banks and other lenders outside New York City. The Morgan Guaranty's loans now yield "participation" buyers returns approaching the prime rate of 71⁄21⁄2 per cent. So Morgan is in effect raising money at rates well above the 64 per cent ceiling set by the Federal Reserve. The Fed last week was reported preparing new rules that would shut off this maverick source of funds.

SUPPLY

But a second, and far larger, new supply would remain uncontrolled. This is the huge "Eurodollar" market overseas. Through the 1950s and 1960s, the U.S. has spent, lent and given away far more dollars than it has earned abroad. A major portion of these dollars has remained in the commercial banking systems of European countries. One estimate puts the total at $23 billion. As the Fed's pinch has tightened this year, big U.S. banks have simply gone to Europe, borrowed these dollars, transferred them to the U.S. and lent them out. Chauncey Schmidt, an executive of Chicago's First National Bank branch in London, estimates that fully $3.5 billion in Eurodollars have been converted into old-fashioned Yankee dollars by American banks since the first of the year. The interest rates, to be sure, are astronomical. In fact, the rate on Eurodollars recently touched 9.1 per cent in London. But so far, at least, this hasn't stopped the banks. Administration and Federal Reserve experts concede that these dodges have delayed the desired impact of government spending and credit restraints. Yet they argue that always-without exception-monetary restraint sooner or later is followed by a slowdown in economic growth and a consequent easing of inflation. There is ample evidence that current restrictions are indeed affecting the financial markets.

For one thing, municipalities have had to defer the sale of hundreds of millions of dollars worth of bonds because interest rates have soared above the legal ceilings that they are allowed to pay. There is even some scattered evidence that bank lending, always the last financial activity to be hit, is beginning to be affected. Many construction firms and home builders, traditionally the first to suffer during credit squeezes because they make such extensive use of loans. were reported by banks to be deferring projects. "We have tight money," said First National City Bank chief economist Leif Olsen with vehemence. "You better believe it."

The problem is that most big corporations refuse to do that. And until the squeeze becomes so tight that bankers actually turn them away empty-handed, there is little likelihood that the big spenders will change their ways. Government and bank economists now hopefully guess that this will start occurring in the second quarter. Even then it could be too late. For the government, mean. while, might have put such tight clamps on business that a recession, which current policy is trying to avoid, would be inevitable.

Mr. WALKER. Let me go back to the first point with respect to the expansion of business loans during the recent period.

Concomitant with that there has been quite a reduction in other types of bank assets such as the liquidation of securities.

There is a big trap in monetary analysis-I'm sure you are familiar with it-that you can fall into here. If you pay too much attention to a particular item on the left hand side of the balance sheet, such as an increase in business loans, and don't look at the right hand side and see what is happening to monetary stock and monetary growth, you can be greatly misled. This is the fundamental argument of the Chicago Friedman School against the interest rate school.

What I am saying is that even though business loans may be increasing at a fast rate, things can still taper off quickly. If you will check the record they were increasing at a fast rate in 1966, but business capital spending topped out in the latter part of that year despite the increase in the loans.

If you have restrictions that keep your money supply from growing, even though you have a shift in the nature of the assets of banking from investments to loans, that is going to have an effect. I think it will haves an effect sooner rather than later.

Senator PROXMIRE. My time is up. Thank you.

The CHAIRMAN. Senator Bennett. May I interrupt here just a minute? We are honored this morning with a visit from the former chairman of this committee.

Most of the time he served as the ranking Republican member. Senator Homer Capehart.

I want to welcome you here to this committee and present you to this audience.

Senator BENNETT. I came in late, unfortunately, and didn't hear the Secretary's prepared statement, but I have been impressed with the debate that followed and I think the Secretary has been able to hold his own.

There was one statement that was made that bothers me. If you have loans of $70 billion in a quarter with an increase of $4 billion, is that at the rate of 20 percent?

Senator PROXMIRE. I am talking about annual rate.

