Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, July 21, 1970 : Memorandum of Discussion

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MEMORANDUM OF DISCUSSION
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, July 21, 1970, at 9:30 a.m.
PRESENT:

Burns, Chairman
Brimmer
Daane
Francis
Heflin
Hickman
Maisel
Robertson
Sherrill
Swan
Mr. Treiber, Alternate for Mr. Hayes

Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.

Messrs. Galusha, Kimbrel, and Morris, Alternate
Members of the Federal Open Market Committee
Messrs. Eastburn, Clay, and Coldwell, Presidents
of the Federal Reserve Banks of Philadelphia,
Kansas City, and Dallas, respectively
Mr. Holland, Secretary
Mr. Broida, Deputy Secretary
Messrs. Kenyon and Molony, Assistant Secretaries
Mr. Hackley, General Counsel
Mr. Partee, Economist
Messrs. Axilrod, Garvy, Gramley, Hersey, Hocter,
Jones, and Reynolds, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Bernard, Assistant Secretary, Office of the
Secretary, Board of Governors
Mr. Coyne, Special Assistant to the Board of
Governors
Messrs. Wernick and Williams, Advisers, Division
of Research and Statistics, Board of
Governors
Mr. Keir, Associate Adviser, Division of
Research and Statistics, Board of Governors

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Mr. Baker, Economist, Government Finance
Section, Division of Research and
Statistics, Board of Governors
Miss Ormsby, Special Assistant, Office of
the Secretary, Board of Governors
Miss Eaton, Open Market Secretariat Assistant,
Office of the Secretary, Board of Governors
Mr. Baughman, First Vice President, Federal
Reserve Bank of Chicago
Messrs. Eisenmenger and Taylor, Senior Vice
Presidents, Federal Reserve Banks of
Boston and Atlanta, respectively
Messrs. Bodner, Snellings, Scheld, Billington,
and Green, Vice Presidents, Federal Reserve
Banks of New York, Richmond, Chicago,
Kansas City, and Dallas, respectively
Messrs. Gustus and Kareken, Economic Advisers,
Federal Reserve Banks of Philadelphia and
Minneapolis, respectively
Mr. Lynn, Director of Research, Federal Reserve
Bank of San Francisco
Mr. Cooper, Manager, Securities and Acceptance
Departments, Federal Reserve Bank of
New York
By unanimous vote, the minutes
of actions taken at the meeting of
the Federal Open Market Committee
held on June 23, 1970, were approved.
The memorandum of discussion
for the meeting of the Federal Open
Market Committee held on June 23,
1970, was accepted.
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 Market Account and Treasury operations in foreign cur
rencies for the period June 23 through July 15, 1970, and a supple
mental report covering the period July 16 through 20, 1970.

Copies

of these reports have been placed in the files of the Committee.

7/21/70
In supplementation of the written reports, Mr. Bodner ob
served that the general tone of the exchange markets in the past
month had continued to be very much as described by Mr. Coombs at
the last meeting of the Committee.

The nervousness and, indeed,

pessimism of the exchange markets regarding the relative levels of
major exchange rates and the possibility of significant changes in
exchange practices surfaced during the course of the meetings of
the Group of Ten deputies in Paris the week before last.

With

reports of an important new U. S. initiative toward greater exchange
rate flexibility, several currencies moved in the directions the
market anticipated they would if allowed such flexibility.

In par

ticular, sterling weakened and the German mark and the Swiss franc
strengthened.
Exchange rate uncertainty, of course, was not the only factor
operating in the markets, Mr. Bodner said.

Throughout the period

there had been significant flows of funds out of sterling and into
marks through Euro-dollars as a result of the pattern of interest
rates prevailing in these markets.

The slight relaxation of monetary

policy in Germany last week, coupled with the easing of pressures in
the Euro-dollar market, had reduced the drain on sterling and helped
to produce a somewhat calmer over-all atmosphere in recent days.
Mr. Bodner reported that sterling had continued its steady
decline from its April highs and currently was trading around $2.3880.
The disparity in interest rate levels between the United Kingdom and

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the Euro-dollar market was the main source of pressure on sterling
during the period, and in early July the Bank of England had to step
into the market and provide about $125 million in support.
however, the retreat had been orderly.

Otherwise,

In fact, given the poor trade

figures released during the month and the outbreak of a major dock
strike, sterling had held up remarkably well, with no intervention
since July 7.

The over-all atmosphere, however, was very pessimistic,

as indeed it had been all along.

Most traders had always felt that

the buoyancy of sterling would not last past the spring and the cur
rent pessimism came as no surprise.

Clearly, for the future very

much was going to depend on how quickly the present dock strike was
settled, the means by which it was settled, and the terms agreed upon.
A prolonged strike certainly would put increased pressure on sterling,
and the Bank of England was running out of room in which to let the
rate take the pressure; at some point fairly soon additional reserves
would have to be used.

The Account Management had already been ap

proached by the Bank of England regarding a possible swap drawing this
month and there might well be further need before the month was out.
The other major weak spot in the system was the Italian lira,
Mr. Bodner continued.

Pressure on the lira had continued to drain

Italian reserves and losses so far this month totaled $370 million.
Continued deterioration in the Italian current account as a result
of widespread strikes, coupled with the ongoing political crises, had
resulted in an increasing chorus of devaluation rumors.

The fact that

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the Italians had drawn down their reserve position in the Fund,
while certainly a desirable move in itself, had intensified the
concern about the lira.

While Italy's over-all reserve position

remained relatively strong, the summer inflow had not materialized
as anticipated and the situation looked, if anything, more serious
than it had a month ago.
Mr. Bodner remarked that the other side of the coin was
represented by the mark, Swiss franc, Belgian franc, and guilder,
all of which had been very strong; the Germans in particular had
pulled in large amounts of money through early July.

In fact,

these German reserve gains--some $700 million spot and $275 million
forward--were not far behind those of June.

Once again there had

been talk of another revaluation or a temporary floating of the mark.
In the last few days a lot of that talk had died down following the
new fiscal policy steps by the German Government and some easing of
monetary policy through a cut in the discount and Lombard rates.
More generally, it seemed to him that the German situation, while it
had been uncomfortable for a few months, was likely to improve.

The

spot rate had been away from the ceiling since the early part of this
month and the over-all German payments position seemed to be moving
into better balance as the effects of revaluation worked their way
through the economy.
Mr. Bodner observed that both the Belgian franc and the
Dutch guilder had remained strong during this period, in part because

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of money market pressures and in part because of speculative exchange
flows.

In the case of Belgium, the System had had to activate the

swap line and now had $50 million of drawings outstanding.

In the

case of the Netherlands, a large inflow of dollars last week pushed
the dollar position of the Netherlands Bank beyond the upper end of
the range that they were prepared to hold and, consequently, the
Dutch would be buying $20 million of gold from the U. S. Treasury
this week.

A request for a swap drawing in the near future was a

distinct possibility, since it seemed likely that there would be
further inflows to the Netherlands during the next few days.
Mr. Bodner remarked that through all of the uncertainties
in the exchange markets in the last month the Canadian dollar had
floated fairly peacefully.

Although the nervousness generated by

the Canadian move had had effects on other currencies, and had sig
nificantly disturbed the markets, the Canadian rate itself had
remained in a very narrow range, with no large flows of funds and
with only very minor intervention by the Bank of Canada.
All in all, Mr. Bodner said, the exchange market picture,
although somewhat calmer in the last few days, was not a very attrac
tive one.

In the middle, of course, was the U. S. dollar with this

country's own enormous balance of payments deficit and continuing
inflation causing increasing concern abroad.

Despite that picture

of almost unrelieved gloom, however, he did not think there would be
a major crisis in the very near future, at least so long as the

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domestic financial markets continued to weather the present storms.
That, it seemed to him, was crucial; major disturbances in U. S.
financial markets--and, in particular, any feeling that the situa
tion was getting out of control--could have the gravest implications
for the exchange markets.

The present obviously was a very difficult

period, but it seemed to him that there were no fundamental reasons
why the problems could not be handled satisfactorily.

The under

lying balance of payments disequilibria that had created past
upheavals had been very largely removed by the parity adjustments
that had already occurred.

With perhaps one or two minor exceptions,

there was no reason to think that the basic exchange rate relation
ships now prevailing involved any major misalignments.

It should,

therefore, be possible to defend them against any serious disturbances.
The principal requirements were that the U. S, authorities deal with
their own domestic problems and that both they and their foreign
colleagues keep cool heads.
By unanimous vote, the System
open market transactions in foreign

currencies during the period June 23
through July 20, 1970, were approved,
ratified, and confirmed.
Mr. Bodner then noted that a $185 million System swap draw
ing on the Swiss National Bank would mature for the first time on
August 14, 1970.

As things stood now, it was anticipated that that

drawing would be liquidated at maturity; the Swiss National Bank
had indicated that it would be prepared to add to its dollar position

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at the maturity of the drawing if it could convert $50 million into
gold, and the U. S. Treasury had agreed to that gold purchase.

Given

the existing uncertainties, however, there was always a possibility
of new inflows into Switzerland that would make it impossible to
proceed with that plan.

Accordingly, he would recommend renewal of

the drawing if that should prove necessary.
Possible renewal of the
$185 million System swap drawing
on the Swiss National Bank was
noted without objection.
The Chairman then invited Mr. Daane to report on his recent
trip to Europe.
Mr. Daane noted that along with Mr. Coombs he had attended
the monthly meeting of central bank governors in Basle during the
weekend of July 4.

Despite the uncertainties in exchange markets

to which Mr. Bodner had referred, the discussion was rather quiet.
Most of the principal points of interest raised during the governors'
go-around in the afternoon session related to matters on which
Mr. Bodner had commented today.

The Governor of the Bank of England

expressed concern about the outflows of funds from Britain resulting
from unfavorable interest rate differentials.

Remarks by the

President of the German Federal Bank foreshadowed the subsequent
reductions in that Bank's discount and Lombard rates--and also the
temporary increase in taxes in Germany and the rescinding of the
investment tax credit, which left more room for easing of monetary

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policy.

The Governor of the Bank of France expressed satisfaction

with recent French progress on a number of fronts.
The main question raised concerning the United States,
Mr. Daane continued, revolved around the possibility of a reduc
tion in interest rate levels.

There was a clear interest on the

part of the governors--including those from countries that had been
gaining dollars--in seeing a reduction in the level of U. S. interest
rates. The feeling was that rates in general were too high and that
the key to a reduction lay in the United States.
With respect to the System's recent Regulation Q action,
Mr. Daane observed, the governors asked--not in a critical waywhy ceilings had been suspended only on CD's of up to 89 days'
maturity rather than on all maturities.

His response had been

that the System had wanted neither to encourage an undue amount of
intermediation nor to expose the United States to a large outflow
of Euro-dollars.

The discussion of the U. S. balance of payments

problem had been surprisingly quiet.

In his comments he had indi

cated that the U. S. balance of payments picture was rather bleak,
but that recent developments in the trade balance were a bright spot.
As to the U. S. economic situation, he had reported that the risks
on the down side had increased recently but that there still was a
problem of inflation to which the U. S. authorities were not obliv
ious.

The governors seemed reasonably sympathetic with this

country's efforts in the area of demand management and some even
appeared to be rather envious of its performance on this score.

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In the evening meeting, Mr. Daane continued, Dr. Zijlstra
raised the question of exchange rate flexibility, asking for views
on two specific matters: the "automatic crawling peg" and interim
floating rates.
crawling peg.

There was absolutely no support for the automatic
He (Mr. Daane) tried to shift the focus to the kinds

of specific questions now being considered in the International Mon
etary Fund, but without success.

The discussion of the second ques

tion devolved into a debate between the Canadians and others regard
ing Canada's recent move to a floating rate.

