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Statement of
William McChesney Martin, Jr.,
Chairman, Board of Governors of the Federal Reserve System,
before the
Ways and Means Committee
of the
House of Representatives

January 22, 1968

It is less than eight weeks since I last had the opportunity to discuss with this Committee the economic and financial
conditions of the country, but these have been eventful weeks indeed.
Production, employment and incomes have all surged to new peaks, and
unemployment has fallen sharply.

With the retarding effects of major

strikes largely behind us, the fundamental strength of expansionary
forces in the economy has been more clearly revealed.
But, unfortunately, the surge in domestic activity has
been accompanied by a further rapid advance in prices.

And, unfortunately,

these developments in domestic activity and prices have been accompanied
by a serious deterioration in our international payments balance,
necessitating the mounting of a new and more stringent program for
temporary restriction of capital outflows and other expenditures abroad.
As the President stated, in his balance of payments message,
"The first line of defense of the dollar is the strength of the American
economy."

That strength is now being sapped by inflation.

second quarter in a row,

nearly

For the

half of the rise in our gross

national product has reflected inflated prices rather than real growth.
Prices have risen at wholesale and retail, for farm products as well as
for industrial commodities.
been accelerating.

Moreover, the pace of the increase has

The rise in the price component of the GNP, which

had slowed to about a 2 per cent rate last spring, was advancing at a
rate of over 4 per cent in the final quarter of the year.




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It is clear from the experience of 1966 and 1967--and
indeed, from many other periods in our history—that we cannot achieve
sustained economic growth under conditions of inflation.

The dis-

tortions that inflation induces in the structure of output and demands,
and the pressures it generates in financial markets, inevitably result
in economic dislocation.

Inflation in 1966 was followed by a cessation

of growth in early 1967; a more severe adjustment was averted only by
the prompt and flexible use of monetary and fiscal policies.
less, there was a penalty topay—
employment —

for

in

Neverthe-

the form of lost production and

the failure to act early enough the preceding year in

containing the emergence of excessive demand pressures.
We are now seeing some of these distortions and pressures
developing again.

Businessmen have already begun to step up their

accumulation of inventories, in part to "beat the price rise."
Negotiators of new wage contracts have built last year's price rise
into next year's wage costs.

But consumers have reacted to swiftly

rising prices by spending more cautiously.
The increase in business ordering and inventory accumulation has been reflected in a faster pace of business borrowing at
banks, accompanied by a reduced flow of banking funds into securities.
In financial markets, the high levels of yields on market securities
has begun to curtail the availability of funds for the financing of
home construction, both by reducing the inflows of consumer savings to
institutions specializing in home finance, and by diverting funds from
mortgages to other types of investment at institutions that normally




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do a substantial mortgage loan business.

Repeating the by-now

familiar cycle, growth in commitments for mortgage lending is being
curtailed, and mortgage yields have already risen back to the peaks
of 1966.
The pressures that developed in financial markets over the
summer and fall of 1967 reflected not only the normal rise in private
demands for funds that accompanies resurgence in economic activity,
but also the extraordinary additional demands arising from the Federal
Government's deficit.

Borrowing by the Treasury in the second half of

last year was more than double that of the preceding year; the Government accounted for more than a quarter of all the funds raised in
credit and equity markets between June and December, compared with
less than a tenth in the comparable period of 1966.
The reaction of other borrowers to this enormous volume
of Treasury financing, and to the possibility of continued preemption
of loanable funds by the Government, was a flood of corporate and
municipal security issues last summer and fall.

The combined pressures

of Federal and private credit demands resulted in a rise in interest
rates that, by December, brought most long-term borrowing costs to
levels well above those reached at the height of the credit strain in
1966.
Pressures in financial markets have abated somewhat in
recent weeks, partly as a result of seasonal factors, partly in
response to peace rumors, and partly because of revived hopes for
greater fiscal restraint.

But in the absence of such restraint, the

Government's financing needs will again press on financial markets.




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Without the added revenues from the proposed surcharge, the Treasury
will have to borrow a substantial volume of funds this winter and
spring, a period of the year when it
of funds to the market.

usually has been a net supplier

Moreover, the prospects of continued large

Treasury financing, and the attendant prospects of continued and-perhaps accelerating—inflation, would undoubtedly stimulate a
renewal of large private financing demands.
If these developments result in renewed and stronger
tensions in financial markets, housing finance would undoubtedly
suffer again, better insulated though it may be from a repetition of
the sharp contraction in 1966.

As I commented to this Committee last

September, it is neither socially justifiable nor economically sound
to put so much of the burden of financing a war on one sector of the
economy.
Distortion in the domestic economy is only one of the
risks we face if excessive demand pressures remain unchecked.

We need

to combat inflation not only to prevent erosion of the value of the
dollar domestically but also to maintain its value internationally.
Our merchandise trade balance has already been sharply
reduced.

It would serve for naught for us to curb international out-

flows on capital account through temporary restrictions, but at the
same time lose the battle to improve the long-run strength of our
balance of payments stemming from the competitiveness of U. S. products
in world markets.

The ability of a country to compete energetically

and successfully in international markets is widely recognized as one




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of the firmest indications of the strength of a currency.

Corres-

pondingly, a country whose international trade position is weak and
seems to be deteriorating may find its currency subject to speculative
attacks.
Changes in the competitive position in international trade
of an industrial country occur gradually over time.

But once lost, a

strong competitive position is difficult to regain.

It would be a

poor bargain to improve our over-all payments position temporarily
through stringent curbs on capital outflows, while neglecting to take
the steps necessary to assure the long-run strength of that position.
That strength depends in large measure on curbing the inflationary
cost and price increases that would make it increasingly difficult for
our exports to compete in world markets and for our domestically produced goods to compete with imports.
The surest way to surmount this threat is through restraint
on public and private spending, the goals of the fiscal program that
the President has put before you.

By reducing to a minimum the risk

of continued inflation, we would demonstrate to the world the high
priority we give to maintenance of the competitive position of the
United States dollar.

Even more important, we would thereby lay the

basis for a balanced and sustainable rate of real economic growth that
is, in the end, the true source of confidence in our currency, at home
and abroad.





Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102