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CONFIDENTIAL May 2 7 , 19^9 THE CURRENT ECONOMIC SITUATION AND OUTLOOK* The g r e a t boom of the F o r t i e s , i t now appears, has l a r g e l y run i t s course. O r i g i n a t i n g as a t y p i c a l business upswing f o l l o w i n g the sharp r e / cession of 1937-38, the "boom gathered strong upward impetus a f t e r the outbreak of war i n Europe, and mounting n a t i o n a l defense expenditures. I t was converted i n t o a " c o n t r o l l e d war i n f l a t i o n 1 1 expansion by our e n t r y i n t o world conflict. A f t e r f o u r years of t o t a l war and removal of wartime c o n t r o l s , the boom r e c e i v e d a f i n a l i n f l a t i o n a r y stimulus from the huge overhang of warcreated l i q u i d resources and from an e x c e p t i o n a l l y l a r g e reequipment backlog and heavy r e s t o c k i n g needs f o r consumers as w e l l as f o r producers and d i s tributors. Pressures on domestic output were also h e a v i l y taxed by demands from abroad where production and trade had been d i s r u p t e d by war much more than i n t h i s country. The boom had many e x t r a o r d i n a r y f e a t u r e s . The average per annum increment i n p h y s i c a l output probably reached an a l l - t i m e r a t e . Unprece- dented sums were spent on war, armaments, and i n t e r n a t i o n a l a i d . Additions t o productive f a c i l i t i e s and advances i n technology were u n p a r a l l e l e d i n t h i s c o u n t r y ^ annals. A whole new f r o n t i e r of economic power and tech- nology was discovered f o r e x p l o i t a t i o n by f u t u r e generations. Throughout the e n t i r e boom p e r i o d and f o r the f i r s t time i n the records of c a p i t a l i s m , i n t e r e s t r a t e s were r e l a t i v e l y s t a b l e a t an e x c e p t i o n a l l y low l e v e l . *Statement by Ralph A. Youngs Associate D i r e c t o r , D i v i s i o n of Research and S t a t i s t i c s , Board of Governor^ of the Federal Reserve System, before the Conference of F e d e r a l Reserve Bank Chairmen, White Sulphur Springs, West V i r g i n i a , May 30, 19^9. - 2 The r e a l income of American consumers during the boom rose by some 30 per c e n t . Incomes became much more evenly d i s t r i b u t e d than ever before i n our h i s t o r y . Probably a higher p r o p o r t i o n of consumers h e l d some l i q u i d assets and had s i z a b l e secondary f i n a n c i a l reserves i n the form of l i f e in- surance, houses, and corporate s e c u r i t i e s than a t the peak of any previous p e r i o d of long-sustained business boom. Considering the i n e v i t a b l e p r o d i g a l i t y of our war finance and the enormous c a r r y - o v e r of spendable resources which i t l e f t us, the r e a l wonder o f the r e c e n t p e r i o d i s n o t t h a t we had so much i n f l a t i o n , b u t t h a t we had so l i t t l e . Perhaps the u l t i m a t e c r e d i t f o r t h i s achievement should go t o progress i n economic democracy. Had we not experienced considerable broad- ening of the average c i t i z e n ^ economic knowledge, our i n f l a t i o n a r y excesses might have had no bounds. The composite of c u r r e n t i n d i c a t i o n s , as my opening comment i m p l i e d , i s t h a t t h i s e x t r a o r d i n a r y boom p e r i o d has now been succeeded by a p e r i o d of readjustment. What are these i n d i c a t i o n s and what importance i s t o be attached t o them? For purposes o f summary a n a l y s i s we may d i v i d e them i n t o two broad groups: c e r t a i n c u r r e n t economic tendencies — straws i n the wind — and c e r t a i n underlying forces and s t r u c t u r a l c o n d i t i o n s . C e r t a i n Current Economic Tendencies Consider f i r s t some of the more s t r i k i n g c u r r e n t economic tendencies: 1. Since l a s t f a l l , d e c l i n e s i n i n d u s t r i a l production, In f a c t o r y man- hours and employment, and i n p r i c e s have been v e r y widespread and much more g e n e r a l than i n any preceding s o f t phase of the boom p e r i o d . - 3 - 2. While declines I n many areas have thus f a r "been moderate, the more s e n s i t i v e areas have shown l a r g e , and even very l a r g e , d e c l i n e s . Some declines — f o r example, i n "basic p r i c e s — have r i v a l e d the sharp and d r a s t i c d e c l i n e s of past periods of major business readjustment. 