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October 29,

Chairman Bccles
L. M, Piser

I have had copies made of the attached letter
and memorandum for distribution to the Board if you
approve.

Is there anything further that you would like

me to do about this question?




Chairman Eccles

COPY

FEDERAL RESERVE BANK OF WH YORK

October 27,

Hon. Marriner S. Eccles, Chairman,
Federal Open Market Committee,
c/o Board of Governors of the Federal
Reserve System,
Washington, 25, D. C.
Dear Marriner:
At the recent meeting of the Federal Open Market
Committee, there was a continuation of the discussion of credit

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policy and Treasury financing which began at the meeting of the

Executive Committee of the Federal Open Market Committee on
October 13th.

In the light of this latest discussion, and of

the memorandum on "Treasury Bills and Certificates11 which
you distributed at our latest meeting, I have set down my
further views in outline form. A copy of memorandum containing
these views is enclosed.
Yours sincerely,

Allan Sproul, Vice Chairman,
Federal Open Market Committee.
Enc.




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FURTHER BOTBS OH CREDIT POLICY AH>
TREASURY
1. Rise in short-term rates will validate present long-term rate, which must be
maintained. Main reason for low short-term rates is the belief that a rise
in long-term rates is likely.
2.

Some validation of long-term rates is, in fact, taking place in market. Fear
of stability of longer-term rates is declining and funds are going out of
shorter securities into longer-term securities in order to obtain higher yields.
In other words, short-term rates are already tending upward and intermediate
term rates are tending downward.

3. Financing and credit program should now permit rise in short rates and offer
more securities of longer term (notes, short, intermediate and long bonds)•
U.* Have to take account of fact, however, that market and public do not clearly
understand these rate relationships. Too drastic or sudden changes at short
end of maturity schedule would run the risk of disturbing or shaking confidence in longer-term rates.
5»

Suggested that bills now be issued having 120 days to run and buying rate be

fixed at 5/fe of 1%.
6. This would have the following advantages:
|%) Maintains existing pattern of financing and types of securities• Too much
monkeying with the machinery, which on the whole is working successfully,
is undesirable unless the risk is offset by great prospective gains.
(b) Will permit some adjustment in amount of weekly till offerings, if necessary, without change in aggregate amount now outstanding. There will be
some mechanical .difficulties involved in going from a 13-vreek bill cycle
to a 17-weelycycj.e, but these difficulties can be overcome.
(c) Will help obtain wider distribution of short-term securities among smaller
banks v/liich have existing excess reserves and whose deposits are increasing
most rapidly - combination of a 5/Q% bill and "]/fe% certificate would unquestionably have wider distribution than one intermediate issue such as a
nine months 3 / W till*
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(d) It would raise cost to banks of "borrowing11 through bill window above cost
of advances at differential rate of \/2.%i Advantage of being able to borrow (by means of purchase and repurchase agreement) without showing bills
payable would offset disadvantage of cost for enough banks to keep bill
afloat. Meanwhile, however, a desirable incentive for increased and ad~
mitted borrowing would be created.
One of the weaknesses of the 3/U/° bill, proposed to replace outstand*
ing bills and certificates, is that, while it also would increase the cost
of concealed borrowing, it would greatly increase the volume of securities
which could be used for nborrowingftwithout showing bills payable.
(8) It would narrow the spread between short and long-term rates which is now
desirable from the standpoint of:
(1) Validating the stability of the long-term rate.
(2) While at the same time reducing the incentive for banks to invest at
the longest term (and highest yield) possible.
(3) Moderating abuse of the pattern of rates. Mbthing which has been
suggested, nor which can be suggested, will eliminate abuse of pattern
of rates (which, up to the present, has been relatively minor in



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volume), so long as an a r t i f i c i a l pattern of rates is
maintained, based on gradually rising yields as maturity
lengthens (which means gradually rising prices as matur i t i e s shorten).
The proposed J>/h$> b i l l would do nothing more to abate this
abuse. It would eliminate the steep forepart of the rate
curve by making the rate from one day to nine months, 3/U
of 1%, but equal or greater profits would be obtainable at
the higher yields farther out on the curve* Playing of the
pattern of rates could go on just as before, based on this
new peg, and in whatever maturities suited the risk-taking
desires of the players.
The only cure for abuse of the pattern of rates would be
a further narrowing of the spread between short-term and
long-term interest rates. This the J>/h% b i l l fails to
do - i t merely picks a new place in the existing rate
curve at which to put in our peg.

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Mote: The argument that the System is encouraging the expansion of
bank credit at a 5 to 1 ratio by purchasing b i l l s from banks which,
in turn, buy certificates and longer-term securities, seems to be
based on a misapprehension, to wit: that the System has been making
more reserves available than was required by the increase in currency
in circulation and the increase in deposits requiring reserves. This
is not the case. During the present year currency circulation alone
has increased $3,635#OOO,OOO while System holdings of Government
securities (in a l l accounts) have increased only $2,6^2,000^000.

A.S.

10/26/145

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