There was general

dissatisfaction--which he shared--with the way in which the Canadian
action was taken, with the absence of clear objectives, and with the
lack of any sense of the time within which there would be a move back
to a fixed rate.

The Canadians made the same defense they had made

on other occasions--namely, that they had no other means of coping
with the very large inflows that were occurring, and that they had
been unable to establish a new fixed rate because of uncertainty as
to its appropriate level.

They also expressed their allegiance to

the Fund's Articles of Agreement, and noted that the decision had
been made by the Canadian Government and not by the Bank of Canada.
Mr. Daane remarked that he had attended only a part of the
July 7 meeting of Working Party Three with Mr. Solomon, and would
not comment on developments there in light of Mr. Solomon's report in
his memorandum of July 13.1/

On July 8 he and Mr. Solomon had

1/ Copies of this memorandum were distributed to the Committee
on July 15. A copy has been placed in the Committee's files.

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participated in a meeting of the deputies of the Group of Ten.

That

meeting had been called to consider further the question of exchange
rate flexibility, following up the discussions that had been going
forward in the Executive Board of the Fund.

Press reports had indi

cated that the United States was undertaking a major initiative in
the area of flexible exchange rates.

However, Under Secretary

Volcker made it clear that this country was not proposing anything
new, but was simply carrying forward discussions that had been under
way for some time in the Fund.

Apparently, what had sparked the story

in the press was the distribution by someone at the Fund of a U. S.
paper presented by Executive Director Dale suggesting changes in a
draft of the Fund report now in preparation.

That report, which was

being prepared for consideration at the Fund and Bank meetings this
fall, would consist of two parts.

The first part would be an objec

tive review of the whole subject of exchange rate flexibility,
setting forth the pros and cons of the various issues involved.

The

second part would consist of the conclusions of the Executive Board.
The second part, which obviously was the more difficult to prepare,
was the subject of discussion at the deputies' meeting,
To sum up the present status of the matter, Mr. Daane said,
it was agreed that much had been accomplished under the par value
system involving stable but adjustable parities that had been estab
lished at Bretton Woods.

There was agreement that further consid

eration should not be given to unlimited floating rates, to
substantially wider margins, or to automatic crawling pegs.

The

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areas for possible further consideration included, first, some small
widening of margins; second, small and prompt changes in parities,
when necessary to ward off an incipient fundamental disequilibrium
that would eventually necessitate a large change; and third, transi
tional changes in parity.

The second possibility was viewed as likely

to be the most fruitful line for further consideration.

All involved

the overriding question of whether they would require changes in the
Fund's Articles of Agreement, but that question was left unresolved.
Mr. Daane observed that there probably would be a meeting of
the ministers and governors of the Group of Ten on the eve of the
Fund and Bank meetings this fall.

It seemed clear that there would

be no consensus on the matter, and that it would be carried over
for further study during the next year.
One interesting sidelight, Mr. Daane continued, was that the
discussions were of a character quite different from the earlier de
liberations on Special Drawing Rights because there was division
within the Common Market involving more than a split between the
French and other members.

The Germans and Italians were much in favor

of adding flexibility to the exchange rate system.

The French,

Belgians, and some others (most notably the Japanese) were completely
negative, and the British were not inclined to take a firm stand.
The U.S. position was that it was not seeking a lot of revaluationswhich, it thought, would be bad for the dollar--but it was seeking
a mechanism under which any necessary changes in parities could be
made in a less disruptive manner than in the past.

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Mr. Hersey then presented the following statement on inter
national developments:
One member of the Committee--as Governor Daane has
already told you--as well as staff members who were in
Europe for meetings on the Fourth of July weekend and in
the following week did not encounter a great deal of anx
iety about the U. S. balance of payments. Mr. Solomon
has suggested that perhaps this was because Europeans
are preoccupied with worries about their own inflations.
It may be, too, that central bank and government people
in Europe are well enough informed to understand that
monetary policy here is still one of restraint. And, of
course, the news of the first-quarter balance of payments
was stale, and people in Europe could not yet be aware
that the second-quarter liquidity deficit will eventually
be published at something like $1-1/2 billion, that it
was really well over $2 billion when adjusted for special
transactions, and that the official settlements deficit
was also over $2 billion. These are quarterly figures,
not annual rates, and they follow first-quarter deficits
of a broadly similar order of magnitude. A natural ques
tion to ask is what view we in the United States, and at
the Federal Reserve, should be taking of figures like
these?
Odd as it may sound, I believe there is less call
for alarm now than in July a year ago, or two years ago,
or three years ago. Let me take those situations in
chronological order.
In July 1967, we had come through a half year in
which the adjusted over-all deficit was only $2 billion,
about half as large as this year's. But an expansionary
money policy was paving the way for a new acceleration
of price inflation in this country and a new upswing in
U. S. imports.
In July 1968, a state of euphoria about the inter
national standing of the dollar was beginning to set in.
This was after the new two-tier gold system had begun to
look workable, after heavy foreign buying of U. S. equities
had been building up, and after grandiose ideas about the
French franc had collapsed. The intake of funds through
the Euro-dollar market by U. S. banks was growing. But
the U. S. trade surplus had almost disappeared, and before
the end of 1968 our net exports of goods and services were
going to be down to a rate of only $1-1/2 billion.
By July 1969, the worst had passed--in some respects.
Net exports were clearly headed upward at last. Monetary

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policy was appropriate to the country's needs, both with
respect to the balance of payments and with regard to the
more strictly domestic aspects. A basically very ugly
balance of payments position was being disguised and
beautified by an unbelievably large volume of borrowing
abroad by U. S. banks. Of course we knew very well that
could not continue.
Now, for the first half of 1970, the official settle
ments balance, which was in surplus a year ago because of
the Euro-dollar borrowing, is showing a deficit of over
$5 billion. This was due partly to $1-1/2 billion of net
repayment of U. S. liquid liabilities to commercial banks
abroad during the half year. The other $3-1/2 billion,
representing the half year's deficit on everything else,
is of course a very large sum--a far larger deficit than
we can sustain for very many half years.
Yet, as I suggested at the start, there may be reasons
why we should be no more concerned about the U. S. balance
of payments this July than we were a year ago. Since then
the annual rate of net exports of goods and services has
increased by $2 billion. On the other hand, foreign buying
of U. S. equities has turned negative and sales of U. S.
corporate bonds abroad have shrunk, with a net adverse
swing for U. S. stocks and bonds at an annual rate of some
thing like $3 billion. Partly offsetting this, U. S. pur
chases of Canadian and other foreign securities have been
curtailed greatly--though probably only temporarily.
Overall, the current and long-term capital accounts
taken together seem to have come out about the same in the
first half of this year as in the first half of 1969. But
the shift in composition between trade and capital flows
is encouraging. This judgment rests on two things:
first,
an assumption that sizable long-term capital inflows will
eventually resume, and second, on the proposition--which
admittedly is still to be tested--that because we are
making progress toward stabilization of prices and costs
in this country we can hope for more improvement in the
current account of the balance of payments.
I have been speaking of the current and long-term
capital accounts, and especially of transactions that
eventually get recorded by our statistical apparatus. At
the moment our records for the second quarter still have
many gaps. But it seems not unlikely that as much as half
of the $3-1/2 billion deficit in the first six months of
1970--and certainly a larger proportion than half in the
second quarter--will be ascribed eventually to unrecorded
and unreported movements of funds into Canadian dollars,
German marks, and Euro-dollar deposits. If ever movements

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of these kinds were to become an unceasing one-way torrent,
we would have a true balance-of-payments crisis on our hands.
I do not believe we are at that point now. Admittedly, these
movements may not be quickly reversible. Last year's flow
of unidentified U. S. funds into Euro-dollars was probably
not reversed, but much of last year's flow into German marks
probably was, after the October revaluation. Reversible or
not, these movements are at least not continuous. They can
be explained by reference to particular conditions in the
Euro-dollar market and in the exchange markets for particu
lar foreign currencies--conditions that are changing from
month to month.
For the time being, therefore, I continue to regard
the balance of payments situation as one that calls for
maintenance of as much restraint in U. S. monetary and
fiscal policies as the economy can stand, combined with
watchful waiting, rather than one calling immediately for
new measures.
For the longer run, our commitment to the SDR philos
ophy of rational planning of the growth of international
monetary reserves requires us to achieve a better equilib
rium in our external accounts. We are committed not to
pump unwanted billions of dollars into foreign monetary
reserves, and we do not have enough gold or SDR's to pay
for limitless deficits.
Mr. Hickman asked what effect on the official settlements
balance Mr. Hersey would expect if there were a further downward
adjustment of interest rates in the United States without correspon
ding declines in rates abroad.
Mr. Hersey replied that the answer would depend in large part
on the rate differentials U. S. banks would be willing to pay in
order to avoid reducing their Euro-dollar borrowings below the re
serve-free base.

He personally would consider the matter to be

less significant than effects on the balance of payments through the
underlying economic situation, since much of the Euro-dollar borrow
ings would have to be repaid at some point in any case.

It would,

of course, be undesirable to have the repayments concentrated in a

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short period.

Insofar as the objective of avoiding a heavy concen

tration of repayments was to be served by national interest rate
policies, he thought it was incumbent on Germany and the other
countries whose domestic policies had tended to keep Euro-dollar
rates high to reduce their rates, rather than on the United States
to hold its rates at high levels.

The recent small reductions in

discount and Lombard rates in Germany were to be welcomed, and he
hoped the Germans would take additional actions of that sort before
long.

In general, while he thought that from the point of view of

the payments balance it was important that the United States hold
to an anti-inflationary policy, he did not believe that that required
this country to maintain the highest interest rates in the world.
Mr. Brimmer noted that it had been suggested that the United
States was ahead of Germany--and of European countries in generalin eliminating excess demand from its economy.

He asked whether that

might not imply a lag in the ability of European countries to ease
monetary policy.

If so, the United States might face the prospect

of continued capital outflows for some time.
Chairman Burns said it was his impression that the European
countries were eager to follow the United States in reducing interest
rate levels if this country took the lead in that regard.
remarked that he shared the Chairman's impression.

Mr. Daane

Mr. Maisel added

that he would not be disturbed by capital flows arising from the
kind of lag Mr. Brimmer had mentioned; indeed, one purpose for hold
ing monetary reserves was to permit countries to tolerate such lags.

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Mr. Hickman commented that in his judgment the United States
should take the lead in lowering interest rate levels, and he viewed
as constructive what had already been accomplished in that regard.
However, in light of the current very large deficits in the U. S.
balance of payments, he had some question about the length of the
lead the United States could afford to take if it were not to dam
age confidence in the dollar.
Before this meeting there had been distributed to the mem
bers of the Committee a report from the Manager of the System Open
Market Account covering domestic open market operations for the
period June 23 through July 15, 1970, and a supplemental report
covering the period July 16 through 20, 1970.

