Cheap Money Is Dear

April 18, 1960

The word from Washington is that as a result of the success of the Treasury in selling some long-term government bonds at the legal ceiling rate of 4¼ percent, no action is likely to be taken to repeal or even modify the ceiling in this session. Such a failure to act would be irresponsible. Retention of the old legal ceiling would do no good, and might do incalculable harm.

There is no reason to suppose that the legal interest ceiling in itself saves the government a single dollar in interest costs. It is the plain duty of the Secretary of the Treasury to borrow at the lowest rates, at the smallest costs in the long run, that the market allows him to get. If we ever had a Secretary who was not willing to do that, or not competent to do it, the 4¼ percent legal ceiling on long-term bonds would be futile anyway; for the Secretary can borrow at any rate he chooses on securities with less than five years to run.

Last week I pointed to the administrative folly of retaining a 42-year-old prohibition that today simply ties the hands of the Treasury experts, in daily touch with the market, and prevents them from exercising their best judgment concerning what length maturities to offer. It forces them to glut the market for short-term securities, and raises the average rate at which they can borrow. But the economic folly is much more serious, and deserves longer examination.

CHEAP MONEY INFLATES

A policy of cheap money (i.e., a policy of arbitrarily keeping interest rates down) is only another name for a policy of inflation. The only way interest rates can be held down even temporarily to an arbitrary ceiling is by an increase in the money supply. This increase may be achieved by a direct resort to the printing press. It may be achieved by a return to the policy of forcing the Federal Reserve banks to buy at the predetermined low interest rate all the government bonds offered. The Fed would pay for these either by creating deposits or printing notes against them. This is what is known as monetizing the national debt.

Instead of reducing or holding down interest rates by increasing the supply of money and credit, we may increase the supply of money and credit by reducing interest rates. Low interest rates encourage borrowing at the banks. Other conditions being unchanged, more projects will be undertaken and more money will be borrowed at 4 percent than at 5, or at 3 percent than at 4. When the banks lend, they create deposits against the loans; that is, they in effect create new money. Low interest rates are inflationary when they lead to an undue increase in the money supply. Conversely, the only way interest rates can be held down below the “natural” rate at any time is by an increase in the money supply.

WHAT HAS IT COST?

This inflationary cheap-money policy cannot be kept going indefinitely. The consequent increased number of dollars, of course, cheapens the dollar in terms of goods. In other words, there is a rise in prices. As a result, cheap money eventually costs the government far more in total dollar expenses and interest charges than “tight” money would have cost it. Further, if the inflation and the rise in prices is expected to continue, lenders will begin to insist on a higher interest rate as a sort of insurance premium against depreciation in the value of their loaned dollar capital.

The irony is that it is precisely the people in Congress who are now protesting loudest against “high” interest charges whose policies in the past have done most to raise those charges. It is their spending policies and deficit financing policies that have built up a Federal debt of $287 billion and an annual interest charge of $9.4 billion.

Whether or not Congress now votes to repeal the legal 4¼ percent ceiling on long-term government bonds is no mere technical matter, of interest only to experts. It may be a fateful decision. It may crucially affect confidence in the dollar at home and abroad. A failure of Congress to repeal at this session may prove, in effect, a vote for inflation. If the Democratic leaders in Congress make that decision, they must bear full responsibility for it.