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JANUARY 1962 BUSINESS REVIEW The Great Corporate Profits Mystery Recovery, Market Interest Rates, and Monetary Policy Business and Banking in 1961 FEDERAL RESERVE BANK OF PHILADELPHIA rftttui&l defiant *)4Auc B U S IN E S S R E V IE W is produced in the Department o f Research. Bernard Shull was primarily responsible for the article “ The Great Corporate Profits Mystery,” Clay J. Anderson for “ Recov ery, Market Interest Rates, and Monetary Policy,” and Lawrence C. Murdoch for “ Business and Banking in 1961.” The authors will be glad to receive comments on their articles. Requests for additional copies should be addressed to the Department o f Public In formation, Federal Reserve Bank o f Phila delphia, Philadelphia 1, Pennsylvania. THE GREAT CORPORATE PROFITS MYSTERY A Study in Stability In recent years businessmen have This failure of corporate profits worried and economists have won to respond to economic expansion dered about the strange behavior seems to represent a break with of corporate profits. The economy past experience. has climbed to new heights over 1950, both gross national product From 1929 to the last decade, and corporate profits have shown and profits increased substantially. Only four an uncomfortable tendency to sit still. times in the 21-year period did GNP and profits Since our economy is moved primarily by the move in opposite directions. On the other hand, profit motive, profit stability appears incongru ous with economic expansion. Will profits continue to be depressed in the 1960’s— and, if so, can we really expect our economy in general and corporate investment in particular to grow rapidly? The answers to these questions depend in part, at least, on what lies behind the relative CHART I PROFITS A N D PRODUCTION Between 1929 and 1950, gross national product and cor porate profits pretty much kept pace. Over the last decade, however, production continued to increase while profits seemed to reach a plateau. GN P grew 77 per cent over the fifties; profits were about the same in 1960 as they had been in 1950. PRO FIT-BILLIO NS OF DOLLARS stability of corporate profits. JUST THE FACTS In the 1950’s, the gross national product of the United States increased about 77 per cent; this economic expansion provided a substantial in crease in the material well-being of most Americans. On the other hand, corporate profits after taxes were about the same in 1960 as they had been in 1950.1 l In the national income accounts, corporate profits are adjusted to eliminate "b o o k " profits or losses on inventory that arise from changes in prices. The corporate profit figures discussed above are not so adjusted. When profits after taxes are adjusted for inventory price changes, an increase of $5 billion for the decade of the 1950's is revealed. This is due to the fact that profits in 1950 were over estimated because the cost of replacing inventory, in that year of rising prices, was underestimated. 3 over the last ten years they have moved in There follows a line-up of the major com opposite directions five times; and each time, ponents profits fell while GNP was rising.2 major components of gross national product. of our economy’s performance— the Non-Income Components Had profits kept pace with economic growth Depreciation over the last decade, they would have been about Indirect business taxes $18 billion higher in 1960 than they actually Income Components were— about $41 billion instead of $23 billion. But profits did not keep pace with economic Corporate profits after taxes growth and the $18 billion or so dollar gap was opened up. So the question remains: who or Corporate profits taxes Wages and salaries what killed corporate profits? Supplements to wages and salaries Proprietors’ income O N THE T R A CK OF THE G A P Rent We can view our economic growth over the last Interest decade— the upsurge in gross national product— as an increase in the total value of goods and services produced by our economy. We can also view it as an increase in the income of our families and institutions. For the goods and services produced are, for the most part, dis tributed among businessmen, the producers— the workers, landowners, and lenders— who With corporate profits after taxes about stable over the last decade, a “ profit gap” was opened up by the growth of the other incomes and also the non-income items mentioned. A quick ex amination will help determine where the pay ments that might have gone to profits actually did go. devote their services to production. There are two major items, however, which are included as part of gross production but can’t be counted as part of income received— depreciation and so-called “ indirect business D epreciation a n d indirect busin ess ta x e s Depreciation charges grew very rapidly over the decade; they more than doubled. The growth of depreciation accounted for almost 11 per cent taxes.” Depreciation allowances, more or less, CHART II reflect the production needed to replace wornout capital equipment. If depreciation charges were not made, we would, as a society, be living off our capital and counting it as income. In direct taxes— sales and excise— are included in the price of goods and services sold. These “ hidden taxes” inflate the value of gross produc tion; but they cannot be counted as earned income. 