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BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM ^ '"Office Correspondence Tn Chairman Eooles Date. Subject: Treasury Finance R. A. Mus grave Developments Since your Departure (1) At the Executive Committee Meeting of May 2, the Committee repeated its previous proposal for bill retirement of 600 million dollars during I l y and also recommended retirement of 200 million dollars of bills va maturing June 5» The recommendation for May retirement has since been carried out; the recommendation for the June 5 retirement was changed in accordance with our discussion last Wednesday. At the same meeting Mr. Sproul reported on his preceding discussions with Mr. Wiggins. In respect to the Committee's three point program submitted before your departure, Mr. Viiggins indicated that the first two points (interest charge on Federal Reserve notes and direct exchange of maturing Jbderal Reserve held bills) were acceptable, but that the Treasury wanted to think about procedural aspects regarding the discontinuation of the buying rate. (2) The same day lor. Sproul and the Board members of the Executive Committee lunched with Mr. Wiggins. I understand that Mr. Sproul reported to you in a memorandum on this discussion. Also, Mr. Wiggins1 proposals are discussed in my memorandum to you dated May 13. (Copy attached) Very briefly, Mr. Wiggins argued (a) that action on bills if possible should be gradual; (b) that the program should be handled, if possible, so as to avoid any direct announcement oig discontinuation of the buying rate; and (c) that changes in bill policy now should be adapted to facilitate handling of the certificate problem later. With respect to the certificate problem, his main concern appears to be that with an increase in rates, the price of outstanding certificates might fall below par and that this might destroy confidence in the public debt. No specific solution was proposed by sir. Wiggins but he wondered whether the need for announcing discontinuation of the buying rate might be avoided by issuance of a 6-months or 9-^onths bill which would replace the 3-months bill and which would not be subject to option. Also he wondered whether replacing bills end certificates with a 9-sionths discount security might not solve the problem of avoiding a decline in price below par if and "when the certificate rate should be raised. Mr. Wiggins requested the Committee to connient on these suggestions but* as far as I know, no formal reply was made. - 2 - Our reaction to the two points is as follows: (a) The issuance of a 6-months bill would not avoid the need for announcing discontinuation of the option because it would have to be made clear at the time of issue that such 6-months bills would not become subject to option after three months; (b) Issuance of a 9-Eionths discount security would solve the problem of preventing a decline in certificate prices below par in case the certificate rate is unfrozen* However, this would be so only after all certificates have been refunded and this would take time# Mr* Rouse argues that the market would feel very hesitant to accept a discount security in place of the present certificate and that, therefore,'this approach is objectionable; Dave Kennedy, on the other hand, feels that the market would be pleased to have a discount security and that this approach would be feasible! (c) As to the principle that "certificate prices must not fall below parnf little can be said in its favor* If temporarily the price of very short certificates was permitted to go to a slight discount, this certainly would not reflect on the determination of authorities to maintain bond prices above par. Also, the effect of a slight rise in the certificate rate to 1 l/S or even 1 1 l . would not be such as to lower the price of outstanding bonds and /f notes below par* The principle of!!not below part! as applied to certificates seems to be a red herring* However, Mr* "Wiggins places great emphasis on it. Ity impression is that there is no strong Treasury opposition to action on bills as such but that they wish to view the matter in relation to the certificate problem and that there is considerable opposition to raising