3. M e t a l and metal products i n d u s t r i e s have r e c e n t l y shown considerable evidence of weakness. S t e e l consumption has been d e c l i n i n g , w i t h the l i k e - l i h o o d t h a t the c u r r e n t r a t e of s t e e l output, which i s a l r e a d y 7 per cent below i t s l e v e l i n middle March, i s probably s t i l l i n ezcess of consumption. k. I n v e n t o r y accumulation has slowed down, w i t h inventory of f i n i s h e d goods continuing t o r i s e and inventory of m a t e r i a l s and goods j n process tending t o f a l l . D i f f e r e n t i a l s between product p r i c e s and m a t e r i a l costs, i n some instances wide d i f f e r e n t i a l s , are keeping new orders a t low l e v e l s i n a growing number o f i n d u s t r i a l areas. 5. A f t e r the middle of 19^8 r e s i d e n t i a l b u i l d i n g d e c l i n e d and, despite a marked seasonal expansion t h i s spring i n new s t a r t s , i s s t i l l below y e a r ago l e v e l s . Business construction a l s o i s dovn moderately and, notwithstand- i n g a marked increase i n p u b l i c c o n s t r u c t i o n , t o t a l a c t i v i t y i n the construct i o n i n d u s t r y i s no higher than a year ago. 6. T o t a l business expenditures f o r p l a n t and equipment have l e v e l e d o f f , w i t h expenditure plans i n d i c a t i n g declines i n the second h a l f y e a r . Farmers a l s o seem t o be p a r i n g expenditures f o r equipment and l a n d and c u r r e n t farm i n f l u e n c e s appear t o f a v o r some d e c l i n e i n farm investment. 7. Consumer spending, excepting expenditures f o r s e r v i c e s , food, and automobile^ has been d r i f t i n g downward much of the time since l a s t September, w h i l e personal saving i n r e l a t i o n t o disposable income has been r i s i n g . Accompanying the r i s e i n personal saving has been a tendency towards l a r g e r consumer holdings of l i q u i d assets. - 8* k - Business f i n a n c i a l p o s i t i o n s show signs of decreasing l i q u i d i t y , and the d i s t r i b u t i o n of f i n a n c i a l strength and l i q u i d i t y i s l e s s widespread than a year ago. I n a d d i t i o n , f a c t o r s sustaining p r o f i t l e v e l s have weakened s i g n i f i c a n t l y , p a r t i c u l a r l y i n the case of medium-size and smaller e n t e r prises. The r a t e of business f a i l u r e s has a l s o been creeping up f o r some months. 9. C r e d i t demand a t banks has tapered o f f and, together w i t h a r e l u c t a n t l e n d e r a t t i t u d e apparently assumed by many bankers, has r e s u l t e d i n a sharp r e d u c t i o n i n t]be volume of outstanding bank l o a n s , e s p e c i a l l y of loans t o business e n t e r p r i s e s . New s e c u r i t y f i n a n c i n g , corporate p r o f i t s , and undis- t r i b u t e d earnings are a l l somewhat lower than i n the second h a l f of l a s t y e a r . C e r t a i n Basic Forces and Conditions C h a r a c t e r i s t i c symptoms of the t a p e r i n g o f f phase of a boom are impressive enough i n themselves. They need, however, t o be r e l a t e d t o various f o r c e s and s t r u c t u r a l conditions of more basic importance: !• Sustained high l e v e l s of postwar output have gone a long way toward s a t i s f y i n g the more urgent d e f e r r e d demands f o r many consumer goods, i n c l u d i n g automobiles and houses. No doubt many consumers have exhausted t h e i r savings or c r e d i t , or both, and consumers g e n e r a l l y show more choosiness and d i s i n c l i n a t i o n t o buy because they expect lower p r i c e s . 2. I n v e n t o r i e s have been replenished a t a l l stages of production and business expenditures f o r b u i l d i n g up i n v e n t o r i e s and customer r e c e i v a b l e s have ceased t o provide a s i g n i f i c a n t f i n a n c i a l stimulus. Declining prices, f o r example, reduce the d o l l a r investment needed t o m a i n t a i n necessary holdings of inventory and customer d e b t , and i n many f i e l d s lower c u r r e n t asset investment i s becoming an important c o n t r a c t i v e influence. - 5 - 3. Business has invested huge sums i n p l a n t and equipment since the war i n order t o meet a combination of backlog and c u r r e n t l y a r i s i n g demand. With backlog demand l a r g e l y s a t i s f i e d , c a p a c i t y i n many i n d u s t r i e s i s n o t only excessive a t c u r r e n t p r i c e s , but i n some i n d u s t r i e s may t u r n out t o be excessive even a t m a t e r i a l l y lower p r i c e s . 