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:
In general, pressures on financial markets have abated
since the Committee last met and interest rates have moved
lower--in some cases substantially--as the written reports
to the Committee describe in some detail. The massive shift
of credit from the commercial paper market following the
Penn Central insolvency has been accommodated so far by the
banking system in a relatively smooth fashion, although be
neath the surface a number of frantic negotiations were
required and serious problems still remain. The Federal
Reserve contributed to this orderly adjustment process in
first, through the Board's prompt action to
three ways:
remove Regulation Q ceilings on short-term CD's; second,
through reassurances to member banks that the discount
window was available in case of need and by indications
that the System would provide the reserves required for
a shift of credit back into the banking system; and third,
through the maintenance of comfortable money market condi
tions through open market operations supplemented by
increased discount window use. In addition, the slowdown

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in the economy and the recent disturbances in the finan
cial markets, particularly the decline in the stock market,
have tended to lessen inflationary expectations, even
though there is continued market concern about cost-push
pressure on prices.
The problem of the moment does not appear to be so
much one of general pressures on financial markets, even
though credit demand remains strong. Rather it appears
to be a more selective problem reflected in both the
commercial paper market and the corporate market and
arising out of the enhanced sensitivity of investors to
credit risks. While the commercial paper market has per
formed better since the first week following the Penn
Central affair, some continued attrition must be expected
as investors discriminate against two types of borrowers
in the market. The first type is the lower-rated indus
trial concern or finance company--a Baa rated concern,
for example--that places paper in the market through a
dealer. Dealers are finding considerable investor resis
tance to such paper, and more and more firms are being
forced into the banks. Fortunately most, but not all, of
the lower-rated firms probably have 100 per cent bank line
coverage. But these same firms--and indeed other similar
firms that are not involved in the commercial paper marketare also experiencing difficulty in raising funds in the
corporate bond market, as the widening spread between Aaa
and Baa yields testifies. For some of them--particularly
those with expanding financial needs--there is a real ques
tion of whether they can find adequate financing from any
source.
The second type of problem involves a number of fi
nance companies that issue paper directly and whose parent
concern is currently experiencing a poor profit performance
or some other type of problem. Investors have been shying
away from these issuers--although day-to-day experience
varies--even though the finance companies are themselves
in good shape and are considered by the banks to be per
fectly good credit risks. While banks have been willing
to negotiate additional credit lines and to purchase
receivables without recourse, the sheer magnitude of the
amounts in question--sometimes involving legal lending
limits for the banks--could make the problem a serious one
if the drain continues. There is, consequently, a risk
that the problems of a large finance company in .finding
financing or a series of failures of smaller concerns
could set off a general deterioration of market conditions,
and we should be alert to that possibility.

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The Treasury bill market--as the Government and
agency securities markets generally--has benefited
from the investor shift towards quality. Despite the
fact that the Treasury has raised $5 billion of new
money in the bill market over the past four weeks,
rates have declined and a favorable atmosphere persists.
In yesterday's regular Treasury bill auction average
rates of 6.38 and 6.44 per cent were set for three
and six-month bills, respectively, down 25 and 49 basis
points from the levels established in the auction just
preceding the last meeting of the Committee. Dealer
bill positions are substantially higher than the ab
normally low level at the time of the last meeting,
reflecting mainly acquisition of new tax-anticipation
bills originally purchased by banks in the special
Treasury auctions. They do not appear to be excessive,
however, judged by any normal standard, and as the blue
book 1/notes there should be a substantial demand for
bills over the next few weeks.
In the conduct of open market operations, our main
goal over the past four weeks was to make sure that
money market conditions--particularly as reflected in
the Federal funds market--were kept comfortable amid
the churning caused by developments in the commercial
paper market. In this our work was both assisted and
complicated by the apparent willingness of member banks
to make greater use of the discount window. Early in
the period, we decided that if there was good evidence
that member banks were acquiring reserves by increasing
their takings at the window we should hold back on
reserve supply through Desk operations. As a conse
quence, in the two weeks ending July 15 borrowings
turned out to be quite high, but the resulting high
net borrowed reserve figures had no market impact, as
participants focused on the comfortable level of the
Federal funds rate. The week ending July 15 was, in
fact, complicated by some of the largest underestimates
of reserve drains from market factors that I can ever
recall in the projections. As the week progressed we

1/ The report, "Monetary Aggregates and Money Market
Conditions," prepared for the Committee by the Board's staff.

7/21/70

-20-

supplied a very large volume of reserves and the in
creased willingness of banks to borrow tended to
minimize the impact of the reserve shortfall on the
money market. With that experience behind us, I would
tend to agree with the blue book forecast of a more
normal level of borrowings at the window. At the same
time we should be alert to the possibility that a freer
use of the discount window might tend to result in a
greater supply of reserves than we might otherwise
want.
As far as the aggregates are concerned, the credit
proxy is expanding far more rapidly than had been pro
jected at the time of the last meeting. So far the
expansion appears to be limited to a replacement of
credit previously extended through the commercial
paper market rather than a growth of total credit in
the economy. As long as this is the case there would
appear to be little cause for concern. The staff
projection of a 14 per cent annual growth rate for the
third quarter as a whole appears to me to be on the
conservative side, since the banking system will be
called on to make good a further shortfall of credit
in the commercial paper market.
The money supply is currently projected to grow
at a 10 to 11 per cent annual rate in July, with some
part of the growth perhaps related to a jump in com
pensating balances associated with the negotiations for
additional bank lines and take-downsof lines by refugees
from the commercial paper market. For the quarter as a
whole, however, the Board staff projection of a 5 per
cent growth rate is identical with the path set forth
at the time of the last meeting. The New York Bank
staff, on the other hand, is projecting a more rapid
6.5 per cent growth rate for the quarter, with an 8
per cent growth rate for August in contrast to the 2
per cent rate projected by the Board. Should the New
York projection turn out to be right, alternative B of
the directive
1/ would call more clearly than alternative
A for some firming of money market conditions over the
period until the Committee meets again, even keel
considerations permitting.

1/ The alternative draft directives submitted by the
staff for Committee consideration are appended to this
memorandum as Attachment A.

7/21/70

-21-

The Treasury, as you know, will announce next
Wednesday the terms of its refunding of $6.5 billion
maturing August issues, of which $5.6 billion is held
by the public. Some participants in the Government
securities market appear to favor a straight exchange
offering, but others are for a combined exchange-cash
offering. The latter approach would appear to fit in
well with the Treasury's need for some $4 billion
additional cash by early September, since it would
cover attrition and permit some cash to be raised in
connection with the refunding. Incidentally, I would
plan to exchange the System holdings of $489 million
maturing issues into the new issues offered by the
Treasury in proportion to the public's expected sub
scriptions.
Market sentiment coming into the refunding is more
favorable than it has been for some time and the tech
nical position of the market is good. However, as the
green book.1/
sets forth in some detail the Treasury's
cash outlook appears to have deteriorated substan
tially as expenditures are running above, and receipts
below, budget estimates. Cash needs over the balance
of the year now appear to be well above estimates at
the time of the last refunding and there is some risk
that the disclosure of these needs could have an adverse
effect on market sentiment. Incidentally, there is a
possibility--I hope a remote one--that the Treasury
might run short of cash temporarily in mid-August. In
this connection, counsel for the Committee has indicated
that paragraph 2 of the continuing authority directive
authorizing the New York Bank to lend up to $1 billion
directly to the Treasury has been in a state of de facto
suspension since July 1 because of a delay in Congres
sional action to renew the System's authority to make
direct loans to the Treasury. That legislation should
be enacted shortly and paragraph 2 would then become
effective again.
By unanimous vote, the

open market transactions in
Government securities, agency
obligations, and bankers'
acceptances during the period
June 23 through July 20, 1970,
were approved, ratified, and
confirmed.
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.

-22-

7/21/70

The Chairman then called 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. Partee made the following statement concerning economic
developments:
In the past several weeks a somewhat better atmo
sphere has developed with respect to the business sit
uation. It cannot be said with any certainty that the
low point in over-all activity has been reached, even
though some of the incoming statistics recently have
shown less weakness. But it does appear more probable
than a month or two ago that significant further declines
may be avoided. Thus, industrial production dropped
considerably less in June than in previous months, and
the earlier downturn in manufacturers' new orders appears
to have lost momentum. Retail sales data indicate that
consumer spending is holding up relatively well, as
expected, and the June increase in housing starts pro
vides confirmation that that sector will now very likely
be in a strengthening trend. New layoffs of workers
also have diminished considerably in the last month or
so, although the over-all employment picture continues
quite weak.
The first official GNP estimates for the second
quarter, which became available late last week, also add
to the impression of a bottoming out in the business
decline. The increase in current dollar GNP, at $10.6
billion, was appreciably larger than in the first quarter
and real GNP increased very slightly, in contrast to
the sizable first-quarter decline. The composition of
the GNP change, however, was weaker than these summary
figures imply. The expansion in final sales slowed
markedly, despite large supplements to personal income
resulting from current and retroactive increases in
social security and Federal pay rates, and the saving
rate rose sharply to its highest level in two years.
Business fixed investment showed virtually no increase
for the second quarter in a row, while Federal purchases

7/21/70

-23-

declined on balance and expansion in State-local pur
chases slowed. In short, the improvement in GNP
depended almost entirely on an ending of the decline in
inventory investment, which, with June figures still
missing, is estimated to have been a little higher
than in the first quarter.
The GNP data also showed a significant decline in
the rate of inflation, with the deflator rising in the
second quarter at a 4.2 per cent rate--well under the
first-quarter rate and less than we had been expecting.
Not too much should be made of this, since we understand
that the moderation--aside from the fact that the first
quarter deflator incorporated the effect of the Federal
pay raise--resulted mainly from a shifting of the
relative weights in the index towards less inflationary
sectors. But other developments also indicate that
some progress is now being made in the area of prices
and costs. Farm product prices have declined in recent
months, reflecting mainly improved supplies, and have
contributed to a considerable slowing of the rise in
the over-all wholesale price index. Sensitive indus
trial materials prices also have declined recently,
and the incidence of price increases among industrial
commodity groups in June was the lowest since last
August. On the cost side, reductions in force have
brought a resumption of the rise in labor productivity,
which goes back two quarters in manufacturing and was
extended last quarter to the private nonfarm sector as
a whole. The gains in productivity, of course, serve
to offset part of the continued rapid rise in employee
compensation, though admittedly not much offset is
possible in such cases as trucking, where the teamsters'
settlement finally turned out to be 13 per cent per
annum.
As to the future, the staff continues to expect a
modest recovery in economic activity during the second
half and extending into 1971. The principal features
of the recovery, as we see them, will be a recovery in
residential construction, more rapid growth in State
local capital outlays, and a reasonably strong expansion
in consumer spending that will moderately exceed pros
pective growth in disposable income. The business
community also generally appears to be expecting an
upturn,judging from many of the District contacts as
reported in the red book.1/ In both cases, however, the
1/ The report, "Current Economic Conditions by District,"
prepared for the Committee by the staff.