the certificate rate. (3) I understand from Mr. Rouse that he has had repeated discussions with Treasury people on the restricted long-term issue and that the Treasury (including Mr* V/iggins) appeared to favor it up to a point, when some objection arose. This was discussed in my memorandum of May 26. (Copy attached). However, chances for fairly prompt action on a restricted tap issue, sold on a limited quota basis should seem fairly good. My impression is that institutional investors would be pleased to take it after they realize that no marketable issue xdll be available* Also, a limited amount of, say, 1 billion should be sufficient to meet the main pressure* Financing Outlook The attached Table I shows the Treasury financing picture as we now see it* The expenditure figures are on the optimistic side since we have assumed a 2*5 billion dollar reduction in the budget figure for fiscal 19U8» The receipt figures allow for inoome tax reduction as provided for in the Senate bill* If the bill does not become law, receipts in the second half of calendar 19^7 will " e 1*3 billion higher and receipts in the first b half of I9I48 Yd 11 be 2*2 billion higher. It is evident from our figures that the retirement program is about over. Assuming retirement of 1 billion dollars of certificates maturing on c - 3June 1 and no additional bill retirement during June, the balance at the end of the fiscal year will be about 2.5 billion including 1 billion of free gold, 900 million of war loan deposits and 600 million of cash deposits with the Federal Reserve. We expect budget deficits in July and August and some surplus in September, Assuming that 500 million dollars of certificates are retired on July 1 and allowing for only voluntary cash redemptions on August and September maturities, the balance by the end of September will be 1.8 billion. Also, we estimate that there will be a budget deficit during the last three months of the year* Allowing for changes in nonmarketable debt and again assuming some voluntary cash redemptions of maturing issues, it will be necessary during this quarter to raise approximately 1.5 billion dollars in the market if the Treasury balance is not to fall below 1.7 Mllion dollars. (Since tELs includes 1 billion dollars of free gold, it is about as low as the balance can fall unless the gold is monetized). The outlook for the first quarter of 19k8 is better, as a surplus of about ij. billion is anticipated. For the first half of the calendar year 19^48 redemptions of about 3 billion (including about 1.5 billion voluntary cash redemption will be possible. Thus, there will be no cash retirements but probably new financing in the second half of this calendar year. Ao the same time there will be h*h billion of note maturities on September 15* (See Table II). Also, there will be 700 million dollars of bond maturities each on October 15 and December 15« This raises the question whether we want to continue to refund maturing notes and bonds into certificates as lias been done since the beginning of 19^4-5 > or whether we want to bring out some new medium or longer term issue. It is evident that refunding policies will have to depend closely on what is done along the other lines, for instance* (1) If a nonmarketable restricted issue is brought out, more cash will be available to retire some of the bank held maturing debt and some of the pressure on the long rate will be relieved. (2) If the certificate rate is permitted to rise, the need for replacing the maturing longer term issues held by banks in order to maintain their earnings will be less serious than it if the certificate rate remains unchanged. Llarket Developments The Federal Reserve Bank of New York, since the beginning of April has sold for Treasury and System Account J4JL8 million dollars of bonds in the open market, comprising 255 million of restricted bonds and 163 million of bank eligible bonds. (See our memorandum of May 20, copy attached). This sales program has been a factor in holding down prices but nevertheless some price advance has been resumed. (Table III) At the beginning of the program of sales for Treasury Account, the market was very sensitive to a small show of bonds, as it had been made cautious