2 Using the sign test, the hypothesis that the directions of change were not related in the earlier period can be rejected with a confi dence of greater than 99.5 per cent. It seems reasonable that the experience since 1950 represents a break with the earlier period but due primarily to the briefness of the later period, this hypothesis cannot be statistically supported with a comparable degree of confidence. 4 A LARGER SHARE FOR DEPRECIATION A N D TAXES During the 1950’s, a growing share of gross national product was composed of depreciation allowances and payments to Government in the form of “hidden” taxes— excise and sales taxes included in prices. Depreciation and the so-called “ indirect business taxes” accounted for over one-fifth of the total in GN P over the decade. RATIO of the total increase in gross national product. While corporate profits after taxes were stable We shall have more to say about this very over the 1950’s, profits before taxes did increase important cost later. CHART IV Excise and sales taxes also increased rapidly; these taxes almost doubled. They accounted for a little less than 10 per cent of the total increase SLO W G O IN G FOR PROFITS of these components to gross national product Profits, prior to corporate profits taxes, did increase somewhat over the 1950’s ; but they increased at a slower rate than any other type of income and, as a result, at a slower rate than total or national income. The ratio of corporate profits to national income, as shown in the bottom panel, decreased significantly over the decade. Interest accounts for a relatively small proportion of total income; but it increased more than 325 per cent over the decade. Employee compensation, accounting for well over half of total income, increased about 90 per cent over the decade. increased in a fairly consistent fashion. PER CENT in gross national product. Non-income components of gross national product, then, accounted for something in excess of 20 per cent of the total economic expansion over the decade. As Chart I I shows, the ratio The corp orate profits ta x The share of corporate profits taken by federal, state, and local governments— particularly dur ing the Korean War— was unusually high. As Chart I I I shows, the governments’ share was considerably higher than in the early postwar years. CHART III THE G O VERN M EN T SHARE During the Korean War, federal, state, and local govern ments took, in income taxes, about 53 per cent of total corporate profits. In more recent years, government has taken a somewhat low er proportion of profits. But the government’s share has not fallen back to the levels of the early postwar years. PERCENTAGE RATIO PERCENTAGE RATIO 1950 '5 2 '5 4 '56 '5 8 '6 0 5 CHART V THE CORPORATE CONTRIBUTION The proportion of total national income created by corporations did not change much over the 1950’s. In other words, corporations were about as important as income creators in 1960 as they had been in. 1950. But the share of the in come corporations created that went to profits declined considerably. All other forms of corporate income payments — as the bar charts show— grew relatively more important. RATIO PER CENT about 11 per cent. The increase in the receipts taxes, and interest income. These accounted for of governments from corporate profits accounted about 86 per cent of the over-all increase. for about 2 per cent of the total increase in gross national product. FITTING THE PIECES TOGETHER Although the above items accounted for the lion’s O th er incom es share of economic growth in the 1950’s, they Corporate profits, even before taxes, registered cannot be accused, out of hand, as being re the slowest rate of growth of all types of in sponsible for the relative stability of profits. come. As Chart IV indicates, interest income Simply because they increased is not a reason, in increased most rapidly, followed by employee and of itself, for profits not to increase. One possible reason for the poor showing of compensation. Compensated employees— recipients of wages, corporate profits compared to other kinds of salaries, and related payments— were, by far, the income is that the corporate sector of our most important beneficiaries of advancing out economy— as an income creator— might have put. Employee compensation is the largest single been growing less important. component of gross national product; it absorbs This is a possibility, but on investigation it well over half of total output, and it almost is not borne out. As Chart V shows, the im doubled over the 1950’s. portance of the corporate sector did not change The increase in total output over the last much over the period. It was just that larger decade, then, was distributed among a number proportions of the income that corporations were of payments. In order of importance: employee creating compensation, salaries, interest, and taxes, and a smaller pro depreciation, 6 indirect business during the decade went to wages, portion went to profits. The types of incomes and payments that during the 1950’s— at a rate comparable to gross national product. increased rapidly do, inevitably, direct our atten The data available in the national income tion. They can all be found on the corporate accounts are meager; yet they provide a clue as income statement— as costs of doing business. to what kinds of costs were most important in Since profits did not increase over the decade, depressing profits. As Chart VI