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A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washington, D.C., on Tuesday, August 31, 1965, at 9:30 a.m.


Martin, Chairman
Irons, Alternate for Mr. Bryan
Treiber, Alternate for Mr. Hayes

Messrs. Bopp, Hickman, and Clay, Alternate Members
of the Federal Open Market Committee
Messrs. Wayne and Swan, Presidents of the Federal
Reserve Banks of Richmond and San Francisco,
Mr. Young, Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hexter, Assistant General Counsel
Mr. Noyes, Economist
Messrs. Baughman, Garvy, and Holland, Associate
Mr. Holmes, Manager, System Open Market Account
Mr. Cardon, Legislative Counsel, Board of
Mr. Williams, Adviser, Division of Research and
Statistics, Board of Governors
Mr. Reynolds, Associate Adviser, Division of
International Finance, Board of Governors
Mr. Axilrod, Chief, Government Finance Section,
Division of Research and Statistics, Board
of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors

Mr. Patterson, First Vice President of the
Federal Reserve Bank of Atlanta
Messrs. Sanford, Mann, Ratchford, Brandt, Jones,
Tow, Green, and Craven, Vice Presidents of
the Federal Reserve Banks of New York,
Cleveland, Richmond, Atlanta, St. Louis,
Kansas City, Dallas, and San Francisco,
Mr. Meek, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Anderson, Financial Economist, Federal
Reserve Bank of Boston
Messrs. Rothwell and Duprey, Economists at the
Federal Reserve Banks of Philadelphia and
Minneapolis, respectively
Upon motion duly made and seconded, and
by unanimous vote, the minutes of the meeting
of the Federal Open Market Committee held on
August 10, 1965, were approved.
Before this meeting there had been distributed to the members
of the Committee a report from the Special Manager of the System Open
Market Account on foreign exchange market conditions and on Open Mar
ket Account and Treasury operations in foreign currencies for the
period August 10 through 25, 1965, and a supplemental report for
August 26 through 30, 1965.

Copies of these reports have been placed

in the files of the Committee.
In comments supplementing the written reports, Mr. Sanford
said that the U.S. gold stock should be unchanged for the current
statement week, the fifth consecutive week without any change.


Stabilization Fund was acquiring $50 million of gold today from the
United Kingdom, which would bolster the quite low holdings of the
Fund, and within a few days the U.S. should be receiving its share



of a moderately sizable distribution of gold from the gold pool
operations in August.

The only September order for gold received so

far had been from Austria, for $12.5 million. At the moment it
appeared that French takings might be quite moderate in September
because of that country's apparently moderate gain of reserves in
In the London gold market, Mr. Sanford continued, turnover
continued generally heavy until about mid-August.

On August 17, how

ever, the Communist Chinese finished their buying, for the time being
at least, with a total of $55 million which, together with $45 million
they had purchased earlier, gave them a total of $100 million of gold
acquired this year.

Also, the announcemert of the Russian wheat pur

chases and their subsequent actual sales of gold--amounting to nearly
$100 million--greatly dampened the speculative demand for gold.


reaching nearly $35.19-1/2 earlier in the month, the fixing price
dropped as low as $35.10-5/8 by the 20th.

Subsequently, it had tended

up again--today it was $35.1209--as demand picked up once more.


it had for some time, the demand reflected the general uneasiness con
cerning sterling and developments in Vietnam.

The gold market now was

reporting rumors that Russian sales might be resumed this week, which
seemed plausible in view of the size of the $450 million Russian
Canadian wheat deal.
The foreign exchange markets continued to be highly nervous
regarding sterling, Mr. Sanford observed.

The better United Kingdom



trade figures for July evoked only passing recognition and sterling
came on offer prior to each weekend.

However, the weekend offerings

became decidedly less as August progressed.

Contrary to the worst

expectations for the latest long weekend (Bank Holiday), the selling,
which had developed in moderate degree last Thursday (August 26), did
not carry over into Friday.

Nevertheless, the month's support opera

tions had made substantial inroads into British reserves.

In order

to offset some of the month's losses the Bank of England had availed
itself of the

remaining $225 million under its $750 million swap

facility with the System, drawing $60 million on August 24 and $165
million on August 27.1/

Among the other principal currencies, Mr. Sanford continued,
the Canadian dollar had been in heavy demand in connection with the
forthcoming Canadian wheat shipments to Russia, and the Bank of Canada
had acquired some $125 million of U.S. dollars during this period.
The immediate impact of those acquisitions on reserves had been
reduced somewhat by forward swaps.

On the continent, the Dutch

1/ Three sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material related to certain
transactions by the Bank of England.



guilder was initially strong in connectior with uneasiness regarding
sterling, and the System absorbed $25 million from the Netherlands

Bank on August 11 with guilders drawn under the swap facility with
that Bank.

The next day the System resumed selling three-month for

ward guilders to the market through the intermediary of the Nether

lands Bank.

The extent of such forward sales--$1.3 million equiv

alent--was limited, as the inflow of funds into the Netherlands
tapered off and the Dutch money market eased.

The System also acti

vated its swap arrangement with the Bank of Italy by drawing $100
million equivalent of Italian lire to absorb dollars from that Bank,
which had been gaining heavily in recent weeks.

The System also

absorbed $55 million from the National Bank of Belgium's holdings by
using Belgian francs available under the Belgian swap lines.
In the area of third-currency swaps, Mr. Sanford said, the
System prepaid its remaining $5 million equivalent sterling-guilder
swap with the Bank for International Settlements by entering into a
German mark-guilder swap for the same amount with that institution.
A similar transaction was made for Treasury account, in the amount
of $7.5 million.

As a result, all of the sterling which had been

used in third-currency swaps with the BIS had now been released.
Mr. Sanford reported that, pursuant to the approval of the
Committee at its August 10 meeting for renegotiation of interest rates
applicable to drawings under the swap arrangements with the central



banks of England, Canada, and Japan, the arrangements with the Bank
of England and the Bank of Canada now provided for interest rates to
be computed on the basis of the 90-day U.S. Treasury bill rate, as
was the case with most of the other swap arrangements.

He also had

discussed the matter with the local representative of the Bank of
Japan, who in turn had been in touch with Tokyo, but as yet there had
been no final decision concerning revision of the rate applicable to
drawings on the arrangement with the Bank of Japan.
In reply to Mr. Robertson's question, Mr. Sanford said that
the existing arrangement with the Bank of Japan called for a flat 3
per cent interest rate on drawings.

In the case of the Banks of

England and Canada, the rate prior to renegotiation had been 2 per

If the Japanese agreed to an adjustment, practically all of

the System's swap arrangements would be on a U.S. Treasury bill rate

The Belgian arrangement still involved a fixed rate, but

there had been several adjustments that kept it close to the prevail
ing Treasury bill rate.
Thereupon, upon motion duly made
and seconded, and by unanimous vote, the
System open market transactions in foreign
currencies during the period August 10
through 30, 1965, were approved, ratified,
and confirmed.
Mr. Sanford then recommended that the $100 million swap
arrangement with the Netherlands Bank, which matured on September 15,
be renewed for a further period of three months, in agreement with
that Bank.

Renewal of the swap arrangement
with the Netherlands Bank for a further
period of three months, as recommended by
Mr. Sanford, was approved.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering open market operations in U.S. Government securities
and bankers' acceptances for the period August 10 through 25, 1965,
and a supplemental report for August 26 through 30, 1965.

Copies of

both reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes com
mented as follows:
The past three weeks have not been particularly joyful
ones in the Government bond market. Bond prices, after edg
ing lower in the first few days of August, turned more
decisively downward in the past few weeks as dealers concluded
that their inventories were too high but found little appetite
among investors apart from the official accounts. On the plus
side, there has been a significant reduction in dealer hold
ings of issues due in more than five years--from about $490
million on August 9 to $285 million on August 27--but the
decline has been largely traceable to purchases for the Sys
tem Account or Treasury investment accounts with little
evidence to suggest that prices have reached an attractive
range for other investors.
The price declines during the past three weeks, ranging
from about one-half point to nearly a full point for a number
of long-term issues, have provided no fewer than 16 Govern
ment securities with a yield of 4.25 per cent or higher (based
on the dealers' bid quotations).
Thus, the 4.25 per cent
interest rate ceiling has once again become an effective con
straint on Treasury debt management policy.
To reiterate briefly the factors underlying the market
adjustment, the main reason seems to be a continued display
of strength in the economy and the prospects for further
gains ahead. These prospects stem partly from anticipations



of increased military outlays in connection with Vietnam,
but they also reflect a generally more buoyant mood in the
economy. Bond market participants are keenly aware of the
strength of bank loan demand, of business demands for credit
in general, and of the possibilities implicit therein for a
somewhat firmer monetary policy. Indeed, one of the more
obvious depressants of Treasury bond prices is the higher
yield now required to market high-grade corporate bondsapparently in the neighborhood of 4.70 per cent for AA
rated utility bonds, compared with about 4.45 per cent
earlier this year. Moreover, the corporate bond market
itself has generated little enthusiasm among investors even
after moving to higher rates as a feeling has persisted that
still further increases may lie ahead. Several large issues
will reach the market during the first half of September,
providing a good test of the market's distributive capacity.
Treasury bill rates have also adjusted higher on balance
during the past three weeks with weakness most pronounced in
the longer bill maturities. The average issuing rates of
3.89 and 3.99 per cent for the three- and six-month bills in
yesterday's auction compared with rates of about 3.85 and
3.95 per cent three weeks ago. The latest one-year bill,
auctioned last week at an average rate of just over 4 per
cent, was up 13 basis points from the auction rate a month
earlier. In part, the rise in bill rates is seasonal in
nature. For one thing, the demand from the auto companies
is light at this time of the year. But beyond this the
rate rise probably reflects an abatement of demand that may
be related more generally to increased corporate needs for
The money market has been steadily firm in the past
three weeks with Federal funds trading mainly at 4-1/8 per
cent on all but a few days. Sporadically, some Federal
funds trading has occurred in modest volume at 4-1/4 per
cent. While the volume of such trading has not been large,
it seems to have had a fairly pronounced effect on the
funds market--tending to dry up the selling of funds before
In turn, this has helped to produce a
calendar weekends.
bulge in member bank borrowing over recent weekends, which
has been mitigated but not entirely offset by the System's
use of short-term repurchase agreements. Even so, member
bank borrowing in the recent period averaged about the
same as in the several preceding weeks--roughly $1/2 bil

System open market operations withdrew reserves
seasonally during the last three weeks, chiefly through the
net maturity of holdings under repurchase agreements. Out
right holdings declined by a net of $62 million as a reduc
tion in Treasury bill holdings in the early part of the
interval was only partly offset by coupon purchases in the
latter part.
Looking ahead, it would seem appropriate to meet part
of the remaining reserve need in the Labor Day week through
additional purchases of coupon issues.
Shortly thereafter,
it presumably will be necessary to absorb reserves again
with the approach of the mid-September float bulge. The
next major reserve position--and if past history is a guide,
it could be a very substantial one--would not come until
the very end of September or early October.
Mr. Mitchell asked whether the recent levels of dealer
holdings of long-term Governments were much in excess of the amounts
needed for the dealers to perform their function of making a market.
Mr. Holmes replied that markets could be made at any level
of dealer holdings.

In his judgment, however, the size of their

holdings of long-term Governments over an extended period earlier
this year was related to their market-making function.

