The members called the inflationary trend “unavoidable” (Board Minutes, February 17, 1959, 15). They mentioned rising wages, continuing budget deficits, increased demand for government projects and services, agricultural subsidies, and stockpiling of materials. They claimed that increased demands for spending were not matched by willingness to pay higher taxes.

232. Minneapolis asked for an increase before it held a directors’ meeting, presumably based on conversations with its board members. The Board waited a few days, then approved the change. Robertson dissented. On March 12, the directors met and voted the change. I believe this is the first such incident. Frederick Deming, president of the bank since April 1957, later served as Treasury undersecretary in the Johnson administration.

Some of the pressure on the money market reflected loss of gold. During second quarter 1959, the U.S. gold stock declined by $732 million, approximately 3.5 percent of the stock. Nearly half the decline ($344 million) was a payment for a quota increase at the International Monetary Fund. The U.K. withdrew half the remainder ($200 million). The Federal Reserve sterilized the outflow to the extent that it affected the money market, but the manager allowed borrowing and interest rates to increase (and free reserves to decline), so on these measures sterilization was incomplete.

The strong expansion continued. Real GNP rose 5.1 percent in the first quarter and 7.8 percent in the second. The unemployment rate fell to 5.2 percent in April from a 7.5 percent peak the preceding July. Despite the 90 percent margin requirement, stock prices continued to rise at a 25 to 30 percent annual rate. At its meeting with the Board, the Federal Advisory Council described the economy as “moving upward on an expanding front” (Board Minutes, April 28, 1959, 2). Unemployment remained high in some regions. The FAC urged the Board to maintain restraint but not increase it. The members expected strong demands for credit for the rest of the year.
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233. In March, the Board had published proposed regulations of credit to brokers and dealers in stocks and to banks lending on margin. On May 1, the Board voted on the proposed regulations. The purpose was to reduce speculation. The regulations prohibited substitution of securities within margin accounts and regulated withdrawal of cash and securities from such accounts. Equity owners and traders would be barred from withdrawing cash (or securities) equal to 90 percent of the value of securities sold. The Board approved limitations on cash withdrawals unanimously, but it rejected, four to three, controls on the substitution of securities within a margin account. Martin, Balderston, Shephardson, and King made up the majority; Szymczak, Mills, and Robertson voted for the new controls. The Board approved some, and rejected other, technical amendments to margin requirements. The new rules took
effect on June 15. The discussion, over several months, showed that the real bills tradition had not vanished but it had weakened. Chairman Martin held a mixed view. He did not oppose selective controls or regulation, but he questioned whether tighter rules would be effective. “Governor Szymczak referred to the difficulties involved in administering selective credit controls” (Board Minutes, February 13, 1959, 6).

The May 5 FOMC meeting brought discussion of two new issues. For the first time, a staff member briefed the members on gold flows, balance of payments, and the international accounts. Some members described the recent gold outflow as temporary, but Woodlief Thomas was both correct and pessimistic. He found the origin of the problem in the use of monetary and fiscal expansion to maintain full employment. These policies raised prices and wages and reduced the country’s competitive position. A main point of his comment went to the heart of the issue—monetary policy could not achieve two separate goals, one domestic, the other international. This did not evoke any response from the members. They seemed slow to recognize the problem.

The second new topic was the Liberty Loan Act of 1918. The act set a 4.25 percent ceiling on the coupon that the Treasury could offer on longterm bonds. Several issues had reached that range by the spring of 1959. Governor Mills argued that very restrictive monetary policy exacerbated this problem by setting off “a spiral of contractive credit forces” (FOMC Minutes, May 5, 1959, 27). If the policy continued, the banks would have to sell bonds at a loss. Policy was “unnecessarily and unwisely restrictive” (ibid., 26). “[T]he destructive influence of constantly falling prices for U.S. government securities can lead to disorderly market conditions whose correction might defeat the very policy purposes that have been sought after” (ibid., 27).

