Interest rates keep climbing, but people keep borrowing and lenders keep lending.
"Expensive easy money," one economist calls it, and he's right. Whether it's for a mortgage, a short term loan to finance business inventories, or long term money to build a new plant or shopping center, the money is there for most borrowers -- if they are prepared to pay the price.
Where is the credit crunch like those that cut short several other post-war economic expansions when the Federal Reserve began pushing up rates to slow down the availability of credit?
And where is the intense political pressure that normally falls on the Fed when rates begin to soar? Federal Reserve officials are amazed at how little there has been even as rates have hit record levels.
The pressure has not developed this time around precisely because money has remained available to every sector of the economy. Some important regulatory changes, a different approach by the Fed, and more agressive actions by financial institutions to raise lendable funds have made the difference.
The result of the changes, so far, has been a much slower, more diffuse impact of monetary policy on the economy. Since the federal budget has been moving sharply in the direction of restraint for a year and a half, and will continue to do so during fiscal 1980, this unexpected new look in monetary policy could turn out to be just what the doctor ordered to slowing inflation without causing a devastating recession.
Some government officials, including Treasury Secretary G. William Miller, have suggested that the current high level of interest rates is simply a direct result of equally high inflation rates. With the Consumer Price Index rising at a 13-plus percent rate, they claim, "real" interest rates are "negative" -- meaning that buying something today with borrowed money and paying interest on the loan is still cheaper than waiting a month or a year and paying cash.
If real rates are negative, is it any wonder there is so little complaint about them?
But the officials, anxious to avoid complaints, gloss over how the comparison between inflation rates and interest rates should be made. A 12-percent interest rate on a 30-year mortgage is not negative unless inflation is higher than 12 percent over the life of the mortgage, not just when the loan is initially made. Nor are today's rates negative to a business borrower who needs to finance an inventroy rising in value at only 8 percent a year.
The real explanation is that, in the past, credit often didn't just become more expensive, it dried up altogether. Usually housing bore the brunt of tight money.
In 1974, when housing was being clobbered as usual, the then-chairman of the Federal Reserve, Arthus Burns, also successfully jawboned the banks into holding their prime lending rate at 12 percent. That was fine, except that the cost of funds was so high that loans at 12 percent were not profitable for the banks. As a result, they sharply curtailed their lending activity and the economic slump worsened rapidly.
This year, neither former Federal Reserve Chairman Miller nor his successor, Paul Volcker, who took over last month, has urged banks to hold down their rates, even though the prime is now at 13 1/4 percent and rising.
To the contrary, Volcker is known to think that interest rates have had to rise both to show that the Fed will not tolerate inflation rates anything like the current 13 percent rate, and to slow down the expansion of the money supply, which has been soaring since last April.
Volcker is determine to get control of the money supply, and the techniques the Fed uses for that purpose involve pushing up interest rates. He is said to think that the higher interest rates should begin to show results -- a slower growth of the money supply -- soon.
Last week a three-person minority on the seven-member board, expressing concern that with a recession underway, further increases in rates could hurt the economy, opposed Volcker and the majority on whether to raise the Federal Reserve's discount rate, the interest rate banks pay when they borrow from a Federal Reserve bank.
Such opposition could make it difficult for the Fed to raise rates much further, even though one member of the board, Henry Wallich, declared later in the week that interest rates were not yet high enough to suit him.
Volcker himself seems to be prepared to stop pushing rates upward as soon as it can be done without appearing to abandon the fight against inflation, and without further weakening the dollar on foreign exchange markets.
While he has publicly declined to label the current economic slowdown a recession, the reason is not that Volcker believes there will be no recession. Rather, he is said to be concerned that simply using the word generates added pressure to restimulate the economy, a course he has said publicly is not appropriate at this time.
Ending the string of interest rate hikes is not apt to be the main issue facing the Federal Reserve as it sets policy in coming months. Traditionally, when a recession takes hold, the demand for credit falls away. The question at the Fed will be whether to hold the line, to let rates drift downward, or to push them down to combat the recession.
But the effect of higher rates on the economy may be as radically different from the past next year as it was this year. Take, as an example, the housing industry, where the change has been greatest.
Normally, when market interest rates rose, savers withdrew their money from the thrift institutions that make most of the country's mortgage loans and instead bought Treasury bills or some similar instrument. The thrift institutions, faced with the prospect of disintermediation, as this process is called, stopped making mortgage loan commitments. Would be buyers, unable to get mortgages, could not buy. And the number of new homes constructed usually plummeted.
Little of that happened this time around. First, beginning in the middle of 1978, federal regulators allowed the thrifts to issue so-called money market certificates, which paid a return higher than Treasury bills. Even though the allowable rates on the certificates have since been reduced slightly, savings money has not poured out of the thrifts. Mortgage money can still be had -- albeit at 12 percent and with higher down payments and "points," a loan origination fee in which each point equals one percent of the value of the mortgage.
In addition, many thrift institutions have scoured the country, and even the world, to find more money to lend. Many have increased their borrowing from the Federal Home Loan Banks. Some have agressively tapped the money markets, issuing jumbo certificates of deposits on which they pay rates competitive with commercial banks. And at least one California savings and loan even floated a bond issue in the Eurodollar market to get funds.
As a result of this striking difference in housing finance compared to earlier post-war periods when the Federal Reserve began tightening rates, new housing starts have fallen only from a 2.1-million-unit-rate a year ago to a 1.8-million-rate last month. From mid-1973, when starts were also running at a 2.1-million-rate, to August, 1974, they plunged to only a 1.1-million-rate.
Many economists expect the level of housing starts to fall to a 1.4-million or 1.5-million-rate early next year. Still, that will have been a relatively gentle slide by past standards, and the rebound will not therefore be as sharp, either.
Since the cost of money rather than lack of availability has rationed credit, policymakers can't simply turn on the money tap again. They never really turned it off.
To some extent, the same thing will be true in other credit sectors. No group has been starved for credit, and it is unlikely there will be any surge in demand for credit when rates start to fall.
So long as the progressive tightening of fiscal policy continues, the federal government will be competing less and less with private borrowers in the nation's credit markets.
Put together all these considerations, and the Fed's policy dilemma looks transitory -- and not nearly as serious as it is usually thought to be.