Until recently

dealers anticipated that long-term rates would be stable or declining,
on the basis of their expectations that saings would continue at
the earlier high rate and that the pace of economic expansion would

Accordingly, for the time being they had been willing to acquire

and hold a large volume of longer-term issues, and that could be con
sidered to be part of their function.
Mr. Mitchell then asked whether net sales of longer-term
Governments recently had not been almost entirely to official accounts.
Mr. Holmes replied that that had been the case most recently.




there had been some periods of net investor demand in the 5-10 year
maturity area, but at that time the dealers had been interested in
building up their portfolios, believing that that would be profitable.
At the moment dealers probably would not be able to lighten their
holdings substantially further through sales in the market; at present
rate relationships investors preferred corporate securities to Govern

Knowing that the demand was light, the dealers were not pres

sing their holdings of Governments on the market, since the only
effect of such action would be to push prices lower.
In reply to a question by Mr. Hickman, Mr. Holmes said that
there had been little speculative unloading of intermediate- and
long-term securities acquired in the last two Treasury refundings.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
during the period August 10 through 30,
1965, were approved, ratified, and con
Chairman Martin called at this point for the staff economic
and financial reports, supplementing the written reports that had
been distributed prior to the meeting, copies of which have been
placed in the files of the Committee.
Mr. Noyes made the following statement on economic conditions:
With the outcome of the steel negotiations unknown, the
dimensions of the Vietnam buildup uncertain, and the future
of sterling in doubt, it seems almost futile to attempt to
draw any conclusions from the things that have actually hap
pened this summer. But, in fact, some of our doubts have been



resolved. We were concerned at the beginning of the year
about the prospects for business investment in the second
half, and about the possibility that private construction
activity could not be maintained. The adjustment from the
extremely high post-strike rates of auto sales carried at
least a troublesome potential, as did the reduction in the
stimulus from Federal fiscal policy in the first half.
All these things added together suggested the possib
ility, if not the likelihood, that overall activity might
well level off this summer, and that we might even see
declines in some important sectors before the end of the
year. Even as late as July 13, I was reliably informed,
and so advised the Committee, that GNP would be up about
$7 billion in the second quarter and that industrial pro
duction had leveled off at the advanced 141-142 rate. I
might well have added that the relatively favorable 4.7
per cent unemployment figure for June reported at that
meeting, was due in part to an unexplainably small increase
in the labor force in that month and that we expected a
rise in July.
As you are all already well aware, the kindest thing
one might say about this information is that it was unduly
conservative. GNP was up $9.5 billion, industrial produc
tion hit 144 in July, and unemployment dropped to 4.5 per
cent and maintained that rate in August.
On the other hand, the rather mild concern I expressed
about price developments seems to have been just about
right. On average, wholesale industrial prices have nei
ther advanced further nor retreated from the level they
reached in mid-June, and the rate of advance of agricul
tural commodities has slackened, at least.
At the same time, there is very Little basis for
hoping that we will return to the unu;ual stability in
wholesale prices that prevailed for five years, until just
about a year ago. New wage settlements in the first half
have averaged 3.8 per cent, with above guidepost settle
ments in such important industries as aerospace, aluminum,
cement, and glass. I have no idea how the reported dif
ferences between the companies and the steel workers will
be resolved--with or without a strike--but it seems almost
too much to hope that the package will be truly within the
guidelines. In these circumstances, at least a continued
upcreep in wholesale prices seems the most realistic



The consumer price index has few friends, and I have no
desire to argue the significance of a change in it of one
tenth of a point, but it is up again for July to 110.2 per
cent of the 1957-59 average and would have been up another
two-tenths had it not been for the excise tax reductions.
It does not seem to me that any of these developments
can be fairly characterized by the much overused and abused
word "inflation."
I would prefer simply to say that the
economy is continuing to show, in prices as well as in other
areas, some of the typical characteristics of the expansion
any phase of a business cycle. This, in itself, is cause
enough for concern.
I cannot conclude without mentioning once more the
irventory situation. We have just learned that the book
value of manufacturers' inventories ircreased by over $700
million in July--the largest monthly increase since last
October, and considerably more than double the average
monthly rate for the first half. This is on top of the
three quarters of overall inventory accumulation which the
revised GNP figures show to have averaged at an annual
rate of $8 billion. It is hard to see how we can make the
necessary inventory adjustment, whenever it comes, without
far-reaching repercussions throughout the economy. A major
problem for all Governmental stabilization policies looms
ahead if we are to cushion this adjustment. How far ahead
I cannot say, except that it is almost certainly more than
four weeks.
It is obvious, I think, that I have consciously tried
to avoid belaboring the immediate uncertainties that are
so much on all of our minds today. But just as we should
not exaggerate their importance, it wculd be foolhardy to
ignore them. Until we know whether there is to be a steel
strike, a settlement within the guidelines, or one well
above them, it is impossible to say anything very meaning
ful about the economic climate in which monetary policy
will have to operate in the weeks immediately ahead. This
would seem to me to counsel against a change in policy at
this time, even if such a decision might necessitate more
drastic action later.
Mr. Holland made the following statement concerning financial
The credit review could be crowded into one sentence
this morning: Bond markets have turned weaker, even while



the money market on average has remained roughly stable,
and credit flows have continued apace
This statement is
correct in broad outline, and it sums up the dilemma of
sorts that current events pose for policy; but there are
some details submerged in these simple generalizations
that I think can help to illuminate the appropriate path
for resolving today's policy questions.
First, I have been struck by the pressing size of
business demands for external credit to help finance
large inventory and capital outlays. Corporate bond
flotations have been unseasonably large all summer, and
as such have compounded the recent bearishness of dealer
and investor expectations. Moreover, such flotations
have no. served to replace bank loans, but are in addition
to a persisting rapid business loan expansion. To be
sure, we should anticipate that some moderation of business
loan expansion will take place whenever the steel-using
industries shift from piling up to drawing down their heavy
stocks of steel; but the dimensions of that turnaround
may not turn out to be so great, if purchasing agents
come to expect, say, a procession of selective steel
price increases over time and/or a substantial increase
in metals consumption by the military.
Enlarged business borrowing is significant because
of the extent to which it is supporting business invest
ment outlays that are growing disproportionately relative
to overall economic expansion. As the year has progressed,
there has been a breaking away from the more balanced
relation between business equipment and consumer goods
output that previously had been a feature of this longest
of peacetime business expansions.
An analyst concerned with this developing imbalance
might regard some rise in corporate bond yields as being
therapeutic, and he might also favor some firming of bank
lending terms to businesses and be disappointed at how
little hard evidence of the latter is at hand. Butthis
may be more a commentary on the deficiencies in our infor
mation network than a confirmation that bank lending terms
are unchanged. As compared with before June, banks are
borrowing more at the discount window, paying more for
Federal funds, spending more money to attract time deposits
and even long-term capital funds; and unloading Governments
at lower prices. Adding all these factors together, they
seem to me to suggest an appreciable and slowly cumulating
marginal pressure on the banking system. It would be sur
prising if banks were not moving gradually to pass some of



the pressures on to their customers, in the form of higher
interest rates and stiffer lending conditions. It would
also be typical for banks, however, to accompany such action
with further securities liquidations, even at increasing

Here a more generalized difficulty begins to take shape.
Further bank sales of Government securities--and, for that
matter, also any bank backing away from the municipal marketwould put added pressures on capital markets that are already
strained by bearish dealer and investor expectations. Dis
cussion this morning and the staff comment on question 5 1/
have already amply detailed the sources of the changed market
psychology. Suffice it to say that banks may be gradually
moving into a position to make that market atmosphere still
worse--not likely by massive sales but by a continual drib
bling in of selling pressures.
In such circumstances, the capital markets, left to
their own devices, would almost surely lack the resilience
to recoup much of the price losses of the last month, and
could easily generate some further interest rate increases.
There could also be some arbitraging of past rate advances
across other markets not yet much affected by yield adjust
ments, thus applying an element of interest rate restraint
to a number of economic sectors where no major imbalance
of resources and demand now exists.
Is such a development desirable, or at least tolerable?
The answer to that question, of course, is bound up in the
consequences of the steel settlement, the Vietnam build-up,
and the sterling crisis--all events which are still very
much uncertain but which key financial markets have already
discounted importantly. In effect, once again the workings
of securities market expectations have managed to get the
financial cart in front of the economic horse.
At this juncture, monetary policy would seem to be
facing two broad alternative courses. One would be con
tinuing to hold money market conditions stable, pending a
clarification of the economic outlook. Under this approach,
some bank adjustments would probably proceed, and the long
term markets would remain depressed, and by the time of
the next Treasury financing, around the end of September,
I would think a somewhat firmer atmosphere of financial
restraint would probably have percolated through the
economy. The contrary approach--to reverse the spread of

1/ Certain questions suggested for consideration by the Committee, and
staff comments on them, are given at a later point in these minutes.



a somewhat more restrictive atmosphere--would necessitate
an overt easing of reserve pressures on the banking system,
and probably also aggressive official buying of coupon
issues to remove what is left of the overhang in the market.
If the latter seems to go too far toward market "rigging,"
a variation of the "no change" directive that would embody
at least some solicitude for the struggling bond markets
would be to continue to keep money market conditions on the
average fairly stable, but to operate the System Account in
ways which (a) would lighten pressure on the long-term mar
ket relative to the short market, and (b) within the money
market, would increase pressure on the dealer financing mar
ket relative to the banks. This, for example, would imply
emphasizing purchases of coupon issues whenever reserve
additions are called for, and bill sales when reserve absorp
tion is necessary.
Financial conditions by themselves, of course, cannot
indicate which one or variant of these alternatives is the
right choice at the moment. That has to depend basically
upon one's own presumptions as to how the current major
uncertainties in the economic picture are likely to be
Mr. Reynolds then presented the following statement on the
balance of payments:
Since mid-year, the U.S. balance on "regular" inter
national transactions has reverted tc deficit, as everyone
expected it would. Indeed, this seems to have happened as
early as July, contrary to the impression we had 3 weeks
ago from incomplete data. The size cf the deficit is not
particularly large on a seasonaly adjusted basis--perhaps
$200 million for July and August together according to the
data so far available, or about the same $1-1/4 billion
annual rate as in the first half-year. Nevertheless, it
is a deficit.
On the official settlements basis, on the other hand,
there appears to have been a continued seasonally adjusted
surplus in July and August, since there was a very large
inflow during those months of foreign private liquid funds.
Usually a development of this kind would be encouraging.
But this time, as at the end of 1964, a large part of the
inflow may represent the other side of the renewed run on
sterling, and may prove temporary. Whenever sterling
finally turns the corner, we should expect to see some
foreign private funds flow out of dollars again and back
into sterling.



The detailed information so far available does not
help at all to explain the deterioration since mid-year
in transactions other than inflows of foreign liquid
On the contrary. During July, there was a
further large reflow of U.S. bank credit. Outstanding
bank credit to foreigners is now not only far below the
ceilings set by the voluntary restraint program, but is
also lower than at the end of 1964. As the staff comment
on question 3 points out, there is reason to think that
other factors in addition to the program may be restrain
ing bank lending to foreigners this year. In particular,
the IET, firmer domestic credit conditions, and easier
conditions abroad in Italy and Japan, seem to be playing
a useful adjusting role.
Merchandise imports dropped sharply in July, another
superficially favorable development. However, one-third
of the drop resulted from a change in the way the statis
tics are compiled, and most of the rest is thought to
have resulted from the seamen's strike on American ships,
which lasted from June 15 through today (August 31).
Exports will probably also prove to have been affected by
the strike. So we seem doomed to another several months
of uncertainty about recent trade trends, although it
remains clear that, for the year to date, exports have
been much less buoyant and imports more buoyant than in
1963 and 1964.
Finally, sales to U.S. residents of new issues of
foreign securities were not particularly large in July
August. They will be much larger in the third quarter
as a whole than in the second quarter, but most of the
increase is scheduled for September.
Thus, the July-August deterioration must be
attributed to changes in the wide variety of items that
we cannot yet measure, and most of which have not yet
been measured even for the second quarter. Nevertheless,
the deterioration comes as no surprise, since temporarily
favorable factors were known to have played a large role
in the second-quarter payments surplus.
Most analysts, I think, would still expect a "regular"
transactions deficit of the order of $1-1/2 billion for
the year as a whole, implying some moderate further dete
rioration during the remaining four months. Outstanding
bank credit to foreigners seems likely at least to stop
declining. New securities issues will be large, as I
mentioned (although Canada may have to take some action
to damp down Canadian borrowing here, now that wheat sales



to Russia have improved its payments outlook).
while steel imports should ultimately decline, total imports
are likely to stay high for the rest of the year, and there
is little in foreign business developments to suggest an
early expansion in exports.
Also, it still seems to me that we should expect some
appreciable deficit on the official settlements basis for
the year, even though there has been none to speak of dur
ing the first 8 months, since this pleasant and unexpected
result seems to have depended on the prolonged sterling
crisis that must sooner or later subside.
Views about the outlook for sterling seem to have
become less pessimistic in recent weeks. The July export
figures helped, but there has also been a more fundamental
reappraisal, symbolized by the fact that Britain's National
Institute for Economic and Social Research now believes
that the planned elimination of the basic deficit by the
end of 1966 will come about, whereas it did not think so
in May.
It has become increasingly evident that the anti
inflationary actions of the Government are taking hold.
The labor market has become a shade less tight, though it
is still tighter than it was a year ago. Price increases
have slowed down a little; much of the increase in the
retail price index since February seems to be attributable
to increased excise taxes. Bank loans have expanded very
little since the end of 1964.
It has also become increasingly evident that there
has been more spirit in the British economy than was
earlier believed, and also more need for anti-inflationary
policies. Real GNP continued to rise pretty strongly into
the first quarter, when it was 4 per cent higher than a
year earlier--a performance comparable to that of the
United States when account is taken of slower labor force
growth in Britain. Plant and equipment outlays in manu
facturing increased about 14 per cent in real terms during
this period, even after one discounts some inflation of
the first-quarter figures by companies anticipating an
adverse change in tax treatment. Even if plant and equip
ment outlays now level off, the total for the year will be
up substantially.
Thus, while market views about sterling may continue
unsettled for some time, there seems to be a feeling in
the air that an adjustment of the right sort is underway,
even though no one can feel certain of its speed or extent.



