Long & Short Seesaw

To help boost the economy, the Federal Reserve Board last week unlimbered an old fiscal weapon that President Kennedy and many liberal economists have long wanted restored to the nation's antirecession arsenal. The Fed announced it would begin buying U.S. notes and bonds of longer maturity.* By entering the long-term market, the Fed can shorten the supply of bonds, push prices up--and thus help nudge yields lower. Since Government bond yields tend to set the tone of all interest rates, this policy would be expected to push long-term rates down, make money cheaper and thus encourage business expansion. At the same time, the Fed and Treasury hope to keep short-term rates from slipping, lest this encourage short-term investments to go abroad, thus step up the gold outflow. The action represents an about-face from the "bills preferably" policy under which the Fed since 1953 has done most of its buying and selling of securities in the short-term market, i.e., U.S. Treasury bills.

Last week's policy switch also represents a sharp about-face for William McChesney Martin, 54, the shrewd, conservative chairman of the FRB. During World War II and the early postwar years, the Fed was little more than the Treasury's valet, pegging bond prices to keep interest charges--and the cost of the war--low for the Government. Though the policy was fine for wartime, in peace it made the Fed, as one chairman, Marriner Eccles, complained, "an engine of inflation." Finally in 1951 the Fed rebelled, refusing to support the price of Treasury bonds. In the ensuing Fed-Treasury "accord," the Fed reasserted its independence, got out of the long-term markets.

Presidential Pressure? One of the architects of the Fed's 1951 accord was Martin, and that same year he took over as chairman, with the task of making "bills preferably" stick. Since the Eisenhower Administration viewed the Fed as the primary means of reining inflation, he had little trouble. But early in the campaign Kennedy made plain that he thought the Fed had swung from its earlier valet role too far toward an independent, negative role in monetary control. He wanted more Fed-Treasury cooperation, especially as he viewed the Fed as only one means of controlling credit.

Did Kennedy pressure Martin into the Fed's new role? The answer: no. Kennedy had indeed called Martin in and explained his views. They were also the views of some of the Fed's own members, notably former New York Fed Vice President Robert Roosa, now Under Secretary of the Treasury. They wanted the Fed to get back into long-term interest issues. Since long-term rates were already easing, Martin sensibly agreed to help give them a downward nudge and his critics a chance.

The world of finance is plainly skeptical that the Administration, even with Martin's skillful aid, will be able to nudge down long-term rates while keeping short-term rates up. In the past, short-and long-term rates have tended to move in the same direction.

Contradictory. On the long-term side, the FHA recently lowered interest rates on home loans from 5 3/4% to 5 1/2% The Treasury has begun switching more of its financing into short-term securities: by satisfying the demand for short-term investments, it can thus drive short-term interest rates up. The demand is clearly present in the market: fortnight ago, a Treasury refunding offer of $6.9 billion in 18-month notes at 3 1/4% was oversubscribed by nearly $19 billion. The firming of short-term rates, plus other keep-gold-at-home measures, has already begun to pay off. London gold prices last week dropped to $35.08 1/4% an ounce, lowest in five months and below the official U.S. price, thus scaring off speculators and slowing London sales to a trickle. To help keep things that way, Kennedy last week asked Congress to 1) cut from $500 to $100 the amount of duty-free goods U.S. tourists can bring home, and 2) exempt from U.S. taxes the interest earned by foreign banks who buy Treasury securities.

Among the bankers who frankly doubt that the Government can make the seesaw work is Roy Reierson, chief economist of the Bankers Trust Co., who told the Joint Economic Committee of the Congress that "essentially the aims are contradictory." He pointed out that as bond yields decline, the inducement to invest at long term will weaken, and investors may switch to the short-term market, driving rates down there as well. Other critics are also afraid that the abandonment of the "bills preferably" policy will commit the Fed to supporting long-term holdings, upset the market and launch a new round of inflation. But Martin, who has carved out the Fed's reputation for independence in the last decade, has no intention of letting the image be chipped away now. He has made plain he will cooperate with the Administration as long as long-term rates are moving downward anyway, but will not use the Fed's purchasing power to buck the market if the trend turns up. Its entry into the long-term market last week was cautious: it bought only two U.S. issues worth some $13 million.

Even so, the Administration was counting on considerable psychological effect from its "open-mouth" efforts to talk down long-term rates. At week's end, the rates on 91-day Treasury bills in the short-term market rose to a three-month high at 2.496%. But yields on U.S. bonds also rose. Traders and investors were waiting to see just how far the Fed would cooperate with the Administration, how determined it is to drive rates down.

* In the U.S. debt-issue markets, a bond is usually any obligation payable in five years or more, a bill comes due in a year or less, a note is any Issue redeemable in the period between a bill and a bond.

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