Monday, Sep. 03, 1956

A Pinch in Time

In the midst of unsurpassed prosperity, money was scarcer in the U.S. last week than at any time since the Depression. Major U.S. banks, struggling to meet the massive demands of business for plant expansion, increased the prime rate (minimum interest charged the biggest, most reliable borrowers) from 3 3/4% to 4%. By upping the price of money to the highest level it has reached in 23 years, bankers hoped to stretch available credit to satisfy the pyramiding requirements of established customers. Smaller businessmen will be paying at least 5% for loans, while many companies that have not set up lines of credit may find they are unable to raise money at any price.

As anticipated (TIME, Aug. 27), the Federal Reserve Board in midweek followed the commercial banks' lead by authorizing five district banks (New York, Chicago, Philadelphia, Richmond and Cleveland) to hike discount rates for the sixth time in 17 months. The discount rate--the basic charge to member banks for short-term loans--is expected to reach a uniform 3% (up from 2 1/4%) at all Federal Reserve Banks this week, raising the banker's cost of borrowing to a 23-year high.

Between the Reefs. By boosting the price of money and keeping it scarce, the FRB hopes to steer the economy through the twin reefs of industrial overexpansion and wage-price inflation. The demand for loans is outstripping the supply because record levels of employment, wages, spending, business investment and construction are straining U.S. credit resources more heavily than they have been pressed since 1929.

In the competition for cash, borrowers are turning from the securities market to the banks; expansion loans to business by banks since the first of the year have soared nearly $2.5 billion (to $28.6 billion--150% more than the increase in the same period last year). At the same time, businessmen have been borrowing funds for long-term projects on the short-term market, hoping that interest rates will come down. Meanwhile, to damp down the demand for credit, the Federal Reserve has let the overall supply of lendable bank funds dwindle.

The squeeze was felt throughout the economy last week. The Treasury's 91-day-bill rate, the money market's most sensitive indicator, rose .22% to 2.82%, a 23-year high. Soaring interest costs for long-term corporate bonds prompted would-be borrowers to postpone new issues; low-interest (3%), 40-year Government bonds sagged in value. While higher interest rates had been partially anticipated on the stock market, stocks dropped to the lowest point in seven weeks, then rallied at week's end. The Dow-Jon'es industrial average closed at 507.91, off 7.88 points for the week.

Clear Road Ahead. The hike in discount rates was intended not only to cool off the demand for credit but to ease down on inflation. The FRB moved none too soon. The Government announced last week that the cost of living jumped 0.7% for the second straight month in July, setting a new record (17% above the 1947-49 level). Moreover, the upsurge, paced by bigger-than-seasonal rises in fruit and vegetable prices, promises to take another bite out of the dollar. As a result of the cost-of-living increase, 1,250,000 union workers will automatically receive 3-c- to 5-c- hourly wage raises under escalator contracts geared to the price index, thus 1) increasing the cost of the products they make, 2) encouraging higher wage demands by other workers, and 3) stoking up prices by pouring new money into the consumer market.

Most bankers are confident that inflation can be pinched off without killing the boom. Says Federal Reserve Board Chairman William McChesney Martin Jr.: "I have faith in the future of this country. The road ahead is clear. The only question is: Shall we be irresponsible and drive along that road at 90 m.p.h. with one hand on the wheel? Our recent action was one of a series of moves indicating our faith in the economy, but warning some people not to go too fast."

This file is automatically generated by a robot program, so reader's discretion is required.