shows, corporate corporate costs must have increased much faster payments of wage and salary supplements, and than corporate sales. Had costs risen no faster depreciation allowances, increased much faster than sales, profits would have about doubled. than sales in the 1950’s. Tax payments increased Sales actually increased by over 70 per cent CHART VI THE COST-PUSH O N PROFITS Since 1949, corporate sales have about doubled. They have increased at a rate comparable to gross national product. But some costs increased much faster than sales. Supplements to wages and salaries— including most fringe benefits— increased much more rapidly; and so did depreciation allowances. Tax payments, too, increased more rapidly than sales. On the other hand, wages and salaries— without the fringe benefits— increased at ap proximately the same rate as sales. INDEX (1949 = 100) somewhat faster than sales. Wage and salary payments proper— without the supplements— increased at about the same rate as sales; an increasing proportion of sales receipts was not earmarked for wages and salaries proper. For a more conclusive determination, we have to go to the greater detail provided by the income tax returns; and, also, to the critical industries that largely shaped the total corporate profit experience. S O M E A D D IT IO N A L EVIDENCE The corporate profit figure conceals a diversity of experience in many different parts of the economy. Corporations, as a whole, did not seem to prosper in the 1950’s; but some kinds of corporations did much better than others. Cor porations in the communications industry, for example, did very well. Others, in agriculture, did very poorly. In evaluating the profit performance of the major industrial sectors over the past decade, two critical industries stand out— trans portation and manufacturing.3* They seemed to have had common and representative, as well as strategic, experiences. Over the decade, profits of corporations in transportation declined a good deal. Profits in 3 Profits for each of the ten corporate sectors listed below were cumulated from 1951 to I960. The impact of each sector's profit experience on total corporate profit was determined. The sectors were as follows: agriculture, manufacturing, mining, construction, communications and utilities, transportation, wholesale and retail trade, services, finance, all other. 7 manufacturing— accounting for about half of PERCENTAGE C H A N G E * total corporate profits— increased but the in TO TA L crease was relatively small. Detailed data on costs and receipts for these industries are available only to mid-1958.4 But a comparison of cost experience in the early postwar years when profits were relatively good (1946 to 1950) and in the more recent period (1950 to 1958) is revealing. In order to make this cost comparison, two A ll industry 1946-1950 1950-1958 M anufacturing 1946-1950 1950-1958 Transportation 1946-1950 1950-1958 DEDUC TIO NS REC EIPTS TO TA L DIRECT IND IREC T 59 63 58 70 59 59 56 106 59 50 55 59 56 49 52 99 36 39 27 50 24 40 34 79 * Years are tax or fiscal rather than calendar years. major types of costs must be broken out— (1) those we might call the direct costs of operations Many other industries had similar experiences and sales; and (2) the other, less direct costs during the 1950’s. For industry as a whole, of doing business. In 1950, the direct costs, direct costs did not rise any faster than receipts. including costs of materials and wages, ac However, the indirect costs rose much more counted for about 80 per cent of total costs; the rapidly. It appears, therefore, that these indirect multitude of other costs we have labeled “ in costs were chiefly responsible for the relative direct,” stability of profits. including depreciation, depletion, amortization, advertising expenses, pensions, and Of the indirect costs that can be broken out, other wage supplements, and interest payments, depreciation, depletion, and amortization charges accounted for the rest. were the most important contributors to the In the case of both manufacturing and transportation, as can be seen in the accompany rapid increase in the total. They rose at over twice the rate of total sales. Some of the rapid increase in depreciation ing table, total receipts in the 1946 to 1950 period increased more rapidly than total costs; allowances in the 1950’s may reflect the elimina neither type of cost increased so rapidly as tion, more or less, of the unrealistically low receipts; both industries experienced substantial allowances in the late 1940’s. In the early post increases in profits. war years, depreciation charges were largely In the 1950 to 1958 period, however, total based on depression prices and seriously under costs in both industries increased more rapidly estimated current replacement costs. As a result, than receipts. But, as the table indicates, the in profits were, in all probability, seriously over direct costs went through the roof, while the estimated at that time. And the “ true” growth direct costs of operations and sales, in both of manufacturing hidden.5 and transportation, increased only at about the same rate as receipts. In par ticular, depreciation, amortization and depletion, pensions and other wage benefits, and interest payments increased at very rapid rates. 4 The data from income tax returns are for fiscal or tax years. 