To Rescue the Dollar
Faint hearts do not win victories--and President Carter desperately needed an economic victory. Raging inflation was undermining the economy at home; overseas, the plunge in the value of the dollar posed a gigantic threat to the stability of the whole world financial system. Wild routs on the currency and stock exchanges were threatening to make his Stage II anti-inflation program a joke before it ever had a chance to get started.
So Carter made the bold move. He and his aides put together a dollar-rescue plan that amounts to a sharp and startling reversal of previous policies and aims to restore credibility to America's currency. The plan involves serious risks of starting a recession, and, at the very least, will slow down the economy. Thus Carter also risked alienating important Democratic constituencies--labor, blacks, liberals generally. But the Administration's economic team put the program together adroitly, with a sense of drama that won cheers from the world business community and provoked the most volcanic response on financial markets since Richard Nixon's surprise announcement of a wage-price freeze in 1971. The essence of the program: massive intervention on exchange markets to prop up the dollar and a switch to a really tough anti-inflation policy.
The week's drama began at 8 a.m. last Wednesday, when phones began ringing in the homes of startled reporters all over Washington. Administration officials told the newsmen that they had better get to the White House for an important announcement at 9. The callers gave no hint of what it would be about. Promptly on the hour, a grim-faced Jimmy Carter strode into a briefing room, climbed onto the podium and read a terse statement: "The continuing decline in the exchange value of the dollar threatens economic progress at home and abroad, and the success of our anti-inflation program ... It is now necessary to act."
Then Treasury Secretary W. Michael Blumenthal ticked off a list of drastic measures that the Treasury and the Federal Reserve Board will take to uphold the greenback. The key moves: 1) raising the federal discount rate by a full point to a record 9.5%, the sharpest jump in 45 years; 2) reducing by $3 billion the funds that U.S. banks have available to lend; 3) amassing $30 billion in foreign currencies, nearly all borrowed, to support dollar prices on foreign exchanges; 4) greatly increasing U.S. sales of gold.
The practical aim of these steps is to break the deadly circle in which inflation devalues the dollar, which in turn pushes up the prices of imported goods, which in turn worsens inflation. But like many governmental economic steps, this is also a psychological action designed to show the world that Carter is finally ready to move determinedly against U.S. inflation, which recently hit an annual rate of 10%. Said Carter to a Wall Street crowd, as he stood later in the week beneath a bronze statue of George Washington outside Federal Hall: "I mean business. I do not intend to fail and I will not fail."
Unlike previous Carter economic measures, which were thoroughly leaked so far in advance that the actual announcements became anticlimaxes, this one hit the financial markets with a bang. On the currency exchanges, investors and speculators who had been dumping dollars in the conviction that Washington would do nothing much to stop the slide scrambled to buy back bucks. In chaotic trading on Wednesday, the dollar rose 5% against the Japanese yen, 7% against the West German mark and 7.5% against the Swiss franc. Gold, which speculators buy when the dollar is sick and sell when they think it may recover, fell a startling $23 an ounce by the end of the week, to $215.
On Wall Street, rising interest rates are usually viewed as the worst of all poisons for the stock market. Yet traders were initially so excited by the promise of a steadier dollar that they optimistically bid up share prices with record speed; the Dow Jones industrial average jumped 35 points Wednesday, its largest one-day rise in history. On the commodity markets, prices for future delivery of cattle, soybeans and cotton briefly fell, partly in the expectation that inflation really would slow down. Oddest of all, bond prices rose sharply, and long-term interest rates actually fell. Apparent reason: a dollar recovery and less inflation might bring interest rates down in the long run, however high the Federal Reserve may jack them up over the next few months.
Bankers and businessmen quickly hailed the measures, which many thought long overdue. "Superb!" exclaimed Robert Abboud, chairman of First National Bank of Chicago. "It is stiff medicine but very much needed medicine, and I applaud the Administration for having the courage to apply it." Ford Motor Co. Vice Chairman and President Philip Caldwell said the dollar-saving moves should "slow inflation and re-establish growth on a healthier basis." Richard Kjeldsen, senior international economist for Security Pacific National Bank in Los Angeles, asserted, "The President's economic package is drastic, abrupt and volatile--it's just what the doctor ordered."
