Tape 113 - Credit crunch in 1973

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-	Welcome once again as MIT professor Paul Samuelson	0:02
	discusses the current economic scene.	0:05
	This biweekly series is produced	0:07
	by Instructional Dynamics, Incorporated,	0:09
	and was recorded October 23rd, 1972.	0:11
-	A vast number of questions	0:15
	have been accumulating from subscribers.	0:17
	There been so many things to talk about	0:20
	that I haven't been able to get to them.	0:21
	Perhaps today is a good time	0:24
	to try to answer some sampling from them.	0:25
	Well, where to begin?	0:29
	Perhaps let me begin first with something practical.	0:32
	I have here a question.	0:36
	Exactly where do you stand on the issue there will	0:38
	or will not be a credit crunch next year	0:42
	that will bring on crises like those in 1966 and 1970?	0:46
	There have been repeated rumors	0:55
	of a credit crunch to come next year.	0:58
	Appeal to such rumors is often made	1:03
	to explain the failure of the stock market	1:05
	to advance in this year of rapid overall GMP advance.	1:09
	I don't know who are the sources of the rumor	1:18
	of a credit crunch as such.	1:24
	I do know that some very respected analysts	1:28
	in the money market, like Henry Kaufman of Salomon Brothers,	1:31
	have been making speeches and giving out estimates	1:35
	that interest rates are going to get higher,	1:40
	and in the short run, get considerably higher.	1:43
	But that is necessarily the same thing as a credit crunch.	1:48
	Indeed, the questioner has asked	1:55
	about whether the 1973 punitive credit crunch	1:58
	will be like those of 1966 and 1970.	2:02
	Well, 1966 and 1970 weren't really the same thing at all.	2:07
	They weren't exactly the same kind of credit crunch.	2:13
	They were both years of tight money	2:19
	if you use as your test for tight money a slowdown	2:22
	in the rate of growth of the money supply.	2:26
	They were both years of tight money	2:29
	if you use as your test of tight money general increases	2:32
	in interest rates, particularly, short-term interest rates,	2:38
	but also long-term interest rates.	2:42
	Beyond that, I'm not sure that the resemblance	2:45
	is a very close one.	2:48
	In 1970, we had a stock market decline	2:54
	of some considerable magnitude.	3:00
	Many of you will painfully remember that by May of 1970,	3:03
	the Dow Jones Industrial Averages, those 30 stocks,	3:08
	which in 1966 had been very near a thousand,	3:13
	had got down to I believe it was 630-ish.	3:19
	Then again, there was the Penn Central crisis.	3:27
	That was an old-fashioned bankruptcy.	3:30
	And it did send shock waves through the system.	3:34
	Suddenly, commercial paper was no longer commercial paper.	3:38
	Suddenly, commercial paper was commercial paper	3:42
	issued by Penn Central, issued by General Motors,	3:44
	issued by Chrysler Motors.	3:51
	These were three different cases.	3:54
	And some of you will remember	3:56
	that the Chrysler credit rating actually came	3:57
	into questioning for a very brief time	4:01
	in the wake of the Penn Central shock.	4:05
	Now I would not say that the existence of bankruptcy	4:13
	in a tight-money year like 1970 is completely coincidental.	4:20
	One of the functions of tight money,	4:26
	one of the ways that it operates	4:30
	is to make credit more expensive.	4:33
	It makes new money short.	4:40
	That's the Federal Reserve's modus operandi.	4:43
	And that tends other things be equal	4:47
	to make the cost of borrowing money expensive,	4:49
	and the yield on all sorts of competing securities,	4:53
	mortgages, bonds, goes up.	4:57
	And whenever there's a strong wind	5:01
	that blows in the apple orchard,	5:04
	it's the weak apples that fall.	5:06
	Now you can blame the wind for the falling of the apples,	5:12
	or you can blame the weakness of the apples.	5:15
	I would prefer to say it's the interaction of those two.	5:18
	So it may well be that the Penn Central disaster	5:20
	could've been averted for a little while	5:25
	if 1970 had not been a year of tight money.	5:28
	But nevertheless, there were special features	5:33
	about Penn Central which have been long incoming.	5:37
	They have to do, of course, with the automobile,	5:40
	and the truck, and the airplane.	5:42
	They have to do with the long-run union situations.	5:44
