WHY INTERESTS RATES HAVE BEEN RISING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP57-00384R001200010003-6
• Release Decision: RIFPUB
• Original Classification: K
• Document Page Count: 4
• Document Creation Date: December 20, 2016
• Document Release Date: July 11, 2001
• Sequence Number: 3
• Publication Date: July 1, 1953
• Content Type: MAGAZINE

Approved For Release 2007/02/24: CIA-RDP57-00384R001200010003-6
Why Interest Rates
Have Been Rising
E. SHERMAN ADAMS
Deputy Manager of the American Bankers Association in charge of
the Department of Monetary Policy
W.
HAROLD BRENTON, presi-
dent of the American
Bankers Association, re-
cently stated:
"W e can't expect some 'Of our
citizens to understand the justifica-
tion for higher interest rates under
existing conditions unless they are
told the reasons. It then logically
follows that bankers should explain
to their customers the role of inter-
est rates in a free enterprise econ-
omy."
Businessmen and individuals have
been finding that borrowing has be-
come less easy and more costly.
Some have the impression that
either the Federal Reserve System
or the banks, or perhaps both, have
somehow been "pushing up" inter-
est rates. It is hard for them to
see how tighter money contributes
to the welfare of the American Nevertheless there is widespread
people. agreement among competent author-
Actually, the whole cause of sound ities on the broad principles of mon-
monetary policy is involved. For etary policy, and these fundamentals
although the Federal Reserve Sys- can be understood by non-experts.
tem has not been "pushing up" in- The essential points which should
terest rates, the rise in rates does re- be more widely known and under-
fleet the fact that, for several years, stood, can be summarized as fol-
the System has not prevented them lows :
from hardening. This policy has
helped to halt the erosion that had
been taking place for years in the
purchasing power of the American
dollar. It operates today as a safe-
guard against renewed inflation.
Explaining the role of interest
rates to the public is by no means
an easy assignment. A whole new
generation has grown up which has
never before seen anti-inflationary
monetary policy in action. The sub-
ject is rather technical and on some
aspects the experts disagree.
(1) Like all other prices, in-
terest rates-the price of credit-
are the result of supply and de-
mand forces, except when they
are rigidly dictated by govern-
ment.
INTEREST rates reflect the relation-
ship between the supply of loanable
funds and the demand for them.
When demand is large relative to
supply, interest rates inevitably
tend to rise. When the opposite
July 1953
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situation prevails, rates decline.
For many years before World
War II, for example, the sup-
ply of funds was large and, with
business in the doldrums, demands
for money were small. As a result,
interest rates persistently declined
to the lowest levels on record.
During the war, the Government's
needs for borrowed money were
enormous. To facilitate this bor-
rowing and to hold down its cost,
the Federal Reserve System, through
its open-market operations, main-
tained a fixed pattern of rates for
Treasury borrowing throughout the
war.
(2) The fundamental reason
for the hardening of interest rates
since 1945 is the business boom,
which, like all booms, has been
accompanied by large demands
for credit.
DURING a boom, everybody wants
to borrow. The businessman wants
to increase his inventory, buy new
machinery, expand his plant. The
public, fully employed and optim-
istic, wants to borrow to buy new
homes, new cars, new appliances.
That, of course, is just what has
been happening in this country, on
an unprecedented scale, ever since
the end of World War II. And the
Federal Government, for most of
these years has been borrowing too.
This huge demand for credit is
the basic reason why interest rates
have been rising. Market yields on
long-term Treasury bonds turned
upward early in 1946, and short-
term rates started up in 1947. For
several years, the rise was gradual.
Banks were eager to make loans
and, in addition, the Federal Re-
serve System, for a variety of rea-
sons, kept pumping out more funds
in support of the market for Govern-
ment securities.
(3) The public welfare nor-
mally requires that money should
tighten and that interest rates
should rise when inflation threat-
ens.
