Regional President Speech

, The 'Budget Q, 'Regulation and Gold: Three Issues forToday and Tomorrow Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The Budget Regulation Q, and Gold: Three Issues for Today and Tomorrow by Karl R. Bopp So much has happened in banking and finance My view is that neither central bankers nor since we last met that it is difficult to choose observers should measure policy or the need for a which of many current events to talk about. change in policy by movements in a single or Meanwhile, critics of the Federal Reserve System, even a few financial variables. The System has whatever their leaning, have had a field day. By been and is continuing to invest large efforts in choosing the measure that supports his view, the order to develop a better grasp of the relation­ critic can prove almost anything—to his own ships among financial variables and developments satisfaction—but not to the satisfaction of other in the real economy—which, after all, is the ulti­ critics who choose another measure. mate objective of policy. I am a member of a For example, those who believe simply that so-called Steering Committee which has devoted the Federal Reserve controls the money supply several years with first-class staff assistance to and that the money supply controls everything studying possible benefits from a redesigned dis­ else in the economy insist that the Federal Reserve count window which, among other things, might began a disastrously easy money policy about the reduce administrative surveillance and make time we met here last year. They conclude we changes in the rate more meaningful. followed an easy money policy because last spring We now publish our policy record approxi­ and summer the money stock was increasing at a mately 90 days after each meeting of the Federal near-record rate of 9 per cent and total member Open Market Committee. The record and our bank deposits at a rate of almost 12 per cent. reasoning are there for all to see. On the other hand, those who believe simply I shall not, therefore, go into that record in that the Federal Reserve fixes interest rates and detail today. Instead, I shall concentrate on three that interest rates fix the rest of the economy de­ interrelated developments—each of which could scribe that same period as one of extremely tight be a speech in itself. The first might be entitled money because interest rates rose even faster than “The Failure of Fiscal Policy”; the second, “The in 1966 and to the highest levels in decades. Dilemma of Regulation Q”; and third, “The Twi­ Incidentally, it is a bit—well—disconcerting to light of Gold.” These titles, though over-dramatic, learn that in some cases the same individuals who sum up three basic issues of the past year and— a few years back criticized us severely for not pay­ more important—of the long run as well. Indeed, ing enough attention to rates are now criticizing the thrust of my remarks is that in all three cases us for paying any attention to rates at all, but we are confronted with presssing problems that such is the life of any banker—central or com­ not only call for immediate solutions, but have mercial ! important implications for the longer run. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The Budget stalemate indicates once again that two-way flex­ ibility—use of fiscal policy to restrain as well as Most—if not all—of our current financial prob­ to stimulate—remains to be mastered. As a re­ lems stem from the failure to get timely changes sult, some observers of economic developments in fiscal policy. Substantial and continuous budg­ have become disenchanted and are moving to etary deficits, in an economy utilizing nearly all the view that the best that can be hoped for is to of its resources, have been heavily responsible for establish a stable fiscal policy and leave respon­ recent price increases. This renewed burst of in­ sibility for counteracting swings in the economy flation, in turn, has contributed to a further to monetary policy. The disadvantages of such deterioration in our balance of payments and a course are obvious when we observe the level further weakening of the prestige of the dollar. of interest rates today. A more flexible fiscal The need for restraint in the fiscal program of policy remains worth striving for, and I haven’t the Federal Government has been obvious for lost hope. many months. Whether one is a New Economist or an Old Economist, the combination of a budget Regulation Q deficit of over $20 billion, which is what it will amount to in the fiscal year 1968, and a price The second issue with important short- as well as level rising at an annual rate of 4 per cent spells long-run implications is the dilemma of Regula­ bad economics. tion Q. The Federal Reserve’s experience in It also spells bad politics. A tragedy is that dif­ changing ceiling rates on time and savings de­ ferences of political views as to how to close the posits is brief and inconclusive. When ceilings budgetary gap have stalemated action on both were raised in December 1965, they helped make spending and taxes for so long. Because of parti­ possible a rapid growth of money and credit in san political considerations, as well as more early 1966. When they were not raised in the fundamental philosophical disagreements, law­ summer and fall of 1966, they helped to produce makers and administration officials are clinging the credit crunch. to their respective concepts of the ideal solution As credit tightens and interest rates rise to to the budgetary problem and are unwilling to historically high levels, commercial bankers find make concessions in spite of the urgency of the it increasingly difficult to compete at existing situation. This is the short-run failure of fiscal ceilings. If, however, commercial bank ceilings policy. are set too high, other financial institutions, sub­ Perhaps even more serious is the implication ject to various restrictions, may find it difficult for the longer run. Are we to face such grave to compete with commercial banks. If open mar­ situations again and again as time rolls on? Al­ ket rates rise above the ceiling rates, many though the theory of flexible fiscal policy is just investors—principally large investors but increas­ as sound as it ever was, the possibility of it being ingly even ones having smaller portfolios— put to practical use has been dealt a severe blow. channel funds out of financial institutions and This is a great disappointment, particularly inas­ into marketable securities. This disintermediation much as the tax cut of 1964 had led many to be­ can have far-ranging effects upon financial insti­ lieve that the principles of flexibility were finally tutions and the particular markets which they taking hold as a working proposition. The current serve. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The Federal Reserve has just recently raised charge on loans. the ceilings for large-denomination CD’s. This Institutional and statutory rigidities which indicates clearly a desire to avoid the kind of impair efficient functioning of our financial crunch that occurred in 1966 without precipi­ structure are man-made problems; so it would tating the kind of disintermediation that drained seem that they could be removed readily. As you funds out of the housing and municipal markets know, however, artificial and arbitrary market during the same period. Whether these new ceil­ impediments are difficult to eliminate, mainly ings will be adequate only time will tell. because of the support they receive from special- The problems with interest rate ceilings stem interest groups in legislative halls throughout largely from efforts of monetary policy to keep the nation. the rate of economic growth within sustainable Longer-run solutions to the problems of in­ limits. To the extent that appropriate fiscal meas­ terest rate ceilings are possible. I do not give up ures are carried out, the burden upon monetary on this as an ultimate goal. First, it is desirable to policy is decreased and the pressure on interest broaden opportunities for the various kinds of rates is reduced. Therefore, a short-run solution financial institutions to compete with each other. to the problem of interest rate ceilings under This would mean that arbitrary distinctions Regulation Q is a timely and appropriate fiscal among types of institutions would be reduced. policy to supplement a restrictive monetary pol­ Second, it is desirable to develop broader and icy. more efficient secondary markets for mortgages The dilemma posed by Regulation Q points up and other debt instruments. Improved flows of a longer-run problem which gives rise to it. Prin­ funds among markets make it easier and more cipally, this is the imperfection of competition efficient for banks to adjust their asset positions. in financial markets. Personally, I would prefer For example, the better the secondary market for not to be in the business of setting ceiling rates municipal bonds, the easier and less costly it is on time and savings deposits. I would rather for banks to use them as a type of secondary operate in an economy in which institutions reserve. would be free to compete against each other for I believe that usury restrictions deserve special existing supplies of funds; and price would regu­ attention now. Originally, usury legislation was late the allocation of funds. adopted to protect the public from unscrupulous Unfortunately, the various kinds of financial money lenders—a goal which is still in favor in institutions have special restrictions that govern this era of concern over consumer protection. I their activities. Savings and loan associations, for am sympathetic with the principle of aiding con­ example, cannot invest in corporate bonds. Mu­ sumers; but there is a difference between consu­ tual savings banks can operate only in certain mer protection and interest rate ceilings estab­ geographical areas. Secondary markets for mort­ lished by usury laws. gages are not as fluid as some other kinds of Usury ceilings were established in relation to markets. Federal agencies regulate the rate of interest rate levels prevailing at the time. Perhaps interest which savings institutions can pay for framers of usury provisions thought that the funds. Furthermore, many states impose usury ceilings were set high enough to present no sub­ ceilings on the rates which these institutions can stantial future problem to borrowers or to lenders. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis However, as rates have climbed to historically Federal Housing Administration raised the ceil­ high levels, the usury limitations have become a ing on interest rates on mortgages which it in­ problem. They may protect the borrower from sures. Also, Fannie Mae has instituted an auction paying high rates; but in today’s markets they process for determining prices of mortgages it are more likely to prevent him from getting the buys. These actions are a step toward removing funds at all. some of the impediments to funds flowing into I am reminded of a story from the days of the mortgage market. More such actions are wartime rationing. needed if we are not to be faced periodically with A woman went into a store to buy pork chops. financial disruptions in periods of high interest The butcher told her the price was a dollar a rates. pound. Gold “Why your competitor across the street is charging only 75^.” The third issue before us is the twilight of gold. “Please, madam, why don’t you go there to I use the word “twilight” advisedly because the get them?” question of gold still sets off a great deal of pyro­ “Oh! he doesn’t have any to sell.” technics. Nevertheless, it seems clear that the “Well, when I don’t have any to sell, my price role of gold as well as that of the dollar has been is only 50^.” weakened by recent events. Because interest rate ceilings vary among In the short run, gold has occupied the center states, lenders often find it advantageous to shift of the stage. The decline of over $2.5 billion in funds to other geographical areas. The shift may United States gold reserves since your meeting a not coincide with the relative need for funds year ago is an indication of the difficult state of among the areas. Now, roughly four-fifths of the the U.S. dollar in the world economy. states have more lenient usury laws than do The liquidity considerations of the United Pennsylvania, Delaware, and New Jersey. States should not be confused with questions of As you know, new truth-in-lending legislation solvency. Each year our nation grows wealthier passed Congress and was sent to the White House in relation to the rest of the world. During the yesterday. Knowledge of costs can give real pro­ ten years ended in 1966, U.S. investments and tection to the consumer-borrower. Companion assets abroad jumped by 126 per cent to $112 legislation on the state level to remove or sub­ billion, while foreign assets and investments in stantially revise usury provisions would be timely the U.S. increased by 91 per cent to $60 billion. and appropriate. Recently the Pennsylvania Leg­ So, the United States with net investments of over