America's Money Crisis
THE EGORNEW A THE
By NICHOLAS DAVENPORT
HE economic storm signals are flashing a I warning red to the captains of industry. I could hardly believe my eyes when I read the relatively bullish forecast of the National Insti- tute of Economic and Social Research in its latest bulletin—that the Wilson freeze-up will not produce an actual recession. Do not these academic economists know the elementary facts of business life? When money becomes tighter and tighter and dearer and dearer no business can remain unaffected and in the end frustration and the loss of confidence bring new industrial investment to a halt. Our economy was already turning down—witness the fall in the industrial production index and the rise in unemployment —when the severe deflationary measures of July were announced. Now comes a fresh warning from the slump in Wall Street. The monetary squeeze which the Federal Reserve Bank is ruth- lessly applying will surely kill the great American boom—in spite of the Vietnam war-- and con- tract the best market for British exports.
To understand the American threat we must go back to July of last year when the Federal Reserve first raised the re-discount rate in de- fiance of President Johnson's wishes. This caused the President to wash his hands of the monetary business and leave it to Mr McChesney Martin, the Federal Reserve chairman, to make a mess of it, as bankers usually do. In December the re-discount rate was raised again—from 4 per cent to 41 per cent—and bank credit began to be squeezed. As this did not appear to have any anti-inflationary effect, the bond market con- tinued to drop and interest rates to rise. Treasury bonds have fallen to yield over 51 per cent and Federal Agency bonds over 51 per cent. (A Federal Home Loan Bank issue has lately had to offer 6 per cent.) The commercial banks have raised their 'prime' loan rate three times since December and it now stands at 6 per cent. They used to require their borrowers to leave in 10 per cent of the advance: now they require 20 per cent. So a loan at 6 per cent is costing 71 per cent. This is not far short of the high overdraft rate now charged by British joint stock banks, which is 1 per cent to 11 per cent above the 7 per cent Bank rate.
The American business world, which has not seen such high money rates for forty years, is becoming scared that it will not be able to finance its normal expansion. Has not Mr Henry Fowler, the Treasury secretary, already told the banks to refuse loan requests rather than raise loan rates further? So the more desperate businessmen are rushing to their life assurance companies to raise loans on their life policies which they are entitled to do—up to their surrender value—at the non-commercial rate of 5 per cent. There was an increase of 40 per cent in life policy loans in May, the total reaching a record $8,000 million. This is all very well for the businessman but if the rush goes on it will 'bust' the life assurance companies. In fact, most financial institutions in America are already facing a grave liquidity crisis. Interest rates are therefore likely to be forced even higher. As this will tend to keep funds away from the savings and loan associa- tions, which chiefly finance housing, the govern- ment has sponsored a Bill to curb an 'interest rate war' among competing financial institutions, but it is doubtful whether it will pass Congress. It is also doubtful whether an Interest rate war' will do anything but aggravate the inflationary pres- sures now evident in the American economy. Since the beginning of the year wholesale prices have been rising at an annual rate of 4.4 per cent and retail prices at over 31 per cent. The government's 3.2 per cent guidelines for wages and prices have already gone by the board. Recent pay contracts have seen to that and the unions are getting in an ugly militant mood for next year's big negotiations.
What we are witnessing is the breakdown of President Johnson's financial policy, if ever he had one. He has been trying to hide the real cost of the Vietnam war, which is said to be rising at the rate of $2,000 million a quarter. He has been stubbornly refusing to raise taxes to meet his colossal military expendi- tures. He has acquiesced in the use of monetary measures when he should have been using fiscal measures to ease the pressure on the national resources. In fact, he has been pursuing the travesty of an economic policy. He has been pre- tending that America is rich enough to finance both a costly war abroad and the launching of the Great Society at home (with $3,000 million to be spent annually on 'Medicare') without upsetting the price level or the balance of pay- ments. It has been impossible and the cost of the President's financial gamble is an 'interest rate war' which will cause first a slow-down in housing and business investment and finally a general business recession not later than 1967. Wall Street is nervously discounting this miser- able prospect. It has already fallen over 20 per cent from its 'high' and shows no sign of halting its panicky retreat.
The American money crisis is hurting poor Britain in more was than one. The rising de- ficit on the US balance of payments has caused the American Treasury to curb by taxation busi- ness investment overseas, both direct and port- folio. This has prompted the foreign subsidiaries of American corporations to use up all available sources of credit in Europe with the result that the Euro-dollar rate has moved up to 6 per cent. To make matters worse the rise in American domestic rates is pulling 'hot' money away from London and the Continent to New York. This has put pressure on sterling, as the Prime Minister has admitted. and is likely to aggravate the world upward trend in interest rates. For those who are too young to have experienced a credit famine with prohibitively dear money I Can assure them that it generally ends up in a world trade recession. Then our export trade will fall as the growth in world trade slows down. Everything can. of course, be blamed on the Vietnam war. But it is dangerous folly to fight wars on dear money and attempt to curb the resulting inflation by raising interest rates higher and higher. for this only adds fuel to the infla- tionary fires by putting up prices and wages. President Johnson. if he really intends to fight a 'Thirty Years' War' in the Far East, should raise new taxation at home and put the American economy on a war footing—under government control—instead of exporting his troubles to the business world abroad and Great Britain in particular.
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