As the bond market continued to fall April 30, President Reagan's two top monetary strategists in a closed-door, Cabinet-level meeting put the blame squarely on the nation's central bank: the Federal Reserve Board, headed by Paul Volcker.
Assistant secretary of the Treasury Beryl Sprinkel and assistant budget director Lawrence Kudlow did not mince words. They indicted the Fed for inflating the money supply in a vain effort to force interest rates down. The perverse result of money-supply tinkering has been higher interest rates (the prime moved to 19 percent Monday). That threatens Reagan's economic program with disaster no matter how strong he is in Congress.
Responsible administration officials talk guardedly of a possible financial panic later this year, with failing lending institutions and bankrupt small businesses. That is why key administration officials want a quick, well-publicized Oval Office meeting where Ronald Reagan would deliver a Dutch Uncle lecture to Chairman Volcker.
There is little that the Fed can do quickly to retrieve the situation. But the spectacle of the Fed chairman paying homage to the president might sweeten the temper of financial markets. That, combined with Reagan's success toward passage of his budget and tax programs, could halt the ruinous drop in bond prices, which are tied to interest rates.
Critics of the Fed say I told you so. The economic task force headed by budget director David Stockman had prepared a section of the federal economic report sharply critical of Fed operations. But the president's orthodox outside economic advisers, headed by Arthur Burns (a former Fed chairman himself) and Alan Greenspan, killed the report. A policy of detente with Volcker was established.
As detente was pursued, "the Fed printed money," in the words of one bitter administration official. Such Reaganites believe that unwitting expansion of bank reserves caused by clumsy Fed tinkering the past three months have sent interest rates to the sky and frightened financial markets into the cellar.
The fright in the markets was heightened by $35 billion in new federal borrowing since the beginning of the year. The White House staff, led by Edwin Meese III, long ago smothered the declaration of economic emergency suggested by Stockman and Rep. Jack Kemp during the transition. As a result, there was no appeal to Congress for quick action on the budget and tax cuts.
But, say the Reaganites, tax-cutting and budget-cutting progress was good enough to warrant more favorable market reaction. It was overridden by what administration monetary experts consider an inept, doctrinaire Fed staff tinkering with bank reserves in ways that perhaps even Volcker does not fully understand. To its critics, the Fed is a runaway bank exceeding its balance.
As the bond market continued to fall on April 30 and, even more seriously, on May 1, Miss Rosy Scenario gave way to Mr. Bleak Forebodings inside the administration. With small businesses unable to borrow funds, the prospect of bankruptcy for small banks and savings and loan institutions is possible.
The administration's principal recourse is to send a message to the markets that Reagan is truly serious about curbing inflation. That explains Stockman's decision to try cutting another $5 billion in the last five months of fiscal 1981. It also will explain the expected biting of the bullet when Stockman cuts back on Social Security payments for future years.
In this climate, a tax bill that would appeal to the big investors is now transformed from a luxury to a necessity. The across-the-board cuts as outlined in Kemp-Roth are not enough. The administration needs a sharp, quick drop in taxation of dividends and interest, plus a meat-ax cut in the capital gains rate.
Even with all this, critics of the Fed feel the Reagan-Volcker summit is essential. If the notion can be conveyed that the Fed chairman's knuckles have been rapped, a little confidence might return. Any sign that the central bank no longer will tinker with interest rates would be welcomed.
To some key administration officials, the Fed's ability to confuse markets would be markedly reduced if, once again, the dollar were tied to a standard commodity -- green onions, silver or, most likely, gold. Thus, the current crisis might have a gold lining. If so, that will come later. Today's goal is mere survival, and there is no overwhelming confidence that it will be achieved.