F-A-I-R  U-S-E  C-L-A-I-M-E-D 

Copyright 1981 Newsweek  
Newsweek

August 31, 1981, UNITED STATES EDITION

SECTION: THE COLUMNISTS; THE COLUMNISTS; MILTON 
FRIEDMAN; Pg. 43

LENGTH: 762 words

HEADLINE: Churning at the Fed

BYLINE: MILTON FRIEDMAN

BODY:
"Churning" a customer's stock-market account--that is, 
engaging in much trading as a means of generating 
commissions--is regarded as a serious offense, and 
any "customer's man" who engages in the practice is 
subject to severe penalties.

What then are we to make of the churning engaged in 
by the U.S. Government's banker--the Federal Reserve 
System? In 1980 the manager of the Federal open-
market account at the Federal Reserve Bank of New 
York (the system's "customer's man") made purchases 
and sales of U.S. Government and Federal-agency 
securities totaling nearly $2 trillion. The net 
change in its holdings was $4.5 billion--which means 
that the system engaged in more than $350 of gross 
transactions for each dollar of net purchases. These 
transactions accounted for one-quarter to one-half of 
all the transactions of dealers in U. S. Government 
securities other than the Fed itself. That is 
churning with a vengeance. 
 
Fine Tuning:

The Fed engages in this churning because of the 
operating procedures that it uses in conducting 
monetary policy. Before October 1979 the churning was 
produced by the fine tuning required to peg the 
Federal-funds interest rate, which it took as its 
direct operating guide. Since then, the Fed no longer 
pegs the Federal-funds rate. Instead, it now seeks to 
fine-tune the amount of "nonborrowed reserves" it 
makes available to banks, selling securities whenever 
nonborrowed reserves, as estimated most imperfectly 
from day to day, exceed its target and buying 
securities whenever nonborrowed reserves fall short 
of its target. In the process of its fine tuning, it 
manufactures all sorts of ingenious short-term 
contracts out of longer-term government securities: 
matched purchases and sales, for instance, and 
repurchase agreements, or "repos."

In my opinion, this fine tuning, and the churning 
that accompanies it, not only is unnecessary but 
actually reduces both the predictability and 
effectiveness of monetary policy. The churning serves 
only to muddy the waters, introduce uncertainty and 
speculation and waste the taxpayers' money.

Suppose, for example, that in 1980 the Fed had 
produced the same net change in its portfolio ($4.497 
billion) by buying every Monday morning $86.48 
million of securities (plus whatever exchanges or 
purchases were required to replace maturing 
securities). I submit that monetary growth during the 
year would have been decidedly stabler, and that so 
would interest rates and the economy.* We have an 
enormously sophisticated and efficient private 
financial structure. It can be counted on to smooth 
random week-to-week fluctuations and systematic 
seasonal movements in reserves, the demand and supply 
of credit, monetary aggregates and the like at least 
as well as the experts at the open-market desk. And 
its task would be far easier if it knew precisely 
what the Federal Reserve was doing than it is in the 
present state of uncertainty, where high-powered 
financial experts specialize in trying to read the 
Federal Reserve tea leaves.

* See Anatol B. Balback, "How Controllable Is Money 
Growth?" Federal Reserve Bank of St. Louis Review, 
April 1981, for examination of a much less drastic 
change in this direction.

Changing the Tune: Eliminating the churning will not 
be easy. The officials on the desk, who are engaged 
in buying and selling billions of dollars of 
securities every week, who are subject to pressure 
and influence from important people and are resisting 
that pressure--how can they fail to be impressed by 
the importance of what they are doing? Can they 
believe it is "full of sound and fury, signifying 
nothing"? And, needless to say, neither the handful 
of securities dealers who earn millions of dollars of 
commissions each year through the churning nor the 
Board of Governors of the Federal Reserve System, who 
ultimately guide the churning, can be expected to 
welcome its elimination.

Yet the case is not hopeless. The same situation 
existed for many years in the foreign-exchange 
market, with the Federal Reserve and the Treasury 
engaging in day to-day intervention (speculation) in 
a vain attempt to control exchange rates. Recently, 
the Fed and the Treasury jointly announced the 
termination of such intervention except under 
"extreme circumstances"--producing howls of 
disapproval from other central banks but no other 
untoward consequences. It also produced the 
resignation of the able public servant who had been 
in charge of such foreign-exchange operations. He has 
moved to greener pastures, where his ability can be 
constructively employed.
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