Some of the euphoria clearly passed the bounds of logic, and by week's end a reaction was setting in. Though the dollar continued gaining abroad, stock and bond prices fell back somewhat. The drop indicated that realism was replacing mere enthusiasm. Carter's new program is welcome because it is far better for Government to face up to its difficulties than to continue temporizing. But the fact that the Administration and the Federal Reserve felt such drastic steps to be necessary indicates how seriously the economic situation had been deteriorating.
Impressive as the dollar's immediate gains were, the greenback will stabilize in the long run only if Carter and the Fed demonstrate that they will stick to a tight-money policy as long as may be necessary to reduce inflation, which could be several years. Meanwhile, higher interest--New York's Citibank led the parade last week by increasing its prime rate to a numbing 10.75%--will raise the cost of borrowing by businessmen to build factories or buy machinery and by consumers to finance new homes, cars or college educations.
The result, according to many economists--including those who think that the President had no choice--is greatly to increase the chances of at least a mild recession next year (and "mild" might mean a rise in unemployment to 7 million people, from almost 6 million now). Grumbles Arthur Okun, a member of TIME'S Board of Economists and sometime Carter adviser: "The foreign exchange speculators got their way. We are going to build fewer houses and buy fewer cars in order to defend the dollar."
On the eve of Carter's surprise announcement, Otto Eckstein, head of Data Resources Inc., a computerized forecasting firm, was still not ready to forecast a downturn. His current view: "We now predict recession. At these [interest] rates you are going to drive down housing and construction." Specifically, Eckstein's DRI estimates that there is a 55% chance of recession. Milton Friedman, guru of the conservative monetarist school of economists, gloomily asserts, "We have gone beyond the point of restoring the economy without a recession."
Blumenthal vigorously disputes the idea that last week's Government actions made a recession inevitable. He contends that the downward spiral of the dollar and stock market was mostly a result of a "perverse psychological climate." The President's shock treatment, he predicts, "will turn the situation around." It will give business leaders and consumers confidence that Carter intends to be tough in defending the dollar and fighting inflation, so that they will go on buying and investing. That view has some support even among businessmen who concede that the new program will cause them some trouble. Robert Corson, treasurer of Foxboro Co., a Massachusetts maker of controlling and recording instruments, warned his collection agents that they may have to lean harder on customers to pay their bills: "People try to get free credit out of their suppliers when it gets harder to borrow elsewhere." Nonetheless, he says, "people are glad to see some measures being taken, and the psychological boost might actually encourage expansion."
If the U.S. does avoid recession, it will be a close call. Real gross national product--output of goods and services, discounted for inflation--is rising about 4% this year. The Administration's 1979 target is 3%, a rate that would keep inflation from getting worse but might not be enough to prevent unemployment from rising above its October level of 5.8% (down slightly from 6% in September). Privately, however, Administration officials indicate that they would accept a growth rate of 2%, which would certainly mean more unemployment, even though the U.S. would probably not technically be in a recession.
In any case, the steps Carter finally took last week could no longer be put off. Many economists and foreign moneymen had been urging them for months. But Carter was obviously worried about the dangers of recession and unemployment, and so he kept convincing himself that the dollar might be miraculously rescued by an improvement in the U.S. trade deficit (down from almost $3 billion in July to $1.7 billion in September), by passage of the long awaited and much battered energy and tax-cut bills, and by the President's Stage II anti-inflation program of wage-price guidelines. After all, money traders, finance ministers and central bankers agreed that the long decline had caused the dollar to be grossly undervalued. The greenback will now buy more coffee, clothes, steel or whatever when spent as a dollar in the U.S. than it will when converted into foreign currencies and spent overseas.
