Does the Treasury push the credit markets around?
Has the US Treasury grown up to become the bully of the financial block, shoving aside private loan demand as it rushes to borrow money needed for government spending?
Some economists think so. Some don't.
In the flush times of the early 1960s, government borrowing accounted for about 9 percent of the money raised in America's credit market. By 1980, a recession year, note-shuffing to cover the national debt helped jump the government's share to 23 percent of the $348 billion credit market.
Donald Maude, chief financial economist of Merrill Lynch, recently told the Senate Budget Committee that the increased federal share of the pie came at the expense of the private sector. The result, he said, has been "an apparent crowding out of nonfinancial corporate borrowing from the credit markets."
Mr. Maude's testimony came on the final day of hearings designed to educate the budget committee on the health of the economy. The main thrust of questioning over the four sessions concerned the delicate balance between budget and tax cuts, a key relationship in whatever economic legislation the new Congress might pass.
Mr. Maude -- an accountantlike man in a light gray suit, surrounded by dark senatorial pinstripes -- was called to explain how the federal government's financial activities affect Wall Street money men. He talked of the shawdowy, complex relationship between government red ink, the Federal Reserve's control of the money supply, and the prime rate.
"As the federal government has been in the process of piling up red ink and crowding other borrowers out of the credit markets," he said, "interest rates over the past 20 years have successively ratcheted up to historically high levels."
This put the Federal Reserve between a rock and an onrushing automobile, he said. They could hold down interest rates by monetizing of the debt through Treasury security purchases -- but that increases the money supply, thus fueling inflation. The Fed failed at what was probably an impossible balancing act, said Mr. Maude, and solved neither problem.
How, the senators asked, can this experience benefit us in 1981?
The economist replied that the deficit and its effects must be carefully watched. Big supply-side tax cuts might be self-defeating without fiscal restraint.
"The initial impact of these cuts will be the creation of huge deficits and Treasury financing requirements unless matched by significant spending cuts in other areas," he said.
Supply-side cuts, say proponents, will increase economic activity and thus eventually increase tax revenues. But it takes time for America's productive capacity to retool, and Mr. Maude says this lag could be crucial. A sharp increase in the federal deficit (even if predicted to be short-term) would force the Treasury to grab an even bigger share of the private credit market -- sending interest rates back up, past last year's record highs.
Mr. Maude says such an occurence would "discourage the very capital expansion programs so desperately needed to sustain an increase in productivity and economic growth."
Squinting at their witness through a blue haze of smoke and TV lights, the senators nodded and thanked him.
But not everyone is so sure the government is such a credit bully.
Suppose that Ronald Reagan succeeds in cutting taxes at a $30 billion to $40 billion annual rate starting in the second quarter, postulates a Citibank newsletter. The federal government will still borrow less money in 1981 than it did in 1980, says the newsletter, if two events occur:
1. Interest rates stay below their unusually high fourth-quarter 1980 rates. This could save the government $13 billion in interest costs.
2. If Mr. Reagan cuts the budget even half as much as he says he will, this would stabilize the deficit at $65 billion in fiscal 1981. Federal credit needs would then be about 5 to 10 percent less than they were last year, according to the Citibank newsletter.
Jim Lothian, vice-president of financial research at Citibank, says the Treasury isn't muscling anybody away from credit they need.
"The bottom line is that we find a statistically significant, but not a substantial, effect," he says.
Mr. Lothian says his research shows that over the last 20 years the federal government's incursion into the credit market has raised rates slightly. But he says the government has little power over short-term rates, and in any case has had negligible effect on the market since the 1960s.
"I don't think you're going to get the end- of-the-world scenarios some people are talking about," he said.
Mr. Lothian said it would take a "really massive increase" in federal spending to affect the markets at all.
And the Citibank newsletter said its interest-rate predictions would not change much even if the government started to borrow more heavily.