8 profits over the decade was, therefore, Interest charges, taxes, and wage supplements 5 The replacement and expansion of prewar plant and equipment at postwar prices, and the 1954 liberalization of methods for cal culating depreciation, have tended to increase depreciation allow ances rapidly. The overestimation of profits because of unrealistic depreciation allowances in, say, 1950 should be added to the over estimation stemming from inventory profits discussed in footnote 2. These two sources of overestimation could explain a significant proportion of the profit gap described above. such as pensions also contributed importantly Moreover, to the extent profits are restrained to the rapid rise of indirect costs. There is no by growing depreciation charges, our concern reason to believe that these costs were under about corporate investment has to be qualified. estimated at the beginning of the decade. Rapid Depreciation allowances, unlike other costs of increases represent a substantial pressure on production, presumably represent funds that will profits. find their way into gross investment. There were other cost items as well which While depreciation allowances are different made contributions worthy of mention. However, from other costs, they are, nevertheless, not the they cannot be mentioned individually because same as profit. There is need for new, net in they are lumped together in the income tax vestment as well as replacement if the economy returns in a category called “ other deductions.” is to grow and prosper. Some of the factors that seriously restrained C O N C L U S IO N S A N D CONJECTURES profits during the 1950’s may well continue to It turns out, then, that there were many reasons operate in the 1960’s. There is considerable why profits didn’t increase in the 1950’s. Just attention being given to more liberal deprecia about all of them can be found on the cost side tion allowances. If they are permitted, they will of the income statement. The costs that appear tend to increase costs. Government pressure for to have exercised the largest restraining influence increasing tax revenue seems still to be growing; on profits were those indirectly related to opera corporate profits represent a very important tions and sales— depreciation, interest, pensions source. In addition, the demands of employees and other wage supplements, and taxes, among for supplemental and fringe benefits may in others. But all these costs did not affect profits in crease in the years to come. the same way; and all of them do not have the services represents, perhaps, one way of off same implications for capital spending. Gertrude setting the Stein, notwithstanding, a cost is not a cost is particularly indirect costs that are frequently not a cost. It appears that profits were depressed in the A rapid growth of demand for goods and persistent growth of costs— and determined by social and political considerations. A more rapid growth of productivity is a way 1950’s, partly because of a rapid rise in depreci of meeting increases in demand while restraining ation allowances; these allowances were prob costs of operations and sales. The dilemma that ably too low in 1950 and have risen rapidly confronts us is simply this: in order to get since. But the increase in many other indirect increases in demand and improvements in effi costs— fringe benefits, taxes, and interest, for ciency, more new investment is necessary; and example— more clearly reflect what has com to get this new investment, profits, themselves, monly been called the “ profit squeeze.” may first have to improve. 9 RECOVERY, MARKET INTEREST RATES, AN D MONETARY POLICY Business activity turned upward early in 1961, recent rate behavior. Recognizing the difficulties and before the end of the year total output had involved, this article attempts to analyze demand surpassed its pre-recession peak. For the most part, the pattern has been similar to the recov and supply forces in order to throw light on the question of why the rate lag in the 1961 recovery. eries of 1954-1955 and 1958-1959. But there Our primary concern is market rates rather than have been significant differences, two of the customer loan rates charged by lending institu important ones being the behavior of interest tions. rates and monetary policy. Market rates have responded less promptly, U P W A R D A N D D O W N W A R D S W IN G S IN and an easy money policy has been pursued B U SIN E SS A N D RATES longer than in the other two upswings. Federal Rates, just as other prices, respond to shifts in Reserve authorities have been confronted with a demand and supply. An expansion in business twofold problem— promoting recovery and sus activity usually generates increases in demands tained growth without aggravating the balance- for credit. Businessmen borrow to help finance of-payments situation. They have pursued a growing inventory and working capital needs, policy of maintaining ample reserves and ready and larger expenditures for plant and equipment. availability of credit in order to foster recovery, Consumers want more credit to buy automobiles, and to facilitate absorption of the unemployed other and unused productive capacity. At the same declining time, the Federal Reserve has attempted to demands for credit. durables, and output homes. result in Recession reduced and private supply reserves in ways that would minimize Government demand for credit is not so downward pressure