WHEN credit expands at a reason-
able rate, it performs a vital func-
tion of financing increased produc-
tion and consumption. It is when
credit expands too fast that we get
into trouble. When our economy is
operating at full capacity, then a
big increase in borrowing and spend-
ing is bound to bid up prices. Under
these circumstances, a substantial
increase in credit, even for "pro-
ductive purposes," turns out to be
unproductive and inflationary from
the standpoint of the economy as
a whole.
The best way to prevent such an
overexpansion of credit is simply
to permit the increased demands of
borrowers to cause some tightening
of credit and some hardening of
interest rates. This curbs the ex-
pansion of credit in two ways :
Some potential borrowers are dis-
couraged by the higher cost; others,
usually the least creditworthy, are
unable to obtain credit accommoda-
tion.
The alternative would be inflation
and instability. The cost of higher
rates is negligible compared with
the toll taken from everyone's pock-
et by inflation. It is infinitesimal
measured against the losses of in-
come that occur when an inflation-
ary boom leads to a depression.
Sound monetary policy is in the
interest of the entire community.
(4) Since the outbreak of the
Korean war, the Federal Reserve
has permitted credit to tighten in
order to combat the threat of in-
flation.
THE outbreak of the Korean war
generated renewed demands for
credit. As always, this tended to
tighten credit conditions. Bank
loans had doubled since the end of
World War II, and many banks
were beginning to "run out of
money." Since Korea, bank loans
have increased another 50 percent,
so more and more banks have been
approaching the position of being
"loaned up."
The Federal Reserve System could
have kept credit easy if it had de-
cided to pump out all the additional
funds required to meet the increased
demands. Obviously, however, such
a policy would have provided no
restraint against excessive credit
expansion. The Reserve System has
therefore followed a policy of trying
to supply enough additional funds
to finance increased production but,
at the same time, to prevent credit
from expanding too fast. In short,
it has curbed inflationary pressures
by permitting the abnormal demands
for borrowing to tighten credit con-
ditions.
Its most dramatic move was in
March of 1951 when, with the
Treasury's acquiescence, it stopped
supporting Government bonds at
par. Before that, life insurance
companies and other lenders had
been able to sell Governments to
the Federal at par or better and
thereby obtain additional funds to
invest in mortgages and new cor-
porate bond issues. This made
available a virtually unlimited sup-
ply of cheap long-term credit. By
stopping its support of Government
bonds at par, the Federal Reserve
ceased to be an engine of inflation.
(5) Interest rates are still rela-
tively low for this stage of the
business cycle.
INTEREST rates today appear high
only in comparison with the excep-
tionally low rates which developed
during the long period of depressed
business preceding World War II.
It was an historical accident that
these very low rates happened to
prevail at the time of Pearl Harbor
and were therefore used as a basis
for the low pattern of rates adopted
for the Treasury's wartime fi-
nancing. When we emerged from
the war with a vastly swollen public
debt, there was a strong desire to
keep rates low in spite of their
inflationary effects.
This largely explains why rates
are still low in comparison with
other prosperous periods. Despite
more than a decade of almost un-
interrupted boom-the biggest in
our history-most interest rates are
substantially lower than before the
Big Depression. For example, as
compared with an average rate of
more than 51/2 percent for the
Twenties, lending rates of banks in
principal cities averaged 31/2 per-
cent during the first quarter of
1953. The Federal Reserve discount
rate of 2 percent today compares
with 6 and 7 percent in 1920 and
a range of 3 to 6 percent for the
rest of the Twenties.
sow
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(6) The trend of interest rates
has been upward throughout most
of the free world in recent years.
I N virtually every country of the
free world, interest rates are now
higher than they were before World
War II, and considerably higher
than in the immediate postwar pe-
riod. In fact, the rise in long-term
rates in the United States has been
moderate compared with increases
elsewhere. Our long-term rates are
well below general world levels.
Compared with the Federal Re-
serve's discount rate of 2 percent,
rates of central banks in the United
Kingdom, France, Germany, Neth-
erlands, Belgium, and Sweden range
from 3 to 4 percent.
(7) The present level of in-
terest rates does not result in ex-
cessive earnings for banks and
other lenders.