	They have to do with the decline in the railroads.	5:47
	Now in 1966, you didn't have the same thing.	5:51
	According to the way that I would like to use language,	5:57
	I would say that in 1966 there was a true credit crunch.	6:00
	I believe that the expression was invented	6:05
	to describe that period,	6:10
	or at least was popularized as a description of 1966.	6:11
	Because what you had in 1966	6:16
	was not merely higher interest rates,	6:19
	or not so much higher interest rates,	6:24
	as a widespread unavailability of credit at any rate.	6:27
	Now that's what constitutes the essence of a credit crunch.	6:34
	And so I would not blithely	6:40
	and simply identify higher interest rates and credit crunch.	6:43
	In some ways to me, these are opposites.	6:47
	If the market allows interest rates to go higher,	6:52
	so that at high interest rates,	6:59
	money is available to those who can meet the higher price,	7:01
	then you avoid a credit crunch.	7:09
	Now this is a very informative distinction,	7:12
	because what we had in 1966	7:17
	was essentially the first tight money for a long time,	7:22
	and the general marketplace and our institutions	7:28
	were not geared up to the possibility of such tighter money.	7:32
	That is not the case in 1972,	7:38
	and will not be the case in 1973.	7:40
	For example, let me just remind you what some	7:44
	of the features were of the 1966 period.	7:49
	You had a tremendous amount of so-called disintermediation.	7:55
	I believe that that word was either invented	8:00
	or resurrected to describe what was happening in 1966.	8:03
	The commercial banks began	8:09
	to pay higher interest rates and deposits.	8:12
	For years and years, they had been held down by Regulation Q	8:15
	to rates below those which effectively were being paid	8:19
	by the savings and loan associations.	8:23
	The savings and loan associations, the S&Ls,	8:26
	the commercial banks keep reminding us,	8:30
	are not proper banks.	8:33
	They don't issue checkable bank deposits.	8:35
	I have to be careful because just at this time	8:40
	in my own state of Massachusetts,	8:45
	there seems to have been developed a gimmick	8:47
	which more or less permits people to, in effect,	8:49
	write checks on their interest-bearing savings accounts.	8:55
	This gimmick is being advertised very strongly	9:00
	by the so-called mutual savings banks	9:06
	which are very close to the S&Ls,	9:08
	and a little bit different from the commercial banks.	9:11
	But to go back to '66, by and large,	9:14
	these higher rates of the S&Ls,	9:18
	particularly on the West Coast of the United States,	9:22
	in California, had been sucking money away	9:24
	from the commercial banks.	9:28
	When the commercial banks for the first time in a long time	9:31
	began to retaliate by offering higher interest rates	9:34
	on their deposits, then a lot of the volatile money,	9:39
	what people call hot money,	9:44
	but what we perhaps should call cool money,	9:46
	left the commercial banks, and went to the,	9:50
	I'm sorry, left the S&Ls, and went to the commercial banks.	9:54
	So you had a near crisis in the building industry	9:58
	as everybody feared that banks in California,	10:03
	not simply the worst-run Long Beach, California banks,	10:06
	but all the S&L banks.	10:10
	I'm falling into bad habits of treating S&L	10:14
	as if they're banks,	10:17
	but to tell the truth and shame the devil,	10:18
	they are banks for many, many purposes.	10:21
	Well, they began to lose deposits.	10:25
	And they found it very difficult, therefore impossible,	10:28
	to render credit for builders.	10:32
	And so the whole building industry	10:35
	in California was in trouble.	10:36
	There was a danger that a lot of those S&Ls would go under,	10:40
	that they would not be liquid,	10:45
	that they might have runs on them,	10:47
	and that they would be closed down	10:49
	by the Federal Home Loan Insurance Corporation,	10:51
	and that this would send shock waves	10:55
	through the whole financial community.	10:56
	What the commercial banks were doing to the S&Ls,	11:01
	the free market began to do to the commercial banks,	11:05
	because people found that they could	11:08
	for the first time in a long, long time to great advantage	11:10
	hold marketable government bonds instead	11:14
