That is a problem. That diverts flow to the power beyond that feeds the loader. Then power beyond goes from the loader to 3pt hitch.
In one position, it would bypass the loader and just feed 3pt. In the other position it would feed the loader. Anything in between would create a split flow that would create a shortage of fluid to both. Here is a picture of mine.
View attachment 691382
That said, the symptoms sound like a weak pump or stuck relief valve. I believe that model had a 7GPM pump so maybe doing a flow test would tell you something.
To do that you can discount the hose feeding the loader and pump it into a 5 gal bucket with a mark for 1 gal. Then time how long it takes to fill to that line. Set RPM somewhere between 1500 and 2000 for the test.
I hope that helps!