None of these considerations had much effect on the market. The dollar sellers--basically companies and banks that acquire dollars through normal commercial operations--could see only that the inflation rate was rising in the U.S. while it was going down in other countries, and Washington in their view was doing little to check it. Different sections of the Government were even working against each other. Step-by-step increases in interest rates forced by the Fed failed to halt an inflationary increase in the U.S. money supply. So those who sold dollars regarded the sales as a can't-lose bet. Their thinking: So what if the dollar is undervalued? It will probably go down some more, and Washington won't buy dollars to prop up the price. Get out of dollars and buy yen, marks, gold, anything.
For those who went so far as to sell short in dollars, last week's U.S. measures proved expensive. "We sure hope that we mousetrap some bastards with this," gloated one White House senior aide. And although traders named no names, they indicated that some speculators had been hurt. Said a veteran money dealer in Brussels: "One or two companies got their fingers burned right up to their armpits."
According to money traders, American companies have been selling dollars quite as actively as European and Japanese firms. Indeed, Andre Scaillet, chief money trader in Europe for First National Bank of Chicago, said before last week's rescue that American businessmen "are frequently more bearish on the dollar than the Europeans." Moreover, the selling had spread from U.S.-based multinationals to ordinary companies in the American heartland. In most cases, however, the selling was self-protective rather than speculative in the true sense; if a manufacturer in Illinois bought steel from a German mill, it had a strong motive to sell dollars and buy marks immediately to settle the bill, rather than wait until the steel was delivered when buying the same number of marks might require more dollars.
The turning point, which forced Jimmy Carter to change his mind, came shortly after he went on television Tuesday night, Oct. 24, to announce his Stage II anti-inflation program. He not only proclaimed wage-price guidelines but also pledged to slash the U.S. budget deficit further and ease the inflationary burden of Government regulation on business. Far from steadying, the financial markets went berserk with the wildest selling spree yet, obviously because investors and speculators judged the policy to be not strong enough. The U.S. stock market tumbled into a deepening nosedive that carried the Dow industrials down 105 points in the twelve trading days before last Wednesday. Gold shot up $17 an oz., to $243, in five days. The dollar sank and sank, in five days establishing four successive post-World War II lows against the Japanese yen. To Washington's alarm, the dollar fell not only against the strong German, Swiss and Japanese currencies but also against some of the world's weakest moneys--the Italian lira, the Spanish peseta, even the Canadian dollar, which earlier had fallen further and faster than its U.S. cousin.
The drop opened frightening prospects. As Blumenthal stated on TV last week, an endless fall in the dollar's value would destroy any chance that Stage II could succeed; the rise in import prices would overwhelm the most valiant struggles that companies and unions might make to stay within the domestic wage-price guidelines. And continued or accelerating U.S. inflation would eventually bring a much worse recession than any that might be forced by dollar-propping action. As William Fellner, an economist at the American Enterprise Institute, noted, "The risk of getting a recession that would occur earlier was increased [by the dollar-rescue program], but so were the chances that the recession would be milder than expected."
Further, a collapse of the dollar, the world's central trading currency, could paralyze global trade and investment. That could lead to a severe recession, not only in the U.S. but worldwide. Said one Belgian expert: "The world was facing its worst economic crisis since 1929."
The Administration picked up this feeling in September, when the International Monetary Fund convened in Washington. Even that early, the outlines of the Stage II anti-inflation program had been extensively leaked and discussed in the press. Foreign and American bankers warned U.S. Government officials that if the policy went no further than indicated by the reports they had read, the dollar would continue to fall. Immediately after the IMF meeting, Blumenthal assigned Treasury Under Secretary Anthony Solomon to meet secretly with Fed Chairman G. William Miller and plan what to do in a "worst case" of threatened dollar collapse. Solomon, Miller and two aides met regularly through October but kept their planning secret: Washington was still hoping that Stage II would give the markets confidence.
By Friday morning, Oct. 27, less than three days after the Stage II speech, it was obvious that the hope was in vain. Blumenthal phoned Carter and told him that something had to be done immediately to save the dollar.* The two huddled privately that afternoon following a Cabinet meeting. Carter told the Secretary to accelerate the planning but maintain deepest secrecy.