4. While the average age of passenger automobiles i s q u i t e high com- pared w i t h prewar, suggesting a continuing backlog of automobile demand, the i n d u s t r y i s producing a much l a r g e r p r o p o r t i o n of medium and h i g h - p r i c e d cars of g r e a t e r d u r a b i l i t y than prewar. Signs of some narrowing i n the market f o r medium and h i g h - p r i c e d cars have been e v i d e n t tor s e v e r a l months, and premiums have been g r e a t l y reduced or e l i m i n a t e d even f o r l o w - p r i c e d c a r s . 5. Concurrently w i t h the s u b s t a n t i a l s a t i s f a c t i o n of backlog housing demand, the housing market i s commencing t o f e e l a gradual t a p e r i n g o f f i n such basic forces as a r i s i n g r a t e of marriages and b i r t h s and boom p e r i o d m i g r a t i o n and s h i f t s of p o p u l a t i o n . cumulative. The impact of these forces i s , of course, I t should be remembered, moreover, t h a t spending f o r housing has a l a r g e secondary e f f e c t i n consume^ business, and p u b l i c investment t h a t i s n o t associated i n the same degree w i t h other forms of c o n s t r u c t i o n . The e f f e c t on the economic s i t u a t i o n of d e c l i n i n g construction of new housing i s n o t f u l l y absorbed by an o f f s e t t i n g expansion i n other types of c o n s t r u c t i o n . 6. Farm prospects, assuming f a v o r a b l e growing and h a r v e s t i n g c o n d i t i o n s , are f o r l a r g e crops and continuing pressure of supply on farm and r e l a t e d prices. - 6 - 7* Foreign demands f o r American i n d u s t r i a l goods and foods are l e s s urgent than e a r l i e r and are tending t o s o f t e n . Foreign supplies of m a t e r i a l s and other goods are more ample and more g e n e r a l l y a v a i l a b l e , and hence a more a c t i v e supply i n f l u e n c e i n domestic markets. 8. Examination of the c u r r e n t s t r u c t u r e of commodity p r i c e s discloses many conspicuous p r i c e r i g i d i t i e s and d i s p a r i t i e s between p r i c e s . Some groups continue a t e x c e p t i o n a l l y high l e v e l s r e l a t i v e t o prewar. Prices of used cars and houses are s t i l l high r e l a t i v e t o new car and new house p r i c e s j metal p r i c e s are high r e l a t i v e t o scrap. Wide p r i c e d i s p a r i t i e s f o a t u r e many m a t e r i a l s t h a t are s u b s t i t u t e s f o r one another i n many uses. For the most p a r t , declines i n consumer p r i c e s so f a r have been very moderate i n r e l a t i o n t o those i n wholesale markets. Continuing Strengths and Cushions The American economy has o f t e n been s t i g m a t i z e d as a "boom and bust" economy. This c h a r a c t e r i z a t i o n f i n d s much support i n h i s t o r i c a l r e c o r d , and the very f a c t of the record makes f o r apprehension about the n e a r - t e r m future. We have had the boom. Does the emergence of a readjustment process mean t h a t we must, of n e c e s s i t y , have the "bust"? I n terms of our r e c e n t l y a t t a i n e d peak l e v e l of n a t i o n a l product, t h i s i s t r u l y a 100 b i l l i o n d o l l a r question. We are a l l aware from experience t h a t each f o r c e such as f a l l i n g p r i c e s , p r i c e d i s p a r i t i e s , c u r t a i l e d orders, l i q u i d a t i o n of i n v e n t o r y , duced consumer spending, d e c l i n i n g income, lower investment, re- contributes something to economic c o n t r a c t i o n and together tend t o make f o r a downward s p i r a l e f f e c t , the essence i n short of a " b u s t " . Whether a cumulative down- ward s p i r a l , r e s u l t i n g i n severe and prolonged depression w i l l eventuate, is - 7 impossible t o f o r e t e l l a t t h i s j u n c t u r e . warrant so p e s s i m i s t i c a view. Developments t o date do n o t They do support, however, an e x p e c t a t i o n of continuing moderate c o n t r a c t i o n i n a c t i v i t y . I n considering t h i s p o s s i b i l i t y , i t i s v i t a l l y important t o keep i n perspective the various strengths and cushions t h a t are present i n the current s i t u a t i o n . For the most p a r t , these strengths and cushions are without p a r a l l e l i n past culminations o f extended periods of i n f l a t i o n a r y economic expansion. We can undertake here only t o mention the more im- p o r t a n t ones: 1 . As employment declines the Government a u t o m a t i c a l l y pays out unemployment compensation b e n e f i t s which p a r t i a l l y m a i n t a i n t h e income and expenditures o f the unemployed. 