islature has raised the interest limitation on mort­ $50 billion in the rest of the world is an economi­ gage loans in the state. The action may not be cally sound nation—and it has grown stronger adequate, but is a step in the right direction. year by year. But, we do have a liquidity problem I would hope that in the months and years that demands solution. ahead substantial efforts could be devoted toward The gold problem has been caused by a failure eliminating the arbitrary, man-made impediments of the United States to achieve reasonable equi­ to free competition within and among various librium in its balance of payments with other financial institutions and markets. Recently, the countries. Over the past ten years the aggregate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis deficit in balance of payments has approached can producers to export to foreign markets and $27 billion. These deficits have resulted from a will entice foreign businesses to increase sales in number of factors. The United States has poured American markets. Military outlays overseas can billions of dollars into economic assistance pro­ be expected to continue at a substantial level even grams, helping war-ravaged nations back to their if shooting stops in South Vietnam. And it re­ feet. American corporations, alert to expanding mains to be seen how much over-all reduction in overseas opportunities, have boosted investments the balance-of-payments deficit will be achieved in foreign lands. Our rising income levels have by the President’s program announced on Jan­ enabled more individuals to travel and spend uary 1. abroad. Our military commitments around the The most important step in bringing the bal­ world and particularly in Southeast Asia have ance of payments closer to equilibrium has not been a large drain on dollars. Moreover, foreign yet been taken. That step is a move toward fiscal nations have stepped up competition with Ameri­ restraint. A reduced Federal deficit should help can firms for important markets both in the restrain domestic demand, thereby slowing down United States and elsewhere. Domestically, in­ imports; it should help to hold down domestic flationary pressures have encouraged foreign prices and thus stimulate exports. Furthermore, businesses to sell goods in United States markets, it should pay handsome dividends in improved thereby putting pressure on our favorable balance psychology around the world with respect to the of trade. All of these factors have been operating health of the dollar. for a number of years. Looking to the longer run, progress toward Our Government has taken a number of short- establishing special drawing rights is an en­ run, stop-gap measures to stem the outflow of couraging development. The supply of gold is dollars and gold. There is the voluntary foreign too uncertain to provide a base for a growing credit restraint program with which you are co­ world economy, and it is clear from recent ex­ operating splendidly. Also, we have the interest perience that there are limits to how far dollar equalization tax levied against foreign invest­ liabilities can be expanded through balance-of- ments by United States citizens. We have the payments deficits. foreign investment restraint program which asks The new “paper gold” is another step in the businesses not to ship dollars overseas for invest­ evolution of a more viable international mone­ ment purposes. The Government has cut the value tary system begun with the creation of the In­ of items tourists can bring back duty-free in an ternational Monetary Fund. As this system has attempt to curtail tourists’ spending abroad. evolved, gold has been a declining portion of Restrictions on overseas travel by individuals world monetary reserves—from 72 per cent in have been proposed. And the list goes on. 1948 to 56 per cent in 1967. The “paper gold” In spite of these stop-gap measures, the near­ will be a further supplement to gold, enabling term outlook for the balance of payments is far world trade to grow in a more orderly way. It from good. The likely increase in economic activ­ is, however, no less vital to pursue other policies ity during the rest of the year will continue to which will encourage economic growth through­ produce a large demand for imports. Further out the world, and not restrain it. Recourse to increases in prices will make it harder for Ameri­ quotas and other restrictions on trade would Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis frustrate these very promising efforts. In the case of the Federal budget, efforts should The long-run goal of a more viable interna­ go forward to prevent recurrence of the kind of tional monetary system cannot be achieved, how­ fiscal impasses that we are now experiencing. In ever, unless we bring our international payments the case of Regulation Q, the Fed will be faced closer to equilibrium. with a dilemma every time interest rates get high Conclusions and money gets tight. Efforts to make financial markets freer and more competitive are essential There are many lessons to be drawn from recent if we are not to be confronted with recurring experience. The one I want to emphasize is the problems of disintermediation and adverse allo­ importance of working toward long-run solutions cation of credit. Finally, in the case of gold, to current and persistent problems. The danger in resorting to ad hoc expedients which at best action to put the world’s financial system on a only postpone a showdown is that fundamental more flexible footing should proceed as rapidly solutions may be made even more difficult to at­ as possible. The first step to assure this long-run tain. I am fully sympathetic to the view that solution is for the United States to get its bal­ today’s fast-moving world calls for great flexi­ ance of payments closer to equilibrium. bility. Actions of the Federal Reserve System in We cannot let the house burn down while we recent years, in fact, have exhibited more flexi­ design the most efficient water system. But with­ bility than in any other period of the Fed’s out such a system, we shall be in grave danger history. each time a fire breaks out. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Karl R. Bopp (1968, May 22). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19680523_karl_r_bopp

@misc{wtfs_regional_speeche_19680523_karl_r_bopp,
  author = {Karl R. Bopp},
  title = {Regional President Speech},
  year = {1968},
  month = {May},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19680523_karl_r_bopp},
  note = {Retrieved via When the Fed Speaks corpus}
}