Must We Ration Credit?

February 4, 1957

In Newsweek of Jan. 7 I analyzed a proposal for a “National Economic Council” to overrule the Federal Reserve authorities. Perhaps so thinly disguised a destruction of the Fed’s independence need not be feared at this time. But another and more subtle threat to anti-inflationary policy seems all too likely to succeed, unless its real implications are recognized.

This is the proposal to restore “selective” or “qualitative” credit controls. It has recently come from Elliott Bell, Sumner Slichter, Walter Lippmann, and other sources too numerous to list. It was put forward a year ago in the President’s Economic Report, and also by Allan Sproul, then president of the Federal Reserve Bank of New York. It has the sanction of precedent. Our government used “selective” credit controls at various times between 1941 and 1952. They are widely imposed today in Europe. But the results hardly warrant emulation. Selective credit control is merely one more step along the road toward a command economy. It leads logically back to investment control and to price control.

Selective credit controls are, in fact, government control of short-term investments. The pressure for them comes from special groups of borrowers who want to be favored at the expense of the rest. It comes from monetary managers who lack the courage to refuse such demands; who lack the courage to let general interest rates rise to the point where they will halt inflation. When the price of any commodity is held down by government control, the demand soon exceeds the supply, and the commodity is then rationed. Selective credit controls are merely government rationing of credit.

DISCRIMINATION

To ration credit is, of course, to discriminate among would-be borrowers. The decision is thrown into politics and determined by political pressures. This has already happened. Buying a house, even if you can’t afford it, is considered so laudable that the taxpayers are forced to guarantee 95 percent of the purchase price for you. Buying a refrigerator to put into the house, or a car to get to work from it, is considered much less laudable, so that the terms on which the seller was allowed to extend credit even at his own risk were tightened or “liberalized” by bureaucratic decree. Buying shares in Wall Street (i.e., investing in large-scale industries that increase production and create jobs) is considered so antisocial that the government forbids the seller or the lender to accept less than a down payment of 70 percent of the full price.

Government “selective” credit decisions are made, in short, on the basis of popular pressures and prejudices. Even if the record were better than this, what are we to say of a system which gives a group of government bureaucrats power to encourage borrowing for one purpose and to discourage it for another; to decide that there should be a boom in industry X but that industry Y should be choked to death? The only reason why “selective” credit controls, here and abroad, have not proved intolerably disruptive is that (for reasons explained in this column of March 5, 1956) such controls seldom achieve their aims.

PRECISE INSTRUMENT

It is possible to deal here with only one or two of the many arguments that have recently been put forward in favor of selective credit schemes. It is contended, for example, that “overall quantitative credit control” is “a pretty crude weapon.” The truth is that it would be hard to conceive of a more precise and truly selective instrument for allocating the supply of real savings among creditworthy borrowers than overall market interest rates that are allowed to reflect the real conditions of supply and demand. It is nonsense to say that a general rise in interest rates hits only “the little fellow” and favors “the big corporations.” One might just as well argue that a general rise in wage rates hits only the little project and helps the big project. Any general rise in costs merely shuts off the marginal projects, regardless of size, that do not seem likely to earn the higher costs.

This is the meaning and function of free markets, in the price of loanable funds as in the price of raw materials and in wages.