Loosen the Bonds?

On Christmas Eve in 1947, the U.S. Treasury gave a present to U.S. bankers: it would continue to support the price of long-term Government bonds above par by having the Federal Reserve banks buy bonds back at the "pegged" price if there were no other buyers. With this arrangement, the Government hoped to make it easier to sell "Treasuries." Furthermore, this deal would keep down interest rates, in line with its "cheap money" policy on long-term bonds, and it would stabilize the bond market. For a while the plan worked --but only for a while.

Last week, in spite of controls and planning, interest rates were on the rise, and the market was far from stabilized. So many big securities holders--insurance companies, banks, finance companies, etc. --were unloading their Government securities that FRB was forced to buy up $1,422,000,000, the greatest amount ever bought in one week. Part of the selling was caused by the banks' need for more cash reserves, because of FRB's tightening up reserve requirements (TIME, Aug. 16 et seq.), but there was enough other selling to rouse bankers into the hottest fiscal argument of the year on the pegging policy.

Though it all sounded like so much stratospheric financial gobbledygook, it was far more than that. The pegging of the market was a potent inflationary force, and ill-advised tinkering with it might bring the whole boom tumbling down.

Drop the Peg. Until recently there has been little complaint about pegging of Government bonds. Bondholders liked the guaranteed market. But as commercial interest rates edged upwards (Reynolds Tobacco Co. had to promise 4 1/2% last week on a $26 million issue of preferred stock, compared to 3.6% on an issue in mid-1945), big bondholders, notably insurance companies, began to unload on FRB. They could put their money in better paying private issues or out to loan. Had the unloading reached such a point that FRB should stop supporting the market?

One man who thought so was the Equitable Life Assurance Society's Thomas I. Parkinson. Said Parkinson: "Neither banks nor life-insurance companies have any right to expect a guaranteed buyer." Parkinson thought that FRB should let the bonds find their own level in a free market. His argument was that lower bond prices meant higher yields, and higher yields on Treasuries would in turn push up the commercial interest rate. Making credit more expensive, thought Parkinson, would help nip inflation.

The Real Culprits. The case for support was made before the American Bankers Association last week in Detroit by its former president, Frank C. Rathje, of Chicago's Mutual National Bank. Dropping the peg, he said, might well "provoke a storm." The real inflationary culprits, charged Rathje, were not the banks, but the non-bank lending agencies, primarily the insurance companies.

In the twelve months ending June 30, he said, the insurance companies had cashed in nearly $3 billion worth of Government securities, twice as much as the banks, and had upped their loans and investments by $6 billion. Altogether, said Rathje, the lending power of non-bank interests had risen by $15 billion, or at three times the rate of FRB member banks. His remedy: put the lending of non-bank agencies under federal regulation.

ABA's outgoing President Joseph M. Dodge admitted that "pegged bond prices are an inflationary process." But he thought that scrapping the supports would probably not do much good in checking inflation, and in effect the chance of upsetting the delicate handling of the U.S. public debt was not worth taking.

End the Boom? No one knew for sure what would happen if the peg was abandoned. But Secretary of the Treasury John Snyder was well aware of what had happened in 1920. Liberty Bond prices dropped abruptly nearly 20% and helped pull the whole economy into a postwar slump. And in 1920 the interest-bearing public debt amounted to only $24 billion. This year, with $251 billion outstanding, the Treasury thought the shock to the U.S. might be far worse.

Furthermore, the Government had to think of sales: its need for public money is far from over. In the next twelve months it must refund $49 billion worth of maturing securities, in the next five years $100 billion, not counting any new borrowing to finance the armament program ahead. It expects to do this refunding by getting much of its cash from the bond market, which depends on public confidence in the stability of Government bonds.

Was there a middle way? In the current FORTUNE, Russell C. Leffingwell, chairman of J. P. Morgan & Co., Inc., suggested one course. He is against supporting the bonds above par because it "makes the market, and not the Federal Reserve, the master" of the U.S. money supply. He suggested that FRB have no pegged price, but support the market only when it thinks necessary. In effect, it should let the price of Government bonds fluctuate within set limits. Many another banker would go further and withdraw support until the price had fallen below par, then peg it somewhere below par. That would force big bondholders to hold on to their bonds until maturity or take a loss--and thus much inflationary credit would be squeezed out of the economy. If bonds continued to flood into FRB, it looked as if the Treasury would soon have to do something to stop the dumping.

This file is automatically generated by a robot program, so reader's discretion is required.