2 . Payments under the farm support program s i m i l a r l y h e l p t o m a i n t a i n income tod reduce the dangers of u n l i m i t e d farm p r i c e declines. 3 . F e d e r a l expenditures on goods and services a r e i n record peace-time volume and some f u r t h e r increase i s probable. State and l o c a l government expenditures are expected t o expand conside r a b l y because of pressing needs f o r schools, h o s p i t a l s , other p u b l i c b u i l d i n g s , and roads. 4 . Consumer f i n a n c i a l p o s i t i o n s are strong as a r e s u l t of p r e v a i l i n g high incomes and l a r g e and w i d e l y d i s t r i b u t e d l i q u i d asset holdings. Many more consumers than ever before have subs t a n t i a l secondary reserves i n the form of l i f e insurance, corp o r a t e s e c u r i t i e s , and e q u i t i e s i n homes. 5 . From the standpoint of providing a mass market f o r our mass production system, c u r r e n t income a l s o i s probably b e t t e r d i s t r i b u t e d than a t any p r i o r t i m e . 6 . Labor i s more widely organised than ever before t o r e s i s t severe cute i n wage incomes. 7 . The Board's annual Survey of Consumer Finances, Just comp l e t e d , shows t h a t there continues t o be a l a r g e demand f o r automobiles, household appliances, f u r n i t u r e , and houses. A t lower p r i c e s , p o t e n t i a l demands f o r goods and services would seem t o be very g r e a t . Where s u b s t a n t i a l p r i c e reductions have occurred r e c e n t l y , increased buying has tended t o absorb p r e v i o u s l y excessive stocks. Survey data r e f l e c t i n g consumer a t t i tudes and expectations show t h a t , w h i l e the preponderant expectat i o n i s f o r p r i c e declines t h i s y e a r , few consumers expect l a r g e declines. - 8 - 8 . Ten years of an i n f l a t i o n a r y "buyers market have r u s t e d the merchandising s k i l l s of i n d u s t r y and, t r a d e . P u t t i n g these s k i l l s again t o work so t h a t our mass production system becomes f u l l y reconverted t o a mass merchandising-production system can h e l p r e e s t a b l i s h s e n s i t i v e contact "between consumption and production. 9 . Business f i n a n c i a l p o s i t i o n s o v e r - a l l are strong i n comp a r i s o n w i t h prewar, and lower m a t e r i a l costs together w i t h increased p r o d u c t i v i t y are p r o v i d i n g a d d i t i o n a l f l e x i b i l i t y t o f i n a n c i a l management. 1 0 . A high l e v e l consumption economy w i l l continue t o r e q u i r e l a r g e c a p i t a l expenditures by business and farming. Substantial programs of c a p i t a l expenditure doubtless a w a i t lower construction and equipment costs. I n a d d i t i o n , many new expenditure programs may be s t i m u l a t e d by narrowing margins between costs and p r i c e s . 1 1 . While a r e d u c t i o n i n personal incomes and housing p r i c e s may make p a r t of our l a r g e mortgage debt v u l n e r a b l e from the standpoint of the borrower (who enjoys lower i n t e r e s t r a t e s than p r e v a i l e d , f o r i n s t a n c e , i n the l a t e T w e n t i e s ) , widespread use of mortgage a m o r t i z a t i o n and of Government guarantees provides the l e n d e r w i t h important p r o t e c t i o n s . 1 2 . The f a c t t h a t the postwar p e r i o d has been f r e e o f specul a t i v e excesses i n the s e c u r i t i e s markets, the g e n e r a l l y strong f i n a n c i a l p o s i t i o n of i n d u s t r y , and the g r e a t strength of the banking system a r e f a c t o r s t h a t make a prolonged and d r a s t i c l i q u i d a t i o n l e s s l i k e l y than i n other periods of d e c l i n e . 1 3 . I t seems q u i t e u n l i k e l y t h a t the money supply w i l l cont r a c t over the months ahead. On the c o n t r a r y , i t appears probable t h a t Treasury d e f i c i t f i n a n c i n g through the banks w i l l more than o f f s e t any loan c o n t r a c t i o n which might occur, thus having an expansive impact on the money supply. Ik• The c r e d i t supply i s l a r g e and e l a s t i c and the cost of c r e d i t — short and l o n g - t e r m — continues t o be low. 1 5 . The Employment Act of 19^6 e s t a b l i s h e s maintenance of economic s t a b i l i t y as the o b j e c t i v e of n a t i o n a l p o l i c y . This o b j e c t i v e i m p l i c i t l y recognizes a