The gale-force disturbances blowing through the United States and world financial systems are forcing Federal Reserve Board chairman Paul Volcker to walk a narrow and difficult policy road.
In its role as defender of the dollar's value, the Fed in recent months has let interest rates rise in an effort to slow the economy's robust growth and prevent a rekindling of inflation. Longer term, the slowdown may allow interest rates to fall.
Retail sales figures released Wednesday offer one sign that the economy may be cooling. After surging 3.1 percent in April, the figures climbed just 0.2 percent in May. That pace ''would be consistent with some slower growth'' of the gross national product, says Commerce Department chief economist Robert Ortner.
But until a slowdown is confirmed, the Fed's ability to control inflation by tightening up on credit is being hobbled by the plight of third-world debtor nations and the impact those debtor nations' woes are having on the US banking system.
The Fed is the lender of last resort to troubled banks. And anytime Fed operations in the credit markets kick up, interest rates, developing nations' interest payments rise. That makes paying back the $800 billion they owe to the US and other banks that much harder.
Loans to Latin American nations were one factor in the run on Continental Illinois National Bank & Trust Company last month. Latin loans also sparked unfounded negative rumors and a resulting decline in the price of the stock of Manufacturers Hanover Trust Company. ''The Fed has put priority on the near-fatal run on Continental and the nervousness about Manufacturers Hanover. That is a major source of concern to the Fed,'' says David Jones of Aubrey G. Lanston, a government securities dealer.
As a result of the conflict between its monetary role and its lender-of-last-resort responsibility, ''The Fed is boxed in. It has no significant flexibility to move one way or the other,'' says Jerry Jasinowski, chief economist at the National Association of Manufacturers. As a result, ''interest rates will stay in a narrow band for the next quarter,'' he contends.
The debt caldron is boiling again: Argentina and the International Monetary Fund have been unable to come to agreement on terms of a major loan package. The IMF loan would allow Argentina to pay $5.5 billion in interest charges this year on its $43 billion debt.
Over the weekend the government of President Raul Alfonsin rejected an economic plan proposed by the IMF staff. In a highly unusual move, it sent an alternative proposal directly to IMF managing director Jacques de Larosiere. ''Alfonsin's attitude is noncooperative. It is beyond my comprehension where this thing could go,'' says Merrill Lynch bank analyst James Wooden.
On June 30, however, some $500 million in interest payments owed by Argentina will be more than 90 days overdue. Unless payment is received or bank regulators allow the rules to be broken, US banks will be forced to classify their share of the loans as nonperforming and subtract earnings the loans produced from their income statements.
That blow to earnings could have a serious effect on the US banking system. Estimates by First Boston Corporation, disputed by the banks involved, show that major lenders to Argentina could be forced to chop their second-quarter earnings by 15 to 60 percent if Argentina did not pay the banks by the end of this month.
''Confidence in the banks will be destroyed if they have to write down that much,'' says Ben E. Laden, chief economist at T. Rowe Price Associates Inc. ''The Fed will be dealing with more than one bank where confidence in the financial markets is at stake.''
To encourage action from Argentina, US Treasury Secretary Donald Regan will not say whether the US government will extend the June 15 deadline for a commitment for a $300 million loan to Argentina. The loan would let Argentina repay other Latin Americans nations which advanced funds to it in March, in order to pay overdue interest until the IMF loan came through.
Even if Argentina makes its debt payment in time, the Continental Illinois situation appears no closer to a solution. Last month there was a run on the bank during which major depositors withdrew about $7 billion. The institution was saved from collapse only when the government pumped in $1.5 billion in capital, allowed the bank to borrow heavily from the Fed, and guaranteed that all depositors and other creditors would be fully protected. Since then, federal officials have been looking for an institution with deep pockets to invest in or merge with Continental.
This week, both First Chicago Corporation and Chemical New York Corporation said they would not acquire the ailing Continental. The two banks had been seen as the institutions with the strongest potential interest in Continental.
At a congressional hearing Tuesday, Federal Deposit Insurance Corporation (FDIC) chairman William Isaac said that merger possibilities for the bank are diminishing and that Continental ''needs a capital infusion, an investor group to acquire stock.'' Among options still open, banking sources say, are a possible acquisition by Sanwa Bank, a large Japanese institution, or by a US investor group led by Drexel Burnham Lambert. Drexel is an expert in low-grade, high-yield bonds known in the investment community as ''junk bonds.''
Banking experts say that time is running out for a solution to the Continental situation. The danger is that even with the infusion of $1.5 billion from the FDIC, customers will lose confidence in the bank and withdraw funds, reigniting the crisis. For that reason, experts say, a merger with a stonger institution is a better solution than an infusion of capital aimed at letting Continental go it alone.