The National Institute is much more pessimistic
about the longer-run outlook, foreseeing great dif
ficulty in earning a sufficient payments surplus to
repay debt and rebuild reserves without an unconscion
able dampening of growth at home. But several features
of this gloomy prognosis raise questions, and the
margins of error are wide. First, the Institute
assumes (admittedly arbitrarily) that there will be
no net short-term capital movements over the period
of its projection. This seems an excessively cautious
assumption; I would think some considerable part of
the capital that has fled during the past year of
crisis might later return. Second, the Institute
regards any level of unemployment above 2 per cent
as profoundly unsatisfactory (in much the same way
that scme people feel the U.S. economic performance
has been poor because the unemployment rate here is
above 4 per cent), and its projections, being based
on past trends, allow nothing for the success of new
efforts to increase the flexibility of the economy.
In fact, of course, the point of the projections is
to emphasize the need for such new efforts.
Mr. Ellis asked what Mr. Reynolds thought the effects on the
position of sterling would be if the level of U.S. interest rates
increased further and the rise was eventually confirmed by an increase
in Federal Reserve discount rates.
Mr. Reynolds replied that such effects were difficult to
predict, but on the whole he did not think they would be very great
under present circumstances.

The situation had been different earlier

in the summer, when there as yet was little statistical evidence to
indicate that the necessary adjustments in Britain's situation were
underway, and when there were rumors that the U.S. had decided not to
assist the British further.

A rise in U.S. interest rates then

probably would have been taken as confirmation of such rumors, and



might have had substantial repercussions on the position of sterling.
He would add, however, that his belief that there would be no signif
icant effects now was only a guess, and one about which he felt
particularly unsure.
Prior to this meeting the staff had prepared and distributed
certain questions suggested for consideration by the Committee, and
comments thereon.

These materials were as follows:

(I) Business conditions.--What are the implications of the
renewed rapid increase in industrial production in June and
July for developments later in the year?
The renewed rapid increase in industrial production in
June and July--seasonally adjusted--reflected mainly further
advances in output of business equipment and materials to
levels about 10 per cent above a year earlier. Consumer goods
output recently has continued to show little change at a level
on the average only 5 per cent above a year ago. Unless
demands for output are greatly stimulated by military devel
opments or accelerated consumer spending, the rate of advance
in industrial production will probably slow in coming months.
One special factor this summer has been the continued
high output of steel and steel products to build up stocks
further for protection against a possible strike September 1.
With output of some other materials already at or near
capacity rates, curtailment in steel can be expected at
least to slow down the advance in the materials component
of the index.
Backlogs of orders for business equipment have continued
to rise and developments in Vietnam may provide some further
stimulus to equipment output. The rise recently--and over
all of the past year--has been very rapid, however, and no
substantial acceleration appears likely. Industrial capacity
continues to grow as the large amount of equipment ordered
and produced earlier comes into full use, and capacity might
begin to appear excessive fairly soon unless consumer takings



Whether the rate of increase will be adequate, however,
is questionable. Retail sales have been high, and expected
advances in income--including the higher Social Security
benefits--should sustain further rises. But auto sales would
need to increase from their recent annual rate of 8.8 million
units to a rate of 9-1/2 million even to maintain the level
of auto output expected to prevail through September. Retail
stocks of home goods and apparel have been rising even though
output has not increased from the record levels reached at
the beginning of the year.
To date, developments with respect to Vietnam have not
been such as to give any sharp direct impetus to buying by
either consumers or businesses. It seems increasingly likely
that the economic stimulus from stepped-up Vietnam activities
will be imparted more gradually over time, as actual military
outlays and orders grow. The precise timing and dollar amount
of the increases in military expenditures, however, are still
highly uncertain.

Prices.--Considering demand and supply developments over
past year and price behavior during this period, what are
prospects for stability in industrial commodity prices in
months ahead?

Increases in industrial prices over the past year have
been selective and for the most part limited. Unless the
wage settlement results in a significant steel price rise,
and unless activities in Vietnam are stepped up sharply,
continuation this autumn of the recent pattern of price
performance would seem to be more likely than any appreciable
general increase in price levels.
As earlier in this expansion, increases over the year
were largest for nonferrous metals, which were up 8 per cent
in response to further world-wide increases in demands that
strained available sources of supply even when supplemented
by withdrawals from U.S. stockpiles. For steel, changes in
prices have been small so far despite heavy inventory demands,
partly because of growing competition from abroad on an in
creasing range of products.
One important factor limiting the advance in industrial
prices over the past year has been continued stability in
labor costs per unit of output. With rapidly increasing volume
of output and continuous modernization of plant, productivity



has increased about as fast as hourly wage costs. Profits have
risen sharply, even in many industries where prices have not
risen. A slowing in the rise in industrial production in this
country probably would also retard further gains in productivity.
If at the same time wages should rise more rapidly, unit labor
costs would come under upward pressure.
On the other hand, some of the influences tending to hold
prices in line this past year will still be operating in the
months ahead. New and more efficient plant is continuously
coming on stream and the work force is expanding--although in
the younger and industrially urtrained age groups. Demand
abroad for materials may continue to show somewhat less growth
than earlier.
At the moment, attention is focused on the steel settle
ment, which may be followed by some price advance. An important
question would be whether price advances that might be initiated
would hold. Demand for steel will be considerably reduced for
some months after a settlement and any price advances announced
will be subject to test during that period.
(3) Balance of payments.--To what extent is U.S. bank lending
to foreigners being limited by factors other than the voluntary
restraint program?
During the first seven months of 1965, U.S. banks actually
reduced the amount of credit outstanding to foreigners by $100
million, whereas for the year as a whole a net increase of
nearly $500 million would be consistet with the 105 per cent
VFCR ceiling. If outflows are being significantly restrained
by forces other than the voluntary restraint program, they may
remain small for some time; but if the program is the dominant
restraining influence, renewed outflows of more than $500 mil
lion might be expected during the remainder of the year without
the banks exceeding their ceilings.
The voluntary program presumably is the main constraint
for some 40 banks that were still above their ceilings at the
end of July. It probably also dominates the foreign lending
behavior of a few large banks that have cut back below their
ceilings in order to make room for scheduled loan disbursements
or anticipated use of credit lines later this year, particularly
those banks that have sold off loans to their foreign branches
at some cost. Furthermore, seasonal influences would normally



reduce bank credit outflows by roughly $150 million in the first
seven months of the year. But these considerations do not ex
plain the absence of any net bank lending to foreigners so far
this year; additional factors must also be acting to restrain
At least three such factors may be at work on the supply
side. First, having made very large foreign credits last year,
partly in anticipation of the IET and controls, some U.S. banks
may be wanting to go slow for a time on further foreign lending.
Second, new economic difficulties in Japan and some other coun
tries, and recent failures like that of the Atlantic Acceptance
Corporation in Canada, may have reduced the credit-worthiness
of many potential foreign borrowers in U.S. eyes. Third, strong
domestic loan demand, and a slight firming of U.S. credit cordi
tions, may have reduced the eagerness of banks to lend abroad.
On the demand side, application of the IET to medium- and
long-term bank loans to borrowers in developed countries, for
purposes other than financing U.S. exports, has made this coun
try a less attractive source of funds for those borrowers.
Secondly, the leveling off of U.S. exports this year probably
has been accompanied by a decline in new financing needs.
(When U.S. exports last leveled off, in 1962, outflows of U.S.
bank-reported capital dropped to $45C million from $1,260 mil
lion the year before.) Third, a marked easing of credit
conditions in Italy and Japan, which borrowed heavily here
last year, may have reduced demand in those countries for U.S.
funds as compared with domestic funds.
It is too early to assess statistically the relative
importance of such factors, although nuch light might be shed
by the explanations that might beelicited from individual
bankers. It is clear, however, that U.S. bank lending to
foreigners currently is being significantly restrained by
economic forces and by the IET, as well as by the VFCR
(4) Bank credit.--What accounts for the accelerated growth in
bank time deposits since mid-year, and what are its implications
for continued bank credit expansion?
Time and savings deposits grew at a seasonally adjusted
annual rate of 15.0 per cent in July, and appear to be increas
ing at a 20 per cent rate in August. The growth of time
deposits since midyear thus has approached the high rates of
early 1965, after slowing to an 11.5 per cent rate during the
second quarter.



Three main factors seem to be important in explaining this
development. First, the unusually large increase in savings
accounts at weekly reporting member banks--and most likely at
other banks also--probably stems in part from the substantial
increases in nonfarm personal income and private financial
savings generated by the vigorous pace of economic expansion
this summer.
Second, there is some evidence in July of another shift
in financial asset preferences of the public from savings and
loan association shares to commercial bank time deposits.
According to preliminary estimates savings and loan shares rose
only $0.4 billion (seasonally adjusted) in July, one-half the
gain of July 1964 and the smallest increase since January.
While information now available on yield relationships does
not fully explain the shift of saving flows from associations
to commercial banks, trade sources attribute it to more
aggressive promotional efforts by bankers.
Finally, facing a continued and pervasive increase in
loan demands, banks have been more willing to bid for CD money
since midyear. Large increases in outstanding CDs at banks
outside New York City took place in July, when interest rate
relationships allowed these banks to be aggressive issuers,
and in August major New York City banks returned to the market
in size.
Looking ahead, time deposit growth might not continue to
keep pace with a strong fall loan expansion, since returns on
competing market instruments have moved slightly higher and the
attraction of funds away from savings and loan associations
that developed in July may not persist. Assuming no further
change in interest rate relationships, however, and a contin
uing rapid growth in incomes, interest-bearing deposits at
banks should continue to increase at rates higher than in the
second quarter, thus contributing to further substantial
expansion in bank credit.
(5) Capital markets.--To what extent does recent price weakness
in the bond markets reflect current supply-demand considerations
as opposed to psychological factors?
Declines in U.S. Treasury bond prices since late July
seem to reflect primarily a shift in dealer and investor
expectations. In other bond markets, while changed expecta
tions have exerted their influence, price movements have



reflected changes in the volume of current offerings as well.
In the case of corporate bonds, for example, an unseasonably
large calendar of new offerings has tended to confirm changed
expectations and has reinforced their price-depressing effects.
In the case of municipals, on the other hand, a marked--albeit
essentially seasonal--cut-back in August offerings has helped
to keep prices relatively stable.
Earlier in the summer, although uncertainties concerning
Vietnam and sterling were recognized, market psychology was
dominated by a general presumption that the pace of economic
expansion would slacken following a steel settlement. While
ic was felt that the momentum of the economic expansion
already prevailing would continue to generate unusually heavy
business demands for external financing through the summer,
questions were being raised whether these demands would persist
so strongly later in the year.
Escalation in Vietnam, coming on top of the unexpectedly
strong summer economic performance, has erased market doubts
concerning a possible economic slow-down, and instead has
given rise to concern that the combined pressures from a
continuing capital boom and rising Federal expenditures might
trigger more widespread commodity price increases.
With this change of perspective, investors have revised
their judgments both as to future supplies and future demands
for funds. Demands of businesses for external financing are
now expected to be maintained at levels well above normal,
and some--as yet indeterminant--increase in Treasury borrowing
is generally assumed. At the same tine discussion has intensi
fied as to the chances for a shift to a more restrictive
monetary policy and a further increase in Federal Reserve dis
count rates.
During this same period, the markets were swept by a wave
of pessimism about sterling. While this attitude was later
moderated by the improved British trade figures for July, inves
tors are still highly sensitive to the possibility of renewed
deterioration in the payments positions of both Britain and the
United States.
In short, price weakness in Treasury bonds over the past
month has been the result chiefly of expectations which events
have not yet confirmed or disproved. In response to these
expectations, dealers have pressed to reduce their inventories



