Corset for a Fat Lady

The U.S. economy has been expanding so rapidly that Arthur Okun, chairman of the President's Council of Economic Advisers, last week had to reach a long way for a suitably descriptive simile. He settled for "a fat lady munching candy." Said Okun: "Nobody can promise her a lovely figure overnight if she stops nibbling, but the more she overindulges the more serious the risks become."

The risks that were worrying Okun--inflation at home and a threatened dollar abroad--last week prompted the Federal Reserve Board to give the nation its third dose in five months of some painful economic medicine: higher interest rates. The Reserve Board voted unanimously to raise its discount rate from 5% to 51%. That increase in the amount the Fed's district banks charge for borrowed funds applied initially to loans to member banks from the Federal Reserve banks of New York, Philadelphia and Minneapolis. The other nine reserve banks were expected to take similar action quickly.

Twin Perils. Few bankers expected another boost so soon. And the Fed's surprise move amounts to a monetary corset for the fattening economy. "We are in the midst of the worst financial crisis since 1931," said Reserve Board Chairman William McChesney Martin. The nation, he maintained, faces "uncontrollable inflation" or an "uncontrollable recession" because of an "intolerable balance of payments deficit side by side with a budget deficit."

To avert those twin perils, said the globally respected central banker, the U.S. must cut its budget deficit in the fiscal year starting July 1 from a prospective $20 billion to less than $8 billion. Achieving such a reduction would require not only prompt enactment of the Administration-backed 10% income-tax surcharge but budget cuts at least as large as anything Congress has proposed. Moreover, said Martin, he has already told President Johnson that unless the U.S. slashes its balance of payments deficit, that problem will inexorably lead to a world devaluation of currencies. "This would not be the end of the world," he added, though he prophesied that it would cause tremendous damage to the U.S. as a world power. "To a certain extent," he said, "we have been living in a fool's paradise."

Vanishing Surplus. Martin barely hinted at another reason for the Reserve Board's new tightening of the monetary brakes. So far this year, the traditional surplus of American exports over imports has melted to "virtually no surplus at all." According to insiders who have seen preliminary estimates, the first-quarter trade figures due to be announced this week are so discouraging that they might even have started another run on the dollar had the Fed not acted when it did.

The first result of the 51% discount rate, highest since the 6% rate posted by the New York Reserve Bank for three months in 1929, was a rush by commercial banks to lift their minimum lending rate from 6% to a record 61% annual interest. That "prime rate," as bankers call it, applies to borrowing by their bluest-chip corporate customers. Other interest rates throughout the economy scale upward from that level. Bankers predicted that loans will now grow costly enough to crimp small businessmen, capital-goods industries and local government construction projects. Worst hit, as usual, will be new housing, which is uniquely sensitive to a downturn when rates jump--as mortgage lenders agreed they surely will. A more immediate reaction came on the New York Stock Exchange, where the Dow-Jones industrial average fell 11.56 points in the week's final trading session. The drop not only erased earlier gains, but left the bellwether index at 897.65, an 8.04-point loss for the week.

Tighter Cinch. Along with its discount-rate boost, the Federal Reserve lifted, from 51% to 61%, the maximum interest that commercial banks are permitted to pay on large time deposits--money left with a bank for a specified period. The new ceiling applies to "certificates of deposit" of $100,000 or more with maturities of six months or longer. By this action, the Fed hopes to prevent sharp deposit losses, which would further disrupt the already nervous financial markets.

The Fed also hopes that its move will cool an economy in which, as C.E.A. Chairman Okun aptly put it, "too much good news is bad news." His largest worry: the record $16 billion surge in consumer spending during the first three months of the year. Personal income spurted by the same amount to another record, reaching an annual rate of $659 billion. Though the total economy expanded by $20 billion, 40% of that record growth was mere inflation. If that continues, along with balance of payments and budget deficits, the Federal Reserve may well feel forced to cinch up the monetary corset still tighter.

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