by the cash redemption of bills out of war loan balances and by the Treasury-Jbderal Reserve discussions on changes in credit policy. Since April 30, sales for Treasury Account have -kincreased greatly in momentum. The effectiveness of the sales program has been lessened, however, but "without the additional supply of bonds, prices would have risen substantially. Moderate outright purchases by savings banks and shifting out of eligible issues sufficed to exert a strong pressure on prices of restricted 2 l/2 per cent bonds because of the complete absence of a market supply* There is, however, a growing underlying demand based on bark shifting and there is reason to expect that the price rise may be accentuated in the near future. Banks under pressureof reduced earnings have begun to carry out their buying program, they are beginning to feel that v i t an impending recession rlh no rise in short rates vail be effected in the next six months and that bond prices will not fall significantly even if a slight rise in short rates should be permitted. The supply of bonds from System Account is strictly limited and there is no way of determining how much additional long-tern bonds will be made available for sale by the Treasury. (Total holdings of 2 l/2. per cent bonds in trust accounts anount to 5 billion dollars.) War loan deposits are rapidly approaching a minimum working level so that war loan calls which exerted the main pressure on reserves are nearing their end. In short, indications are that bank shifting into longer term securities which has not been arery strong factor since spring of 19U6 now gives indication to become of real importance* Conclusions . 1» Consideration of the financing outlook, especially in conjunction with the growing pressure in the market, make a strong case for vetoing the tax bill, 2» The market has probably by now discounted the effects of unfreesing the bill rate, if unaccompanied by action on certificates. 3» The argument that bill action must necessarily preceed action on certificates has some merit but is frequently over-done. I . Therefore, if no early certificate action is anticipated, there j. is no excessive hurry about completing discontinuation of the option account. That is, we might consider the Treasury approach of doing away with the option more gradually. c 5. With lespect to the certificate rate: As an anti-inflation device, it is rather late in the day for letting the certificate rate rise. As a measure of meeting bank earning needs and preventing shifting and further monetization it may or may not be effective. The result will depend in part on whether the rate will have to be re-frozen at a higher level (in which case the effect will be^ slight) or whether scmo flexibility and thereby increased uncertainly (which will make longer issues less attractive) can be maintained. Tfilhat bothers m most about permitting the certificate to rise in e order to "offer the banks a bribe11, i s that the f i r s t bribe may well lead to a second and so forth without accomplishing much. Some other approach i s needed; or, at least, the banks must be told effectively that the game can not develop into a spiral* 6. There i s a good case for bringing out a long bond on a restricted basis. But to the extent that the main pressure comes from the banks this will take care of only a small part of the problem* c STRIC1 CONFIDENTIAL May 2 9 , ESTIMATED TREASURY CASH BALANCE (In b i l l i o n s of d o l l a r s i / ) Fiscal year 19I4.7 i9li» .friscai^^rs 191+7 Jan.- Apr.JulyJan.Deo«f2jj£ June '1+7 June July Aug. Sept. Oct. Nov. Dec. Mar• 1 June 19U7 I9I+8 Treasury cash balance, s t a r t of period Net receipts Expenditures 2 / Surplus or d e f i c i t Change in nonmarketable debt Retirement of marketable debt I4/ Net change; General fund balance 5 / Cash balance Treasury cash balance, end of period 6 / lfe •£ 18 # 9 - •!* • 2.7 -13*0 -10*7 3/+ -10.9 - 3a 3.1 2J+.0 22.6 5.6 7.7 .7 .6 2.5 3.5 2.5 4.7 2.k 5.1 - J± + .4 -1,0 -1.0 -1.0 2.5 3.6 -1.2 + .9 - .5 - .8 - .8 1.7 1.7 2.3 2.6 - .3 + .3 - .1 - .1 - .1 1*6 1.6 4.1 3.U + .7 - .5 + .2 + ,2 1.8 1.8 2.0 2.6 2.1* 1.7 2.1 3.U 2.7 2.3 3.5 12.2 8.2 - .7 - .2 - . 1 +4.0 + . 1 + .1 - , 1 + .u +1.2; - .5 -2.1; + . 