Interest rates soar, tensions rise between Reagan and Fed chief

Interest rates climb, stocks tumble, the economy slows, and tension may be mounting between the next President of the United States and the nation's top central banker.

Both men -- Ronald Reagan and Paul Volcker -- describe inflation as domestic enemy No. 1. They are determined to knock it down.

But there is a crucial difference. Mr. Volcker, as chairman of the Federal Reserve Board, already is on the firing line. Mr. Reagan has yet to begin.

The way Volcker is going about his hard and painful task threatens to nudge the giant US economy back into recession about the time Reagan becomes a president.

Also, Volcker has expressed doubts about the wisdom of a major income tax cut -- such as Reagan wants -- unless it is accompanied by equivalent trims in government spending.

Reagan says that is just what he will do -- slash the budget. The extent to which he can or will do so remains to be seen. Meanwhile, Volcker and his cohorts at the Fed feel lonesome in a chilly wind.

Their immediate problem is that, in key categories, the money supply has been growing faster than the targets the fEd set as prudent nd responsible for 1980.

This means, as a Fed official acknowledged, that for the rest of the year, "There can be no growth, and perhaps even a reduction, if the targets are to be met."

"In fact," said another high-ranking Fed offin the money supply would bring about a real credit crunch and a considerable rise in interest rates.

"Practically speaking, I don't think we can do that, but it will be, nontheless, a December of restraint."

When the central bank pulls tighter on the credit reins -- i.e. restricts the amount of money banks can lend -- the price of money rises.

The price of money -- what borrowers, large and small, must pay for funds -- is expressed in interest rates. Already those rates are high enough to tip housing back into a stall and leave new cars languishing unsold on dealer lots.

"The residential market," said a builder of town houses in Arizona, "is being killed. I'm paying two points above a floating prime to borrow for construction loans."

When the prime rate hovered at 17 percent, this man paid 19 percent to borrow money -- a cost he hopes to recover in the final sales price of his units.

Now top US banks, led by Chase Manhattan Bank, have raised their prime -- the rate charged to their best corporate customers -- to 18.5 percent. That boosts the cost of money for less privileged borrowers to 20 percent or more.

With banks paying 17 percent interest on large certificates of deposit, says a top banking source, bankers are setting their primes even higher, a tactic called "marginal cost-plus pricing."

"I build small rental houses," said a black contractor in Washington. "but the cost of money has stopped me. People can't pay enough rent to cover my costs."

A crimp in the sales of durables threatens to widen into a general slowdown of consumer spending, especially since families will be hit by higher social security taxes come Jan. 1 and, as the year goes on, probably by higher food and fuel costs.

Recession, plus double-digit inflation, is not the economic recipe with which Reagan would like to start his tenure at the White House.

This may explain why Edwin Meese III, the President-elect's closest aide, studiously avoids praising Volcker and the way he is doing his job.

None of this will impel Volcker to offer his resignation when Reagan takes office, according to Fed officials. The chairman's term runs until August 1983, and the President has no power to remove him.

Also, Volcker is widely respected among foreign bankers and investors, whose confidence helped to bolster the dollar after Volcker accepted the Fed helm at President Carter's behest.

For the man in the White House and the man at the Fed even to appear to be at odds would burden not only themselves but also could hurt the dollar.

A report that Volcker might resign for family reasons also is vigorously denied at the Fed's white marble headquarters here, set back 200 feet from the roar of traffic on Constitution Avenue.

"Simply untrue," snapped a Fed Official. "We think it must have been leaked by someone in the Reagan entourage."

What troubles some advisers to the President-elect is not monetary stringency itself (REagan, after all, supports this), but the erratic behavior of the money supply during 1980 and the inability of the Fed to keep within its targets.

"A lot of [Reagan advisers]," said a senior banker, "are quite strict monetarists. They only judge performance by the aggregates," i.e. the amount by which the nation's money supply grows.

"From their point of view," the banker added, "policy has been poor," because in two of the most important categories, the growth of money already has exceeded the 1980 targets.

Adding to the problem has been extreme voltility in money-supply performance -- a sharp dip during the second quarter of 1980, followed by equally sharp upward surges in recent months.

Fed officials claim that recent changes in banking laws make it much harder to forecast what money-supply performance will turn out to be.

With the advent of interest-bearing checking accounts and automatic transfers from savings to checking, people are moving their money about in ways hard to anticipate and track.

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