7/21/70

-24-

emphasis should be placed on the modest character of the
outlook. Earlier expectations of a vigorous rebound,
widely held among private forecasters at year-end, seem
virtually to have disappeared. Now there is general
agreement that the shock of the stock market decline,
the larger-than-expected drop in earnings, the liquid
ity squeeze, the rise in unemployment, and the sluggish
economy of the first half have introduced a tone of
caution in business planning and consumer behavior.
The question is whether the implications of this
new caution are fully taken into account in our pro
jections, and in those of businessmen generally. In
the capital spending area, for example, evidence is
accumulating that sizable cutbacks are in progress in
many industries. Dollar outlays for fixed capital, as
I have noted, are now shown in the GNP accounts to have
increased hardly at all since the fourth quarter of last
year. Physical output of business equipment as measured
by the industrial production index has dropped in each
of the last three months, by a total of 4-1/2 per cent.
And many of the District summaries comment on reports
of cutbacks and stretchouts of capital spending projects
which have yet to show up in the figures. Similarly,
some Districts comment that businessmen feel that inven
tories are too high. The data suggest a mixed picture,
but with over-all stock/sales ratios relatively high
and the ratio of inventories to order backlogs in
durable goods manufacturing very high and still rising,
there certainly would seem to be room for some cutbacks
if businessmen seriously want to tighten up their
operations.
For my part, therefore, I am not so certain that
the business decline has come to an end. I can readily
visualize a relatively sharp falling off in business
capital outlays, already in progress and extending into
1971, with consequent effects on employment, incomes,
consumption, and inventory balance. And I can also
imagine a period of inventory liquidation which, though
relatively brief and followed by some rebuilding of
stocks, would put off the over-all business recovery
until later in the year or early 1971.
Even if a resumption of the rise in business activity
is now at hand, however, every indication is that it will
be slow and halting--probably interrupted in the fall by
strikes. The profits squeeze, moreover, makes certain
that business will be striving for increased efficiencies,

-25-

7/21/70

that productivity consequently will continue to improve,
and that gains in output will be associated with a rel
atively smaller pickup in employment. Unless the labor
force continues to decline, which it has done over the
past two months but which seems extremely unlikely for
any extended period, one implication of moderate output
growth would be a continuing gradual uptrend in unem
ployment.
Under these circumstances, and with the economy now
operating well below capacity, it seems to me that credit
should be made rather freely available. There is much
to be gained, and little risk, in encouraging more credit
use to stimulate housing, State-local construction, and
consumer durable goods buying, and to finance the inven
tories that firms wish to hold. The time may even have
come, given the lags in spending and the apparent cur
tailment in current plans, to provide a little encourage
ment to capital spending plans. This, it seems to me,
requires declining interest rates and a sense that
external financing is and will remain reasonably available.
Good progress has been made toward lower interest rates
over recent weeks, but I believe that further progress
would be highly desirable in the months ahead. Toward
this end, and abstracting from the near-term constraints
of "even keel," the System should be prepared to encourage
and accept substantial rates of expansion in money and
bank credit.
Mr. Axilrod made the following statement concerning financial
developments:
Most of the financial market pressures of concern
to the Committee over the past several weeks appear to
have abated, although the commercial paper market remains
rocky. Long-term market interest rates have dropped
about 40 to 70 basis points from their mid-June peaks.
And stock prices, while fluctuating, are on their most
recent reading about 5 to 15 per cent above late-May lows,
depending on the index used. Thus, the rather generalized
crisis of confidence in which investors appeared to be
abstaining from both stocks and bonds seems to have passed.
In its wake, however, there do remain problems in
particular areas, notably the commercial paper market.
And even in the stock and bond area investors have become
much more selective. As a result, while prices have
improved on these securities, higher quality issues have

7/21/70

-26-

been favored. In the bond market the yield spread
favoring high-grade corporates has widened by about
25 basis points since mid-June, and in the stock market
prices have risen relatively less on the American Ex
change than on the New York Exchange. In short-term
credit markets, Treasury bill rates from the 3-month
area out have dropped 20 to 50 basis points since the
last meeting of the Committee, while private short
term rates have dropped considerably less and some,
like commercial and finance company paper, have shown
no rate decline at all,
Under the circumstances, even with the much im
proved tone in stock and debt markets generally, the
Committee probably should approach credit markets with
a certain wariness. With the commercial paper market
in a parlous state, a relatively large rechannelling
of credit flows appears to be in process. And profit
and liquidity conditions remain difficult enough in
some business and financial sectors of the economy so
that the odds on another confidence crisis, generated
by the failure or near-failure of some sizable company,
are certainly not trivial, though they well may have
diminished.
In the month of June outstanding non-bank-related
commercial paper dropped around $1 billion, seasonally
adjusted. The unadjusted weekly data we have for non
bank commercial paper showed a $2 billion decline in
outstandings in the week ending July 1, followed by
little net change during the next statement week--but
then, rather surprisingly, followed by a further $1
billion drop in the week ending July 15. The weakness
thus far in July is occurring at a time when in past
years there has been at least some seasonal recovery.
At the same time as outstanding commercial paper
has declined, total loans and investments of banks have
been increasing at an accelerated pace, financed
mainly by aggressive bidding for CD funds by banks
in the 30-89 day area where Regulation Q ceilings have
been suspended. During the past three statement weeks,
large negotiable CD's outstanding are estimated to have
risen by about $3 billion, reflecting the sharpest weekly
increases in the history of the series. The effect of
this unusually rapid recent CD growth on bank credit
expansion can best be seen in the weekly adjusted bank
credit proxy series, which rose by about $4 billion over

7/21/70

-27-

the three statement weeks ending July 15--roughly the
period since Regulation Q was suspended. This accel
erated rise has led the staff to forecast, given roughly
prevailing money market conditions, a 17 per cent annual
rate of increase for the adjusted proxy for July over
June and a 14 per cent rate of increase for the third
quarter.
While the growth of bank credit is accelerating
markedly, as compared with the second quarter, it does
not seem as if this will be accompanied by a near-term
upsurge in credit raised by private sectors of the
economy. U. S. Government credit demands have been
enlarged in recent weeks and will probably be larger,
after allowance for seasonals, in the third quarter
than in the second. But the volume of funds raised in
private credit markets, while remaining sizable by his
torical standards, does not appear to be rising and may
even be dropping off. As just noted, there has been a
continued attrition in outstanding commercial paper.
And in other markets, corporate bond issues are likely
to be at a slightly slower pace in July as compared
with June, while State and local government offerings
are expected to show little net change between June
and July, despite the drop in interest rates and the
greater availability of bank funds. Thus, the early
summer data that we have appear to be consistent with
a view that at the moment the growth in bank credit
primarily represents a rechannelling of credit flows.
And while the increase in bank credit availability
might encourage somewhat greater total borrowing as
time goes on, this would not be an unwelcome prospect,
given the outlook for a relatively slow rate of economic
growth.
The dimension of the prospective expansion in the
adjusted credit proxy--14 per cent in the third quarter
as against 6-1/2 per cent in the second--looks consider
ably less fearsome when funds raised by banks through
short-term market instruments are excluded, as one
might on the grounds that these instruments are funda
mentally little different in economic and financial
effect from short-term debt instruments issued by
borrowers directly. After subtracting large CD's,
Euro-dollars, and bank-related commercial paper from
the adjusted credit proxy, the growth rate in July is
reduced from 17 to 10 per cent and for the third quarter
from 14 to 8 per cent. The comparable figure for the
second quarter would be reduced from 6 to 4 per cent.

7/21/70

-28-

In terms of open market operations, the calmer
atmosphere in over-all financial markets would seem
to permit the FOMC to move back to placing greater
emphasis on monetary aggregates, a desirable devel
opment in my view. At the same time, remaining
financial uncertainties, particularly as they pertain
to the commercial paper market, make it desirable to
permit an enlarged expansion of bank credit should
that be required, as seems to be the case at the moment,
at least to sustain normal financing flows. Finally, I
continue to believe that the real rate of return on
capital--that is, the expected return on capital out
lays after allowing for price increases--is diminishing;
and if this is not to have an excessively dampening
effect on the economy, long-term interest rates should
be encouraged to decline further. Such a decline may
be consistent with a 5 per cent rate of growth in the
money supply in the third quarter, but I would continue
not to be averse to a somewhat higher rate of growthtaking into account that the real value of cash balances
(after allowing for the effect of price increases)
dropped in the second half of 1969 and did not increase
at all in the first half of 1970 despite a 4 per cent
annual rate of rise in the nominal value of the out
standing money supply. I take the decline in the real
value of cash balances over the past year and the ac
companying sharp rise in market interest rates to be
good over-all indicators, when taken together, of a
liquidity squeeze that is by no means yet unwound.
Thus, I would tend, in alternative B, to permit, or
encourage, the money supply to grow at around a 6 per
cent annual rate--which would, of course, be close to
the New York Bank staff projection mentioned by
Mr. Holmes.
Mr. Brimmer asked whether the reasons were known for the
differences between the growth rates in money projected at the Board
and the New York Bank.

The difference in the projections for

August--for increases at annual rates of 2 and 8 per cent, respectively--seemed particularly large.

-29

7/21/70

Chairman Burns remarked that before Messrs. Holmes and
Axilrod responded to that question he might note that the record
showed some substantial differences not only between alternative
projections but also between projections and events.

For example,

in May the money supply had increased at an annual rate of 3.5 per
cent, but early in that month the Board staff was projecting a 9
per cent rise.
Mr. Holmes said he did not know the specific reasons for
the difference in the figures for August, but in general such
differences reflected the fact that the two groups of projectors
worked independently of each other.

There was still some differ

ence between the Board and New York Bank figures for July; perhaps
as the July picture became clearer the projections for August would
be brought closer together.

With respect to the growth rate in

money for the third quarter as a whole, he thought the difference
between the Board's projection of 5 per cent and New York's of
6.5 per cent was quite small, considering that only a few weeks of
the quarter had elapsed.
Mr. Axilrod agreed with Mr. Holmes that the difference
between quarterly growth rates in money of 5 and 6.5 per cent was
very small for projections--particularly those made this early in
a quarter--given the past margin for error in such projections.
However, a difference between 5 and 6.5 per cent might be quite
significant when considering targets for the Committee's operations.

-30

7/21/70

He added that the Board's staff had arrived at about the same
projection for third-quarter money supply growth, given GNP and
bill rates, using two different techniques--the regular judg
mental procedures that yielded monthly as well as quarterly
projections and alternative procedures employing the quarterly
econometric model.
Mr. Brimmer remarked that in his judgment the distinction
Mr. Axilrod had drawn between targets and projections was a cru
cial one.

He would hope that any differences in recommendations

for targets would reflect different assessments of the needs of
the economy rather than simply differences in projections.
Mr. Hickman said he considered the 5 per cent growth rate
in money suggested in the blue book as a target for the third
quarter to be quite reasonable under existing circumstances.

If

developments over the next month suggested that such a growth rate
could not be achieved without a decline in interest rates the Com
mittee could consider the matter at its next meeting.

He then

asked whether there would be any substantial period before the next
meeting in which operations would not be constrained by even keel
considerations.
Mr. Axilrod replied that the answer would depend in part
on how the Committee chose to interpret "even keel" at this point;
as the members knew, that question had been considered in a recent

-31

7/21/70
staff memorandum.1/

The terms of the Treasury's August refunding

would be announced on July 29 and the payment date would be
August 17, the day before the next scheduled meeting of the Com
mittee.

Thus, under a traditional interpretation of even keel,

System operations would be constrained during virtually the whole
inter-meeting period--except perhaps for the remaining three busi
ness days of this week.

Personally, however, he had always had a

bias toward a more flexible approach to even keel, particularly
at times when the shift under consideration was in an easing
direction.

To illustrate the kind of flexibility he had in mind,

he noted that the Federal funds rate often rose during periods of
Treasury financing as a result of dealer financing demands.

If at

the same time the aggregates were growing more slowly than the Com
mittee desired, he would not consider it inappropriate to supply
additional reserves in the process of resisting such a rise.
Mr. Maisel commented that if a traditional approach was to
be followed it was important that the money market conditions pre
vailing at the beginning of the even keel period be the appropriate
ones.

For example, if revisions made this week in the projections

of the monetary aggregates were generally downward, it would be
desirable to end the week with a lower Federal funds rate than
otherwise.

1/
The memorandum referred to was entitled "'Even keel' and the
monetary aggregates" and dated July 17, 1970. A copy has been placed
in the Committee's files.

-32-

7/21/70

Mr. Holmes noted that there would not be much opportunity
to make such an adjustment since the next revisions of the projec
tions would not be available until late Thursday, when only one
business day would be left for the purpose.
Mr. Eastburn remarked that he had found the staff memoran
dum to be quite helpful.

He shared Mr. Axilrod's preference for a

more flexible approach to even keel.

In general, he thought it

would be better to vary money market conditions as needed to keep
the aggregates on target--and meet any problems posed for the
Treasury by a restructuring of financings--than to try to compensate
after a financing for large misses in the aggregates resulting from
the maintenance of an even keel.
Mr. Daane noted that, as the staff memorandum pointed out,
the Treasury might have to price new issues more generously if
greater volatility in market conditions during financings increased
the risk to underwriters.

While he thought there might be merit in

the arguments for a more flexible approach to even keel, he was not
prepared to go so far as to force the Treasury to restructure its
financing techniques.
Chairman Burns commented that some flexibility no doubt
was desirable; the Committee would not want to adhere slavishly to
an even keel policy.