of longer-term issues, and investors have tended to hold back
from bond purchases at prevailing prices. Price softness in
the market has also been abetted from time to time by some bank
selling and by a tendency for some investors to switch out of
Governments into corporate bonds in response to the recently
more attractive yield spread in favor of the latter.
In the corporate bond market, expectations of heavy fall
financing have been an important fac:or in recent price declines,
but it remains difficult to sort out the extent to which market
reports of prospective new issue volume represent firm plans
for financing as opposed to mere conjecture. Some unexpected
additions to the August calendar already scheduled for Septem
ber is sizable. However, it is not yet clear whether total
September offerings--including private placements--will run
much ahead of the $1.1 billion average monthly volume for the
year to date.
Finally, although a substantial, partly seasonal, increase
is expected in new municipal offerings after Labor Day, there
is no tirm indication that this volune will run significantly
ahead of the average monthly volume prior to August. Even
though the August new issue volume has been well below July,
municipal dealers' inventories since mid-August have climbed
back around the $800 million level. Such an inventory build
up could be evidence of a less active bank interest in the
face of current and expected loan demands; alternatively, it
may merely be a reflection of investor caution associated with
the recent shift in expectations. Nevertheless, the combina
tion of the change in market psychology and the larger September
calendar could conceivably lead municipal dealers, like Govern
ment dealers, to press to lighten their inventories, thereby
spreading recent price weaknesses to the tax-exempt market as
(6) Money market relationships.--Assuming a continuation of
current monetary policy, what range of money market conditions,
interest rates, reserve availability, and reserve utilization
by the banking system might prove mutually consistent during
coming weeks?
In August weeks net borrowed reserves and member bank
borrowings have averaged around $170 million and $550 million
respectively, not much changed from their June-July averages.
The rate on 3-month Treasury bills has fluctuated in a 3.80
to 3.87 per cent range, moving to the upper end of that range
most recently as market demand for bills has tapered off



seasonally. Federal funds have continued to trade mainly at
4-1/8 per cent, with trading below that rate more infrequent
than earlier and a small amount of trading at 4-1/4 per cent
reported. Despite the consistently firm atmosphere in the
funds market, dealer loan rates in New York have been main
tained at the lower end of their 1965 range, as major banks
in the City have remained in relatively comfortable reserve
positions and dealer financing requirements have declined.
Assuming a continuation of current monetary policy and
ro new disturbances from international developments, net
borrowed reserves could remain in a $150 to $200 million
range in the weeks ahead, but with bill rates fluctuating
over a somewhat wider and higher range than recently. The
3-month bill could fluctuate between 3.85 per cent, or a
little below, up to around 3.95 per cent. Seasonal con
traction of bill demand in August will be followed by money
market pressures during the mid-September tax and dividend
period and a Treasury financing in the bill area in late
September or early October. Temporary declines below cur
rent levels are also possible, on the other hand, especially
if the System should meet a sizable portion of its reserve
needs around Labor Day through purchases of bills in the
market and if public fund demand expands seasonally in early
As noted under question 5, yields in the U.S. and
corporate bond markets have risen recently. Since this
rise has reflected more a change in market expectations
than changes in current supplies and demands, these markets
could be entering a period of pause as participants wait
for developments to confirm or deny their changed outlook.
Some further rise in Treasury bond yields should not be
ruled out, however, particularly if banks begin to press
securities on the market more and more in order to make
room for expected fall loan demand or if dealers encounter
difficulty in reducing further their still sizable bond
positions. Municipal yields could come under some upward
pressure as fall approaches, if strong bank loan demand
results in curtailed commercial bank purchases of these
bonds and/or municipal dealers try to lighten their large
In the environment described, continued vigorous bank
credit expansion is to be expected. Loan demands appear
considerably greater than seasonal, and banks will be helped



in accommodating loan requests by the strong growth in their
time deposits (as indicated under question 4).
The growth in
money supply will probably continue erratic, aggravated by
sharp swings in the Treasury's cash balance in August, Septem
ber, and October. On the average, however, the demand deposit
component of the money supply might expand at an annual rate in
the neighborhood of 4 per cent over the months ahead.
Chairman Martin then called for the go-around of comments and
views on economic conditions and monetary policy, beginning with Mr.
Treiber, who made the following statement:
The domestic economy has continued to advance vigorously
on a broad front. The most recent data on industrial produc
tion, new orders for durable goods, personal income, retail
sales, employment, corporate profits, prospective capital
spending, and other factors add up to a distinctly buoyant
current picture. The prospective step-up in spending, trig
gered by the developments in Vietnam, has added to the
The wage negotiations in the steel industry have not
yet produced a settlement, and the President has intervened
to press the parties for a settlement without a strike. Thus,
a long strike does not appear likely. Some reduction in
customers' steel inventories appears in prospect for the
remainder of the year. Such inventory reduction, plus a
continuation of a sideways movement in residential construc
tion, may be blessings in disguise as tempering factors in
a rapid economic expansion.
Pressures on prices are a cause for increasing concern,
as added demands for goods and services press against the
more limited availability of unused resources. Increases
have been announced recently for a number of important indus
trial materials. Some reduction in wholesale prices as well
as consumer prices might have been expected in view of the
reports that about three-fourths of the recent excise tax
reduction had been passed on to consumers; yet such prices
failed to decline in July and may have risen in August.
Some selected increases in steel prices appear probable
regardless of the nature of the wage settlement in the steel
Recent balance of payments figures underscore the
temporary nature of the second-quarter improvement. The
underlying tide in payments is clearly against us. So far



in the third quarter we have seen a greater than seasonal
decline in the trade surplus and increase in the tourist
deficit, and a noticeable rise in the volume of new foreign
securities issues placed here. In the absence of clear
prospects for offsetting developments, a poor balance of
payments record for the third quarter seems inevitable.
Since our last meeting, there has been some improvement
in international financial sentiment with respect to sterling,
but the situation is still delicate. A renewed deterioration
in sentiment, or other international developments, could
being pressure on the dollar in international markets and
on our own sensitive domestic markets.
The demand for bank credit continues to be strong.
There is no clear evidence that the growth of bank credit,
or of all credit in use, has slackened from its rapid secondquarter pace or that it has declined to the rate of growth in
overall production.
The most recent figures fcr the New York City banks show
further substantial strength in total credit and in business
loans. Bank liquidity has continued to decline. The moderately
tighter lending terms gradually put into effect by many banks,
particularly those in the major centers, over the first half
of the year apparently continue as these banks still foresee
possibly stronger than seasonal fall loan demands. As the
yields on new issues of top-quality corporate bonds have
risen to levels above the prime rate some sentiment is now
being expressed for a rise in the prime rate, which has not
been changed since it was reduced from 5 to 4-1/2 per cent
in August 1960. With higher yields on corporate bonds and
continued heavy demand for ban credit, some upward move in
bank rates is logical.
Although expenditures of the U.S. Government are expected
to rise, its income is also likely to be higher; it is probable
that the Treasury's borrowing needs during the remainder of
1965 will be modest, and could be satisfied through the sale
of Treasury bills. The auction sale of such additional bills
should serve as no constraint on System policy and its imple
mentation. Since the last meeting of the Committee, market
prices of Government bonds have drifted lower as dealers have
reduced their inventories. There is still considerable un
certainty in the market stemming from discussions about the
future of sterling and the implications of the Vietnam situation
coming at a time when domestic economic activity is buoyant
and moving strongly upward.
In my opinion some restriction in domestic credit avail
ability is now called for. Domestic considerations counsel



such a move before inflationary pressures gain further
momentum; and the need to bring about a fundamental improve
ment in our international balance of payments is still
pressing. The approach should be cautious in view of the
uncertainties in international financial markets and the U.S.
Covernment securities market.
As evidence of firmer conditions in the money market
flowing from such a move, somewhat higher net borrowed
reserves and somewhat greater member bank borrowing from
the Federal Reserve Banks would seem appropriate. Federal
funds might be expected to trade predominantly at 4-1/8 per
cent with more frequent trades at 4-1/4 per cent, and the
yields on Treasury bills might be expected to rise moderately.
As for the form of the directive, I favor alternative B.1/
I would not favor an increase in the discount rate at
this time. If a firmer open market policy is adopted and
money market rates move higher, careful consideration of an
increase in the discount rate may well be appropriate before
Mr. Ellis reported that the prevailing business situation in
New England was one of high, if not record, activity.
had generally equaled or surpassed expectations.

Summer business

Barring the unpre

dictable effects of steel developments on regional activities, the
general expectation was for a vigorous fall season.
The essential outlines of present conditions, Mr. Ellis

continued, were provided by summary statistics:

In July, manufactur

ing output was up from June, and 8.1 per cent above a year ago;
employment also was up over the month, and 2.2 per cent higher than a

year earlier; unemployment, seasonally adjusted, about held its own
relative to June, and insured unemployment was down 19 per cent in
the year to a low not reached on a comparable basis since July 1956.
1/ Two alternative drafts of the directive prepared by the staff are
appended to these minutes as Attachment A.



Those bare-bcne statistics were fleshed out by recent news stories
that gave some flavor of events.

The furor about special requests

to Secretary of Labor Wirtz to allow 500 experienced Canadian apple
pickers into New England emphasized that there was a crop to be
picked, even though its quality had certainly been affected by the
extensive drcught this summer.

Seventeen counties in New England

had been officially classified as disaster areas because of the
drought, thereby entitling farmers to special access to Federal
loans and reauced feed costs.

Meanwhile, tourist attraction centers

were having a good season, with an average attendance increase in
July of 7 per cent over July 1964.

Several of the District's shoe

manufacturer. had announced price increases on their spring lines
that would average about 5 per cent.
The financial counterpart of those trends continued to be
sharp expansion, Mr. Ellis remarked.

Deposit balances at monthly

reporting mutual savings banks in the District increased only 0.5
per cent in July compared with plus 0.7 per cent in July 1964,
primarily because withdrawals were heavier and new deposits lighter
than last year.

In contrast, savings deposits at the reporting mem

ber banks increased 1.7 per cent on average in the three-week period
ending August 28, to record a 16 per cent year-to-year gain.


that growth apparently did not satisfy the banks' objectives, however,
since they reached into the negotiable certificate of deposit market--



in some cases with higher rates--to achieve a sharp expansion in "all
other time deposits" that brought the year-to-year gain to 27 per

The weekly reporting bank sample indicated that those funds

had been flowing principally into business loans, which showed a 19
per cent year-to-year gain, and into real estate loans, where the
gain was 22 per cent, about twice the national average.
Because monetary policy operated with a substantial time lag
between actions and their ultimate effect on the economy, Mr. Ellis
said, it was inevitable and proper .hat policy be shaped in light of
business prospects on the immediate horizon.

Last spring the pros

pect of a substantial slowdown in business activity in the fall
influenced the Committee's decisions to make no further probing moves.
Now, on the threshold of the fall season, although details were still
clouded by the uncertainty of the steel negotiations, there seemed
to be a much more general expectation that further substantial advances
would occur this fall.

Assuming that the Vietnam buildup would continue

at about the present rate and that the steel production interruption,
if any, would be of short duration, it seemed likely that industrial
production would continue to rise.
In Mr. Ellis' judgment there was little prospect for stability
in industrial commodity prices in the next few months; the uptrend
that started in late 1964 would probably continue.