Mills’s demand for an easier policy received no support. Even New York expressed concern about inflation. Inflation was “lurking in the shadows” (ibid., 16). But it was not imminent, so easing policy was wrong but additional restraint could wait. Several members expressed concern about wage increases and the prospect of a steel strike.

Martin and Hayes were absent. Balderston presided and stated the consensus for an even keel until after the Treasury completed its financing. Then he added, “His own personal opinion was that the desk ought to tighten appreciably before the next meeting” (ibid., 42–43). Rouse rejected the suggestion. It would be “pulling the rug from under the money market” (ibid., 43). He doubted that he could tighten, and he was not eager to try.

The mood changed dramatically in three weeks. The main topic at the May 26 meeting was the size of the next discount rate increase. Thomas’s staff report favored an increase, citing the rise in stock prices and increase
in the money stock, and for the first time it highlighted a renewed gold outflow.
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The loss of gold aroused Hayes. He now cited inflationary dangers, especially strong growth of credit and rising stock prices. “[T]he time has come for a decisive signal” (ibid., 17). He proposed a one percentage point increase in the discount rate, if the Treasury would support it, strong statements by the president of the need for non-inflationary wage increases, and a change in the FOMC’s directive to recognize “inflationary tendencies” (ibid., 18–19).

Robertson and Shephardson also supported a one–percentage point increase. A smaller increase of one-half percentage point was fully anticipated, so it would have no effect.
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The FOMC was cautious. Most members favored an increase of 0.5 percentage points, and Martin wanted to move in a “normal way” to avoid a sense of panic (ibid., 49). Only Governor Mills opposed, warning again about the cumulative effect of System policy. He accused the others of having “panicked about anticipated events which had not as yet come into palpable and clear perspective” (FOMC Minutes, May 21, 1959, 35).
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Seven reserve banks wrote prior to the meeting to suggest a change in the directive. All of the proposed changes included a statement about sustainable growth and avoidance of inflation (Memo Riefler to FOMC, Board Records, May 25, 1959). Most of the presidents expressed their belief that low inflation contributed to maximum sustainable growth, a position
that they would emphasize in the 1980s and 1990s after neglecting it in the intervening years. None of the proposals suggested a tradeoff between inflation and growth or that inflation contributed to growth, views that became prominent in the 1960s. Without dissent the FOMC changed the directive to call for “restraining inflationary credit expansion
in
order
to
foster
sustainable economic growth and expanding employment opportunities” (ibid., 54; emphasis added).

234. Young mentioned “a deepening concern in foreign circles” about the trend of the United States’ payments deficit (FOMC Minutes, May 26, 1959, 6). Arthur Marget, of the Board’s international staff, warned that earlier justifications for the payments deficit no longer applied. Europe had recovered. The U.S. was less competitive now, and it had to adjust.

235. Banks had increased the prime rate by 0.50 percentage points. The Board had discussed the size and timing of a discount rate change a week before. Most governors preferred to wait because they did not want to follow the prime rate increase immediately. Governor Mills opposed any change on grounds that it would raise interest rates, forcing banks to sell securities at a loss, weakening the Treasury market, and possibly doing “irreparable” harm (Board Minutes, May 19, 1959, 2). The Board’s only action was to recommend a technical change in treatment of outstanding discounts when discount rates changed. It left the policy decision to the reserve banks but it recommended applying the new rate to existing loans.

236. Robertson and Mills almost always disagreed. The disagreement was substantive. Mill’s statements suggest that he was very concerned about the ability of the Treasury market to absorb rate increases but also wanted to wait until evidence of inflation became clear. Robertson argued that “for monetary policy to be effective there must be uncertainty in the market place as to the future trend of interest rates. . . . The aim of the Federal Reserve, therefore, should be to foster a level of interest rates that there can be no certainty whether over the foreseeable future, interest rate levels will trend up, trend down, or remain relatively stationary” (FOMC Minutes, May 26, 1958, 36). There was no thought that the System and the market had a common interest in information and in each other’s actions. Further, members did not recognize their dependence on the market’s responses or that the market’s responses depended on its assessment of System’s prospective actions.