Tying Its Own Hands

April 11, 1960

In the last two or three months there has been a sharp fall in interest rates. As a result it is being frequently said in Washington and in press that the U.S. Treasury’s efforts to get Congress to remove the statutory limit of 4¼ percent on long-term government bonds have become altogether futile; that the proposed legislation is in “indefinite eclipse,” and that the whole dispute has become “pointless.” But before we so hastily bury the issue it might be wise to ask if it is really dead.

It is true that a few months ago some long-term Treasury issues were selling at prices to yield about 5 percent and that within recent weeks some have been selling to yield less than 4¼ percent. It is true that the government’s 91-day bills, which sold at rates to yield 4.75 percent in early January, have recently been put out at yields of only 2.79 percent.

The need for Congressional action looks less urgent than it did a few months ago. But it remains no less important. It would be, in fact, dangerous for Congress to postpone it. In the recent high interest rates Congress got an unmistakable warning. It will have to bear full responsibility for the consequences if it ignores that warning. President Eisenhower raised the issue in a message as early as last June. It became more urgent after he raised it. If interest rates can fall unexpectedly they can also rise unexpectedly. The latest issue of long-term bonds that the Treasury attempted—the 4 percents of 1969, put out in 1957—rose to 110 to yield about 2.94 within a year of their sale. Less than two years after that they had declined to about 94, at which their yield was 4.71 percent.

WHY KEEP IT?

Instead of asking what need or point there is in removing the statutory interest rate ceiling, we should be asking what need or point there is in keeping it. If the ceiling were repealed, no harm whatever would follow. It would not in the least increase the interest rates the government would have to pay. The Secretary of the Treasury, as now, would not try to borrow at the highest rates possible but at the lowest rates possible, in accordance with his plain duty.

But though the statutory ceiling does no good, it retains great possibilities for harm. Last week the Treasury felt obliged to offer the 4¼ percent ceiling rate for new bonds. When interest rates on government long-term bonds are above 4¼ percent, it forces the Treasury to borrow at short-term (less than five years). This leads to congestion in the market for short-term securities, forces up interest rates on such securities, tends to raise the average rate at which the government can borrow, and prevents the Treasury from achieving a manageable balance in maturities.

PRESCRIBING INFLATION

Two issues are involved here—the administrative and the economic. The administrative issue is whether the terms, maturities, balance, timing, and interest rates of 50 or more different issues of government securities should be determined by Treasury experts, in daily touch with the money market, or whether these decisions should be prescribed blindly and far in advance by a lay Congress concerned with a hundred other matters. The 4¼ percent ceiling on long-term government bonds was written into the law more than 40 years ago. Fortunately for us now, that ceiling was not imposed, as it consistently might have been, on short-term as well as long-term borrowing. Fortunately, also, by historic accident, the statutory ceiling we now have is the 4¼ percent imposed in 1918, and not the 3¼ percent earlier fixed by Congress in 1917.

Administratively, it is folly for the government to tie its own hands. But the economic case against the ceiling is even more serious. The only way interest rates can be arbitrarily held down to the ceiling (even temporarily) is by an increase in the money supply, either directly, or indirectly by forcing the Federal Reserve Banks to return to the pegging of interest rates by buying government bonds and monetizing the national debt. In effect, this is what Senator Douglas and his Congressional committee have been proposing. The failure of Congress to remove the ceiling now can only undermine confidence in the dollar both at home and abroad.