on short-term rates and thus closely associated with changes in the volume of avoid and business activity. State and local borrowing has stimulated swings in business activity tend to have inverse intensifying the outflow of gold short-term funds. The lag considerable in risen steadily during the postwar period. Cyclical interest discussion. rates Why has the sluggish effects on Treasury borrowing. response of rates? What are the differences, if The supply of credit is not geared so closely any, in the factors influencing rates in this as demand to cyclical swings in business activity. recovery as compared with other postwar recov Saving, the principal source of funds for meeting ery periods? Does the rate lag reflect monetary credit demand, is fairly stable. Commercial bank policy, debt management, a weak demand for credit, the other source of funds, tends to vary Factors inversely with business activity. With cyclical influencing interest rates are too diverse, too swings in credit demand impinging on a more intangible, to be able to pin down the causes of stable supply, tighter credit and rising rates credit, or a large flow of savings? 10 YIELDS O N UNITED STATES G O VERN M ENT SECURITIES PER CENT PER ANNUM * Change in series. usually accompany business expansion; greater earlier periods. (It is too soon to tell whether credit availability and falling rates are charac the rise in the bill rate in the latter part of last teristic of recession. year marks the beginning of a general upward trend.) By the same length of time after the THE RATE LAG 1958 upturn began, the bill rate was two and It is clear from the charts that market interest a half times its level at the recession trough, rates have responded more slowly to business and had risen about 60 per cent in 1954^1955. expansion than in of Rates on intermediate- and long-term Gov 1958-1959 and 1954-1955.* The three-month ernments have moved upward, but the rise has Treasury bill rate has moved within a narrow been considerably less than in the corresponding range, with no observable upward trend, in phases of the 1954-1955 and 1958-1959 up contrast to substantial increases in the two swings. The average yield on intermediate-term * Statistical comparisons, unless otherwise noted, are for the same length of time from recession trough for the three latest recovery periods: 1961, 1958-1959, and 1954-1955. Data, except personal sav ing and corporate retained earnings, are not seasonally adjusted. Governments is only slightly higher than when the recovery periods the recovery began, as compared with increases YIELDS O N G O VERN M EN T SECURITIES 3-MONTH TREASURY BILLS never dropped as low as 2 per cent in the latest recession, but dipped below 1 per cent in each of the other two. The fact that recovery began with rates at a higher level might tend to retard or moderate the rise; however, it seems unlikely that the higher level would long delay an increase in rates if business expansion resulted in credit demands pressing strongly against a limited supply. D e m a n d factors There is no statistical measure of credit demand in the sense of amounts borrowers would be willing to take at various interest rates; however, changes in credit outstanding are a fairly good indicator of the strength of demand, especially in the early part of an upswing when there is not much of a problem of rationing a limited supply of credit. Measured in this way, the increase in over-all credit demand has been similar to the two previous recoveries. Commercial bank loans outstanding have risen 4 per cent from the recession trough, about the same as in 1958-1959, but well below the 11 per cent rise in 1954^1955. Response of consumer demand for credit to the forces of recovery has been about the same as in 1958, but much less than in 1954-1955 when a surge in automobile sales generated a sharp rise in consumer installment credit. Demand for long-term credit has been sub cent in 1954^1955. The rise in yield on long stantial in the current business expansion. Total term Governments has also been more moderate. mortgage debt outstanding has moved up at Corporate AAA bond yields have risen some about the same rate as in 1954-1955 and what, but the increase has been substantially 1958-1959. Corporate demand, as reflected by less than in 1958-1959. Another feature which should be recognized new securities offerings, was especially large in is that interest rates were at a considerably issues have been well above the other two up swings. State and local government offerings are also running above 1958-1959. higher level when the latest recovery began than in the earlier periods. The bill rate, for example, 12 the early months of the 1961 recovery; new term D EM A N D FACTORS CORPORATE SECURITY ISSUES* INDEX (TROUGH = 100) credit, make it difficult to compare strengths of total credit demand in the three recovery periods. Analysis of demand factors, however, fails to reveal differences that account for the markedly slower response of market rates to forces of the current recovery. Factors influencing su p p ly Saving and bank credit are the two sources of funds to meet credit demands. Personal saving, which accounts for the largest part of total saving, has increased at about the same rate as in 1958, but considerably more than in 1954. The net increase in assets of savings institutions, a good indicator of the flow of