Toward a Sounder Currency

A notable battle in the war against cheap money--which is the real and basic war against inflation--has now been won. It was a defeat for Treasury Secretary John W. Snyder and for Harry Truman, who had backed Snyder's cheap-money policy against the advice of the nation's best economic and banking brains.

The key issue at stake was whether the Federal Reserve Board must bow to White House pressure and continue to peg, or support, the price of Government bonds above par, thus continuing to make available billions for credit inflation any time that banks or insurance companies wanted to unload their bonds. Harry Truman had insisted that FRB continue the support policy, but had become alarmed at the uproar this had caused.

Last week, with no peep whatever from the White House, FRB stopped supporting Government bonds. In effect, FRB served notice that from now on it will let the Government bond market fluctuate, and will support it at no predetermined level.

The unpegging was apparently part of the agreement between FRB Chairman Thomas B. McCabe and Snyder on the terms of the Treasury's new $19.6 billion refunding bond issue (TIME, March 12), which is intended partly to freeze bank reserves--another point FRB wanted. The new bonds will bear 2 3/4% interest, an increase of 1/4% over present long-term bonds.

The new bonds issued by the Treasury, which mature in 1980, can be acquired by turning in present long-term bonds paying only 2 1/2%. But they can be converted or transferred before maturity only by exchanging them for marketable five-year notes bearing only 1 1/2% interest. Since these 1 1/2% notes will undoubtedly sell for a discount in the open market, anyone who sells the new bonds will take a loss. The Treasury apparently thinks the penalty will be big enough to keep bondholders from selling, thus freeze the bonds.

When FRB pulled its peg, the long-term 2 1/2% bonds, which had been supported above par, slumped to par. But FRB had picked a shrewd time to drop its support. It was the same day that Snyder announced the details of his new issue. Insurance companies and other big buyers liked the terms so well that they jumped into the market and prices steadied, although down from the pegged level.

With a free market in bonds, chances are that prices will drop, thus interest rates will automatically rise. There is little danger that Government bonds will fall very far. If the market becomes "disorderly," FRB will certainly start supporting the bonds again, since its job is to provide an orderly market.

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