On Saturday, Oct. 28, Blumenthal, Solomon, Miller, Anti-Inflation Czar Alfred Kahn and Council of Economic Advisers Chairman Charles Schultze agreed on the main elements of the dollar-rescue plan during a four-hour meeting in Blumenthal's conference room. Most of the ideas were first voiced by Solomon, but they were scarcely new; non-Government people had been urging them for months. The group decided to get Carter's approval that night.
The President, returning from a grueling campaign swing through four New England states, took a helicopter to the White House rather than going to Camp David as planned; reporters speculated that he was meeting secretly with Soviet Ambassador Anatoli Dobrynin. Just before 10 p.m., the economic advisers slipped into the White House by side doors. Solomon had excused himself from a dinner party at which he was the host by saying he had to meet some steel-industry officials. In a one-hour meeting with Carter in the basement map room, where they were least likely to be observed, they cemented the plan.
Next day Solomon met separately with German and Japanese officials who had been invited to the U.S. in great secrecy, because the approval of their governments was needed for the foreign-currency borrowings. (Japanese Vice Minister of Finance Takehiro Sagami blandly told anyone who asked that he was going to Washington for a medical checkup.) Though the White House denied it, the story in Europe is that Carter himself phoned some foreign heads of government, including West German Chancellor Helmut Schmidt, to tell them what his aides were planning. Schmidt, a bitter critic of Washington's failure to prop the dollar, exclaimed to an aide as he heard about the new plan: "Na, endlich!" (Well, at last!). On Halloween morning, when Blumenthal phoned Solomon from the airport in Tulsa, Okla., Solomon informed him that everyone concerned had approved the plan; Blumenthal proceeded to a meeting of the local economic club and gamely listened to a Tulsa banker denounce him for doing nothing to defend the dollar.
The cloak-and-dagger secrecy had its desired effect; money and stock traders were caught completely unaware when Carter unfurled the program Wednesday morning (All Saints' Day is a holiday in much of Europe). Details of the plan:
P: A one-point increase in the discount rate at which the Federal Reserve lends to commercial banks, pushing it to 9.5%. That was the biggest jump since 1933,* and the more startling because the rate had already been at a record high of 8.5%. It will tend to raise all other interest rates by varying amounts, especially since the Reserve Board coupled the move with action to push up the so-called Fed funds rate at which banks borrow from each other; Fed funds rose about three-fourths of a percentage point, to almost 10%.
P: A 2% rise in the reserves that banks are required to keep against deposits of $100,000 or more. Formerly, the reserve requirement had ranged from 1% to 6%; now it will be 3% to 8%. The result: banks will have to hold in their vaults about $3 billion that they otherwise could have loaned out. That will act directly to hold down the increase in money supply, if the interest-rate boosts do not do the job.
P: A vast expansion of Treasury borrowings to defend the dollar. The U.S. will borrow nearly $20 billion in yen, marks and Swiss francs from the Japanese, German and Swiss governments and the IMF. In addition, the Treasury will sell up to $10 billion in bonds denominated in marks, Swiss francs and yen to private investors overseas. The whole $30 billion will be available to buy up surplus dollars to prevent their price from going down further. Explains Federal Reserve Governor J. Charles Partee: The scramble to sell dollars resembled "a classic run on a bank, and the reaction was also classic. You have got to stack the money out in front and say, 'Take it.' Pretty soon you'll see that people won't want it."
P: A quintupling of the amount of gold the U.S. sells each month from its vaults. The U.S. has been selling 300,000 oz. a month; beginning in December, the sales will be increased to "at least" 1.5 million oz. At present prices, that would be worth more than $320 million--but the hope is that the sales will drive the price down and make the dollar look better.
Taken together with his earlier pronouncements, these steps mark not just a sea change but an ocean change in Carter's economic policies. As recently as January, his budget and economic messages charted a policy of stimulating the economy to bring down unemployment by tax cuts and big deficits; inflation got secondary mention and the exchange value of the dollar virtually none at all. Now the President says he is committed to a program of holding down federal spending, reducing the deficit, lessening regulation of business, raising interest rates and tightening money supply. It all sounds very Republican; about the only Democratic element left in the package is the wage-price guidelines.