personal saving into credit instruments, has been about the same as in the two earlier recoveries. Retained earn ings of corporations show the usual sharp rise for periods of recovery. The increase has been somewhat less than in 1958, but more than in 1954-1955. The principal difference on the supply side has been the position of commercial banks. Their total loans and investments have increased somewhat more than in the two previous recoveries. A more significant difference, how ever, has been their capacity to extend credit— their ability to meet loan demand and to continue to increase their investments. For an explanation, let’s take a look at reserve positions and monetary policy. M o n e ta r y policy The Treasury has been a net borrower. Federal Reserve actions impinge directly on Marketable Government securities outstanding bank reserves, which in turn determine the have increased about $5 billion since the begin capacity of commercial banks to make loans and ning of the recovery period. The net increase in purchase securities. More reserves mean more 1958-1959 was $10 billion, and it was $3 billion capacity to extend credit; less reserves mean in 1954-1955. less capacity. Fluctuations in demand, especially for short The Federal Reserve has pursued an easy 13 SOURCES OF SUPPLY PERSONAL SAVING* INDEX (TROUGH = 100) indicator of the degree of ease in bank reserve positions, has remained at about the recession level, except for short-term fluctuations. In 1958-1959, however, the reserve position had shifted from net free to a small volume of net borrowed reserves; and in 1954^1955, free reserves had been reduced to about $100 million. Member bank borrowing from the Reserve Banks tells the same story. Daily average borrowing is still at about the recession level, in contrast to substantial increases in the two previous recoveries. Expectations Interest rates are sometimes influenced by what people think is going to happen as well as by actual events. Expectations may have a signifi cant influence on market rates temporarily, especially near cyclical turning points, but the effects are short-run unless confirmed by the expected events. The quick turnaround in the Government securities market in mid-1958 affords a good illustration of the impact of expectations. Until about midyear, many expected the recession to be the longest and most severe of the postwar period and, as a result, anticipated continued strength in the Government securities market and a further decline in interest rates. A conjuncture of events, however, led to a sharp turnaround in expectations. The flow of data began to indicate emerging business recovery. A large deficit in prospect for fiscal 1959 meant the Treasury would be a substantial borrower. Improved business prospects and a large Treasury deficit pointed to a substantial * Fourth quarter estimated; seasonally adjusted. “ Saving and loan associations, life insurance companies, and mutual savings banks. increase in credit demand and higher, not lower, rates. Also, the quick shift from pessimism to money policy longer than in the two earlier optimism came at a time when large speculative recovery periods. Average free reserves, one holdings of Governments, especially the recently 14 FREE RESERVES A N D B O R R O W IN G S OF MEMBER BAN KS the current recovery has probably discouraged actions in anticipation of higher rates and, more FREE RESERVES important, has prevented the tightening of credit required to reinforce and sustain increases that might have been induced by such actions. M A T U R IT Y STRUCTURE OF RATES Borrowers want credit for different lengths of time, and lenders and investors have different preferences as to maturity. For this reason, market rates vary for different maturities of securities of the same quality and credit risk. At any one time, therefore, instead of a single rate on Government securities there is a whole range or pattern of rates. The accompanying charts show “ yield curves” — that is, yields on the various maturities of Government securities BORROWINGS outstanding at about the end of the recession BILLIONS OF DOLLARS and at later dates during the ensuing recovery. Borrower preference as to maturity is deter mined primarily by the length of time credit is needed. Lender and investor preferences vary mainly according to liquidity needs. Commercial banks, with the bulk of their liabilities payable on demand or short notice, preference for shorter have a strong maturities, whereas savings institutions, with less need for liquidity, prefer longer maturities. Changes in economic conditions are unlikely to affect supply-demand relationships equally in offered 2 % ’s, had been built up in anticipation all maturity sectors of the market. Both demand of in and supply tend to be more volatile in the expectations touched off a rise in market rates— short- than in the longer-term sector of the a rise which was accelerated by heavy liquida market. As a result, short-term rates fluctuate tion of speculative holdings of Governments. more widely during the cyclical upward and lower, not higher, rates. The shift Expectations of business recovery emerged downward swings in business than long-term more gradually in 1961 and in 1954-1955 than rates. There is a certain amount of mobility of in mid-1958. Thus far there has also been less funds among maturity sectors but it is not fear of inflation than in the 