A number of forth

coming price increases for this fall had been announced, in such items



as machine tools, paper, rubber products, yarn, cement, and sulphuric

With the economy continuing strong, there was no reason to

think those plans would be cancelled.
Coupled with those developments, Mr. Ellis continued, were
reports from bankers that they anticLpated that fall credit demands
would match or exceed seasonal patterns.
bankers, faced with such expectation

It was understandable if

and with their own reduced

liquidity, were contributing to the market pressures that were reduc
ing the prices of long- and intermediate-term Governments.


more, the yield spread between new corporates and Governments of
about 40 basis points was high by recent standards, and had begun to
stimulate switching from Governments.

Although many banks held few

Governments, prospective strong loan demand could be expected to
reduce further holdings of Governments where feasible.
In that context, Mr. Ellis asked, what was the proper role
for monetary policy?

It seemed clear that, with continuing strong

loan demands, even a modest probing action such as he had been advo
cating in recent meetings would lead to an upward movement of
interest rates; indeed, it was possible that the present posture of
policy would lead to rate increases if demand strengthened.


changes might include upward movements in yields on all maturities
in the Government list, an advance in the prime rate, and, in due
course, a confirming rise in the discount rate.

In short, if the



Committee started on that path, its course was not likely to be
reversible in the near future.
Were sterling not in its present weak and sensitive position,
Mr. Ellis said, he would have no hesitation in advocating that the
price of money be allowed to rise in response to domestic demands
this fall, despite the immediate uncertainties.

But sterling had to

be considerec, and during this critical fall period it was difficult
to judge what expectational effects might flow from general rate
increases in the United States, including a discount rate increase.
Perhaps he exaggerated the possibilities of repercussions on sterling;
his analysis might be two months behind that of Mr. Reynolds.


would like to hear how others would appraise the alternative possi

Meanwhile, he was persuaded that policy should not be

materially altered during the next four weeks.

That interval should

provide more insight on the steel labor negotiations as well as on
the significance of the present peace feelers concerning Vietnam.
And the market would have been allowed to settle down, if other events
led in that direction, without having been tilted by a policy move.
His own definition of "no change," Mr. Ellis observed, would
involve a target for net borrowed reserves centered at $150 million,
with the expectation that borrowings would continue to average over
$500 million.

Three-month Treasury bill rates might fluctuate near

the top of their recent range, and Federal funds rates might hold



generally at a 1/8 per cent premium.

He would accept alternative A

of the draft directives, but would interpret it in terms of the third
alternative that Mr. Holland had described--to call not for easing
actions but for operations designed to help stabilize the long end of
the market, by providing needed reserves through purchases of longer
term issues and withdrawing reserves, when necessary, through sales

of short-term issues.
Mr. Irons reported that business activity in the Eleventh
District, as in the nation as a whole, continued at a very high level.
Industrial production was up, construction was strong, new car sales
were high, employment continued to rise, and unemployment remained at
the low rate of 3.3 per cent.

The situation in agriculture was highly

favorable this year; the weather had been excellent throughout the
District, and there would be increased cotton yields and higher out
put of wheat and other crops.

Cattle prices were holding steady at

the improved levels of three months ago.

In sum, District economic

conditions were unusually good--in some respects almost startlingly

With respect to financial developments, Mr. Irons continued,
bank loans continued to rise, particularly in the commercial and
industrial and consumer loan categories.

Banks were continuing to

reduce their Government securities holdings and at the same time were
increasing their holdings of other securities.

Time and savings



deposits had risen; so had demand deposits, although by a smaller

Purchases of Federal funds were rather high, averaging about

$800 million in the past three weeks, with sales averaging about $650

Borrowings from the Reserve Bank had been low; banks had

been obtaining money from other sources.

Bankers were expecting

heavy loan demands over the rest of the year, in excess of usual
seasonal requirements.

Bankers and businesmen generally thought

that the business outlook was strong and that some further price
rises were possible, although they were concerned about the same
kinds of uncertainties that had been mentioned today.
Turning to the national situation, Mr. Irons said that the
question facing the Committee was whether the elements of strength
in the economy were sufficient to prevail over possible unfavorable
developments; or, in other words, how much weight should be placed
on the present uncertainties in deciding or policy.

In his judgment,

the Committee should place a considerable amount of weight on them.
One might conclude that some moderate firming was in order, along
the lines Mr. Treiber had mentioned, in view of the very high level
of economic activity, the somewhat less favorable balance of payments
situation, the likelihood of increased Federal expenditures as a
result of Vietnam, the continued inching up of prices, the optimism
of businessmen, the rapid expansion of credit, and the ability of
banks to obtain the funds they needed for further credit expansion.



It seemed to him, however, that this was not a good time for firming

With the steel negotiations still in process, the problems

of sterling still unresolved, and other uncertainties, it was prefer
able, in his judgment, not to change the posture of policy signifi

He would hold a steady course while watching developments

over the coming four weeks closely, and reconsider the situation at
the next meeting.
Perhaps, Mr. Irons observed, it would be desirable to reduce
the pressures on long-term Governments by purchases of coupon issues,
with some offsetting sales of Treasury bills, as had been suggested.
It might be charged that such actions would savor of a pegging opera
tion, but he thought they could be carried out short of that point,
Mr. Irons thought that the time was approaching at which the
Committee would have to begin moving toward a firmer policy.


that time arrived he believed it would not be long before an increase
in the discount rate would become inevitable.

At the moment he would

be reluctant to see a discount rate change.
In accordance with his policy views, Mr. Irons continued, he
preferred alternative A to B for the directive.

He thought, however,

that there should be more emphasis on the existing uncertainties than
in the staff's draft.

As he had indicated, it was because of those

uncertainties that he preferred no change in policy; if they had not
been present he certainly would have favored alternative B.


quently, he would prefer language that indicated the dominance of the



uncertainties over the evidences of strength in the economy, if the
Committee decided not to change policy today.
Mr. Swan reported that the economic situation in the Twelfth
District was somewhat mixed.

Aerospace employment was up in July

and the industry's July forecast was for further increases over the
next four months.

On the other hand, the unemployment rate for the

District rose rather sharply in July, in contrast to the national

Not enough details were available as yet to indicate defi

nitely where the unemployment rise occurred, but it seemed to be
related primarily to the situations in agriculture and construction.
District housing starts in July were at the lowest level in five

Nevertheless, the demand for lumber had remained rather strong,

with further scattered price increases.
continued at high levels.

Nonresidential construction

There had been a number of strikes in the

building trades that, for the most part, were relatively short and
were settled on terms rather favorable for labor.
Mr. Swan commented on the adequacy of the labor supply for
harvesting the tomato crop that he had mentioned at the previous

The growers estimated that they needed 23,000 workers, and

Secretary of Labor Wirtz's committee had now certified about 18,000
or 19,000.

The canners were faced with reduced acreage and prospects

of a shortage of labor for harvesting, but earlier in the year they
had held very substantial inventories of tomato products.

In the



second quarter, however, the canners had shipped some thirteen million
cases, as compared with nine million in the same period last year.
Thus, the canners would start the new season with smaller than usual
inventories, and substantial price increases on canned tomato products
were expected.
As to banking developments, Mr. Swan continued, the general
impression in the District, as elsewhere, was one of strong demand
for loans.

The fact remained, however, that in the three weeks end

ing August 18, the rate of expansion in bank credit at District weekly
:eporting banks was considerably less than in the rest of the country
and also less than in the District a year ago.

Much of the rise that

did occur was due to the increase in holdings of securities other than
Governments, which was greater at District reporting banks than in the

rest of the country.

The increase in holdings of other securities

seemed to be related in considerable measure to a policy decision by
one of the District's larger banks to shift a substantial volume of

funds from the Federal funds market into short-term municipals in light
of current interest rate relationships.

Despite the smaller than

national increases in both total bank credit and loans, District banks

were still borrowing in substantial volume at the Reserve Bank, and
they remained in rather tight reserve positions.
Turning to policy, Mr. Swan said that he, too, had been
impressed by the uncertainties in the present situation.

As to the

steel negotiations, along with Mr. Holland he wondered whether, if a



settlement was reached quickly, the following inventory liquidation
might not be much smaller than had been expected in light of probable
military requirements for steel and the possibility of a price increase.
In any case, given the present uncertainties, he did not think that
this was an appropriate time for the Committee to change policy.


was in complete agreement with Mr. Ellis' interpretation of "no change."
Mr. Swan went on to say that he shared Mr. Irons' feeling with
respect tc the directive.


the problem could be met without

any elaborate change in alternative A by referring to the existing
uncertainties in the first sentence, before the statement that "the
domestic economy expanded further."

He also questioned the desirabil

ity of retaining, without qualification, the phrase "gold outflows
have continued" in view of the recent reduction in the rate of out
Mr. Galusha reported that the N..nth District continued to move
forward at a rapid pace.

The extraordinary levels of agricultural

production had engendered a high degree of optimism among District

There was, however, less optimism as to prices.


employment was high, with Minnesota reporting a June-July gain larger
than in any year since 1957.

Tourist income and travel had also

broken records where figures were available.
Credit demand at District banks appeared to be on a plateau,
Mr. Galusha said.

No Twin City banker anticipated a resumption of



the excessive demand of the second quarter.

Credit was becoming

increasingly selective, with the major banks attempting to assert
rate pressure where they could.

There reportedly had been no change

in the quality of credit.
Mr. Galusha said that he would confine his comments on the
staff questions to the first, second, and fifth.

Optimism about the

nation's economic performance in the second half of 1965, and in 1966
as well, seemed to be increasing.

He, for one, was more optimistic

than he had been a few weeks ago.

The third-quarter increase in

money GNP might turn out to be about as large as was recorded in the
second quarter.

Some slowing down in the rate of economic growth

would seem to be on the horizon; more particularly, he expected
smaller quarterly increases in money GNP in the fourth quarter and
for a while thereafter than had been recorded lately, in spite of
the recently announced Vietnam buildup.
The rumbers would indicate that the buildup actually had
started several months ago, Mr. Galusha said.

He directed the Com

mittee's attention to second-quarter 1965 Federal purchases; the
increase between the first and second quarters was impressive.
There probably would be a further buildup and further increases in
GNP over what it would have been in the absence of a larger war.


ever, he could not see the coming buildup as doing more, at least in
the fourth quartet, than offsetting the likely reduction in inventory


In sum, Mr. Galusha's feeling was that the third quarter could

well witness an increase in money GNP of the order of magnitude of
that recorded in the second quarter; and that the fourth quarter would
witness a smaller, if still impressive, increase.

At the moment, there

fore, it appeared plausible that the econony would pretty much hold
its own in terms of resource utilization over the remainder of the

Unemployment and utilization rates might move a bit one way or

the other in coming months, but not, he thought, greatly in either

And he was inclined to believe that whatever general

price pressures existed earlier this year would continue to moderate
over the remainder of the year.
In that connection, Mr. Galusha noted that the changes in
straight-time hourly earnings in manufacturing reported in the "green
book"1/ seemed to him surprisingly small.

In light of the recent

decline in unemployment rates and, more importantly, the record cor
porate profits, he would have expected a considerably larger increase.
But no doubt it was too much to hope that there had been a lasting
change in the behavior of money wage rates, a change hinting of less
cost-push pressure in the future.

He also was encouraged, incidentally,

by the green book report that, after all, unit labor costs had not
been rising.

1/ The report, "Current Economic and Financial Conditions," prepared
by the Board's staff for the Committee.


If Mr. Galusha's view of basic economic developments led him

to favor no change in monetary policy at this time, so also did tech
nical market conditions.

Recent experience strongly suggested that

financial markets were a bit nervous; perhaps "apprehensive" would be
a better word.

The implication was that a modest change in policy-

a probing operation, if one preferred--might not at this moment be

An expression like "slightly firmer" connoted a stable,

disciplined market which did not appear to exist at present.


was considerable risk that a small change in marginal reserve meas
ures would be transformed by market expectations into a dispropor
tionately large rate adjustment, in long-term rates as well as short,
and possibly even in bank lending rates.

Adjustment in those rates

was overdue, and could come even with no perceptible change in the
Committee's policy.

Nor, finally, did he see anything in balance of

payments developments sufficient to warrant a change in policy at
this time.

In brief, he still favored alternative A of the draft

Mr. Scanlon reported that the Seventh District economy had
moved through the midsummer months without losing momentum.

