A detail man peeks at credit for '85: high demand but no crunch
Boston — Ever since 1948, James J. O'Leary has been engaged in something of an arcane art. Each year he makes up detailed tables projecting the demand and supply of credit. Probably fewer than half a dozen people go to that trouble in the United States. The basic point of this laborious exercise is to predict the future of interest rates.
Last year Dr. O'Leary, formerly vice-chairman of United States Trust Company of New York and now an economic consultant to that money-managing firm, figures he was ``batting a thousand.'' He held that interest rates would fall in the second half, and they did. That was based on the theory that the boost in rates during the first half would slow the economy, which it did.
Looking at this year, O'Leary offers these relatively cheery predictions:
1. ``Although total demand for credit in 1985 will remain high, it will not place the credit markets under the severe strains experienced during the first six months of 1984.''
In other words, despite the massive budget deficit, there will not be a ``credit crunch.''
2. The decline in interest rates in the second half of 1984 ``has bottomed out or is close to doing so.''
``My expectation is that both short- and long-term rates will remain near current levels through the early spring before beginning to rise gradually and moderately in the second half of the year as the rate of economic growth strengthens somewhat and the inflation rate rises moderately.''
3. Interest rates won't bounce around sharply as they have in recent years. He is expecting the three-month Treasury bill rate to move in the range of 7.5 to 9 percent and the 30-year Treasury bond in a range of 11.5 to 12.5 percent.
Dr. O'Leary figures the US credit markets will raise a total of $743.5 billion this year, boosting total debt outstanding by 10.5 percent. That's a bit down from an estimated $796.7 billion in new borrowings last year. The 1985 figure breaks down this way: The federal government will raise $193 billion; state and local governments, $30.5 billion; corporations, $30.5 billion; home mortgages, $128 billion; multifamily residential (apartments) mortgages, $15 billion; commercial mortgages, $51 billion; farm mortgages, $2 billion; consumer credit, $68 billion; and so on.
Making credit market predictions is a hazardous occupation. O'Leary admits he hasn't always been right. It hangs on first getting a reasonably accurate forecast of the fate of the economy. Then you have to make some assumptions as to where money will flow from and flow to. How much money will be advanced by households, corporations, state and local governments, foreigners, commercial banks, savings-and-loan associations, mutual savings banks, credit unions, life insurance companies, private pension funds, finance companies, and so on? Who will borrow how much of that money?
Demand and supply for credit always balance in such national bookkeeping calculations. But just as the demand and supply for copper, for instance, affects its price, trends in the demand and supply for credit affect its price -- the interest rate.
Most economists use less complicated techniques for predicting interest rates, looking at such broad numbers as money aggregates, forecasts of national output and inflation rates, and international flows of money. They believe they do just as well in their forecasts without breaking out supply and demand for credit in detail.
One of the few who go to that detailed trouble is Henry Kaufman, a renowned economist at Salomon Brothers, the Wall Street brokerage house. Last year Dr. Kaufman forecast rising interest rates in the second half. He was wrong. Kaufman argued that the economy was less sensitive to high interest rates than it used to be. That may be somewhat the case. But housing still slowed.
Always a gentleman, O'Leary pointed out that Kaufman was right in 1980 when he predicted sharply higher interest rates in the second half of that year -- at a time when most economists were saying the opposite. Kaufman's forecast for this year also calls for rising interest rates.
Dr. O'Leary, in an interview, emphasized that his interest rate forecasts hang on his economic assumptions. If the gross national product -- the nation's output of goods and services -- rises much faster than the 2.5 percent rate he has forecast, the demand for credit will be greater and interest rates higher, he cautions. The Federal Reserve System would probably tighten the supply of money to the economy for fear of accelerating inflation.
Similarly, if a ``sharp and sustained drop'' in the foreign-exchange value of the dollar, which he does not expect, produced a significant net outflow of capital to other countries, that would trim the supply of funds in this country and put interest rates higher.
On the other side, ``should the administration and Congress agree on a more impressive federal deficit reduction program than expected, the psychological effect could be to hold down and possibly further reduce the real rate on longer-term obligations,'' O'Leary says.
``So,'' he concludes, ``there are good reasons for being uncertain about the outlook for interest rates.'' That's a good hedge to make, considering the problem economists have had in predicting interest rates in recent years.