"If you can't hit the M1 money targets, change the targets." That's what Chairman Paul A. Volcker of the Federal Reserve seemed to be saying when he testified before the House Banking Committee last week. His statement that the Fed intended to raise M1's growth range was an attempt to calm the market's fear of an imminent tightening of credit due to the large growth of M1 during the first half of the year. At first the market responded favorably, but by the close it surrendered most of its gains.
It would appear that the central bank is trying to buy time in hopes that some of our financial and economic problems would take care of themselves. Perhaps the money supply would slow, or perhaps Congress would get its act together and do something positive concerning the budget deficits, or just maybe the economic recovery might lose some of its vigor.
However, the market saw things differently. Maybe this "retargeting" was good for the market over the short term, but on a long-term basis it was perceived as inflationary. One casualty of this reasoning was the two-year note that was auctioned on Wednesday. It failed to receive any good retail buying interest. Consequently, if the Treasury cannot sell two-year notes to suspicious investors, to whom will it sell some $15 billion of 3-to-10 and 30-year maturities during the last week of July?
The recent Griggs and Santow market letter pointed out that commercial banks purchased about $50 billion of new Treasuries during the first half of the year while the recovery was still weak and consumer and business credit demands flat. Now, as the recovery shifts into higher gear and credit demands are picking up, Griggs and Santow suggest that the banks will have less of a need for Treasuries at a time when the new-issue supply will be even greater than in the first half of the year. This means that the other investors must take up the slack and higher rates could be needed to attract new investors.
Lacy Hunt, the chief economist of the government bond firm of Carroll McEntee and McGinley, pointed out that the major problem for the recovery was the imbalance in federal financing. He said that the deficits symbolize the more fundamental problem of constantly increasing federal spending. He also pointed out that during 1979 through 1982, the annual interest paid on the national debt was larger than the deficits themselves. He added that if the deficits stay around $200 billion a year, and with the interest cost on the debt at 10 percent, the interest expense on our debt will jump by some $20 billion per year, adding more to our woes.
Hunt then looked at the relationship between our personal savings versus government borrowing. He noted that savings have been declining while the governments needs were increasing. In 1970, $4.73 of savings were available for each $1.00 of government borrowing. In 1983, Hunt estimates that 58 cents of savings will be available for every dollar of government borrowing. He concludes that one reason that the money supply is growing is that the Fed must create more money to cover the needs created by the huge deficits.
The bottom line for this exercise is that in a normal business recovery or expansion, rising credit demands can be expected to increase interest rates. It's a natural and expected phenomenon. However, when you superimpose the added demnds of financing a $200-billion deficit on top of the genuine credit needs, and when these demands are seeking a finite amount of savings, something has to give. And that something will be interest rates, regardless of whether the monetary growth targets are changed or not. Prices may rise again, but we have seen the interest rate lows for the cycle.