Nqwp~
orbitant profits" for banks and
other creditors. This, they say, is
a "bare-faced steal" from the pock-
ets of debtors and taxpayers.
It is true, of course, that low
interest rates do benefit borrowers
but only at the expense of savers
and other lenders. For about two
decades, borrowers have never had
it so good, but savers have never
had it so bad. The long period of
low interest rates greatly increased
the cost of life insurance and private
pension plans. It seriously reduced
the income of endowments, hospi-
tals, educational institutions, and
others.
The real answer, however, is that
to the extent that higher interest
rates contribute to a stable economy
and a stable dollar, they are benefi-
cial to all groups-and particularly
to the taxpayers who must pay for
a vast rearmament program.
As for the banks, tighter money
is by no means an unmixed blessing.
It has restricted the growth of their
loans and investments and has
caused substantial losses and de-
preciation in their bond portfolios.
Higher interest rates have induced
many corporations to draw down
SOME of the proponents of always-
easy-money contend that higher in-
terest rates are resulting in "ex-
A
their bank balances to invest in
short-term Government securities.
Finally, part of the Federal Re-
serve's restrictive program was a
SELECTED INTEREST RATES.1910 -1953
INCREASED DEMANDS FOR CREDIT J
HAVE BEEN PUSHING
INTEREST RATES UPWARD
FOR SEVERAL YEARS
High IGrade Bond Yields*
7-
Bank Rates on Business Loans
2" - \
I
ARE STILL LOW F I
COMPARED WITH Prime Commercial Paper
BEFORE THE BIG DEPRESSION
0'
a
I I I I I I I I I I I I I I I I I I I I I I l I l i i
p 910 1915 1920 1925 1930 1935 1940 1945 1950 19530
Composite series: 1900.19 Standard Statistics' High-Grade Railroad Bonds. 192030 Moody's Aaa Railroad Bonds 1931-53 Moody's Aaa Public Utility Bonds
i
d
se
A Federal Reserve series, rates on short-term loans in principal cities. R ? series rev
V Federal Reserve series, 4.6 month paper in New York City
boost in bank reserve requirements
in 1951 and this deprived the banks
of the use of about $2-billion of
their assets.
At this stage of the business
cycle, with loans at record levels,
the banks ought to be showing
really good earnings. Last year net
profits of all member banks aver-
aged less than 8 percent of total
capital accounts, and dividends
amounted to only 3.7 percent. If
this is the best the banks can do
at such a time, what will their pos-
ition be when the abnormal demands
for credit subside and interest rates
again decline?
This situation is reflected in the
fact that most bank stocks are
quoted at less than their book
values. The verdict of the invest-
ment market is that bank earnings
are not too satisfactory.
(8) The existence of market
depreciation in bank bond ac-
counts is no reason for objecting
to the principle that interest rates
should be permitted to rise.
THERE are many bank directors-
and probably some bankers-who
do not understand, and are unhappy
*401 1`11
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about, the depreciation in their
banks' bond portfolios.
The fact is, of course, that rising
interest rates mean declining bond
prices-they are, indeed, synony-
mous. The market yields of Govern-
ment securities are the basic inter-
est rates which affect the level of
all other rates. When these market
rates of interest on Government ob-
ligations are low, all other rates
tend to be low. When they rise,
all other rates tend to rise.
It would be nice, from the stand-
point of lenders, to have both high
money rates and high bond prices,
but that is literally impossible. We
simply cannot have it both ways.
One consolation about lower bond
prices is that new investments can
now be made at higher rates than
formerly. Another, for most banks,
is that bond depreciation is largely
academic because most of those
book losses will never have to be-
come real losses. The average bank
will probably achieve somewhat bet-
ter earnings in 1953 than last year
or the year before, and it is these
actual results, after all, that really
matter. Finally, some banks can
use bond losses to good advantage
for tax purposes.
But the real, answer is that it
is essential to the health of a free
enterprise economy that interest
rates should be flexible. That means
bond prices will decline under cer-
tain conditions as well as rise under
others. Moreover, it is not the
banker's job to try to outguess the
bond market. These fundamental
facts about the banking business
should be understood by every bank
director.