governmental r e s p o n s i b i l i t y f o r i n t e r c e d i n g i n economic readjustment t o prevent a "bust 11 . - 9 Business P o l i c i e s and Government P o l i c i e s t o Cope w i t h Economic C o n t r a c t i o n These are sturdy underpinnings and t h e i r capacity t o absorb conside r a b l e economic readjustment without s t r a i n i n g the l i m i t s o f s o c i a l tolerance should n o t be underestimated. We should recognize t h a t they are reenforced i n many areas of a c t i v i t y by able and w e l l - i n f o r m e d managements, a l e r t t o the p i t f a l l s of a changing economic s i t u a t i o n and aggressive i n coping w i t h i t s problems. Now t h a t postwar restocking needs are s a t i s f i e d and the economy i s adapting t o sustainable peacetime requirements, s u b s t a n t i a l economic readjustments are h i g h l y d e s i r a b l e and necessary t o a t t a i n a balance i n r e l a tionships between production and consumption, among p r i c e s , and i n the s t r u c t u r e of production. I f these i n t e r n a l adjustments are made as the need f o r them a r i s e s and a t a time when t o t a l demand i s g e n e r a l l y strong, reduct i o n s in o v e r - a l l a c t i v i t y may be moderate. I f e s s e n t i a l readjustments are delayed and allowed t o accumulate, recession i n g e n e r a l a c t i v i t y may be serious• I n view o f the notable strengths t h a t abound, our present reces- sion should be moderate, even though sharp declines may be experienced i n some l i n e s . Whether recession w i l l t u r n out t o be moderate w i l l depend, of course, on the appropriateness and timing of business, f i n a n c i a l , l a b o r , and Government p o l i c i e s . I t i s an easy temptation i n a p e r i o d of readjustment such as t h i s t o place the blame on p u b l i c p o l i c i e s and t o look t o p u b l i c p o l i c i e s as the cure. Eeadjustment i n a f r e e e n t e r p r i s e economy i s i n the f i r s t a matter of p r i v a t e p o l i c i e s . i.e., instance F l e x i b l e adaptation of merchandising programs — of p r i c e s , marketing p o l i c i e s , and costs — and the wise a d m i n i s t r a t i o n - 10 of p r i v a t e d e b t , i s a t the h e a r t of the readjustment process. If business responds promptly and d e c i s i v e l y i n i t s problem area w h i l e m a i n t a i n i n g as f u l l y as possible i t s volume of output, and i f bankers and other lenders f i l l t h e i r o b l i g a t i o n s as f a r - s i g h t e d c r e d i t o r s , then the prospect of moderate economic c o n t r a c t i o n w i l l n o t only be r e a l i z a b l e , but r e a l i z e d . Government can make i t s most important c o n t r i b u t i o n t o readjustment a t t h i s e a r l y j u n c t u r e by f o l l o w i n g p o l i c i e s t h a t encourage business and consumer expenditures or remove impediments t o such expenditures; t h a t maint a i n p u b l i c expenditures on a prudent b a s i s ; t h a t assure the continued a v a i l a b i l i t y of an ample supply of low-cost c r e d i t t o worthy borrowers; and t h a t improve the economy's f i s c a l and f i n a n c i a l s t r u c t u r e . Tax revenues w i l l d e c l i n e as readjustment proceeds, and Government may confront substan* t i a l deficits. Readjustment d e f i c i t s , however, should n o t be a source of undue concern t o the informed c i t i z e n . I f t h e r e i s one lesson of f i s c a l p o l i c y t h a t has been w e l l taught by h i s t o r y , i t i s t h a t Government can n e i t h e r t a x an economy out of a depression nor can i t r e s t o r e p r o s p e r i t y by d r a s t i c a l l y slashing i t s own expenditures. We have n o t , i n t h i s century anyway, solved the problem of d i s t r i b u t i n g a l l t h a t our t e c h n i c a l genius enables us t o produce — except through the stimulus of world war and the i n f l a t i o n a r y a f t e r e f f e c t s . To my mind t h i s does n o t mean t h a t we l a c k the w i l l and the w i t t o f i n d reasonably satisfactory solutions• Prom p r a c t i c a l experience, we know a g r e a t d e a l more today of techniques - - o f ways and means - - of moderating extreme swings of the business c y c l e . We need t o p e r f e c t them, t o time them b e t t e r , and t o c l e a r away the fogs of ignorance and p r e j u d i c e t h a t are the g r e a t e s t danger i n p e r p e t u a t i n g democratic c a p i t a l i s m -
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