The only

weak spot was steel, where strike prospects remained uncertain.


balance, he believed that unless there was a prolonged strike the
impact of a cutback in steel probably would be confined largely to
that industry and to associated transportation and materials-supplying

The final demand for goods and services appeared to be strong



and getting stronger.

Continued strength in new orders for capital

goods, together with announcements of long-range capital expenditure
programs of firms in the steel, auto, chemical, and petroleum indus
tries, indicated the continuance of high and perhaps accelerating
rate of outlays well into 1966.
A considerable number of machine tool producers, encouraged
by growing backlogs, had raised prices by 2-1/2 to 12 per cent, Mr.
Scanlon said.

A moderate uptrend in average wholesale prices con

In part, that was related to the escalation of military

operations in Vietnam.

There still appeared no indication that the

general price uptrend was accelerating.
Mr. Scanlon noted that District labor markets appeared to
have tightened further.

There was no major area with a substantial

labor surplus, in the District, now that South Bend had been reclas
Figures for District banks indicated relatively greater
slowing in growth of total bank credit in July and August than did
national figures, Mr. Scanlon said.

The banks had continued to

reduce broker and dealer loans and holdings of Government securities,
although their business and real estate loans and other securities
had increased further.

Business loans had risen faster in the Dis

trict than at all weekly reporting banks, and larger gains than in
the same period last year were reported for most of the major indus
trial categories.

Bankers generally reported that loan demand was



strong, but there was some difference of view as to whether it would
be strong enough to provide upward pressure on interest rates.
The basic deficit position of the Chicago banks had continued
to grow somewhat larger despite reductions in their holdings of Govern
ments and dealer loans, Mr. Scanlon continued.
those banks had declined since the end of July.

CDs outstanding at
Borrowings at the

Reserve Bank's discount window had risen somewhat over the past three
weeks, although the number of banks borrowing--both reserve city and
country--had declined, and total borrowing was relatively small.
While Mr. Scanlon interpreted the available evidence as
indicating a continued expansion in business activity and probably a
further reduction of the now small supply of unused resources in the
Seventh District, the magnitude and duration of the adjustment in
steel remained uncertain.

Therefore, he would favor no change in

policy posture at this time.

He recognized that that might be erring

on the side of excessive ease, but he did not favor additional probing
actions because he questioned whether even a slight firming was pos
sible at this juncture without a rather prompt increase in the discount

It would seem to him that any firming would, for example, result

in Federal funds trading at 4-1/4 per cent quite regularly.

He doubted

whether the Committee could have that situation for more than a very
limited period of time without encountering difficulty in administer
ing the discount window.

Accordingly, he did not favor a change in



policy unless the discount rate was changed, and he would prefer to
wait a bit

longer before making that move.

He preferred alternative A

for the directive to be adopted today, with the same reservations that
Mr. Irons had expressed.
Mr. Clay said that the national economy continued to exhibit
an impressive performance in terms of both expanding activity and
increasing employment of manpower.

The pattern of activity in the

Tenth District was quite different from that nationally, as was
evidenced by the fact that nonfarm employment, seasonally adjusted,
had failed to increase this year.

The contrast between District and

national growth was attributable largely to smaller cyclical variabi
lity in District manufacturing, as a result of relatively heavy
concentration in nondurable goods manufacturing.

Reductions in

defense-oriented industries had been a factor in the District's employ
ment pattern.

By contrast, some defense plants in the District would

now experience increases in employment before the end of the year, as
a result of the expanded military program in South Vietnam.


included both stepped-up activity in going facilities and reactivation
of facilities that had been on a stand-by basis since the Korean war
A contrast between the nation and the Tenth District was
apparent also in banking developments, Mr. Clay continued.

The rates

of expansion in bank credit, total loans, business loans, and consumer
loans at District banks this year all had been less than the national



rates of increase.

Growth in those categories had been somewhat larger

at District country banks than at District city banks, however.


growth in bank credit relative to available funds in many country banks
was such that they were making extra efforts to attract and hold depos
its by increasing their interest rates paid on time deposits to 4-1/2
per cent.

Competition with savings and loan institutions was a factor

in that competitive effort.

For the most part, rural banks did not

increase their time deposit rate to the 4-1/2 per cent level at the
time of the modification in Regulation Q permitting it, and the Reserve
Bank had no organized data as to the proportion that were at that level

His impression was gained from reports of Reserve Bank represent

atives calling on banks.
Mr. Clay went on to say that as long as the improvement in the

national economy took place in an orderly fashion, as it had thus far,
it was a further step toward the achievement of national economic goals.
The staff analysis carefully reviewed the factors involved in the pro
spective situation and, it seemed fair to say, gave evidence that
further advance in the months ahead likely could continue to take place

in an orderly fashion.

The qualification concerning the uncertainty

as to the amount and timing of military expenditures set forth in that

analysis was a very important one, however.

Moreover, it was difficult

to know what effect changing attitudes and expectations growing out of

recent developments might have on private economic decision-making.



Added to that was the crucial decision being awaited in the current
steel wage negotiations.
The logical thing to do in terms of monetary policy, it seemed
to Mr. Clay, was to continue essentially the current policy and to
watch closely both domestic and international developments.


and capital market forces influenced by expectations already had placed
upward pressure on yields and had led to somewhat uncertain money and
capital markets.

Obviously, that policy position would need to be

modified by any sudden developments in the military or international
fields requiring monetary policy action.

Alternative A of the direc

tive drafts appeared satisfactory to him.
Mr. Wayne commented that in the Committee's policy discussions
from time to time there had been references to the market's tightening

That had rarely happened because the Committee had usually

intervened to affect the situation one way or the other.
seemed to him that it had happened in recent weeks.

But it

With no change

in monetary policy, a firmer tone had developed in both the money
and capital markets, whether for financial or psychological reasons.
Of course, that might be a delayed reaction to the Committee's firmer
policy of the past six months.
In any case, Mr. Wayne said, he was content to see the develop
ment continue for the present.

He would favor maintaining reserve

availability at about its present level.

If recent market trends

continued, that would probably mean somewhat firmer money market



conditions and higher short-term interest rates.

Those conditions

would be appropriate in view of the vigor with which the economy was
moving forward, the uncertainties on the military front, and the
fiscal stimuli the economy would be receiving in the next few weeks.
Also, some additional firmness here would be helpful to Canada in
coping with inflationary pressures.

On the other hand, he believed

that any overt move toward tighter credit, and especially an increase
in the disccunt rate, would be unwise now in view of the weakness in
the capital market and the position of sterling.
Mr. Wayne noted that recent increases in industrial production
had centered chiefly in equipment and materials, and had apparently
been associated with rising defense procurement, steadily expanding
business capital outlays, and metals stockpiling.

While the metals

stockpile was likely to be reduced, he anticipated that defense orders
would probably continue to increase and recent reports indicated that
businessmen had once again raised their sights on plant and equipment

On balance, he expected industrial production to increase

over the remainder of the year but at a rate somewhat more moderate
than in June and July.
Despite steadily expanding capacity, Mr. Wayne said, prospects
for stability in industrial commodity prices did not look encouraging.
Private demand continued to rise and public outlays were moving up in
several major areas.

A wage settlement was forthcoming in steel which,

if it followed patterns already set this year, might well place
additional pressure on the industrial wage structure.

In brief, strong



demand and higher wages seemed likely to keep industrial prices under
some upward pressure through the remainder of the year.
On the basis of contracts with District banks and given the
international rate structure, Mr. Wayne believed that foreigners were
still prepared to step up their borrowing here and that the banks
would expand their foreign lending substantially were it not for the
voluntary program.

Application of the Interest Equalization Tax to

bank loans had probably effected some restraint, but he thought that
the voluntary program was at the moment the most significant restraint
preventing a sizable increase in bank lending to foreigners.
Mr. Wayne observed that the growth rate of time deposits at
weekly reporting banks thus far in 1965 had been about equal to the
average for the past four years.

On an unadjusted basis, the recent

acceleration in the growth rate did not appear to be more significant
than other fluctuations which had occurred during that period.


the rate in the second quarter was probably depressed appreciably by
heavy tax payments; payments of individual and corporate income taxes
were approximately $4 billion more in the second quarter than in the
first, whereas last year the difference was only $800 million.


ondly, the recent rise was probably stimulated by the reportedly
heavy loss of savings at savings and loan associations in July.


recent buildup in time deposits suggested that banks were in a position
to continue lending and investing at a good pace.

When they had taken



care of the demand for business and consumer loans they would probably
put most of the remaining funds into municipals and mortgages, as they
had been doing.
Mr. Wayne thought the current price weakness in the bond
markets was attributable in large part to psychological factors and
those, in turn, appeared to stem from a reappraisal of domestic economic
conditions and from continued uncertainty over the future of the pound.
The market now apparently saw some possiblity that the economy might
become overheated in the coming months instead of easing off, as had
been widely predicted.

Speculation regarding the coming steel settle

ment also was causing some apprehension.

As a precaution against the

possibility of higher interest rates and a tightening of monetary policy,
dealers had been reducing their positions in longer-term Government
securities while investors had been shying away from long-term commit
Fifth District business continued to advance in line with
national trends, Mr. Wayne said.

The latest survey reflected some

improvement in business sentiment, with expectations now about evenly
divided between further improvement and stability at present levels.
The statistical record also indicated continuing strength, with sub
stantial gains in nearly all sectors of nonfarm employment and rising
man-hours in most of the principal manufacturing industries.


textile business, in particular, remained in an unusually strong



At this early stage in the tobacco marketing season the

average price of flue-cured was 18 per cent higher than a year ago
and dollar sales were up 30 per cent.
Returning to his starting point, Mr. Wayne said he believed
that the Committee's policy should be essentially one of no change,
maintaining a level of reserve availability about equal to that of
the past three weeks.
the directive.

Obviously, he would prefer alternative A for

He questioned the desirability of placing additional

emphasis on uncertainties since "no change" implied a continuation
of the steady pressure to which the Committee had been committed for
some months.

In his opinion, the Manager should be authorized to

provide additional reserves if market forces produced more than a
moderate firing of money market conditions.
Mr. Robertson made the following statement:
It seems clear that major factors are at work or in
the offing that might well call for a reappraisal of all
Government stabilization policies, monetary policy included.
I have in mind, particularly, the steel wage-price picture
and the escalation of outlays for Vietnam; but there is
also the cliff-hanging exhibition being put on by sterling.
In each of these areas, however, we do not yet know what
is going to happen.
In the absence of other impelling reasons for chang
ing monetary policy, therefore, I favor holding a steady
course until we have had an opportunity to better weigh
the import of developments in these key sectors. So far
as I can judge, no other factors are so compelling. Price
performance continues restrained, and monetary expansion
is not out of bounds. Commodity markets have been remark
ably stable considering all the loose talk about the size
of our Vietnam build-up and its possible consequences for
the economy.



Such uncertainties in the outlook, however, have helped
to give the financial markets a case of the jitters, and the
resultant increases in long-term interest rates are running
well ahead of the apparent changes in real demands. I rec
ognize this bond market weakness has developed for reasons
largely unconnected with the stable money market conditions
being maintained by the Manager, but I think we also ought
to recognize that a persistence of such higher long-term
rates can exert a tightening influence on the economy, other
things being equal, and that monetary policy needs to be
framed with this in mind. I personally would not want to
act overtly to create offsetting ease in reserve availability
until and unless the steel and Vietnam pictures are resolved
in a way that makes it likely that no added monetary restraint
would be required this fall. But, at the same time, I would
certainly not wish to move in the opposite direction and
thereby compound the tightness already evident in some longer
term markets.
As I said at our last meeting, 1 would be prepared to
see the bill rate work lower, if investor shortening of
maturities produces any such tendency, but I frankly doubt
that it will occur. With that qualification, I would direct
the Manager to maintain about the same money market conditions
as have prevailed since our last meeting. Accordingly, I
would vote for alternative A of the current directive.
Mr. Shepardson said he concurred completely with the view that
buoyant conditions existed throughout the economy.

But he also was

concerned about the uncertainties abroad with respect to the position
of sterling and the Vietnam situation, and about those at home relat
ing to the still-uncompleted steel wage negotiations.

Like some others

who had spoken, except for those uncertainties he would feel that con
ditions now called for a further move toward tightening.


with the uncertainties--and particularly those concerning the steel
negotiations, the outcome of which might or might not have a signif
icant effect on developments--he thought it would be inappropriate to
change policy at this time.