However, too large a deviation from even keel

might at times result in a potential failure of a financing, and a
consequent need for large-scale operations by the System.

7/21/70

-33
Mr. Daane said he had two questions regarding the draft

directives.

First, the intended difference between the two alter

natives for the second paragraph was not wholly clear.

Secondly,

he was puzzled by the proposal to eliminate the reference to
"liquidity strains" in alternative A and to both "market uncer
tainties" and "liquidity strains" in alternative B.

In his judgment

such deletions would imply that the situation had improved more than
it in fact had.
Mr. Holmes observed that, as he understood it, the difference
between the two alternatives for the second paragraph was one of
emphasis.

Alternative A, like the directivesadopted on May 26 and

June 23, emphasized interest rates and financial market conditions;
alternative B, like the directives issued earlier in the year,
emphasized the monetary aggregates.

It was entirely possible that

operations would be the same no matter which alternative was adopted.
However, if the money supply were growing more rapidly than targeted,
the Desk would react more quickly under alternative B than under A.
Mr. Swan remarked that while there might be some difference
in emphasis under the two alternatives, that difference was likely to
be small since operations would be constrained by even keel considera
tions--even if the Committee should decide to follow a somewhat more
flexible approach to even keel.
Mr. Holmes concurred in Mr. Swan's observation.

-34

7/21/70

Mr. Hickman agreed that the choice between the two alter
natives was not likely to have much of an impact on operations,
noting in that connection that the same targets were suggested for
both in the blue book.

Nevertheless, he thought it would be desir

able to adopt alternative B, since it made clear that the Committee
was not indifferent to the growth rates in the aggregates.
In response to a question by Mr. Sherrill, Mr. Holmes said
he thought alternative B would involve a shade more flexibility
with respect to the interpretation of even keel.
Mr. Holland referred to Mr. Daane's question regarding the
proposed deletion of certain references in the alternatives for the
second paragraph.

With respect to alternative A, he remarked that

the staff had suggested deleting "liquidity strains" because it
appeared that such strains had become more selective in recent weeks
and were now focused mainly in the commercial paper market.

On that

ground, it had seemed that the problem would be adequately indexed
by the reference in the second paragraph to "market uncertainties",
which it was proposed to retain.

As the members would note, the

draft of the first paragraph included a statement on developments
in the commercial paper market.
As to alternative B, Mr. Holland continued, the staff had
suggested deleting references to both market uncertainties and
liquidity strains from the first sentence on the ground

that such

references would be essentially redundant, given the proposed proviso

7/21/70

-35

clause relating to excessive pressures in financial markets.

However,

there might be advantages in retaining the references in the first
sentence of the paragraph.
Chairman Burns commented that while the atmosphere in finan
cial markets appeared to have improved recently there was little
question in his mind that liquidity strains persisted beneath the
surface.

Accordingly, he thought a reference to such strains should

be retained in the second paragraph of the directive.
Messrs.

Daane and Hickman concurred in the Chairman's view.

Chairman Burns observed that he had been disturbed by the
very high level of member bank borrowings in the last two statement
weeks, and wondered whether the System should not have supplied more
reserves to moderate the increase.

He asked whether the sharp rise

in borrowings was unexpected.
Mr. Holmes replied that the rise in the week ending July 15
was greater than he had anticipated.

However, since the Federal

funds market had remained comfortable, it had seemed desirable not
to duplicate through open market operations the reserves the banks
were acquiring by borrowing.

There was an unexpectedly heavy reserve

drain from market factors in the same week--some $1.2 billion, com
pared with a projection at the beginning of the week of about $100
million.

As that shortfall became evident day by day the System

made large reserve injections through repurchase agreements; indeed,
a record volume of RP's was arranged during the course of the week.

-36-

7/21/70

Chairman Burns expressed concern over the risk of becoming
accustomed to very high levels of member bank borrowings and of
interest rates.

He doubted that the economy could thrive if

such conditions persisted.
Mr. Brimmer noted that borrowings had risen about $790
million during the three weeks ending July 15.

However, a staff

estimate indicated that about $480 million of that increase was
related, in one way or another, to developments in the commercial
paper market.

After allowance for those developments, the rise

did not appear unduly large.
Mr. Axilrod agreed that borrowings related to commercial
paper developments were of a different character from other borrow
ings.

He noted, however, that even such special borrowings had to

be repaid, and the longer they remained on the books the more anxious
the banks involved would be to liquidate them.

As time passed the

special borrowings were likely to become increasingly similar in
the banks' view to regular borrowings; and he would expect a con
stant level of borrowings to be associated with upward pressure on
the Federal funds rate.
Mr. Eastburn said he shared the Chairman's concern about
the level of borrowings.

He asked whether the Manager thought it

would be possible to reduce that level through open market opera
tions without having a marked effect on interest rates.

-37-

7/21/70

Mr. Holmes replied that he thought such an outcome was
possible in the period ahead since the Desk probably would be
supplying reserves in any case.
Mr. Morris remarked that, as he had advised the Board last
week, he thought the recent suspension of Regulation Q rate ceilings
for large-denomination CD's with maturities of 30 to 89 days was
producing an undesirable concentration of outstanding CD's within
a very narrow maturity range.

He asked whether the staff had any

view as to the probable consequences for the money market and the
level of Euro-dollar borrowings by banks of a suspension of rate
ceilings on longer maturities--say, out to six months.
Mr. Partee said he would want to have a detailed study
made before attempting a final response to the question.

His

offhand reaction, however, was that an action of the sort Mr. Morris
suggested would have little over-all effect on the banks' ability
to attract CD money relative to funds from other sources, since
they were already free to compete in the most important maturity
segment of the market.

However, the recent Regulation Q action

had been designed to convey a sense of temporariness, in order to
discourage banks from using the proceeds of CD sales for long-term
lending and investing and from drawing down their Euro-dollar
borrowings below the levels of their reserve-free bases.
ceiling rates were now suspended on longer-term maturities

If
that

-38

7/21/70

sense of temporariness might be lost and bank operating policies
correspondingly modified.

No doubt such an action would improve the

maturity distribution of CD's, although it was still too early to
say how much maturities had shortened as a result of the partial
suspension now in effect.
Chairman Burns noted that the average maturity of CD's had
been decreasing even prior to the Board's action, apparently reflect
ing uncertainty about the likely course of interest rates.
Mr. Holmes added that most of the bankers he had talked
with recently seemed to prefer the shorter-maturity CD's even apart
from their competitive advantage in attracting such funds, since
they hoped to roll them over later at lower interest rates.
Mr. Sherrill suggested that a shortening of maturities for
the borrower (the bank) might actually represent a lengthening of
maturities for the investor, since many of the latter were shifting
out of the generally very short-term commercial paper market.
In response to a question from Mr. Brimmer, Mr. Morris said
he would not expect banks to become more aggressive in their over-all
bidding for CD's if the ceiling suspension were broadened, and he
would therefore not expect any substantial impact.

Despite the

efforts of the Board, most banks seemed to regard the step already
taken as the beginning of a permanent change, and decisions on Euro
dollar repayments seemed to be based chiefly on rate differentials.
He also suggested that a liberalization of bank lending policies, which

7/21/70

-39

the impression of temporariness had been intended to avoid, might
actually be desirable.

In any case, he was concerned that the

limited suspension now in effect might be building an element of
instability into the banking system and thought a broadening of
that suspension would bring about a sounder liability structure.
Mr. Coldwell commented that fundamental questions might
be involved in a broadening of the ceiling suspension.

The origi

nal action had been taken in direct response to the problems in the
commercial paper market.

To extend that action without such imme

diate justification could, he suggested, have implications of a
legal nature and in terms of competitive inequities among banks.
Chairman Burns suggested that the problem would resolve
itself if market interest rates continued downward to levels at
which present ceiling rates would again become competitive.

More

generally, the question Mr. Morris had raised probably could not
be resolved satisfactorily by discussion today; staff study would
be required.
The Chairman then suggested that the Committee turn to a
general discussion of the economic and financial situation and outlook.
Mr. Heflin commented that, except for the balance of pay
ments and the general tone of the international exchanges, the
surface information on economic and financial conditions now appeared
more encouraging than at the time of the last two meetings.

However,

in spite of recent encouraging data on prices and production and the

-40

7/21/70

welcome improvement in financial markets, there still were serious
problems to be faced.

The problem that concerned him most was the

prospect of an acceleration in cost-push pressures.

The disturbingly

large teamsters' settlement and the likelihood that it would become
the norm for the important negotiations still ahead could only
aggravate the problem, and excessive wage increases undoubtedly
would soon be reflected in the price indexes.
Because of their effects on both expectations and prices,
Mr. Heflin said,he viewed the wage-cost increases as a threat to
the recent improvement in financial markets--much of which he felt
had been due to the better performance of prices over the past
month or two.

Also, if costs continued to rise, that would certainly

aggravate the unemployment problem; although the unemployment rate
had declined a little in June, it was likely to rise again, perhaps
to levels above those projected in the green book.

The combination

of rising unemployment and any new difficulties in the financial
markets would put considerable strain on the Committee's ability
to maintain a moderate growth path for the aggregates.

In sum, he

thought the apparent improvement in conditions during recent weeks
should be interpreted with caution.
Mr. Francis remarked that during the last six months the
results of policy actions taken over the last eighteen months had
been in evidence.

Even the large injection of money in the second

7/21/70

-41

quarter, which he believed was excessive, was not likely to stop
the System's progress towards reduced inflation.

Money generally

affected spending over a number of quarters, and if the Committee
could avoid a rapid growth in money from here on out, inflation would
continue to slow.

The recent general decline in interest rates in

dicated that the demand for credit was beginning to ease, and doing
so with minimum disruption in the over-all level of economic
activity.
Mr. Francis' main concern at this point was that the Com
mittee might over-estimate the decline in inflation and, by the same
token, the recovery in real growth.

He was not as optimistic as

the green book authors with respect to the outlook for inflation
and real output over the remainder of the year.

If the Committee

followed the policy of moderate growth in the monetary aggregates
it would correct the inflation and provide for resumption of a full
employment growth rate in the economy, but in his judgment that
outcome would probably take several years--rather than several
quarters.
It was Mr. Francis' belief that the price of correcting
the inflationary excesses in the economy was going to be higher
than had been anticipated.

He would hope that monetary policy over

the next year and a half would continue along the lines followed
for the last year and a half.

That moderate approach was working,

and in his view its continuance was essential to the future stabil
ity of the U.S. economy.

-42-

7/21/70

Mr. Coldwell said he sensed several different trends in
what appeared to be a transitional period.

First, there were

persisting inflationary expectations, which were being buttressed
by a rising deficit in the Federal budget.

Second, as Mr. Heflin

had mentioned, unreasonably large wage settlements were being made;
and that would have an impact on corporate profits and on prices.
Third, although the likelihood of a deep recession seemed to have
diminished, there were nagging doubts about the outlook.

Layoffs

were continuing, especially in defense-related industries, and
profit margins were narrow.

Finally, there seemed to be a longing

for certainty in the face of such unsettling developments as the
recent performance of the stock market and the Penn Central insol
vency.

Under those circumstances he thought the Federal Reserve

could make its best contribution by serving as a stabilizing
influence.
Mr. Kimbrel reported that businessmen in the Sixth District
generally shared the feeling that the Federal Reserve was making
considerable progress in attaining greater stability.

Instances

of price shading were beginning to appear for both services and
products--especially citrus fruits and fabricated steel and alumi
num products.

Bankers in the larger cities of the District were

generally pleased with the partial suspension of ceilings on large
denomination CD's, but they were somewhat apprehensive about
competing aggressively for CD funds--a reaction which he understood

-43

7/21/70
the Board had intended.

