Swinging the Big Stick

As Harvard Dean John Dunlop was being sworn in as director of the Cost of Living Council last week, President Nixon pointed to a closet door in his Oval Office. "There's a stick in the closet, a very big stick," he said, "and I will never hesitate to use it in our fight against higher prices and higher taxes."

With that threat of action against wage and price raisers, Nixon was trying to calm fears that his month-old Phase III is a retreat from the fight against inflation. To help make the point, two of the most powerful men in Government took the stick out of the closet last week and started swinging.

Treasury Secretary George Shultz warned a group of oil-company executives at a COLC hearing that the Government might roll back recent increases in the cost of home heating oil. Since mid-January, these prices have gone up as much as 9%. Oil executives say that the increases are a consequence of rising demand, dwindling energy supplies and increasingly stringent environmental regulations that have shifted consumption to low-sulfur oil. The COLC has asked oil companies to submit data this week justifying the price increases.

Federal Reserve Board Chairman Arthur Burns brandished the stick at four Eastern banks that had raised their prime interest rates from 6% to 6%%. Burns sent telegrams demanding figures to support the increase. Within three days, officers of three of the banks--the Bank of New York, Manhattan's Franklin National Bank and Philadelphia's Girard Bank--changed their minds. The one holdout, perhaps temporarily, was Philadelphia's First Pennsylvania Banking and Trust Co.

Bitter Pill. The toughest confrontation was between Burns and the First National City Bank of New York. Citibank's chairman, Walter Wriston, and its president, William Spencer, talked with Burns in separate arm-twisting sessions. With great reluctance, they agreed not to raise the prime rate to 6 1/4 as they had contemplated. The bank issued a hard-edged statement that "the base rate, which previously was determined by the free market, is now being administered by the federal authorities." All this was a particularly bitter pill for Wriston, who is a member of the Cost of Living Council's advisory committee and an important idea man behind Phase III. For many months he has been advising President Nixon to dump fixed guidelines for wage, price or interest-rate increases.

Lest the bankers show any urge to fight for much higher interest rates, Burns has warned them that the Government could always impose mandatory controls on rates. Also, the Federal Reserve can veto bank mergers and acquisitions. Burns is unlikely to use that power in direct retaliation, but the bankers do not want to antagonize him, particularly at a time when they have many acquisitions in the works. Instead of raising the prime now, bankers are likely to offer the 6% rate to fewer borrowers. Or, as Economist Milton Friedman quips, the prime rate is the rate at which banks will refuse to lend money to their best customers. Charges for other kinds of short-term credit--Treasury bills, federal funds, 90-and 180-day commercial paper--will keep edging upward. Rates are rising because loan demand is increasing.

Rising interest rates are regarded by stock investors with alarm. The recent drop in the stock market has been caused by the dollar's weakness abroad and inflation fears in Phase III--but most of Wall Street's anxiety can be linked to rising interest rates. Tight credit can drag on the economy, and high rates on bonds can attract available funds, driving down stock prices.

Wall Street is probably overdoing its pessimism. Interest rates are not likely to rise high enough to produce a serious credit squeeze, as they did in 1966 and 1969. Alan Greenspan, a member of TIME's Board of Economists, predicts that short-term rates will taper off in the autumn after peaking at about 7% for Treasury bills. The Federal Reserve expanded the money supply by a healthy but temperate 7.4% from the fourth quarter of 1971 to the same period last year. Burns appears willing to moderate that growth rate only slightly this year. In December, the money supply soared by 13.3%, but Burns announced last week that it increased "by about zero" in January, the first sharp halt since November 1971. The standstill was probably not intentional, since it is difficult for the Federal Reserve to control the money supply precisely.

In any case, it will be many months before such long-term rates as home mortgages and consumer finance charges will be affected by the rise. Banks and savings and loan associations still have no shortage of lendable money for housing. Most likely, economic expansion during the rest of 1973 will also show itself largely immune to those palpitations. A more pressing concern will be to keep the boom from getting out of hand. By letting other short-term interest rates creep up while he jawbones the prime, Dr. Burns may be trying to fill that prescription.

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