Shortcut to Inflation

September 14, 1959

If the Democrats in Congress object to being called the Party of Inflation, it is hard to understand why they do so many things to earn the title. Nothing so greatly increased the probability of more inflation as the action of the Democratic leadership in the House Ways and Means Committee in shelving the President’s request to remove the statutory 4¼ percent interest ceiling on government bonds running five years or longer.

The law that set this ceiling was passed more than 40 years ago, in 1918. It did no harm as long as it remained completely academic—that is, as long as the market rate for government bonds was well below the ceiling. But when the market rate the government must pay is higher than the ceiling, as now, any statutory limit becomes pernicious.

The President first requested Congress to remove the statutory 4¼ percent interest-rate limit on June 8. After a month, the House Ways and Means Committee replied with a transparently political solution giving the President the right, as a sort of personal favor, to disregard the interest-rate ceiling for a period of not more than two years if he found higher rates necessary “in the national interest.” Then, suddenly, the committee decided not to recommend even this.

HAND TO MOUTH

The practical effect is to prevent the government from offering any long-term bonds whatever, and to force it to do all its borrowing on a hand-to-mouth basis a few months at a time. If the result of such a restriction would be grave for any business concern or corporation, the evil is multiplied enormously when applied to the Federal government, compelled to manage a national debt of almost $290 billion, and forced to borrow $85 billion in the next twelve months simply to cover maturities, redemptions, and seasonal cash needs. The President’s second message of Aug. 25 clearly described the probable consequences of this:

“The vital interest of all Americans is at stake because excessive reliance on short-term financing can have grave consequences for the purchasing power of the dollar. The issuance of a large amount of short-term Treasury debt would have an effect not greatly different from the issuance of new money. Because these securities are soon to be paid off, their holders can treat them like ready cash. Moreover, short-term securities are more likely to become lodged in commercial banks. When a commercial bank acquires a million dollars of governmental securities, bank deposits rise by a million dollars. This is the same as a million-dollar increase in the money supply. When the money supply builds up too rapidly relative to production, inflation is the result. The piling up of an excessive amount of short-term debt poses a serious threat that may generate both the fear and the fact of future inflation at an unforeseeable time.”

FALSE ECONOMY

There are many congressmen who sincerely believe that they are “saving the government money” by forbidding the Secretary of the Treasury to offer long-term bonds at a rate to yield more than 4¼ percent. The irony is that their prohibition will have exactly the opposite of its intended effect. When the long-term market rate is higher than 4¼ percent, the Treasury is forced to do all its borrowing at short term. This concentrates the demand for funds on the short-term market, and forces up short-term rates.

Already, in recent weeks, the Treasury has had to pay 3.9 percent interest for 91-day borrowing, the highest since the dark days of March 1953. It has had to pay 4.5 percent interest for 182-day borrowing, the highest ever paid for this term. And it has had to pay 4.7 percent for one-year borrowing. The belief that short-term borrowing is always necessarily cheaper than long-term borrowing is a myth.

And the crowning irony is that it is precisely the cheap-money zealots who have brought on the inflation that has forced the government to pay double price for everything. They have finally created a situation that is forcing both more inflation and higher borrowing rates. For lenders seek to protect themselves against erosion of their dollar principal.