Nevertheless, he thought most District

bankers believed the suspension was a permanent move and that it
would be extended soon to include the longer maturities.

The

liquidity of the banks had not improved a great deal, and he
doubted that they were prepared to expand their loans signifi
cantly.

Rather, bankers seemed to be directing their attention

to improving their liquidity.

It therefore seemed unlikely that

a further move with respect to Regulation Q would result in
aggressive lending by banks.
Mr. Treiber said it was his general impression that signs
of weakness in the economy were mixed with signs of strength, and
that prospects remained reasonably good for renewed growth in the
not-too-distant future.

However, he was concerned about the outlook

for prices; convincing signs of fundamental improvement in the price
situation were still lacking, while demands for wage increases had
continued large.

In addition, the Federal budget outlook for the

new fiscal year had deteriorated.
As to policy, Mr. Treiber continued, he thought that for
both domestic and international reasons the Committee should
continue the approach now in effect without any basic change.
Policy should remain flexible, poised to deal with any further
market pressures that might develop--perhaps from unexpected
sources.

He would view a steady Federal funds rate in the

-44

7/21/70

neighborhood of 7-1/2 per cent as appropriate for the coming
period.

However, it seemed unrewarding to seek to specify par

ticular figures with respect to borrowed reserves, in view of the
current unsettled conditions in financial markets and the increased
use of the discount window.
Mr. Robertson expressed the view that the present stance
of monetary policy was just about what it should be.

There were

signs of progress in slowing down the rate of advance in prices
and in bringing about a resumption of moderate growth in the real
economy.
Mr. Robertson added that he hoped Administration officials
would refrain from making public statements about the appropriate
course for monetary policy.

In particular, he was concerned about

the possibility that statements calling for an easier policy might
be encouraging enlarged wage demands.
Mr. Hickman said he believed that the decline in economic
activity was bottoming out and, as Mr. Robertson had suggested,
that a resumption of moderate real growth was in prospect.

He

also agreed that there was some evidence that the rate of price
advance was decelerating, although not as rapidly as would have
been desirable.

He thought present conditions called for holding

to a policy of moderate growth in the monetary aggregates.

Under

such a policy he would expect to see continuing indications that
inflationary pressures were subsiding.

-45-

7/21/70

Mr. Swan concurred in the policy views expressed by
Messrs. Robertson and Hickman.

With regard to the so-called

"crisis of confidence" in financial markets, it was his viewwhich he believed was shared by Twelfth District bankers--that
the situation had improved since the last Committee meeting despite
lingering problems in the commercial paper market.

Bankers in his

District had participated willingly in the credit recycling process,
increasing credit lines and making loans where necessary, and thus
far none had requested special discount window accommodation.
With respect to economic conditions, Mr. Swan continued,
the Twelfth District was sharing the kinds of problems facing the
rest of the country, including those resulting from slowdowns of
capital spending and efforts at cost cutting.

Adjustments of those

types were unavoidable, however, if progress was to be made in
controlling inflation.

The District also was being affected by

some special circumstances, such as the employment decline in the
aero-space industry. But, again, that was a part of a process of
curtailing Government expenditures that was essential to the
control of inflation.
Mr. Brimmer observed that he agreed with the staff's
assessment of the economic outlook but differed from their policy
prescription.

Like others today, he thought monetary policy was

on the right track and should hold to a steady course.

Following

up a comment by Mr. Robertson, he thought that statements by

7/21/70

-46

Administration officials regarding appropriate monetary policy
were creating confusion in

the public mind as to the locus of

responsibility for such policy.
creating expectations which,

if

Those statements might also be
disappointed,

could only aggravate

the situation.
Mr. Daane said he expected the shortfalls of capital spend
ing from planned levels to be greater than the staff had projected,
and he doubted that consumer spending would increase enough to fill
the gap.

He shared the concern expressed today about the large

wage increases taking place.

Questions arose as to whether or

not validation of those increases by monetary policy could be
avoided, reminding him of the similar issue that had been debated
at length within the System some twenty years ago.

The same problem

was now being faced by many European countries and had been dis
cussed at the July Basle meeting.
have been uppermost in

Indeed,

it

could be said to

the minds of the governors there.

The

consensus view at Basle--which he shared--was that monetary policy
could not attack the wage-push problem directly and could be
expected to serve effectively only as a tool of demand management.
Mr.

Galusha commented that the staff's projections of

the unemployment rate in
5.8 per cent,

the first

two quarters of 1971--5.6 and

respectively--struck him as realistic.

believed that those levels were too high,

and that if

He also
they were

-47

7/21/70

realized both Congress and the Administration would come under
irresistible pressure to relax fiscal restraint.
Others had suggested maintaining the present stance of
monetary policy, Mr. Galusha continued.

Presumably that meant

seeking growth in money at about a 5 per cent annual rate.

He

would suggest instead that a 6 per cent growth rate be sought
over the second half of 1970.

In his judgment that would have

only a modest effect on prices--there would be slightly less
slowing in the advance of the GNP deflator--but it would have a
significant impact on the general economic climate and on the
rate of growth in real GNP in the first half of 1971.

As to the

formulation of the directive, he would favor returning to a
primary focus on the aggregates.
Chairman Burns said he, like others, had been watching
for signs of an economic recovery.

While there were some such

signs, a convincing case for an early upturn could not be made at
present.

The state of confidence had improved in the past few

weeks, and he thought the System could be proud of its contribu
tion to that improvement.

But relative to the situation earlier

in the year confidence clearly had deteriorated, and the conse
quences of that deterioration would continue to be felt for some
time.

The possibility that worried him most was not a sudden

crisis, but rather the kind of slow erosion of confidence that

7/21/70

-48-

was less visible while it

was occurring than it

became months

afterward.
The Chairman said he thought the unemployment rate might
well continue increasing for a time.
unhappy development.
in

If so, that would be an

On the other hand,

he also expected a slowing

the rate of price advance--a development that the System had

been working to bring about for a long time.

In

general, he was

more optimistic regarding the outlook for prices than he had been
for some time.

The rate of increase in wholesale prices was

diminishing; and he understood that the consumer price index
for June to be published shortly would show some improvement,
although not of a dramatic sort.

It

was important to remember

that consumer prices typically lagged other prices.
Chairman Burns observed that the policy of monetary restraint
was beginning to yield visible results, most significantly in improve
ments in productivity.

Businessmen, reacting to the profit squeeze,

were engaged in strenuous cost-cutting efforts.
figures were right,

If the available

there had been a dramatic rise in manufacturing

productivity over the course of the first quarter, and it appeared
that an equally large increase might have occurred over the second
quarter.

Further gains in productivity could be expected if, as

typically was the case, businessmen remained in a cost-cutting
mood for a time after output began to increase.

Such productivity

7/21/70

-49

improvements should offset much of the effect on costs of the
sharp increases in wage rates that were being negotiated.

Wage

increases of the recent magnitude were deplorable, and he hoped
that the President's modest move toward an incomes policy would
help to slow the rise.

He had supported that move, as well as

the President's recent statement regarding a ceiling on Govern
ment expenditures.
Chairman Burns said he believed the Committee's current
policy was about on course.

However, with unemployment likely

to continue rising for some time and with price advances
slowing, there seemed to be room for a slight relaxation of
policy.

So long as there had been no signs of improvement on the

inflation front, a policy of restraint, carrying with it high
interest rates, had been imperative.

As he had noted earlier,

however, he was concerned about the risk of becoming accustomed
to interest rate levels that perhaps were higher than the econ
omy could tolerate for an extended period.

Although most

rates had now receded from their peaks, they remained high by
historical standards, and he thought a move toward lower rates
was needed to forestall economic difficulties later on.

That

view was reinforced by his belief that the capital spending
boom was ending, and that such spending would decline.

-50

7/21/70

Accordingly, Chairman Burns observed, he would be inclined
at this point to seek a slightly more liberal rate of growth of
money.

Since there would be slack in the economy for some time

to come, such a course would not create the difficulties in the
months ahead that it would have caused if adopted earlier.

Given

the recycling of lending activity through the banking system that
was under way, he favored focusing on the money supply at this
time and would not be disturbed by fairly rapid growth in bank
credit.
The Chairman then called for the go-around of comments
and views on monetary policy and the directive.
Mr. Treiber said it seemed desirable to continue the
present form of directive with primary emphasis on financial
markets while, to the extent possible, promoting growth of the
monetary aggregates within the limit of the System's long-term
objectives.

He favored that course because open market operations

in the coming period would be constrained by even keel considera
tions and because the Committee was not yet out of the woods of
special market concerns.

Thus, he preferred alternative A to B

for the second paragraph of the directive.

As to the first

paragraph, he would suggest a small change in the sentence of the
staff's draft stating that the volume of commercial paper out
standing "contracted sharply around midyear".

Since the decline

7/21/70

-51

apparently had continued well into July, he would revise that
sentence to read that the volume of such paper "has contracted
sharply."
Mr. Francis remarked that St. Louis Bank projections indi
cated that a fairly steady 4 per cent money growth rate over the
remainder of the year would be optimal in order to achieve moderate
growth in total spending and a gradual slowing of inflation.

That

was not significantly different from the main projections used by
the Board staff in the previous month.
In his judgment, Mr. Francis continued, for the purpose of
assessing the impact of System actions on the economy, rates of
change in money calculated from quarterly averages were superior to
calculations based on final months of quarters.

The latter pro

cedure gave greater weight to possible random disturbances in the
two end-months than did the quarterly average method.
Mr. Francis said he viewed the 6 per cent rate of money
growth, on a quarterly average basis, from the first to the second
quarter as excessive and felt that continuation of such a rate
would not be desirable.

According to the blue book either alterna

tive A or B of the draft directives would result in about a 4.5 per
cent rate of expansion in money from the average of the second
quarter to the average of the third quarter.

Although he preferred

a slightly lower rate, he would go along with such a plan.

If

that growth rate was not to be exceeded, it was essential that the

-52

7/21/70

estimated rates of increase of under 2 per cent for August and
September be considered as targets to be achieved.

In his opinion,

alternative B, with its greater emphasis on monetary aggregates,
would more likely result in the targeted path than alternative A.
Therefore, he preferred alternative B.
Mr. Kimbrel said he also had been disturbed by some of the
public pronouncements of the last few weeks.

In spite of even keel

considerations, and in spite of various recent developments, he
would like to move back to the targets for growth in the monetary
aggregates the Committee had adopted earlier in the year.

He

preferred alternative B of the directive drafts.
Mr. Eastburn remarked that he, too, preferred alternative B.
As the Chairman had pointed out, confidence had been shaken.

Many

people believed that, as a consequence of recent problems of confidence
and of liquidity, monetary restraints had been lifted, and that the
Federal Reserve would not be able to bring money and credit under
control for some time to come.

It was quite important for the

Committee to demonstrate as rapidly as it could that such was not
the case, and he thought adoption of alternative B would be helpful
in that connection.
Mr. Hickman agreed with Mr. Eastburn that the need to restore
public confidence in the System's ability and determination to control
the monetary aggregates argued for the adoption of alternative B today.

7/21/70

-53

He noted that the aggregate growth rates associated with B could be
interpreted as involving a slight shift toward less restraint.

As

to specific language, he would favor restoring the references to
market uncertainties and liquidity strains.
Mr. Sherrill said he thought the choice between alternatives
A and B was a close one, although the importance of even keel consid
erations in the coming period made that choice less critical than it
might otherwise have been.

As to economic conditions, he thought

there were not good grounds as yet for believing that a recovery was
under way.

For one thing, the better performance of real GNP in the

second quarter was largely the result of improvement in the inventory
situation, and it would be optimistic to expect much further improve
ment in the second half.