Mr. Shepardson shared Mr. Irons' views about the directive.

The Committee, appropriately in his view, had been changing the word
ing of the first paragraph of the directive from time to time in an
effort to make the language reflect current conditions as it saw them.
He thought the staff's suggested alternative A needed modification if
the Committee concurred in the view that it should not change policy
today primarily because of the existing uncertainties.
He would begin the directive with .he opening statements of
alternative B, which in his judgment presented a better description
of the current domestic economic situation than did the equivalent
part of alternative A.

He would then add language indicating that

the Committee's policy was unchanged in view of the prevailing uncer
tainties, which he would describe more fully than the staff draft did.
For the second paragraph, he would accept the language of alternative
A, except that he would delete the phrase "over the next four weeks"
and say that open market operations shall "continue to" be conducted
in the manner described.

That change seemed desirable because of the

possibility that some of the present uncertainties would be resolved
in a manner that would justify reconsideration of the Committee's
policy posture before four weeks had elapsed.
Specifically, Mr. Shepardson proposed a directive along the
following lines:



The economic and financial developments reviewed at
this meeting indicate that the domestic economy has expanded
further, business sentiment has become buoyant, some prices
have been under upward pressure, bank credit expansion has
been viorous thus far this year, and Federal expenditures
are expected to increase in the months ahead as a result of
the hostilities in Vietnam. Our international payments have
reverted to deficit in August, and gold outflows have con
tinued. However, in view of the continuing uncertainties in
securities and foreign exchange markets, in military develop
ments, and in the steel wage negotiations, it remains the
Federal Open Market Committee's current policy to strengthen
the international position of the dollar, and to avoid the
emergence of inflationary pressures, while accommodating
moderate growth in the reserve base, bank credit, and the
money supply.
To implement this policy, System open market operations
shall continue to be conducted with a view to maintaining
about the same conditions in the money market as have pre
vailed in recent weeks, while taking into account the unset
tled conditions in securities and foreign exchange markets.
Mr. Mitchell commented that he could heartily endorse a great
deal of what he had heard this morning, but he would make a few obser
vations with a different slant.

He thought it was quite likely that

the economy was on the verge of an inventory-cycle turning point.
There was good reason to believe that invertory accumulation had pro
ceeded more rapidly than was generally realized, not only in steel but
also in the rest of the economy.

As evidence of such a development,

Mr. Gehman of the Board's staff had pointed to the differences in
recent rates of output of materials and finished products.

In any

event, as Mr. Noyes had noted, the revised GNP figures showed a rate
of inventory accumulation averaging $8 billion over the last three



quarters, and the book value figures for July indicated an exceptionally
large further increase at manufacturers.

Thus, the inventory situation

probably had gotten out of hand, and a steel settlement undoubtedly
would lead tc some reappraisal of the levels of stocks.
Consumer spending, Mr. Mitchell continued, did not appear to
be rising sufficiently rapidly to warrant real confidence in the out


Nevertheless business confidence was strong; businessmen seemed

to be disregarding the possibility of a turning point in the inventory

The economy might surmount the inventory adjustment by a fur

ther expansion in final takings, but it seemed clearer than it had
earlier that such an adjustment lay ahead.
Mr. Mitchell shared the dissatisfaction others had expressed
with the language of the directives the staff had suggested for this

Perhaps it was not feasible to do anything about it; as

Chairman Martin often had said, nineteen people could not write a
directive without getting bogged down in questions of semantics.
Nevertheless, he also had worked out some possible language, which
read as follows:
The economic and financial developments reviewed at
this meeting indicate that the domestic economy has expaned
further, but with increasing reliance on inventory accumula
tion. Business sentiment has become buoyant. The Government
securities and corporate capital markets have experienced a
significant rise in yield, with top-quality corporate bonds
at their highest yield in four years. Our international pay
ments have reverted to deficit in August, and uncertainties
persist in foreign exchange markets. In this situation, it
remains the Federal Open Market Committee's current policy



to strengthen the international position of the dollar, to
avoid the emergence of inflationary pressures, and to counter
speculative pressures in the bond markets, while accommodat
ing moderate growth in the reserve base, bank credit, and
the money supply.
To implement this policy, System open market operations
over the next four weeks shall be conducted with a view to
maintaining about the same conditions in the money market as
have prevailed in recent weeks, while taking into account
the need to cushion the unsettled conditions in the Govern
ment securities and foreign exchange markets.
In explaining his proposed revision of the second paragraph,
Mr. Mitchell indicated that he thought purchases of coupon issues by
the System Account would be useful in helping to tranquilize the
longer-term bond markets.
Mr. Daane remarked that he had little to add this morning to
what had been said; he agreed that no change should be made in policy,
in view of the uncertainties existing in both the domestic and inter
national situations.

As to the uncertainties in the international

area, he was impressed with the significance of the question that
Mr. Ellis had put to Mr. Reynolds, and with Mr. Ellis' conclusion on
the point.

While Mr. Reynolds did not think the repercussions on

sterling of higher U.S. interest rates would be great at present, he
had indicated that he was unsure of his judgment, and had at least
implied the existence of some risk for sterling in any firming of U.S.
monetary policy.

Mr. Daane was not sure of his judgment either, but

was inclined to take a somewhat less optimistic view.

In any case,

a firmer policy in this country certainly would not help the position
of sterling.


On the domestic side, Mr. Daane said, he agreed with Mr.

Galusha's characterization of the atmosphere in financial markets as

Against that background, the consequences of any

step that appeared to involve further firming--even if it were described
as a "modest" move--were likely to run far beyond the intentions of
those advocating it.

Thus, on both international and domestic grounds,

he would favor standing fast with respect to policy over the period
immediately ahead.
On the directive, Mr. Daane said he had to confess to being
a bit puzzled.

At the previous meeting Mr

Galusha had said that his

(Mr. Daane's) reasoning involved a non sequitur, and perhaps it had.
After further reflection he had concluded that the real difficulty
arose in the attempt to spell out, within a relatively brief first
paragraph, the reasoning underlying the Committee's policy decision.

Within reasonable limits it was perfectly appropriate to recognize
any substantial changes in the factual description of the situation
but, because of the difficulties in attempting to satisfy everyone
the Committee was likely to make its meeting intolerably long if it
tried to spell out all the reasons for its policy decision.
Accordingly, Mr. Daane continued, he would temper his desire
to suggest changes in the staff's draft.

He agreed completely with

Mr. Irons that the existing uncertainties were the primary reason
for not changing policy today and, if the Committee was to explain



the basis of its policy decision, that those uncertainties should be
highlighted in the first paragraph.

As to the second paragraph of the

draft, he disliked the final phrase, which read, "while taking into
account the unsettled conditions in securities and foreign exchange

That construction implied that unsettled conditions were

merely something for the Account Management to keep in mind; but as
he sensed the Committee's views they were the major reason for the
policy decision itself.

Accordingly, he proposed replacing the words,

"while taking into account" with the words, "and to take into account."
Mr. Maisel said he concurred with most of the observations
that had been made, and would comment briefly only on a few points.
He was somewhat concerned because the word "buoyant" was being treated
as having an unfavorable connotation.

He would be happy to see the

economy become more buoyant under present circumstances, with less
than full utilization of resources and with final demand growing no
faster than capacity.

There had been some reduction in the unemploy

ment rate but primarily as a result of the inventory buildup; there
was no indication that final demands had risen to appropriate levels.
He agreed that demand would start moving up now as a result of Viet
nam, and there was a possibility that it would move fast enough to
offset the expected moderation in the rate at which inventories had
been growing.

But that expectation did not provide grounds for a

basic change in policy, and he favored no change between now and the
next meeting.


-59His second point, Mr. Maisel continued, concerned the long

term bond market.

One reason for the prevailing uncertainty was

that the market was unsure of the Committee's policy.

The Committee

should not accept the market's uncertainties as a given datum and
reason for action.

Instead, it should help to resolve those uncer

tainties, and reduce speculative expectations, by operating in the
long-term market in a manner that would make its intentions clear.
In short, the Committee ought to set the market straight.
Mr. Maisel said that he would accept alternative A, as drafted
by the staff, for the directive.

In his judgment the Committee would

get into a great deal of difficulty if it tried to make extensive
revisions around the table.
Mr. Hickman remarked that business news since the previous
meeting of the Committee had been generally favorable, but the major
question of whether or not the economy would continue to move upward
in a balanced and orderly way remained unresolved.

The sharp increase

in the production index in July was unsustainable, and little further
gain could be expected in August.

Autos were unlikely to contribute

further to g ins in industrial output this year and a downdrag from
steel would have to be faced.

Defense spending would provide a

countervailing boost to the economy, but its contribution to aggregate
demand was indeterminate at this time.
A priori, Mr. Hickman said, the economy would seem to be
closer to its potential than there had been reason to hope a month or



two ago, but even that was uncertain since the figures on the production
potential were now being revised.

The best bet now was that GNP would

grow at an annual rate of $9 or $10 billion in both the third and
fourth quarters, or about the same as the second quarter rate of gain.
For the year, that would represent a gain of 6 to 7 per cent, in cur
rent dollars, which was the same as last year's gain.
On the price front, Mr. Hickman continued, recent information
added little to what was known three weeks ago.

Recent movements had

been minor and there still was no evidence of general price inflation.
In the financial sphere, Mr. Hickman said, developments of the
past week or two had been mixed.

Speculation in the London gold mar

ket was reduced by news of Canadian wheat sales to Russia.

The wheat

sales should improve the Canadian trade balance, which should reduce
the amount of the Canadian deficit that would have to be financed in
the United States.

Nevertheless, the pound sterling remained under

pressure, and the U.S. corporate and Government bond markets remained
nervous and unsettled.
Until visibility improved, Mr. Hickman observed, monetary
policy should continue to be moderately stimulative, as it had been
at most times throughout the current business recovery.

In view of

the uncertain outlook, he thought the Committee should take partic
ular care at this time to avoid a gradual creep towards higher net
borrowed reserves.

The Manager was to be congratulated for coming



very close to what he (Mr. Hickman) thought was the correct target of
$150 million net borrowed reserves during the past two weeks.

On the

other hand, the original estimates of net borrowed reserves had become
suspect because of an almost uniform tendency during the past several
months to revise them to deeper levels.

In view of that observed bias,

perhaps an initial target of something under $150 million, say $125
million, might bring the revised figures nearer the desired goal.
Mr. Hickman was not particularly happy with either of the two
draft directives because neither stressed the elements of uncertainty
created by the steel situation and Vietnam, and had been clearly
pointed out by Mr. Irons and Mr. Daane.

With minor modifications,

however, he would accept alternative A, as interpreted by Mr. Ells.
Turning to Mr. Swan's question about the possible rate of
liquidation of steel inventories, Mr. Hickman said he now suspected
that liquidation would be less than had been anticipated earlier.
Nevertheless, he was inclined to agree with Mr. Mitchell that the
economy might be on the verge of an inventory adjustment.

But the

size of actual inventories of steel and other products was not known

Because of the inadequacies of available statistics, it

was difficult to reach firm judgments on such questions and to shape
monetary policy.

As he had mentioned at an earlier meeting, the Sys

tem could usefully devote some resources to improving the quality of
inventory statistics.



Mr. Bopp reported that discussions during the past week with
officials of Philadelphia banks had revealed that the voluntary credit
restraint program was the primary factor limiting foreign lending.
Two of the banks which were slightly above their ceiling because of
prior commitments were refusing loan applications in order to get
within the limit.

Banks below the limit were cautious in making new

loans because they had lines of credit outstanding to good customers
and were uncertain as to the amounts those customers would take down.
The voluntary credit restraint program was also a limiting
factor in more indirect ways, Mr. Bopp continued.

One banker estimated

that as much as 50 per cent of the foreign demand for bank credit from
September 1964 to February 1965 had been in anticipation of future
needs and that some borrowers, finding they had borrowed more than
they needed, had made prepayments.

Several bankers reported that the

restraint program had resulted in banks being more selective in foreign
lending, favoring loans with higher compensating balances and higher
interest rates.

One bank reported raising rates to new borrowers and

another reporting turning down some European applicants because the
rates were too low.