1958-1959 expan sufficient sion. Continuation of an easy money policy in structure of interest rates. to prevent shifts in the maturity 15 One of the more distinctive features of the current recovery has been the stability of short CO M M ERC IA L BANK H O LD IN G S OF G O VERN M ENTS BY MATURITY term rates. This stability reflects several diverse influences. The principal factor tending to raise rates has been the growing volume of business activity accompanied by increased credit demands. Treasury cash borrowing has put considerable upward pressure on short-term rates. Treasury bills outstanding increased over $6 billion during the last three quarters of 1961. Nonfinancial corporations, usually large purchasers of short term Governments as the net cash inflow rises during recovery, have not added to their Govern ment portfolios thus far in the current expansion. An easy money policy has been the major force exerting downward pressure on short-term rates. Banks have been supplied with sufficient reserves not only to meet loan demand but, in addition, to increase their holdings of Govern ment securities. Bank purchases of Governments— both in the recession and thus far in the recovery— have been concentrated in short ma turities, year. mostly Holdings issues of maturing short-term within one Governments relative to deposits are larger than at this stage of the 1958-1959 recovery; however, the ratio of loans to deposits is also higher. Another difference is that banks began liquidating Governments sooner, especially in the 1954-1955 recovery in older to get funds to meet expanding loan demands. The fact that banks have been able to continue buying Gov ernments, instead of having to sell in order to get funds for loans, has been a strong force tending to offset the upward pressure on shortand intermediate-term rates generated by business expansion. Techniques employed by the Federal Reserve 16 the downward pressure on short-term rates. Under authority granted prior to the recession, the Board of Governors permitted banks to count vault cash as reserve. Country banks hold purchases outside the short-term area in the a large part of cash in vault; hence, reserves last ten months of 1961 exceeded $2.5 billion. supplied in this way were not likely to flow to The major part of these purchases was in the the money market as quickly as if the reserves three- to ten-year maturity range. Although it had been supplied by purchasing securities. The is impossible to measure their impact, it does policy of conducting open market operations in seem certain that purchases of this magnitude all maturities instead of short-term issues only, either exerted considerable downward pressure also relieved the downward pressure on short on intermediate- and longer-term rates or the term rates. A substantial part of System pur market for these maturities is very broad. The chases in supplying reserves was in intermediate latter appears not to be the case. and longer maturities, thus diverting the direct impact from short- to intermediate- and longer- S U M M A R Y A N D C O N C L U S IO N S term rates. Causes of the tardy response of market rates to YIELD CURVES O N G O VERN M ENT SECURITIES the 1961 recovery cannot be quantified and measured; however, analysis of demand and PER CENT supply factors does reveal differences that appar ently account for much of the sluggishness of rates as compared with the 1954r-1955 and 1958-1959 recoveries. The explanation does not appear to be on the demand side. Total private demand for credit has shown about the usual response to business recovery. Consumer demand for credit, especially for the purchase of automobiles, has been weaker but corporate, and state and local government demands have been somewhat larger Diverse influences also help to explain the sluggish response of intermediate- and long-term than in the other two upswings. A principal reason for the lag in market rates of business appears to be on the supply side— a greater activity. Here, too, private demand appears to availability of credit made possible by easier have been about as strong as in the other two bank reserve positions. The flow of saving has recovery periods. Treasury debt management not been out of line with other recovery periods. operations have tended to absorb some long Easy reserve positions, however, have afforded term funds. Marketable Government securities commercial banks the capacity to expand both of five years’ maturity have increased loans and investments. The fact that banks have considerably more than in 1958-1959, and about been able to continue as net buyers of securities, the same as in 1954-1955. instead of having to sell securities to get funds rates to over the Techniques policy expanding in volume market for loans, has been a major force cushioning upward pressures on upward pressures on rates, especially short- and implementing have cushioned open intermediate- and long-term rates. System net intermediate-term rates. 