(9) Discussion of the Treas-
ury's recent offering of long-term
bonds has greatly exaggerated its
actual importance.
THE dramatic and controversial
aspects of the Treasury's recent
bond issue have attracted much at-
tention. The chief significance of
the offering is that it indicated a
change from the policy of the past
seven years. It also unsettled the
bond market.
Viewed in perspective, however,
the offering of $1-billion of long-
term Treasury bonds at 31/4 percent
is, in itself, something less than
Ifto, VW
epochal. It will be recalled, for ex- restraint has been in the
ample, that during the 13 years
preceding 1946, the Treasury was
continually bringing out new long-
term bond issues-far more, in fact,
than had previously been issued in
our entire history. Taking taxabil-
ity and tax rates into account,
many of those offerings involved a
higher net cost to the Treasury than
the new 31/4s. Moreover, most of
them were made when the difference
in cost between short-term and long-
term financing was considerably
greater that it is today.
The size of the new issue is, of
course, small. It is about one-tenth
as large as the last offering of mar-
ketable long-term bonds under the
Truman Administration. It repre-
sents less than 2 percent of the
Treasury's obligations due this year.
It is about half of 1 percent of
the total debt.
Its main effect upon the economy
is that it has absorbed some savings
which otherwise would have gone
into capital expenditures. But with
private investment now at a $54-
billion annual rate and with gross
national product exceeding $360-
billion, a Treasury bond offering
of $1-billion does not look very
significant.
(10) It is the overwhelming
informed consensus that the Fed-
eral Reserve has been right in
its general policy of permitting
credit conditions to tighten.
MANY economists would word this
proposition even more emphatically.
In fact, most would probably agree
with the recent assertion of Chair-
man Martin of the Federal Reserve
Board that the stability of the
American economy over the past
two years would not have been
achieved without the contribution
made by Federal Reserve policy.
There is some disagreement
among the experts, naturally, with
respect to certain of the Federal
Reserve's actions. Judgments are
always bound to differ as to ex-
actly how an agreed-upon principle
should be applied under various cir-
cumstances. However, the main
point is that there is almost com-
plete unanimity among competent
authorities on the broad proposition
that a monetary policy of moderate
transparently clear when one con-
siders the alternative. To keep cred-
it easy during such a period would
be to invite over-expansion and
over-speculation, and thereby sow
the seeds for a depression.
It would be a public misfortune
if monetary policy were to become
a political football. Nor would it
make sense either logically or his-
torically. The principle of flexibil-
ity of interest rates has repeatedly
received bipartisan endorsement by
the Joint Committee on the Econ-
omic Report. The present policy of
credit restraint was initiated under
a Democratic administration and
has been developed under three Re-
serve Board chairmen who were ap-
pointed by Democratic presidents.
It has not been basically altered by
the shift to a Republican adminis-
tration.
Conclusion
What of the future? As long as
the boom continues, the Federal Re-
serve intends to adhere to a re-
strictive policy. This could easily
mean some further tightening of
credit.
The degree of restraint that is ap-
propriate as conditions change is
obviously an extremely complex
problem which the Federal Reserve
authorities are constantly studying.
The degree of restriction to date
has been moderate. If desired, pres-
sure could easily be increased. On
the other hand, past experience has
demonstrated that there are serious
dangers involved in putting on the
credit brakes too hard.
When the current boom subsides,
private demands for credit will
slacken and credit will therefore
tend to ease. When that happens,
it is to be expected that the Federal
Reserve will promptly reverse its
policy and permit rates to decline.
Over the years, this alternative eas-
ing and tightening of credit can
make an important contribution to
the stability of our economy.
In a democracy such as ours,
sound monetary policy cannot sur-
vive and be truly effective without
the support of the public, and this,
in turn, requires understanding.
Bankers have a public obligation,
as well as a duty to their own in-
stitutions, to do what they can to
contribute to that understanding.
-Awe
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