	of putting their money	11:17
	in their friendly commercial bank down the corner	11:19
	or in the S&L in another state.	11:21
	And so there were a lot of losses of deposits.	11:25
	This was unexpected.	11:29
	It came on faster than the financial community	11:32
	had by and large anticipated.	11:35
	The result was that lots of insurance companies,	11:38
	lots of banks, lots of lenders were overcommitted,	11:41
	and they simply would not extend new money	11:46
	to anybody at any rate.	11:49
	That is a credit crunch.	11:54
	It was very serious.	11:56
	It primarily took its toll of the housing industry.	11:58
	And the number of housing starts	12:03
	went way, way, way, way down.	12:04
	Precisely because the rest of investment	12:06
	was able to hang on, housing had to go down more.	12:10
	Now I don't say that some promotional	12:16
	commercial construction investment, say shopping centers,	12:19
	did not also have to be cut back.	12:23
	The promoters are the ones who feel most strongly	12:27
	tighter credit conditions,	12:31
	because whether they make $5 million	12:33
	or lose $300,000 depends acutely	12:38
	on whether on their last money,	12:41
	their most risky borrowed money,	12:44
	they have to pay 10% interest,	12:47
	or they have to pay 15% interest,	12:49
	or if they can't get it at any price, then of course,	12:50
	the whole project has to be abandoned or postponed.	12:53
	The point of resurrecting all this is that since 1966,	13:00
	and I think it's instructive to look	13:06
	at 1970 in comparison with 1966,	13:08
	the money market has learned to adjust	13:12
	to tight money as well as easy money.	13:16
	And interest rates are more flexible than they used to be.	13:19
	And this greater flexibility of interest rates results	13:23
	in its being available at some price,	13:28
	at some terms, at some interest rate.	13:32
	Now it may be the case that you have to pay 9%	13:35
	for a house mortgage in a 1970 kind of tight money period.	13:38
	But you can get it at that price.	13:43
	I'm assuming that you can make a certain down payment,	13:47
	you have a certain creditworthiness.	13:50
	There always is, in addition, a rationing by lenders	13:51
	of borrowers in terms of their creditworthiness,	13:56
	of who can qualify for the prime rate,	14:00
	of how much you have to keep	14:03
	in the way of compensatory balances	14:05
	at the bank when the bank gives you a loan.	14:08
	So I would answer this question fairly unequivocally no.	14:12
	I don't expect in 1973	14:19
	that we will have credit crunch of the 1966 type.	14:21
	I don't go on to say that there may not be some weak apples	14:29
	on the tree who in 1973 will fall off	14:33
	and reveal themselves to have been weak all along	14:37
	in the way that Penn Central did.	14:41
	But I think Penn Central was a very traumatic case.	14:45
	I never, for example, thought that the Lockheed case	14:51
	was of the same comparable character as the Penn Central.	14:54
	In the first place,	15:00
	if Lockheed had been allowed to go under,	15:01
	if it had not been bailed out by the U.S. government,	15:04
	and as you know, there were many congressmen	15:07
	and senators who were very critical	15:11
	of that bailing out operation,	15:13
	if that had not been saved, it would not have sent a wave	15:17
	of bankruptcies throughout the whole economy.	15:22
	To put it technically,	15:27
	there would not have been macroeconomic effects	15:28
	of the Lockheed bankruptcy.	15:30
	Now there would've been effects, no doubt,	15:32
	on McDonell Douglas, favorable or unfavorable.	15:34
	The next weakest military supplier would be in trouble	15:38
	when he, it, tried to get credit.	15:45
	And I don't wanna even pass judgment	15:49
	as to whether Lockheed should or should not have been saved.	15:51
	It could be that as a military resource for the country,	15:54
	and we are still in the military business,	15:58
	we still have a security expenditure program,	16:00
	that it was smart to throw good money after bad	16:03
	in order to save a resource for aircraft production.	16:08
	But if in 1973 it turns out that there is another Lockheed,	16:15
	and this time, it might not be in the military sphere,	16:22
	because the testing there has perhaps already taken place,	16:25
