The Economy: The Year of Tight Money And Where It Will Lead

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Rescue with a Catch. During the six weeks when the squeeze was at its worst, Bill Martin was in a hospital after surgery, and Fed policy was being framed by his vice chairman, James Robertson, and the vice chairman of the Fed's Manhattan-based Open Market Committee, Alfred Hayes. On Sept. 1, just after Martin returned to his desk and grasped the situation, the Fed came to the aid of the bankers. It informed them that it was willing to lend them more than before, and at longer terms. But there was a hooker: in a major expansion of its powers, the Fed made clear that it would begin to scrutinize big bank loans on a one-by-one basis, and bankers would have to justify their loans to the federal agency. It was just a step or two short of outright credit control.

Still, the move helped, and the Fed has since taken further action. In the past five weeks it has increased the money supply by $500 million, and interest on 90-day Treasury bills has dropped from 5.5% to 4.8%. Nobody is certain whether this represents a long-term policy change or merely the Fed's usual pre-Christmas easing to accommodate loans during the big-buying season. Demand for money will remain intense next year. The Government will have to borrow heavily in 1967 to finance its budget deficit, and corporations will borrow earlier in the year because the pay-as-you-go tax scheme will step up their payments in the first half, while slightly reducing them in the second half.

The worst of the credit squeeze is over, but the days of 5% mortgages and personal loans are gone, at least for the foreseeable future. Rudolph Peterson, president of California's Bank of America (see box, next page), notes that money rates have drifted upward since 1950 in a pattern of sharp rises followed by drops to levels steeper than before. "Interest rates will ease down over the next year or two," he predicts, "but will end up a bit higher than they were at the start of the current move."

Taxing Their Powers. Throughout 1966, money managers have been trying to cool the economy's real growth to a sustainable, noninflationary rate between 4% and 4½% — compared with this year's 5.5%. Historically, business slows down about six months after the Federal Reserve begins to reduce the money supply — and that is what is presently happening. As 1967 begins, corporate profits and order backlogs are slipping and the boom is less explosive than before. Most businessmen are un certain about the year ahead. What worries them is that the future will be determined largely by factors they cannot control: tax policy, money policy, Viet Nam and labor's wage demands.

Economist Beryl Sprinkel, vice president of Chicago's Harris Trust and Savings Bank, warns that the economy will soon reach a no-return point where recession will be inevitable unless the Federal Reserve steadily eases up on money. The Fed is in a quandary. Its seven governors are concerned about the danger of overcure — too much money tightness contributed to both the 1957 and 1960 recessions, when industrial production dropped. But Bill Martin's men are equally worried that total demand is still too strong, and the nation's balance of payments is too weak to permit any significant easing.