The Bond Interest Ceiling Is Too Low

THE TREASURY SQUEEZE

THE biggest demagogic campaign issue of 1960 revolves around the U.S. Treasury and the mandatory 4 1/4% interest ceiling on all Government bonds of five years or longer. Last year President Eisenhower asked Congress to remove the limitation, imposed in 1918, and Congress turned him down. Last week Ike asked again, and once more a Democratic Congress seems determined to make political capital out of an economic problem.

Every economist agrees that the U.S. Treasury is in a tough spot to refund Government issues that are constantly coming due. With top-grade corporate issues bringing more than 5%, the Treasury cannot sell long-term bonds limited to a 4 1/4% ceiling. The Treasury is forced to get its money by short-term issues, has to keep going to the market to raise cash, thus disrupting short-term borrowing for business and helping to drive up rates.

Nevertheless, a loud and powerful group of Congressmen, including Illinois Senator Paul Douglas and Texas Congressman Wright Patman, refuses to grant the Treasury any relief, crying that interest rates are already too high. "The only inflation we have today," says Patman, with more emotion than economic reason (see State of Business), "is inflation caused by high interest." The critics blame the Treasury for the rising cost of servicing the nation's debt, argue that any further boost in interest rates would cost the taxpayers additional billions. They argue that if the Treasury wants to sell long-term bonds, it has the power to

1) sell them at a discount to increase the effective yield without changing the historic 4 1/4% coupon, or 2) ask the Federal Reserve to support the Government bond market as it did prior to 1951. (In 1953 the Federal Reserve decided to buy only relatively short-term notes and bills.) Says Douglas: "The abandonment of the 'bills only' policy would add another weapon [to use] to help prevent economic fluctuations."

Against such adamant Democrats stand most economists and monetary experts, including such Democrats as House Speaker Sam Rayburn and House Ways & Means Committee Chairman Wilbur Mills. The plain fact, as they are well aware, is that a boost in Treasury long-term rates is probably the most effective way of holding overall interest rates down. By borrowing exclusively in the short-term market, which is the area where business gets its money for temporary or seasonal needs such as carrying inventories or financing sales, the Treasury has sopped up much of the money normally available. The scramble for the remainder has driven up short-term rates, eventually also forced up long-term borrowing costs.

So competitive is the short-term market that the Treasury's newest 91-day bill sells for nearly 4.6%. The effect of short-term borrowing, according to Government estimates, has been to drive overall interest rates up 1/2% in a year, and cost the Government an extra $700 million to carry its debt. The cost to private borrowers has run into the billions, is growing so worrisome that even housebuilders, who once opposed raising the ceiling, are now having serious second thoughts. The Treasury's medium-term "magic fives" of last fall (TIME, Oct. 12) drew some $200 million out of New York savings banks alone, money that ordinarily would have gone for mortgages.

The problem is getting worse with each passing month. It is true, as some Congressmen say, that no long-term debt comes due for ten months. But there will be almost $80 billion in short-and medium-term borrowing. By November of 1961, so much debt will drop down into the one-year-and-under category that the figure will top $92 billion, up from $81 billion in December 1959, in itself equal to the alltime record. The Government's only recourse will be more short-term financing, probably at higher rates.

Administration economists are dead set against trying to sell long-term bonds by gimmicks, meaning discounts, or by trying to force the Federal Reserve to support the market. They argue that this is simply funny-money financing. By supporting Treasury bonds, the Fed would, in effect, be pumping money into the economy, would lose control over the monetary system and take the U.S. down the road to real inflation. Says FRB Chairman William McChesney Martin: "The world now knows that, as the night follows the day, inflation follows any effort to keep interest rates low through money creation."

The best argument against keeping the historic 4 1/4% interest ceiling is that it has not kept interest rates down. The best argument for removing the ceiling is that it will give the Treasury enough flexibility to lessen its reliance on the short-term market. By taking the pressure off these rates, the U.S. will have a good chance of stopping the rise in interest and the squeeze on money that, historically, has almost always ushered in a recession.

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