	the windup of our defense expenditure program	16:29
	has been going on for a long time.	16:34
	So it may show up in some civilian line of industry.	16:37
	That, I will say, is part of the normal ebb and flow	16:42
	of the business cycle in the post-Keynesian epoch.	16:48
	It's not like the old say 1931 situation	16:53
	where practically all property	17:00
	in a city like Chicago was frozen.	17:03
	If it wasn't in default, it couldn't move.	17:07
	You have to look at Homer Hoyt's One Hundred Years	17:10
	of Land Values in Chicago,	17:13
	which covers that Great Depression period	17:16
	to realize how acute the situation was.	17:19
	Well, now I don't think in the age after Keynes	17:22
	that we are very likely to get into such situations.	17:25
	But we are still going to have, we know,	17:28
	rates of retardation.	17:31
	We're going to have recessions.	17:33
	We are going to have long periods of expansion,	17:36
	which means long periods in which excesses	17:40
	of credit will develop,	17:45
	and in which a deterioration of the quality	17:47
	of credit will accumulate.	17:50
	But I don't think it's gonna be permitted in this age	17:55
	to have the secondary domino macroeconomic effects	17:59
	that it had, alas, in an earlier age.	18:04
	I say in the age after Keynes,	18:10
	but you don't have to be a devotee of his particular modes	18:11
	of analysis to agree with my diagnosis.	18:18
	If, for example, you are a stern monetarist who prefers	18:22
	to state everything in terms of rates	18:28
	of change of the money supply,	18:31
	I believe you still can with good conscience agree	18:33
	with what it is that I'm saying.	18:37
	So I now turn to the reformulation of the question,	18:39
	namely, how do I stand on whether interest rates	18:45
	are going to go higher in between now and 1973,	18:51
	and	18:57
	whether that is going	19:00
	to have serious adverse macroeconomic effects?	19:01
	Now I believe I have commented	19:07
	a few tapes back on this question.	19:11
	So	19:15
	forgive me if I repeat.	19:18
	However, since a couple of more months	19:21
	of experience have gone by,	19:23
	a fresh look at the problem is needed.	19:25
	I'm inclined to think that short-term rates will go higher.	19:30
	I'm inclined to think that long-term rates	19:36
	cannot stay immune in a sustained period	19:38
	in which short-term rates are going higher.	19:44
	So I do see some firming of interest rates in the future.	19:47
	And I think anybody who is,	19:52
	has a speculative position in Wall Street	19:56
	in the stock market should take that into account.	19:58
	I think that any corporate treasurer, controller,	20:01
	should take that into account.	20:06
	I think that any insurance company	20:09
	and bank lender should take into account the fact	20:11
	that he can get a little bit better terms	20:15
	for his money in the future.	20:18
	Now this is not a sure thing.	20:22
	I make this diagnosis, this prognostication,	20:27
	on the basis of my best guess about what's going to happen	20:31
	to the general GMP and to prices.	20:36
	I believe that the best way	20:41
	of estimating what's gonna happen to the money market,	20:44
	what's gonna happen interest rates,	20:47
	is first to estimate what's going	20:49
	to happen to the general economy.	20:51
	Because depending upon what's happen in the general economy,	20:53
	I think we have the prime key	20:57
	to what the Federal Reserve is gonna do.	21:00
	And until you know what the supply of money	21:02
	by the Federal Reserve is likely to be,	21:07
	and can pit that against the demand for money,	21:09
	you aren't in a position to make any reasoned guess	21:14
	about what's going to happen to interest rates.	21:20
	And nevertheless, even if I am right in thinking	21:25
	that there will be some upward pressure	21:29
	on prices from now on,	21:32
	that the controls have done even better	21:35
	than one could've hoped for,	21:37
	but that it's only reasonable to expect	21:40
	that they can't continue to do	21:43
	as well as they have been doing,	21:45
	thinking that,	21:50
	and thinking that this will affect Federal Reserve policy	21:51
	in the period after the election,	21:56
	and remembering that the present expansion	21:59
	after the election will be a full two years old,	22:03
	that means that the bloom of youth,	22:07