For another, growth in real GNP later in

the year probably would be held down by weakness in the area of
capital spending.
Mr. Sherrill remarked that the interest rate declines that
had occurred thus far might have been larger than was justified by
the underlying situation.

Rates might stop declining now, and

perhaps even back up slightly, particularly in view of the large
backlog of demands for funds by State and local governments and
others.

In his judgment that would be a healthy development, partly

because further rate reductions of major proportions would lead to
very rapid reintermediation and might aggravate some current problems.

-54

7/21/70
Secondly,

if

U.S.

interest rates remained stable at this point and

European rates declined, the outflow of Euro-dollars would be slowedto the benefit of the balance of payments.
For such reasons, Mr. Sherrill continued, he thought it would
be best to seek stability in

interest rates and money market condi

tions rather than to emphasize the monetary aggregates.
favored alternative A for the directive.

In short, he

At the same time, he hoped

that the third-quarter growth rate in money would neither fall below
5 per cent nor rise above 6-1/2 per cent.
Mr. Brimmer said he did not wish to encourage more rapid
growth in

the monetary aggregates at this point, but he was not

sure which directive alternative was consistent with that position.
He asked whether either alternative implied a liberalization of
policy of the sort he opposed.
Mr. Partee noted that the third-quarter growth rate in
money associated with both alternatives in

the blue book was 5 per

cent, the same rate as had been associated with the directive adopted
at the Committee's previous meeting.

Accordingly, it seemed reasonable

to say that neither alternative involved any appreciable liberalization
of policy.

Perhaps he should qualify that statement because one

might argue that in June the Committee had accepted a 5 per cent growth
rate only as an expected consequence of the temporary objective of
maintaining money market stability, and it

might be said that the

-55

7/21/70

Committee still had the earlier figure of 4 per cent in mind as its
target for the longer run.

If that interpretation was correct, it

could be said that adoption today of a 5 per cent growth rate as a
fundamental target would involve some liberalization of policy.

It

was his impression, however, that the Committee had accepted 5 per
cent as its longer-run target at the June meeting.
Mr. Brimmer then said that he would favor alternative A, on
the ground that its adoption would represent a renewal of the policy
course agreed upon at the previous meeting.

However, he thought that

a reference should be retained to both market uncertainties and
liquidity strains.
Mr. Treiber noted that earlier he had expressed a preference
for no basic change in policy and had interpreted alternative A as
consistent with such a course.
Chairman Burns asked whether there was any disagreement
with the view that a reference to liquidity strains should be
included in whatever directive was adopted today, and none was
heard.
Mr. Maisel said he concurred in the analyses presented
earlier by Messs. Partee and Axilrod, and he would support alter
native B of the draft directives.

He thought the question of

whether either alternative involved a "liberalization" of policy
was largely a matter of semantics.

As he understood the distinction,

7/21/70

-56

alternative A called for holding money market rates in a narrow
range, recognizing that no one could say precisely what the con
sequences would be for the aggregates.

Under alternative B, on

the other hand, the Committee would be accepting the prospect of
relatively large credit flows.

He thought such flows were desir

able at present, and that the Committee should indicate that it
was seeking them.

He would not be concerned--and would not want

the Desk to take any offsetting action--if the New York Bank pro
jection for money growth in the third quarter at a 6-1/2 per cent
rate turned out to be right.

Such a growth rate would, he believed,

be consistent with the policy posture recommended by Messrs. Partee
and Axilrod.
Mr. Maisel added that he accepted Mr. Axilrod's view of
even keel, which called for a relatively flexible approach.
Mr. Daane said he thought the Committee should not be
contemplating any basic change in policy now, against the background
of persisting liquidity strains and market uncertainties, and in
light of the forthcoming Treasury financing.

Moreover, he thought

the present was a particularly poor time to shift away from the
traditional interpretation of even keel since that would add to
market uncertainties.

Those considerations led him to favor

adoption of alternative A, interpreted in the manner the Manager
had proposed earlier.

Within the framework of such an approach--

-57

7/21/70

involving primary emphasis on money market rates--he would be
agreeable to some shading in the direction of relaxation, as
the Chairman had suggested.

With respect to the draft of the

first paragraph of the directive, he would favor deleting the
word "some"

from the statement that "some uncertainties persist"

in financial markets.
After discussion, it was agreed that Mr. Daane's suggestion
for the first paragraph should be adopted.
Mr. Brimmer indicated that he agreed with Mr. Daane's
views on even keel.
Mr. Heflin observed that he did not favor a change in
policy.

On the assumption that neither alternative A nor B

involved such a change, he would prefer B.

The move away from a

focus on the monetary aggregates had been made in light of the
prevailing market turbulence.

He thought this would be a good

time to return to the earlier type of formulation, particularly
since operations in the coming period would probably be largely
determined by even keel considerations in any case.
Mr. Clay commented that there were encouraging indica
tions that progress was being made in the battle against price
inflation and that that was being accomplished within the bounds
of moderate adjustment in the economy.

However, he was not at

all convinced that the battle against inflation had been won.

-58

7/21/70

While inflationary expectations might have been dampened, they
still remained very strong, as did upward pressures of wage costs
on prices.
The recent high rates of growth in bank credit and the
money supply were a matter of some concern, Mr. Clay continued.
Part of the growth in bank credit was related to special circum
stances that might be temporary, but the explanation for the money
supply expansion was less obvious.

Encouragement could be derived

from staff projections of smaller rates of growth for the rest of
the third quarter, particularly in the money supply.

It was impor

tant that the rates of growth over the span of months be kept
moderate.

A 5 per cent rate of growth in the money supply was a

little on the high side, but he was prepared to accept it.

He

thought, however, that care should be taken to avoid an even higher
rate.
Mr. Clay suggested that, under the present circumstances,
it would be desirable to return to the type of directive with
primary emphasis on monetary aggregates.

Thus, draft economic

policy directive B would be appropriate for the period ahead.
Mr. Baughman suggested that the sentence in the first
paragraph of the draft directive discussing bank credit and the
money supply might be broadened to include reference to develop
ments in early July.

-59

7/21/70

Chairman Burns agreed that such a change would be helpful
and suggested leaving the precise language to the staff.
There were no objections to the Chairman's suggestion.
With respect to the second paragraph, Mr. Baughman con
tinued, the accommodative posture first adopted at the May 26
meeting had accomplished its objectives.

He thought the time had

come to return the monetary aggregates to the central position that
they had occupied in earlier directives, as was done in alterna
tive B.

He was somewhat concerned about applying the term "moderate"

to growth rates as high as 5 or 6 per cent, but he did not have
another term to suggest.
Mr. Galusha said he liked the spirit and language of alterna
tive B, but he was disturbed by the Manager's observation that under
certain circumstances B might be more restrictive than A.

He

gathered that that view was related to the fact that the New York
Bank's projections were higher than the Board's.

He thought the

Committee should aim for a 6 per cent money growth rate in the
third quarter as a whole and he favored alternative B on that basis.
In reply to the Chairman's request for comment, Mr. Holmes
said it was his impression that of those members speaking thus far
who favored alternative B, roughly half preferred a growth rate of
money during the third quarter on the high side of 5 per cent and
half favored the low side.

7/21/70

-60
Messrs. Francis and Clay indicated that they would prefer

a growth rate below 5 per cent.

Mr. Hickman observed that he would

have favored something under 5 per cent also had it not been for
the very high rate that apparently was being experienced in July.
Given the July experience, it evidently would be necessary to
tighten money market conditions to bring the rate for the third
quarter down below 5 per cent, and he would not want to see such
tightening.

Accordingly, he thought the 5 per cent rate should be

viewed as a floor.
Mr. Swan said he thought there was little difference in
the implications for operations of alternatives A and B, given their
even keel constraints and proviso clauses.

However, he agreed with

Mr. Heflin that the Committee had shifted to the formulation embodied
in alternative A under special circumstances which were now substan
tially removed.

He therefore strongly favored returning to the

kind of formulation used in alternative B.

He would not view such a

directive as involving a basic change from the policy the Committee
had been pursuing, since it continued to call for "moderate growth"
in the aggregates.

He would accept the 5 per cent money growth

target as being within the range encompassed by the term "moderate",
but he thought any increase beyond that would have to be slight if
it were to fit that description.

7/21/70

-61
Mr. Coldwell indicated that he preferred the emphasis on

money market conditions contained in alternative A of the draft
directives.

However, he had reservations about the instruction

to moderate pressures in financial markets, since he felt that had
already been largely accomplished.

Instead, he would suggest an

instruction to "encourage stability."

He saw some merit in the

implication of alternative B that no significant easing was intended,
but he thought A had somewhat the same connotation.

Moreover, the

latter retained the suggestion of some continuing market uncertain
ties.

On balance, he would prefer his amended version of alterna

tive A.
Mr. Morris thought the substantial improvement in market
confidence that had occurred in recent weeks permitted the Committee
to return to a directive centering on the monetary aggregates.
Accordingly, he supported alternative B.

As for money supply growth,

he would prefer to err on the high side of the 5 per cent target
rather than on the low.
Mr. Robertson made the following statement:
I regard the evidence and analysis presented to us
today as indicating that the economic adjustment is pro
ceeding within acceptable bounds. Unemployment and
interest rates are higher than I like, and the hoped for
slowdowns in price and wage rate increases are more lag
gard. But I think these must be viewed as essentially
the consequences of inflationary excesses that were
stronger and more deeply imbedded in our economy than
had been thought earlier. In these circumstances, I
continue to believe that two of the most important in
gredients of monetary policy are the patience and

7/21/70

-62-

determination to stick with our previously charted policy
of moderate monetary expansion until it bears fruit in an
orderly resumption of noninflationary economic growth.
With this basic policy conviction, I would like to
see us move as soon as we can away from the present direc
tive language, with its orientation to market problems,
and back to the kind of more aggregate-oriented directive
language we hammered out this spring.
I recognize that projecting aggregate movements is
difficult during this interval because of uncertainties
as to the amount of recycling of credit back through the
banking system that may take place. I have no quarrel
with such recycling--even though I regard it as a develop
ment that eases some financial tensions and hence is in
that sense expansionary--but I would emphasize that we
need to be very careful not to slip into the trap of re
garding any size expansion in bank credit as acceptable,
whether it can be directly traced to recycling develop
ments or not. Therefore, I would urge the staff to do
its best to distinguish between the amount of bank credit
expansion that is essentially recycling and the amount of
such expansion that represents bank earning asset increases
more related to broader economic developments and credit
demands. Incidentally, I found Mr. Axilrod's comments
this morning particularly helpful, and I would urge the
staff to continue to keep Committee members and the Desk
informed on this point as bank credit increases.
I am hopeful that the path of moderate monetary
expansion that I am endorsing would also carry with it
I would like
some further softening of interest rates.
to see interest rates work lower, and I believe it is
reasonable to expect some such result as the adjustment
in the economy proceeds. But I would not like to see
either the current level of interest rates or some lower
level of interest rates accepted as a prime target of
monetary policy at this juncture. I believe financial
markets are now sufficiently calm so that we no longer
have to be so assiduous in cushioning them from every
element of pressure. Granting that we must take even
keel considerations into account for most of the period
between now and the next meeting of the Committee, I
believe that we are well advised to take this opportunity
to shift back to the kind of aggregate-oriented directive
we had developed before.

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7/21/70

I believe alternative B for the second paragraph
of the directive as drafted by the staff provides ade
quately for the various concerns I have expressed, and,
accordingly, I am prepared to vote in favor of that
alternative.
Chairman Burns noted that a small majority of the Committee
members had expressed a preference for alternative B for the second
paragraph of the directive.

He reported that the staff had suggested

a revision of the first sentence of that alternative which he thought
was in accord with the discussion.

