When the Fed tightens, a borrower still has options

The Economy

March 31, 1997|By Jay Hancock

IT'S SPRING, time for McCormick & Co. to stock up on raw spices for the year's second half, when sales pick up for oregano, tarragon, ginger, dried onion, red pepper and the like.

As usual, McCormick will borrow money to finance the inventory. A world of lenders awaits its application.

That's another reason to worry that last week's interest-rate boost by the Federal Reserve might not be its last.

McCormick Chief Financial Officer Robert Davey could borrow Eurodollars from British insurance companies. He could -- but won't -- take a flier and borrow Swiss francs, betting that the dollar will grow even stronger against the franc before he has to pay the money back.

He could tap U.S. pension funds. He could sign a note from a mutual fund. He could conceivably issue new McCormick stock.

In short, he could access trillions in capital that is far from the direct grasp of Alan Greenspan and the Federal Reserve.

As it has in the past, McCormick will probably sell short-term, commercial paper and tap banking lines of credit. But the point is that Davey has options for both short- and long-term financing that weren't available to his counterparts 30 years ago.

Last week the Federal Reserve, the country's central bank, sold an increased amount of Treasury securities on the open market.

In so doing, it essentially collected cash, decreased the money supply, depressed the price of short-term paper, boosted short-term interest rates and cranked up the rate on overnight banking loans by a quarter percentage point.

By shrinking the amount of money in the banking system, the Fed's Greenspan is trying to slow the economy and release what he thinks are possible inflation pressures.

The Fed was founded when the banking system dominated credit markets, and its direct control is limited to the banking system.

McCormick, however, doesn't have to go to the banking system. No big borrower does. Banks aren't the only capitalists anymore, and as a result the economy may be a bit slower to heel to Greenspan's command.

The Fed will never lose its control of the economy. "If you can create or destroy money," which is the effect of open-market operations, "you can always have a macroeconomic impact," said James Annable, an economist with First Chicago and a former Fed official. But these days, he added, "Boy, they may have to generate a huge increase in interest rates to do it."

Controls were once more direct.

Up to the 1970s, "Regulation Q" limited the interest rates institutions could pay to depositors. When market rates rose even a little over the cap, funds for lending would dry up.

"You'd blow past Reg. Q, the thrifts would shut down, residential construction would absolutely collapse, and that would generate the overall collapse" in the economy, Annable said. "And interest rates hardly had to move at all."

These days, capital markets are bigger and more fluid, and everybody is able to dance around Fed engineering more easily, he added.

Adjustable mortgages exist. Banks and thrifts can pay what the market will bear.

And the Fed may now have to exert more pressure on the monetary lever and wait longer for an effect.

This is far from proven.

"I wouldn't see any evidence that there's some longer lags than there used to be," said Paul Bennett, senior vice president and deputy research director for the Federal Reserve Bank of New York.

"The markets are super efficient now. Really, the Fed can influence lots of markets. Even the stock market."

There are other reasons, however, to think that the Fed tightening could continue.

The economy just doesn't seem to want to slow down, as evidenced by Thursday's strong housing report and the bond and stock markets' dives.

And many Americans, feeling richer from still-healthy stock levels, may continue the recent consumer-spending jag.

Traditional theory says that Fed money-supply moves affect the gross domestic product six to 12 months down the road.

"I think that certainly GDP will be affected" by last week's action, said Dimitri Papadimitriou, executive director of the Jerome Levy Economics Institute.

"I'm not sure it will be affected as much as traditional theory tells us it will be affected. There is a lot of capital. Certainly there is going to be some retrenchment in consumer spending. On the other hand, the wealth effect is still there."

Pub Date: 3/31/97

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