Cheap Money-Mania

December 21, 1964

The crisis in the British pound, brought about basically because the Bank of England had been glutting the market with too many pounds, should have been a grim warning to our own government on the ultimate consequences of its similar policies with the dollar. Instead, Washington decided to embark on still more credit inflation.

Addressing the Business Council, President Johnson on Dec. 2 warned the nation’s 14,000 banks that in spite of the increase in the discount rate to 4 percent, he did not think “any general increase in the rates which banks charge their customers” was justified. Immediately one of the four banks that had announced a rise in their “prime” lending rate from 4½ to 4¾ percent canceled the increase.

The President’s warning was tantamount to an extralegal form of selective price control. By itself, it might have been ineffective. But it was accompanied by a still more extraordinary action on the part of the Federal Reserve authorities. In the same week they bought nearly $1.1 billion of Federal securities. In other words, they poured that amount of high-powered money into the commercial-banking system, and flooded the short-term loan market with funds.

POURING IN FUNDS

Let us look at a few comparisons. From the end of 1957 to the end of 1963, the Fed’s holdings of government securities rose from $24.2 billion to $33.6 billion. This meant that in those six years the Fed was buying government securities, and monetizing them, at a rate of $1.6 billion a year. This monetary inflation has been the major cause of the deficit in the U.S. balance of payments that began in 1958. But here was an increase in monetized security holdings of $1.1 billion in a single week.

This cannot be dismissed as a merely “seasonal” increase. It brought the Fed’s total holdings of government securities to $37.4 billion, an increase of $3.4 billion over the corresponding week of the year before. The Fed’s action directly contradicted the small increase in the discount rate.

The President’s interest-rate warning must tend to shake confidence. Like his steel-price warning, it was a sort of extralegal price-fixing. It was unnecessary, because the competition among 14,000 banks assures a free market rate. The course the President suggested, moreover, is the opposite of what now needs to be taken. He asked the bankers to “consider the long-term interest of the nation.” But it is precisely the long-term interest of the nation that now calls for tighter credit rather than easier credit, for a halt instead of an increase in new money-and-credit creation, in brief, for a halt in inflation. This is above all necessary to halt the deficit in our balance of payments, about which the President is so rightly concerned.

CRISIS TO CRISIS

Behind the President’s warning, behind the Fed’s debt-monetization, behind the crisis in the British pound, and leading to it, is the fashionable fallacy that constant easy money and constant credit expansion are necessary to prosperity and “economic growth.” But this international inflation game is leading the world from crisis to crisis. It led to the devaluation of the pound from $4.03 to $2.80, and the corresponding devaluation of nearly every other major currency, in 1949. It forced the U.S., with the help of a few European banks, to extend a billion-dollar line of credit to save the Italian lira last March. It forced leading nations first to extend $1 billion aid to save the British pound early in November and then $3 billion more credit a few weeks later to save it again.

How long can these melodramatic rescue operations, in increasing amounts, go on? And what makes them necessary? They are necessary because the world, having thrown away the discipline of the gold standard, has found nothing to take its place. Under the old gold standard, when a country found itself losing gold it quickly had to raise its interest rates and halt its credit expansion to stop the outflow. Now it appeals to other central banks to bail it out by swapping paper currencies and maintaining a synchronized world inflation. That house of cards must some day tumble.