Senator BENNETT. I know, but you are assuming that the $70 billion is all the loans that will be made in the whole year and that you will have four $4 billion increases and that would be 20 percent.

Senator PROXMIRE. I am saying you have a $32 billion increase over 3 months. Multiply that by four. If you get the same rate of increase you will have $14 billion and put that over the $70 billion, it is 20

percent.

Senator BENNETT. You are also assuming that $70 billion is all you will loan the whole year. If you multiply your increase by four you must multiply your base by four.

Senator PROXMIRE. The base I am starting with is $70 billion.
Senator BENNETT. For the quarter.

Senator PROXMIRE. I am talking about annual rate of increase. Well, at any rate, my own conclusion, if you increase at $3 billion over one quarter, you can multiply that by four and then divide it by your base and you get your 20 percent.

We can get together on this.

The CHAIRMAN. I think the mistake came in here. I understand you to say that during that quarter they loaned some $70-odd billion. You meant the total outstanding loans was $70 billion.

Senator PROXMIRE. That is right.

The CHAIRMAN. Then your figure would be right.
Senator PROXMIRE. That is what I intended to say.
Senator BENNETT. That resolves the question.

How long do you think it will take, Mr. Walker, before this bank increase will peak out?

Mr. WALKER. I don't know, Senator. I said I thought we would see results sooner rather than later. Usually an economist is not to be pinned down that much.

I know what the economic facts of life are in running a business institution or a bank and if you are lending money at 72 percent or whatever it may be, and borrowing money at 812 percent or more in Europe and elsewhere in order to make those loans. That is not a viable situation over a long period of time.

It is a stopgap situation in order to honor commitments you made. in the past and you are going to whittle down those commitments for the future.

I would hope in the relatively near future we will see bank lending policies reflecting the very significant degree of restraint that exists now in monetary policy and Federal economic policy in general.

Senator BENNETT. You also indicated that while loans may have increased by this amount, other assets had decreased. Do you have any comparable figures?

Mr. WALKER. Let me look for half a second here. In the fourth quarter of 1968, for example, commercial bank holdings of U.S. Goyernment securities declined by $2,300 million, which is a rather significant reduction.

In January 1969, they declined $1.2 billion. In February 1969, $2.7 billion.

Senator BENNETT. So they are taking their loans away from the Government and giving them to business and they are not increasing the net amount of credit they are putting into the economy.

Mr. WALKER. That is correct. That is one reason we had to pay high interest rates in February in turning over nearly $15 billion of securities.

We have a joke around the Treasury that isn't really funny. We had to pay the highest interest rates since 1965-1865, that is—in paying 6.3 percent on a 7-year issue and 6.4 percent on a shorter term issue.

It's a reflection in part of commercial bank liquidation of U.S. Government securities.

Senator BENNETT. No further questions, Mr. Chairman.
The CHAIRMAN. Senator Cranston?

Senator CRANSTON. I have no questions.

The CHAIRMAN. Senator Goodell?

Senator GOODELL. Dr. Walker, you talked about inflationary expectation running out of the economy. Of course, it's this expectation that becomes perhaps the most critical factor in the economic equation we face now.

When that expectation changes, you might see a disproportionate swing back toward a serious recession. Are you confident that we are not over-coping with this situation today?

Mr. WALKER. I am reasonally confident that we are not reaching the point of overkill.

You will recall last summer there was a great deal of concern that the tax surcharge enacted would result in overkill. I think we learned a great lesson from that.

I think we learned that the basic strength and resiliency of the free enterprise economy of ours in the late sixties is tremendous indeed. This leads me to the conclusion that we can expect success in what Bill Martin refers to as this exciting effort to disinflate without deflating.

The secret is to put on the brakes gradually, but firmly. Don't jam them on and go through the windshield. Don't put the economy through a ringer. Gradually and firmly maintain the pressure. That's what we are trying to do.

Senator GOODELL. You would concede the same combination of money supply, tax rates and Federal spending, or, if you will, surthe housing market, for instance, doesn't bear the major brunt in the expectation?

