INFLATIONITIS: A PROBLEM OF PSYCHOLOGY

IN the manner of Janis Paige in the old Broadway smash, Pajama Game, U.S. bankers are lamenting the discovery that a 71% interest rate "doesn't mean a helluva lot." Pinched for lendable funds by Washington's fight against inflation, the nation's major banks last week raised the cost of borrowing to that level--the fourth rise in little more than three months. The prime rate, the interest that banks charge their best corporate customers, went up a full i% from the 7% rate set only last January. Although the new rate was a historic peak, neither businessmen nor bankers seemed much impressed.

"The real shock is the lack of shock," said Walter Hoadley, senior vice president and economist of the Bank of America. "People seem reconciled to it. Nowadays 71% only seems to confirm inflationitis." It also validates a growing concern that inflationary psychology may be every bit as disabling and difficult to cure as inflation itself.

Reluctant Step. One reason the rate increase caused so little commotion was that it had been anticipated in banking circles for weeks; the only question was which bank would start it. New York's Morgan Guaranty Trust Co. took the reluctant first step. The bank is, after all, well attuned to credit pressures. A leading corporate lender, it was one of the banks most severely squeezed in the "credit crunch" of 1966. This time, the Federal Reserve Board's policy of gradual "disinflation without deflation" has kept U.S. banks at some distance from anything like the 1966 crisis. Though forced to pay interest as high as 81%, the banks have been able to bring home some $2.4 billion in "Eurodollars"--or about one-fourth of the U.S. dollars on deposit in foreign branches of U.S. banks.

Demand for money is likely to remain very high indeed. For one thing, businessmen expect to spend some $73 billion, 14% more than last year, to expand their factories during 1969. "I am frankly disturbed by this evidence of how the collective decisions of investors may help to keep inflation growing," says Treasury Secretary David Kennedy. Because of the "multiplier effect" of capital outlays, each dollar of such investment adds about $2.50 to the total economy. The phenomenon worries Washington for two reasons: 1) it has an immediate inflationary effect, and 2) it could lead to industrial overcapacity followed by a profit squeeze and massive layoffs. Today the nation's factories are operating at only 84% of their capacity, well below the 90% level that normally triggers expansion.

Businessmen are increasing their expansion plans for a variety of interwoven reasons. The momentum of 96 consecutive months of economic expansion leaves most executives confident about 1969, despite all the talk of a slowdown. Last week the Commerce Department reported that factory orders for durable goods--an important indicator of future economic activity--rose by $1 billion in February to a record level of $31 billion. Even a small decline in auto assemblies last month did not prevent industrial production from setting a new record for the fourth month in a row. Recovering from a January slump, personal income increased $5.3 billion in February to a record annual rate of $491 billion. Most of that jump came from substantial wage increases, which spur businessmen to invest in labor-saving new facilities and equipment. Beyond that, says John R. Hunting, president of Philadelphia's First Pennsylvania Banking & Trust Co.: "Borrowers feel that inflation is here to stay and that it's better to borrow now than later."

Many businessmen are tied to spending plans formulated months ago. The rising cost of money has prompted U.S. Steel to review its $600 million-plus 1969 spending plans, but any cuts could not even begin to take effect until September. Before it crimps corporate spending, the monetary squeeze will spread unevenly through other sectors of the economy.

As usual, housing will be hit first and hardest because higher interest rates elsewhere will siphon away funds normally available for mortgages. Small businessmen will feel the pinch immediately. Consumers may expect to pay more shortly for auto and appliance loans. Record bond interest rates have now soared beyond the reach of many local governments, forcing them to postpone many projects such as sewer and water lines and school buildings. New York Telephone had difficulty finding takers for a $150 million issue yielding 7.47%. New York's Consolidated Edison had to pay a record 7.9% on an issue of $80 million of construction bonds. Many treasurers are turning away from bonds altogether, reasoning that it is better to pay 9% or so for a two-year bank loan than to be committed to 71% or more on a 30-year bond.

Usury Ceilings. In many states, certain types of loans are becoming almost unavailable because of the low ceilings on interest rates set by usury laws. Margin loans for stock purchases are drying up in such places as Vermont and New Hampshire. In Michigan, which has a 7% usury limit, unincorporated businessmen and partnerships can no longer legally borrow at a rate that lenders will accept. Illinois lenders shun home loans because of the state's 7% ceiling; now the legislature is moving to up the limit to 9%.

Whether the present mix of fiscal and monetary policies will bring the "gradual" economic slowdown that the Administration wants should be known in a few months. Most taxpayers will be painfully reminded in mid-April that not all of last year's 10% income tax surcharge was covered by their withholding taxes. The federal budget will soon shift to a slight surplus after three years of inflationary deficits. At this point, top Administration officials figure that present measures will begin to bring inflation under control--perhaps without another dose of higher interest rates.

"I think the message is already starting to get through," says Paul McCracken, chairman of the President's Council of Economic Advisers. "Policies can be decisive and persistent without being cataclysmic."

Amid the uncertainties of an ebullient springtime economy, businessmen can only hope that McCracken's vision is correct.

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