The Squeeze of '79

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> An immediate and unusually sharp 1% rise, from 11% to 12%, in the discount rate, which is the interest the Federal Reserve charges to commercial banks that borrow funds from it. Since Federal Reserve rules require banks to keep a certain amount of money in reserve for every dollar in loans to customers, banks that want to increase their lending sometimes turn to Federal Reserve discount funds to do so. Pushing up the cost of those funds discourages banks from borrowing and thereby helps hold down the expansion of credit.

> A requirement that 8% of any dollars acquired by banks from foreign sources for relending to borrowers in the U.S. be set aside and not loaned to anyone. Known generally as Eurodollars, these expatriate greenbacks have accumulated as U.S. payments deficits, starting in the 1960s; lately they have been increasing dramatically as a result of the rising cost of imported oil. Today they form a $600 billion money mountain in Europe as well as in the Caribbean and other offshore tax havens, where they have escaped the control of the Federal Reserve. In the past, when the Fed tried to curb the pace of business—and inflation—by limiting the supply of money, banks were able to circumvent this tightening by obtaining Eurodollars. The 8% reserve requirement will discourage this by making that money more costly for the banks to borrow, since they cannot lend it all to their customers.

> A policy decision that henceforth the Federal Reserve will no longer concern itself with trying to manipulate interest rates, its traditional device for controlling the growth of money, and will just stop creating so many dollars instead. The Fed regulates the level of money in the economy by buying or selling Government securities through its so-called Open Market Desk at the New York Federal Reserve Bank. When the bank buys the securities, it pumps money into the economy; when it sells them, money is drawn out, and interest rates rise. The Fed is now saying that, within broad limits, interest rates can go where they will because the bank will instead be concentrating on cutting down the supply of money directly.

To government leaders throughout Europe and bankers and businessmen around the world, the Volcker package was more than just decisive. It made basic monetary sense, something that foreigners have come to long for in the White House's increasingly ineffectual inflation fight. In the past year, not only have prices throughout the economy surged into double digits and stayed there, but the Administration's chief weapon in the struggle, its year-old voluntary wage and price guidelines program, has proved hopelessly inadequate to the task.

So too has the White House's much touted "dollar rescue package" of last November; it was slapped together as a sort of desperation move to prop up the dollar after foreign bankers last autumn looked at the guidelines scheme, judged it weak and began frantically dumping greenbacks and buying West German marks, Swiss francs and gold. Initially, the November rescue package did stabilize money markets, largely because the Federal Reserve began massively intervening in currency markets to buy dollars and support their value. But inflation kept rampaging domestically, and eventually the dollar began to crumble all over again.