	to use the expression that Jane Austen	22:09
	so often used about her heroines,	22:11
	the bloom of youth was gone	22:14
	in the 18th century after the age of 20.	22:16
	Well, after two years,	22:20
	the bloom of youth of an expansion has gone.	22:21
	And so taking all that into account,	22:25
	I think you will get some higher interest rates.	22:28
	But I don't see why that has to act like a hard wall	22:30
	which the system will hit	22:35
	and will rebound from in a crisis,	22:37
	and panic, and necessarily, in a recession.	22:43
	Moreover, although the Henry Kaufman view	22:49
	is an important one and a persuasive one,	22:56
	there are counterviews,	22:58
	and I like to quote from just a couple.	23:00
	The first that I'm quoting from	23:04
	is from the Manufacturers Hanover Trust.	23:05
	It's from the economics department.	23:09
	It's a study that bears the date, September 1972.	23:12
	The title Flow of Funds: The 1973 Preview.	23:16
	By the way, it has a very nice little quotation	23:21
	from Hilaire Belloc at the top of the text.	23:23
	Oh, let us never, never doubt what nobody is sure about.	23:28
	I read from the synopsis of the results	23:36
	of this Flow of Funds study.	23:40
	The study, by the way,	23:42
	was done by an assistant vice president there, Dimitri N.	23:44
	Balatsos.	23:51
	He concludes, in brief, a subtle shift	23:54
	in the composition of the flow of funds	23:57
	will take place in 1973.	23:59
	Our projections show that as a result of a firming	24:02
	of the demand for short-term credit,	24:04
	the United States financial markets will move	24:06
	from a situation of ample supply toward one where supply	24:09
	and demand will be in closer balance.	24:13
	Even though this development is expected	24:15
	to put short-term interest rates	24:18
	under increased upward pressure,	24:19
	we fail to identify any overwhelming demand surge	24:22
	or supply shortage that would cause major dislocations	24:25
	in the money and capital markets.	24:29
	Thus, we cannot subscribe to the view	24:31
	of sky-high interest rates, a credit crunch,	24:34
	and a mini recession in 1973.	24:37
	Well, with the exception	24:41
	of ruling out a mini recession in 1973,	24:43
	and I think there we must still keep an open mind,	24:47
	the rest of that synopsis, it seems to me,	24:51
	deserves your serious consideration.	24:55
	I have another source that may be	24:59
	of interest to some of my subscribers.	25:01
	Just recently, I've been put on the mailing list	25:04
	of the Argus Weekly Staff Report.	25:07
	This is by the Argus Research corporation.	25:10
	I had written an article that I mentioned on these tapes	25:13
	for the London Financial Times.	25:16
	And in that, I had occasion to give a survey	25:19
	of what the various monetarist forecasts	25:23
	that I knew about were saying,	25:27
	overlapping with and in contrast	25:31
	with the general GMP spread of forecasting.	25:33
	And I received a letter from a Bill Wolman	25:38
	saying that since I'm going to quote monetarists,	25:43
	I might as well be well-informed	25:45
	and get information from still another source,	25:48
	and saying very kindly that he was putting me	25:52
	on their mailing list.	25:54
	Wolman and James Meigs used to be	25:58
	at the First National City Bank, where they were part	26:01
	of the very powerful economics team there	26:03
	who developed quite a reputation for monetarist analysis.	26:07
	Many of my listeners will know of Jim Meigs	26:13
	as one of the able graduates of The University of Chicago.	26:16
	And I believe he served tour of duty	26:21
	at the Federal Reserve Bank of St. Louis with Homer Jones	26:24
	before going on to New York.	26:28
	If I have not already mentioned it,	26:33
	let me say that when I took the Argus monetarist forecast	26:35
	of the general GMP components for the year ahead,	26:42
	I found that it overlapped very considerably	26:47
	with a number of the non-monetarist GMP forecast	26:52
	that I also had in my files.	26:56
	So it doesn't look as if we're going	26:58
	to have an ex ante crucial test this year	27:01
	of monetarism versus non-monetarism.	27:06
	But I quote from the October 17th, 1972 issue.	27:11
	The heading of this section is 1973: A Year of Bugaboos.	27:18
	And I now quote, in recent weekly staff reports,	27:22