It read as follows:

"To imple

ment this policy, the Committee seeks to promote moderate growth
in

money and bank credit over the months ahead, allowing for a

possible continued shift of credit flows from market to banking
channels and taking account of persisting market uncertainties and
liquidity strains."

The rest of the paragraph, including the proviso

clause, would be as shown in the staff draft.
After discussion it was agreed that references to market
uncertainties, liquidity strains, and the Treasury financing should
all be included in a clause immediately following the introductory
phrase "To implement this policy..."

Chairman Burns then remarked that for the Manager's guid
ance it would be helpful if the members would informally indicate
their attitudes with respect to possible deviations from the tar
geted 5 per cent growth rate for the money supply in the third
quarter.

Specifically, abstracting from problems relating to the

Treasury financing, if there were to be any deviations from the

-64-

7/21/70

5 per cent target would the members prefer to have them in an
upward or downward direction?
In the informal poll seven members indicated that they
would prefer to have any such deviations be in an upward direction,
and four members indicated that they would prefer to have them in
a downward direction.
By unanimous vote, the Federal
Reserve Bank of New York was author
ized and directed, until otherwise
directed by the Committee, to execute
transactions in the System Account in
accordance with the following current
economic policy directive:
The information reviewed at this meeting indicates
that real economic activity changed little in the second
quarter after declining appreciably earlier in the year.
Prices and wage rates generally are continuing to rise
at a rapid pace. However, improvements in productivity
appear to be slowing the rise in costs, and some major
price measures are showing moderating tendencies. Since
mid-June long-term interest rates have declined consid
erably, and prices of common stocks have fluctuated above
their recent lows. Although conditions in financial
markets have improved in recent weeks uncertainties per
sist, particularly in the commercial paper market where
the volume of outstanding paper has contracted sharply.
A large proportion of the funds so freed apparently was
rechanneled through the banking system, as suggested by
sharp increases in bank loans and in large-denomination
CD's of short maturity--for which rate ceilings were sus
pended in late June. Consequently, in early July bank
credit grew rapidly; there was also a sharp increase in
the money supply. Over the second quarter as a whole
both bank credit and money supply rose moderately. The
over-all balance of payments remained in heavy deficit
in the second quarter. In light of the foregoing develop
ments, it is the policy of the Federal Open Market
Committee to foster financial conditions conducive to
orderly reduction in the rate of inflation, while encour
aging the resumption of sustainable economic growth and
the attainment of reasonable equilibrium in the country's
balance of payments.

-65-

7/21/70

To implement this policy, while taking account of
persisting market uncertainties, liquidity strains, and
the forthcoming Treasury financing, the Committee seeks
to promote moderate growth in money and bank credit over
the months ahead, allowing for a possible continued
shift of credit flows from market to banking channels.
System open market operations until the next meeting of
the Committee shall be conducted with a view to maintain
ing bank reserves and money market conditions consistent
with that objective; provided, however, that operations
shall be modified as needed to counter excessive pressures
in financial markets should they develop.
The Chairman then noted that a memorandum had been distrib
uted to the Committee from Mr. Maisel, dated June 4, 1970, and
entitled "Emergency Resolutions of the FOMC".1

/

The memorandum

had been prepared in response to a question raised by Mr. Coldwell,
at the March 10, 1970, organizational meeting of the Committee,
regarding the applicability to foreign currency operations of certain
resolutions relating to open market operations during an emergency
that had been reaffirmed at that meeting.

Mr. Maisel had concluded

that the resolution delegating authority to an Interim Committee
applied to foreign currency as well as domestic operations, but that
the resolution authorizing certain actions by Federal Reserve Banks
did not cover foreign operations.

A possible amendment to the

second resolution, consisting of the addition of a subparagraph (4),
was suggested for the purpose of extending its coverage to foreign
currency operations.

1/ A copy of this memorandum has been placed in the Committee's
files.

7/21/70

-66After discussion, the Committee agreed to incorporate the

proposed new subparagraph in the resolution in question.
By unanimous vote, the resolution
authorizing certain actions by the
Federal Reserve Banks that had last
been reaffirmed on March 10, 1970,
was amended to read as follows:
RESOLUTION OF FEDERAL OPEN MARKET COMMITTEE AUTHORIZING
CERTAIN ACTIONS BY FEDERAL RESERVE BANKS DURING AN EMERGENCY
The Federal Open Market Committee hereby authorizes
each Federal Reserve Bank to take any or all of the actions
set forth below during war or defense emergency when such
Federal Reserve Bank finds itself unable after reasonable
efforts to be in communication with the Federal Open Market
Committee (or with the Interim Committee acting in lieu of
the Federal Open Market Committee) or when the Federal Open
Market Committee (or such Interim Committee) is unable to
function.
(1) Whenever it deems it necessary in the light of
economic conditions and the general credit situation then
prevailing (after taking into account the possibility of
providing necessary credit through advances secured by
direct obligations of the United States under the last
paragraph of section 13 of the Federal Reserve Act), such
Federal Reserve Bank may purchase and sell obligations of
the United States for its own account, either outright or
under repurchase agreement, from and to banks, dealers, or
other holders of such obligations.
(2) In case any prospective seller of obligations of
the United States to a Federal Reserve Bank is unable to
tender the actual securities representing such obligations
because of conditions resulting from the emergency, such
Federal Reserve Bank may, in its discretion and subject to
such safeguards as it deems necessary, accept from such
seller, in lieu of the actual securities, a "due bill"
executed by the seller in form acceptable to such Federal
Reserve Bank stating in substantial effect that the seller
is the owner of the obligations which are the subject of
the purchase, that ownership of such obligations is thereby

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7/21/70

transferred to the Federal Reserve Bank, and that the obli
gations themselves will be delivered to the Federal Reserve
Bank as soon as possible.
(3) Such Federal Reserve Bank may in its discretion
purchase special certificates of indebtedness directly
from the United States in such amounts as may be needed
to cover overdrafts in the general account of the Treasurer
of the United States on the books of such Bank or for the
temporary accommodation of the Treasury, but such Bank
shall take all steps practicable at the time to insure as
far as possible that the amount of obligations acquired
directly from the United States and held by it, together
with the amount of such obligations so acquired and held
by all other Federal Reserve Banks, does not exceed $5
billion at any one time.
(4) Such Federal Reserve Bank may engage in operations
of the types specified in the Committee's authorization for
System foreign currency operations when requested to do so
by an authorized official of the U.S. Treasury Department;
provided, however, that such Bank shall take all steps
practicable at the time to insure as far as possible that,
in light of the information available on other System
foreign currency operations, its own operations do not
result in the aggregate in breaching any of the several
dollar limits specified in the authorization.
Authority to take the actions set forth shall be
effective only until such time as the Federal Reserve Bank
is able again to establish communications with the Federal
Open Market Committee (or the Interim Committee), and
such Committee is then functioning.
It was agreed that the next meeting of the Federal Open
Market Committee would be held on Tuesday, August 18, 1970, at
9:30 a.m.
Thereupon the meeting adjourned.
Secretary's note:
On July 15, 1970,
the second of the two letters quoted below
was sent to Mr. Elmer B. Staats, Comptroller
General of the United States, over the
signature of Mr. Holland. This letter was
in response to Mr. Staats' letter of

-68-

7/21/70

June 30, 1970, quoted immediately below,
to Chairman Burns.
Dear Mr. Burns:
The Chairman of the Joint Economic Committee of the
Congress has asked the General Accounting Office to review
the accounting standards and practices of dealers in Fed
eral Government securities in relation to their reporting
to the Federal Reserve System. A copy of the Chairman's
request has been furnished to Mr. Peter Keir of your staff. 1 /
The Committee is concerned with the soundness of the
dealers' accounting in support of the data they report to
the Federal Reserve System, in the reliability and adequacy
of these data, and in the accuracy of the reported profits
taking into account the methods of allocating expenses.
Our review is to be directed entirely to these matters
through interview, interrogation and observation of dealers'
activities. The knowledge and experience of officials of
the Federal Reserve Bank of New York who are involved with
the dealers' operations and reporting could provide valuable
insight as a basis for our review approach and possibly for
an entree to the dealers selected.
We plan to secure our basic data directly from the
dealers and to rely on the Federal Reserve Bank of New York
to validate such data from the Bank's reports and records
if needed. This should avoid any question of compromising
confidential data reported to the Bank by the dealers.
In view of the Committee's interest in speedy completion
of our review, we would very much appreciate your cooperation
in arranging with the Federal Reserve Bank of New York to
assist our representatives and give them the benefit of their
expertise.
Dear Mr. Staats:
I am replying to your letter of June 30, 1970, in
which you asked for assistance in responding to a request
from Chairman Patman of the Joint Economic Committee who
asked for a review of the accounting standards and prac
tices used by U.S. Government securities dealers in their

1/ A copy of this letter from Chairman Patman has been placed
in the Committee's files.

7/21/70

-69

reports to the Federal Reserve System. It is our under
standing that the General Accounting Office would secure
the necessary information for complying with Chairman
Patman's request by direct interviews and observation
of the dealers' activities and that the necessary basic
data would be obtained directly from the dealers. The
Federal Reserve, notably officials at the Federal Reserve
Bank of New York, would undertake to provide the GAO staff
with technical advice and might in addition be asked to
validate from the records of the Federal Reserve Bank of
New York data which the dealers will provide.
Members of the Federal Open Market Committee, which
has jurisdiction in this area, have indicated their
willingness to have the Federal Reserve cooperate in this
study in the manner you have outlined. It is their under
standing that the confidential nature of the dealers'
reports to the System would be protected and on this basis
they interpose no objection to proceeding promptly with
the study.

Secretary

ATTACHMENT A
July 20, 1970
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on July 21, 1970
FIRST PARAGRAPH
The information reviewed at this meeting indicates that real
economic activity changed little in the second quarter after declin
ing appreciably earlier in the year. Prices and wage rates generally
are continuing to rise at a rapid pace. However, improvements in
productivity appear to be slowing the rise in costs, and some major
price measures are showing moderating tendencies. Since mid-June
long-term interest rates have declined considerably, and prices of
common stocks have fluctuated above their recent lows. Although
conditions in financial markets have improved in recent weeks some
uncertainties persist, particularly in the commercial paper market
where the volume of outstanding paper contracted sharply around
midyear. A large proportion of the funds so freed apparently was
rechanneled through the banking system, as suggested by sharp in
creases in bank loans and in large-denomination CD's of short
maturity--for which rate ceilings were suspended in late June. On
average in June there was a moderate increase in bank credit and a
slight decline in the money supply; both rose moderately over the
second quarter as a whole. The over-all balance of payments remained
in heavy deficit in the second quarter. In light of the foregoing
developments, it is the policy of the Federal Open Market Committee
to foster financial conditions conducive to orderly reduction in the
rate of inflation, while encouraging the resumption of sustainable
economic growth and the attainment of reasonable equilibrium in the
country's balance of payments.
SECOND PARAGRAPH
Alternative A
To implement this policy, in view of persisting market
uncertainties and taking account of the forthcoming Treasury fi
nancing, open market operations until the next meeting of the
Committee shall continue to be conducted with a view to moderating
pressures on financial markets. To the extent compatible therewith,
the bank reserves and money market conditions maintained shall be
consistent with the Committee's longer-run objective of moderate
growth in money and bank credit, allowing for a possible continued
shift of credit flows from market to banking channels.

-2

Alternative B
To implement this policy, the Committee seeks to promote
moderate growth in money and bank credit over the months ahead,
allowing for a possible continued shift of credit flows from
market to banking channels. System open market operations until
the next meeting of the Committee shall be conducted with a view
to maintaining bank reserves and money market conditions consis
tent with that objective, taking account of the forthcoming
Treasury financing; provided, however, that operations shall be
modified as needed to counter excessive pressures in financial
markets, should they develop.