A few of the banks were working toward a better

balanced loan portfolio geographically by limiting further expansion
in certain areas, notably Japan.
With respect to the recent rapid upswing in time deposits,

Mr. Bopp said, Third District weekly reporting member banks reported
a substantial 20 per cent increase in total time deposits, on an



annual rate basis, from mid-year through the first two weeks in August.
As in the nation, about one-half of the total increase was accounted
for by an expansion in negotiable CDs.

Inasmuch as CDs typically car

ried a rate in excess of other time deposits, there was a tendency
toward increasing pressure on banks to employ their funds in higher
yielding earning assets and perhaps some upward pressure on loan rates.
Turning to policy, Mr. Bopp said that recent developments
offered diverse guides to action.

Some factors would appear to weigh

on the side of slightly greater restraint, notably the situation in
Vietnam together with some apparent worsening in the balance of pay
ments in August, a slight rise in industrial commodity prices, and
industrial utilization reaching an estimated 90 per cent of capacity.
On the other hand, the moment of truth in the steel negotiations was
approaching with the possibility of some slack resulting from a run
off of inventories, either with or without a strike.

That slack,

combined with increasing capacity coming on stream each month as a
result of record capital spending, should help counterbalance the
events in Vietnam.

It should also be noted that recent industrial

price hikes were still of a selective nature, that revised data showed
continued stability in unit labor costs, and that the August balance
of payments figures were as yet incomplete.

In addition, considerable

nervousness and uncertainty existed in financial markets at this time.
After weighing those several factors, Mr. Bopp would recommend that no
change be made at present in the general posture of monetary policy.


Mr. Fatterson commented that at the last meeting he had

reported reduced gains in Sixth District income and employment and
even some old-fashioned declines, especially in housing.


the Atlanta Bank economists did not think a recession was in the
offing, it had seemed clear to them that the pace of activity had
slowed down in the District.
that was still basically true.

On the basis of the most recent figures,
Of course, significant changes could

not have been expected to have occurred, as it would Lake time for
the increased commitment in Vietnam to have a measurable influence
on the econony.

With one of every seven members of the armed forces

stationed in the District States, however, the impact could come
fairly quickly.
The District textile industry had already been affected,
Mr. Patterson said.

The Reserve Bank directors reported that in

recent weeks the Government had placed heavy orders for sheets,
shorts, and towels.

Even before that happened, textile activity

was high, orc'er backlogs were large, and skilled labor was in shor

Defense procurement could tax capacity in that industry

fairly quickly.
As far as Mr. Patterson could tell, the mortgage markets had
felt little influence of the higher corporate and Treasury yields.
The prevailing mood seemed to be one of caution, and some increase
in FHA and VA discounts was widely expected.

The biggest real estate



news has been the purchase of 3,000 acres of land, at a price in excess
of $5 million, in Southwest Atlanta.

The buyer planned to develop that

land for a $400 million industrial and amusement complex patterned
after the "Six Flags Over Texas Amusement Park" between Dallas and
Fort Worth.

In the long run, the more important event had been the

announcement of a national corporation, Anaconda Aluminum Company,
that it would start the production of aluminum in Georgia, using
porcelain clay or kaolin.

That development could well lead to the

beginning of other aluminum operations in the State.
In examining the influence of the Vietnam situation on banking,
Mr. Patterson said, one had the benefit of later statistics than for
any other sector of the economy.
loans at major city banks.

There had been a step-up in consumer

However, it would be premature to conclude

that customer. were about to rush out to buy automobiles and other
durables because of impending shortages.

The acceleration in consumer

financing did not carry into other bank lending activities.
The basic reserve position of large banks in the District


far in August had been slightly tighter than in July, Mr. Patterson


it was still difficult to find any solid indication

that the modification in Federal Reserve policy this year had held
back the strong credit expansion at District banks.
Mr. Patterson concluded with the observation that it might be
months before the full impact would be seen of the Vietnam situation,



the steel settlement, and the sterling crisis.

In his judgment any

change in Federal Reserve policy would be inappropriate at this time.
Mr. Balderston made the following statement:
The Committee's consensus on policy seems clear but the
situations at home and abroad are quite unclear. Rising
above the turmoil and confusion of the moment is the sickness
of sterling. Its plight, for the moment at least, seems to
dominate the conflicting forces that tend to pull the economy
toward inflationary price rises on the one hand and cessation
of the boom on the other. In view of the struggle to save the
pound and of the continued uncertainty as to the steel settle
ment, I favor a continuance of the present policy. For the
moment a steady posture seems to be indicated until the uncer
tainties diminish.
The underlying forces threatening instability still need
to be watched constantly; the Committee might be called upon
to make a decision without having as much information as it
might desire. Threatening the stability of prices is the
fact that the U.S. is engaged in war. Dr. Roland Robinson,
a former Board staff member, discovered that in 25 of the
first 44 years following the birth of the Federal Reserve Sys
tem the consumer price index was reasonably stable, showing
changes of less than 3 per cent. If one were to exclude the
two world wars and the period of Korean hostilities, that
standard was met in 24 of the remaining 31 years. The cumu
lative price changes during the nonwar years just about
balanced out, leading Dr. Robinson to suggest that, without
the influence of war, the price level at the end of that
period might not have been far different from that prevail
ing almost a half-century earlier.
But once again we are in a war serious enough to disturb
stability in the overall price level and to generate lop-sided
price expectations. In short, war-time price expectations
are biased so that the two-way movement of prices is replaced
by movement in one direction only--and that upward. Conse
quently, the five-year stability in the prices of goods,
though not of services, which has so aided U.S. export volume,
is now threatened not only by the current steel negotiations
but by the even more pervasive pressures of wartime.
Not to be forgotten is the increased spending planned by
the Federal Government in connection with the war against
poverty, as a supplement to the steady growth in State and
municipal spending. That increased emphasis upon fiscal
stimulus also affects price expectations.



On the other hand, the inventory buildup that Mr. Noyes
has stressed would properly be regarded as a threat to the
continuance of cyclical expansion were the U.S. not at war.
Eventually, the inflated volume of inventories must exert a
braking effect upon the rate of production. For example, the
production of autos has exceeded sales since last February.
Despite his concern about those underlying forces, Mr. Balderston
added, the international problem seemed to be dominant at the moment
and, as he had indicated, he would favor continuing present policy.
Like others, he was not happy with the language of alternative A, the
draft calling for no change in policy.

He noted, for instance, that

it contained no reference to the firming of prices.

In his judgment

prices had firmed; with few exceptions, the changes that had occurred
had been in an upward direction.

Unless the Committee chose to accept

Mr. Shepardson's proposal for a more general revision of the first
paragraph, three fairly small changes might be made.

First, the words

"with some firming of prices but" might be inserted in the opening
sentence, after the statement that the domestic economy had expanded
further, and before that relating to international payments.


the first sentence might be added the statement, "For the moment,
international problems appear dominant."

Also, he would strike the

phrase "and to avoid the emergence of inflationary pressures" from
the final sentence of the paragraph.

If the Committee made no policy

change today, it would not be acting for the purpose stated in that
phrase; its present policy was permitting business loans and total
bank credit to grow at rapid rates.

As for the second paragraph,

Mr. Balderston liked Mr. Shepardson's suggested revision.



Chairman Martin remarked that he was in complete agreement
with the consensus that had emerged for no change in policy, and he
had nothing to add to the observations that had been made.

The direc

tive the staff had drafted seemed to be less satisfactory this time
than usual.

He suggested the Committee attempt at this point to

arrive at a directive that would be reasonably agreeable to a majority.
To begin the effort, he proposed that Mr. Mitchell repeat the directive
wording he had recommended earlier.
After Mr. Mitchell had done so, Mr. Daane commented that he
found Mr. Mitchell's proposal unsatisfactory on several counts.


one thing, it implied that the economic advance was resting on inven
tory accunulation and was running out of steam.

That might be correct

but he did not think it represented the judgment of a majority of the

Moreover, there were no references to price developments,

or to the implications of Vietnam.

He was not sure that the Committee

should try to use the first paragraph of the directive as a substitute

the text of the policy record entry. but if it was to make the

attempt a more balanced statement seemed to be called for.
Chairman Martin then remarked that it might be desirable for
the staff to attempt to develop a new draft of the directive on the
basis of the comments that had been made this morning on the original

He proposed that, while this work was in process, the Committee

move into executive session to discuss a memorandum dated today that



had been distributed to Committee members and other Reserve Bank
Presidents, entitled "Contingency Planning for the Government Securities
Thereupon, all members of the staff left the meeting except
Messrs. Young, Holmes, and Sanford.

Mr. Balderston summarized the con

tents of the memorandum that had been distributed, following which there
was general discussion of the actions that might be appropriate under
various possible contingencies.
Chairman Martin then suggested that the Committee members be
prepared for the possible necessity for holding a meeting, either by
telephone conference or with all participants in Washington, in the
interim before the meeting tentatively scheduled for September 28,

There were many uncertainties existing at present, he noted,

and the interval between today's date and September 28 was relatively
Following the executive session the regular meeting resumed
and Mr. Young read two new alternative drafts of the directive that
had been prepared by the staff.

After further discussion, a consensus

emerged in favor of the shorter of the two alternatives.
Thereupon, upon motion duly made and
seconded, and with Mr. Treiber dissenting,
the Federal Reserve Bank of New York was
authorized and directed, until otherwise
directed by the Committee, to execute trans
actions in the System Account in accordance
with the following current economic policy



The economic and financial developments reviewed at
this meeting indicate that the domestic economy has expanded
further, but with markets characterized by uncertainties
as to possible developments in steel, sterling, and Vietnam.
Our international payments have reverted to deficit in
August, and gold outflows have continued, although at a
more moderate rate. In this situation, it remains the
Federal Open Market Committee's current policy to strengthen
the international position of the dollar, and to avoid the
emergence of inflationary pressures, while accommodating
moderate growth in the reserve base, bank credit, and the
money supply.
To implement this policy, System open market operations
until the next meeting of the Committee shall be conducted
with a view to maintaining about the same conditions in the
money market as have prevailed in recent weeks, while taking
into account unsettled conditions in securities and foreign
exchange markets.
In explaining his dissenting vote, Mr. Treiber said that he
agreed that caution was necessary in view of the existing uncertainties
in the bond and foreign exchange markets.

He continued to feel, how

ever, that it was desirable for the Committee to make a further slight
move toward a somewhat lessened degree of credit availability at
present, recognizing that in the prevailing conditions any such move
must be made with caution.

In his judgment such a policy decision

would not have an undesirable effect on the position of sterling.
It was agreed that the next meeting of the Committee would be
held on Tuesday, September 28, 1965, at 9:30 a.m.
Thereupon the meeting adjourned.


August 30, 1965.


Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on August 31, 1965
Alternative A (no change)
The economic and financial developments reviewed at this
meeting indicate that the domestic economy has expanded further, our
international payments have reverted to deficit in August, gold out
flows have continued, and uncertainties persist in securities and
foreign exchange markets. In this situation, it remains the Federal
Open Market Committee's current policy to strengthen the international
position of the dollar, and to avoid the emergence of inflationary
pressures, while accommodating moderate growth in the reserve base,
bank credit, and the money supply.
To implement this policy, System open market operations over
the next four weeks shall be conducted with a view to maintaining
about the same conditions in the money market as have prevailed in
recent weeks, while taking into account the unsettled conditions in
securities and foreign exchange markets.

Alternative B (firming)
The economic and financial developments reviewed at this
meeting indicate that the domestic economy has expanded further,
business sentiment has become buoyant, some prices have been under
upward pressure, bank credit expansion has been vigorous thus far
this year, and Federal expenditures are expected to increase in the
months ahead as a result of the hostilities in Vietnam. Our inter
national payments have reverted to deficit in August, gold outflows
have continued, and uncertainties persist in securities and foreign
exchange markets. In this situation: it is the Federal Open Market
Committee's current policy to move further to strengthen the inter
national position of the dollar, and to counter the emergence of
inflationary pressures, by moderating somewhat the pace of growth
in the reserve base, bank credit, and the money supply.
To implement this policy, System open market operations over
the next four weeks shall be conducted with a view to attaining
slightly firmer conditions in the money market, while taking into
account the unsettled conditions in securities and foreign exchange