	we have made our position clear.	27:26
	Conditions in 1973 will not give rise to a credit crunch	27:28
	or a reacceleration of inflation.	27:34
	Well, you're getting two for one there.	27:36
	You are getting not only a view about a credit crunch,	27:39
	but you're getting a view about what's going to happen	27:42
	to the price level.	27:45
	And I regard this as a respected view	27:48
	of the difference from my own.	27:52
	Namely, that there are natural forces	27:54
	of excess supply in the system, which with a delay,	27:58
	were already working to moderate the rate	28:04
	of price inflation before the price wage controls	28:07
	are put on, and they continue to work in that direction.	28:12
	In concluding, I see I didn't get	28:17
	to more frivolous questions as to,	28:18
	such as what's going to happen to the price of gold?	28:22
	What's the equilibrium supply	28:26
	and demand price of gold over the long run?	28:28
	And still, other questions.	28:30
	I do think, though, that we here a very important question.	28:35
	And let me in concluding just say this,	28:38
	because it's a consideration occurred to me	28:43
	as I read the Argus Weekly Staff Report.	28:45
	We have in this report a monetarist analysis, I presume.	28:49
	But it's generally a more optimistic one	28:52
	than some of the monetarist analyses,	28:56
	which I have been quoting.	28:58
	And we have to ask ourselves,	29:00
	the fact that we're getting a report	29:02
	from a stock market advisory service,	29:05
	does that buy us the direction of the report?	29:08
	And my first and primary answer is no,	29:14
	that professionals make their forecast, and that's it.	29:18
	But I must modify that answer	29:25
	by saying that you're only human	29:27
	if as you compromise among the uncertainties,	29:30
	you aren't affected, even subconsciously,	29:34
	by what your position is.	29:37
	And it is a truism,	29:40
	moreover, a truism which happens to be true in Wall Street,	29:42
	that you can't sell bad news.	29:46
	There is a need for optimistic reports.	29:48
	This was brought home to me several years ago	29:52
	when a dear friend of mine, who for many, many years	29:55
	had been writing a weekly market report, became ill.	29:59
	And I agreed anonymously to fill in for him.	30:05
	And I wrote that report	30:09
	for a fairly extended period of time.	30:12
	I'm not sure how many people noticed the difference.	30:16
	But I was told,	30:19
	and this was one of our largest organizations,	30:21
	that you can't sell bad news.	30:25
	And I was always,	30:27
	when I had somewhat pessimistic forecasts, challenged.	30:29
	I was never censored.	30:38
	But I was challenged for the proof	30:39
	and for the confidence of my view	30:42
	in a way that I wasn't when I had good news.	30:45
	So I guess we must all take this into account	30:48
	in interpreting forecasts.	30:51
-	If you have any comments	30:55
	or questions for Professor Samuelson,	30:56
	address them to Instructional Dynamics, Incorporated,	30:58
	166 E. Superior Street, Chicago, Illinois, 60611.	31:01

Item Info

Title:

Tape 113 - Credit crunch in 1973

Date:

1972

Contributor:

Samuelson, Paul A. (Paul Anthony), 1915-2009

Subject:

Format:

audiocassettes

Language:

English

Digital Collection:

Paul A. Samuelson papers, 1933-2010 and undated

Source Collection:

Paul A. Samuelson papers, 1933-2010

Series:

Economics Cassette Series: Paul Samuelson

Rights:

Limited Re-Use

CC BY-NC 4.0

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This material is made available for research, scholarship, and private study. Copyright in this material has not been transferred to Duke University. For reuses of this material beyond those permitted by fair use or otherwise allowed under the Copyright Act, please see our page on copyright and citations: https://library.duke.edu/rubenstein/research/citations-and-permissions.

Identifier:

RL10082-CS-0111
ref2361_k0f
samuelsonpaul
duke:325134
pstau001111
ark:/87924/r4cc0v933
d3523127-b1df-4f4f-bea4-bd98fe102349

Permalink:

https://idn.duke.edu/ark:/87924/r4cc0v933

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Tape 113 - Credit crunch in 1973

Transcript

Item Info

Economists' Papers Archive

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