Even before last week's measures. Carter's political advisers were worried lest the new economic line alienate supporters on the President's left. Consumerist leaders, for example, are most unhappy about the prospect that regulation might be relaxed. The anti-inflation, save-the-dollar effort might well stir discontent among low-income voters, who may see it as pro-business (though a recession would hurt business sales and profits). Yet Vice President Walter Mondale reported to a final meeting Tuesday night that he had found deep and growing concern around the country about the dollar's plight, so that the political impact of a dramatic rescue program might be to help Democrats in this week's election. Carter's advisers, however, fear that the austerity policy will provide a rallying point for opponents in the party who might challenge him in the 1980 primaries. In the President's view, that is a risk he must take. By far the greater threat to his reelection would be continued high inflation, which angers more voters than just about anything else.
But will Carter's measures work? Only if he holds to them even when the results begin to turn unpleasant. The clearest reaction among economists, bankers and businessmen in the U.S. and Europe last week was that borrowing to defend the dollar would "buy time" to tackle inflation and the trade deficit. That is no insignificant gain; until the mad dollar-selling orgy was stopped, no economic policy of any kind had a chance of succeeding. The Administration has now shown speculators that the dollar can go up as well as down, and the boldest seller will think twice about fighting against an additional $30 billion war chest.
Europeans were quick to point out, though, that last week's rebound of the dollar did no more than restore it to its extremely low levels of three weeks ago; it still takes an even dollar, converted into Swiss francs, to buy a cup of coffee in Zurich. Washington has intervened in the exchange markets before and set off momentary dollar rallies, but it has never bought enough bucks for a long enough time to have any lasting effect. And even $30 billion is not much when measured against the $600 billion or more in greenbacks that are floating around outside the U.S. Holders of those dollars can be persuaded to hang on to them in the long run only if they are convinced that the Administration is serious about bringing down inflation, and can do it.
So the real question is whether Carter and the Federal Reserve will stick to a policy of high interest rates, slower money-supply growth and tight budget restraints when the economy slows significantly and unemployment begins to rise. That goes against Carter's instincts as a populist. Even in his Stage II speech he could not bring himself to say anything about money supply, and some of his politically sensitive advisers wanted to include in that talk a promise of lower interest rates; they were dissuaded only after a drawn-out fight.
The Administration's record for consistency in economic programs is, to put it mildly, not reassuring. Policy has jerked about erratically, from preparing a package of revenue-raising tax "reforms" to abandoning al most all of it; from insisting that a $60.6 billion deficit could not be avoided in fiscal 1979, which started Oct. 1, to slashing that figure to $39 billion. A major problem is that Carter has never chosen one official to coordinate economic policy. Treasury Secretaries like Henry Fowler (1965-68) and George Shultz (1972-74) have often exercised such a role in the past, but Blumenthal has never achieved that stature or authority. Blumenthal deserves some criticism; in addition to his early waffling on the dollar, he badly misread the state of the economy last January. On the other hand, he has been the target of sniping from the White House staff ever since they got the idea he was putting the knife into Bert Lance. Besides, Carter prefers to decide everything himself, listening first to one adviser, then another, and meanwhile his "team" voices a babble of conflicting ideas.
The confusion continued last week. Even as the President was announcing the program that the financial markets had been waiting to hear, some Administration officials most unwisely expressed hope that dollar-buying intervention on the currency exchanges would be necessary only for six months or so; fortunately, nobody noticed much. Kahn, on a TV interview show, was asked whether he would support mandatory wage-price controls if necessary to avoid a recession. He said he would, contradicting a year of Administration insistence that it would never consider controls in a situation short of war or a comparable national emergency. By week's end, Kahn recanted: he told the Senate Banking Committee that it is "terribly important that Congress realize the damage of even authorizing stand-by authority" for controls.
One test of the Administration's consistency will be what comes meetings being held now to prepare the budget for fiscal 1980. Carter has pledged to reduce the $39 billion deficit further, to no more than $30 billion. That will take some fancy cutting. Even if no new programs are started at all, the automatic growth in existing activities would result in a deficit of $46 billion to $48 billion. And the Administration has promised NATO allies that defense spending will rise 3% a year in real terms. So the cutting will have to come out of the budgets of civilian agencies.