8 - .2 - .7 +2.0 + . 8 - .2 +2.0 2.6 3.7 M 3.7 8.0 9.1 -1.1 - .5 -1.6 -1.6 2.1 U+.O 1+2.5 1+1.5 + 1.0 + 8.3 -20.7 -lUk -11.5 2.5 2.5 3^5 35.4 +1.1 •1.7 -3.2 - .U - .1+ 2.1 * Actual* l/ Estimates are based on certain assumptions with regard to expenditures, tax legislation, and retirement policies; (1) expenditures for fiscal 19!$ are assumed reduced by 2*5 billion dollars from the President*s Budget, (2) personal income tax rates are assumed reduced by 20 per cent beginning July 1, 1947* 2/ Including net expenditures in trust accounts• 3/ Including 1*7 billion dollars of securities held by the International Monetary Fund and 600 million by the International Bank* For the third quarter of I9I47, the reduction in marketable debt is assumed to equal ^00 million of cash retirement of July 1 certificates plus voluntary cash redemptions in August and September, notwithstanding full exchange offerings for maturing issues. For the fourth quarter of 19lj7 the increase allows for some new financing which will be offset by assumed cash retirements in the following quarter* Treasury1 s surplus or deficit plus changes in debt may not necessarily add to changes in the cash balance due largely to estimated or actual differences in timing of receipts and expenditures• 5/ The 6 / Beginning with February I9I4.7, consisting of deposits with the Federal Reserve Banks and in wa.r loan deposits """ as shown on Table I I , and 1*0 b i l l i o n of free gold of which 832 million gold transferred t o the cash balance as a r e s u l t of payments t o the International Monetary Fund# Table III BID PRICES OF SELECTED ISSUES OF TREASURY BONDS (Dollar premitun above par of f 100) Statement week ended unrestrict ed, taxable December September 1952-5U 1956-59 Restricted June 1959-62 December I967-72 April 9 3.07 5.15 2.26 3.16 April 16 2.29 5.06 2.15 3.0U April 30 2.30 5.08 2.19 3.08 May 27 3.02 5.10 2.25 3.10 c T a b l e XTi NET SALES OF TREASURY BONDS FOR TREASURY AND SYSTEM ACCOUNTS (In millions of dollars) Period Bank Eligible Total 1*1.1 38.2 79.3 lay 1 - May 28 2lij..O 125.2 339.2 Total 255.1 163,1; 1+18.5 April 3 - April 30 C Restricted o o Detailed Table 12 STRIOTLY CONFIDENTIAL DEB]: RETIREMENT FOR 1 9 4 7 AND J^JNUARY - JUNE 1948 PUBLICJ JJIARKE TABLE SECORI TIES OTHER THAN TREASURY BILL?5 May 2 3 , 1947 (in millions of dollars) Total Redeemed i?or cash F. R. outstand"Commercial F . R. Nonbank Nonbank Banks investors Total ing Banks investors banks 196 — 105 91 401 1,140 3,330 1,007 1,635 303 1,51)8 350 4,954 354 386 1,157 547 3,133 452 153 991 i,9i4B 970 885 ! 1,948 970 93 93 817 2,820 1,017 550 522+ 1,499 425 88 1,000 279 633 243 1,759 2,775 Held b y Issue 1947: J a n . 1 , 7/B% c e r t i f i c a t e s Feb. 1, 7/8$ certificates Mar. 1, 7/8$ certificates Mar. 15, 1 1/1$ notes Apr. 1, 7/8% certificates June 1, 7/8% certificates Commercial banks 1,789 1,721 1,429 885 q86 773 Amount exchanged 3,947 2,11*2 — 1.321 1,775 i July 1, 7/8% certificates ' Aug. 1, 7/8$ certificates Sept.1, 7/8% certificates Sept.15, 1 1/2% notes Sept. 15, 1 l/l$> notes Oct. 1, 7/8% certificates Oct. 15, k lAf° bonds Nov. 1, 7/8% certificates Dec. 1, 7/d% certificates Dec. 15, 2% bonds 1,116 527 655 1,848 733 10 600 233 367 699 674 540 333 1948: Jan. 1, 7/6% certificates 1,512 1,21+0 Feb. 1, 7/6% certificates Mar. 1, 7/8% certificates * 977 liar. 15, 2% bonds ' 766 860 Mar, 15 2 3/1$ bonds Apr. 1 , 7/8% c e r t i f i c a t e s * 462 June 1 , 7/8% c e r t i f i c a t e s • 494 June 1 5 , 1 3/^4% bonds 2,179 T o t a l : 191+7 - Jan.-June 7,583 July-Dec. 7,759 19i4S - Jan.-June •8,490 • 665 260 878 46 12 209 — 637 1,523 351 40 I 101 320 *155 25 3,786 2,61+6 <5,152 161 2,916 1,223 2,341 2,707 1,637 1,440 759 1,775 3,281 701 985 1,184 3,134 3,947 1,135 436 803 813 944 607 380 743 2,398 * 8H4. 309 262 * 539 *1,126 858 7,591 8,425 i * 6,077 ; 1 2,142 1,115 1,223 1,321 *l,775 3,062 18,960 18,830 *17,719 Estimated. Note: Holdings of commercial banks a r e taken from Treasury Survey of Ownership of U# S» Government S e c u r i t i e s for February 2 8 , 19^7* Holdings of Federal Reserve Banks a r e a s of k p r i l 3 0 , 19U7* Cash redemptions of commercial banks a r e e s t i m a t e d . GOVERNMENT FINANCE SECTION, BOiJRD OF GOVERNORS