Mr. WALKER. I can't see that sharp a change in expectation, Senator, without some sort of crises. If we go too far and fall into a crisis that sort of thing can happen. As Chairman Martin testified yesterday, he estimates that the rate of growth in the money stock would be approximately 2 percent of the first quarter of this year.

This is in the lower range of the guideline that the Joint Economic Committee suggested, and to me it's not a starvation diet at all. It's the gradual, but firm restraint that I'm talking about.

Senator GOODELL. Haven't we reached a point with reference to the questions raised by Senator Proxmire which is a matter which concerns all of us-where we will have to find new means to see to it that the housing market, for instance, doesn't bear the major brunt in the transition period such as this?

Mr. WALKER. First of all, I have to repeat that the statistics have been very good indeed, indicating that availability of credit has been maintained to a considerable extent in the housing market, albeit, through higher interest rates.

This is letting your price system work, and I think it's all to the good. Beyond that, I think we have to recognize the fact that if you let economic conditions get out of hand in an inflationary way you will tend to have bigger impacts, when you try to correct the situation, in certain areas of the economy.

I'm very much a believer in fundamental reforms and actions with respect to the housing market. I think we have been very, very laggard in developing the approaches and techniques to doing this.

There are a lot of good ideas kicking around, and I'm sure the new administration is going to come in with proposals of this sort. But if you fall back upon the idea that housing should get some sort of special treatment from the Central Bank you're dealing with dynamite.

You are not only saying that housing is some way preferred to State and local governments, city problems and things of this type, and has a priority over these very important other areas, but you are simply feeding the fires of the inflation which pitch up the interest rates and the housing costs, and keep the home buyer in the vice.

The fundamental answer is to get rid of the inflation. The longrun answer is to improve functioning of the mortgage market.

Senator GOODELL. I think we all agree on that, provided we can accomplish it. I wonder if there was an intimation in one of the comments made by Senator Proxmire that we should impose some device or limitation on the amount of business borrowing or the amount of capital investment.

Is it not the situation where arbitrary imposition of this nature, whatever it would be, would probably do more harm than good?

Mr. WALKER. I think you are dealing with a very "iffy" proposition. The preceding administration, much to the objection of certain people within that administration, and many, many outside economists, saw this very situation develop in 1966. They came to the Congress in September and asked for a suspension of the investment credit. A few months later they had to come back and ask for restoration of it.

What had happened, when these figures were viewed in hindsight, was that this very heavy rate of capital spending which was strongly criticized on the same basis in late 1966 already was topping out. Capital appropriations had topped out in the first quarter of 1966. The overall capital spending rate declined later in the year. This had to be, in my judgment, because of the degree of monetary restraint that existed.

I would very much hate to see a repetition of what I think was a rather sorry chapter in the history of economic stabilization policy in the United States. Today, I feel we are moving close to a cresting out in inflationary expectations, interest rates, and capital spending.

I can't prove it. I do look forward to reviewing the record with Senator Proxmire next January and we will see at that time.

Senator GOODELL. I agree with your analysis with reference to the 1966 suspension of the 7-percent tax credit.

Mr. WALKER. That error will not be repeated by this administration. I can't make that statement too strongly.

Senator GOODELL. I think I would be more concerned if in the next 3 or 4 months capital expenditures by business not only crested out, but dropped significantly, because we are in a situation where we discussed this at great length through the early sixties where we needed to encourage more capital investment which basically is job creation and many of us are anxious that the unemployment rate not go very much higher than it is today, that we maintain a stable, growing economy to provide the jobs.

Certainly the most optimistic feature of the present economic situation is the capital investment by business with reference to this particular point.

Mr. WALKER. No question about it. When I say "crest out" I don't mean a downturn. I mean you move to a sustainable rate of increase. That is our goal. The projected rate of 14 percent--I don't think it will happen-but the projected rate is not a sustainable rate, no question

about it.