One target for the ax is the $12 billion that the Government provides to states and cities under the Comprehensive Employment and Training Act so that they can hire the unemployed for public service jobs. The CETA program has been roundly criticized for putting workers into jobs that provide no useful training for employment in the private economy. None theless, CETA cuts would anger blacks, who regard the program as of potential benefit to ghetto youths, and organized labor, which already is very unhappy with Carter. Last week AFL-CIO President George Meany denounced the Stage II wage-price guidelines as unfair and demanded a special session of Congress to establish mandatory controls. He also took a swing at the dollar-rescue program, contending that higher interest rates would hurt workers. The President's cold response, delivered by telephone to a forum in St. Louis: "We got about as much cooperation from Mr. Meany as we had expected."
In all likelihood, rising interest rates really will hurt. At 10.75%, the prime rate that banks charge their most creditworthy business borrowers is a full three points higher than a year ago. Given the increases last week in the discount and Fed funds rates, predictions are now common that the prime will go on up to 12% or even 13%. Since all other bank lending charges are related to the prime, that would mean higher borrowing costs for everybody. Only once before has the prime reached 12%, and that was in 1974--when the nation's worst post-World War II recession was gathering force.
Rising interest rates are supposed to prompt dollar holders to invest their money in the U.S. in order to earn rich returns. In theory, high rates also restrain the borrowing that fuels inflation. Unfortunately, they hit the economy in uneven fashion. The prize example is housing, an industry almost totally dependent on credit. Right now it is in a furiously inflationary cycle. People think that a new home is likely to increase in value faster than anything else they might buy, so they borrow heavily to buy new houses; the demand causes house prices to shoot up faster still. So far, this cycle has proved impervious to rising interest rates, but at some point it has to break. Both mortgage and construction loans will become so expensive that buyers and builders will not be able to afford them. Trouble is, a decline in housing historically has led the whole economy into recession.
A crackdown on the money supply would increase the pain. In that case, credit would become not just expensive but simply unavailable to some people and businesses. In almost every country, the authority to expand or contract the money supply is vested by law in the government's central bank; in the U.S., that body is the Federal Reserve.
Though there are at least five definitions of what constitutes money supply, the most common one is currency and coins plus checking deposits (Ml). The usual process by which it is expanded: the Fed buys on the open market securities originally issued by the U.S. Treasury, and pays with its own checks, which are backed by no reserves. Thus it creates money out of thin air. Then the checks are deposited in banks by the sellers of the securities and add to the reserves that banks have available to back new loans. (Some of the loans are made to the Government; the more the Treasury has to borrow to finance budget deficits, the faster the money supply grows.) The process is often referred to as "printing money," but that is a metaphor; the literal printing of dollar bills is done by the Treasury's Bureau of Engraving and Printing.
For the past two years, the Fed has set a target of increasing money supply no more than 6% or 6.5% a year. But in 14 of the 21 months through September, money supply grew at a faster rate, sometimes more than twice as fast. The annual rate in September was 14%. Says Chicago Banker Beryl Sprinkel, a member of TIME'S Board of Economists: "Monetary policy has been more expansive than I can remember in my lifetime, except during World War II."
Why? One reason is the speed with which funds can be switched electronically from one bank account to another--for example, from savings accounts, which are not counted in the basic Ml money supply, to checking accounts, which are. A much more important reason is the voracious credit demands of a growing and inflationary economy. The arithmetic is simple: if real G.N.P. increases 3.5% and prices rise 8.5%, approximately the results expected this year, money supply must increase 12% to accommodate both. If it grows more slowly, then either production or inflation--or both--must slow down. A few economists fear that the bite will come out of production, and they oppose anything but a very gradual slowdown in money growth. "Anyone who calls for a sharper cut," says Arthur Okun, "is advocating recession, and he should come out and say so."
Many economists believe that money growth must be slowed or inflation will never subside, and the dollar will never strengthen more than momentarily (a good many of the newly created dollars find their way overseas and are sold on the money exchanges for other currencies). Officially, at least, the Fed agrees. It has been trying to move interest rates up enough to discourage borrowing, so that it will not be under pressure to add so much to bank reserves in order to meet the demand.
So far, that policy has been a flat failure. Individuals and companies have gone on borrowing despite the high rates. One reason: since loan interest is paid in depreciated dollars, it can still be regarded as cheap. If a loan costs 10.5% but inflation proceeds at an 8% rate, the "real" interest rate is 2.5%.
Leif Olsen, a star economist at Manhattan's Citibank, points out that business borrowing from commercial banks in the first nine months of this year rose at an annual rate of 15.1%, and borrowing by households is also at a record high. Borrowing by Government to finance budget deficits adds to the demand. Alan Greenspan, a member of TIME'S Board of Economists, singles out mortgage credit as "a monster loose in the system," devouring money. People are not only borrowing to build new houses but taking out second mortgages on existing homes to finance spending of various types. During the 1960s, Greenspan observes, a one-year rise of $15 billion in mortgage credit was considered large; in the past year the increase has been a staggering $100 billion.
Last week's moves by the Fed just might, at last, slow down money growth. The money supply did in fact increase much more gently in October; during the week ended Oct. 25 it actually fell a striking $5.4 billion, to $358.9 billion. Not much can be read into one week's figures, but the drop came even before the sharp jumps in the discount and Fed funds rates. Bankers view the $3 billion increase in reserve requirements as an especially important, direct move to restrain the money supply.
The simplest way for the Federal Reserve to control money supply would be to feed a predetermined quantity of reserves into the banking system, turn a deaf ear to pleas that it shovel in more, no matter how intense the demand for loans becomes, and let interest rates go wherever the market takes them. The board has traditionally resisted that approach out of fear that an abrupt crackdown in an inflationary economy would cause interest rates to leap up so violently as to produce financial chaos. Miller has said that if the board had tried that strategy in 1974 the prime rate would have hit 20%, and "as a former businessman [he was chairman of Textron at the time] I can tell you that such a level of rates would have been insupportable."
Nonetheless, it seems imperative for the Federal Reserve to tighten up by feeding less money into the banks than people want to borrow from them, an effort in which Miller will need Carter's full support. Though the board runs its own show on interest rates and money supply and is not subject to presidential orders, as a practical matter it must try to coordinate its policy with that of the Administration.
That is only one of the ways in which the President's economic policy will be sorely tested in coming months. Last week Carter was saying all the right things, working a strong anti-inflation pitch into all his campaign speeches on behalf of Democratic candidates. Typically, he told a friendly crowd of 3,000 in the Niles East High School gym just outside Chicago: "I have spelled out to the Congress, to the American people, indeed to the world, a commitment on my part to make sure that we get inflation under control."
In arranging last week's dollar rescue, the Administration also showed a sense of style and timing in economic policy that it had never before displayed. By keeping their mouths shut, officials managed to spring the announcement just when it would do nearly maximum damage to antidollar speculators. And the President demonstrated commendable willingness to swallow bitter medicine that he had long put off taking. But that ought to be only the start.
In October, wholesale prices for finished goods rose at a disheartening annual rate of 11.4%, indicating, as Carter candidly acknowledged, that inflation will get worse for a while before it improves. The President's advisers aim to bring the inflation rate down at least half a percentage point a year. Given the depth to which inflation has embedded itself in the economy, that goal is probably realistic, but it implies a struggle that may last many years before price increases can be reduced to any pace that could be considered tolerable. During those years, Carter will have to demonstrate a far greater steadiness in policy than he has shown to date.
* The call was rich in irony. Blumenthal in 1977 won a global reputation as ''the man who talked the dollar down" because he argued that its drop would bring a beneficial increase in U.S. exports and thus was no cause for alarm.
* A Treasury aide initially told Carter that the increase would be the largest since 1921. Demonstrating his awesome--and to some advisers infuriating --grasp of detail, the President quickly corrected him: there had been a one-point leap in 1933, and the 1921 boost the aide had been thinking of was actually a point and a quarter.
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