17 Techniques in implementing monetary and been designed to help meet the needs of the debt management policies have exerted some balance-of-payments influence on the structure of market rates. The economic recovery. Federal Reserve has tried to supply reserves in Expectations situation apparently and have domestic exerted less ways that would minimize direct downward upward pressure on interest rates than in 1958. pressure on short-term rates. Substantial open The absence of widespread expectation of an market purchases outside of intermediate and inflationary boom, longer downward speculative holdings of Government securities, pressure from short- to intermediate- and long has tended to hold down transactions made in term rates. Treasury debt operations have also anticipation of higher rates. maturities diverted direct and presumably of large BUSINESS AND BANKING IN 1961 The year 1961 opened on a bleak, dreary note. prices, interest rates, and unemployment. All Snow and ice covered much of the nation; clouds three moved sideways during most of the year. of recession hung low over business. Both the Usually, the three series are more sensitive to climate changes in business conditions. and the economy remained chilled through February. Spring finally came and it was especially welcome. It ended the Eskimo weather and it Third district b usin ess Local business followed roughly the same trend as the national economy during 1961— a slow brought recovery in business. The recovery was rapid at first. Industrial start and then considerable improvement. production rose eight points from March to June. The longstanding gaps between the district The inventory sector provided much of the and the nation were narrowed in a number of initial impetus. statistical series. Unemployment was of particu By late summer the economy had begun to lar note. Chronic unemployment continued to be sputter a bit. There was widespread concern lest a problem but, with very few exceptions, the the recovery end prematurely. As things turned rates here improved relative to the United States out, however, it was only a pause to shift gears. total. For example, the Philadelphia Metropolitan The expansion resumed in the fall with con Area matched the national rate for the first sumers leading the way. In the fourth quarter, time in a decade. automobile sales picked up sharply and The following table compares the first 10 or Although the over-all economy expanded from for a selection of district business indicators. March, stability characterized three key areas— The large number of minuses tends to obscure Christmas buying hit record highs. 18 11 months of 1961 to similar periods of 1960 the momentum behind the local economy as Philadelphia banks. They hoped the business 1961 ends. The explanation is that 1961 was a recovery would bring a substantial increase in year of recession and recovery, and only in the loan demand. But new demand was slow to latter part did it begin to compare favorably materialize. Loans of Philadelphia (reserve city) with the previous year. banks were stable until the waning weeks of 1961 when they finally rose above year-earlier LOCAL BUSINESS INDICATO RS levels. Loans in Third District country banks, Third Federal Reserve District— Percent change 1960 to 1961 on Em ploym ent (15 a re a s)* .................................. Factory payrolls* .............................................. Factory working tim e* ..................................... Electric power consum ed by m a n u fa c t u re r s*....... Anthracite coal o u tp u t* .................................... Construction contracts: Residential * * ............................................... N o nre side n tial* * .......................................... Public works and u tilitie s** ........................... C a r load ings (Philadelphia region— 51 weeks) . . . Retail sales, total (excluding national chains) * * .. Departm ent store sales* .................................... A uto m o bile registrations (48 counties, eastern Pennsylvania ) * * ............................................ Bank debits (20 citie s) * * .................................. the other hand, increased pretty much — 1% — 3 — 5 + 2 — 4 throughout 1961. +13 + 7 +36 — 13 — 4 + I policy, and the relatively listless loan demand, — II +11 Net profits of district member banks were In order to stimulate economic recovery and growth, the Federal Reserve System pursued a policy of monetary ease during 1961. This meant that district banks— particularly the Philadelphia banks— remained liquid and had little need to borrow at the discount window. almost 15 per cent higher in the first half of * First eleven months. ** First ten months. 1961 (the latest available data) than in the Construction was a strong feature in the similar 1960 period. Profits on sales of securities Third District during 1961. Contracts rose more rapidly here than in the nation as a whole. The were one of the principal reasons for the in crease. district enjoyed particular strength in public works and in the residential sector— a type of R e serve B a n k o p e ratio n s spending that has widespread effects on the Automation took several giant steps here at 925 local economy. Chestnut Street during 1961. In January our Check Department installed an electronic check C om m e rcial b a n k in g handling system. It was a pilot installation used The past year was a disappointing one for to test the reading, sorting, and listing of checks THIRD DISTRICT B A N K IN G (Millions $) Dec. 31, 1959 Reserve C ity Banks Loans Investments Deposits C o u n try Banks Loans Investments Deposits Dec. 31, 1960 Change in 1960 Dec. 27, 1961 Change in 1961 2,128 945 3,793 2,292 929 4,007 + 164 — 16 +214 2,430 1,085 4,139 + 138 + 156 + 132 2,737 2,392 5,519 3,032 2,432 5,791 +295 + 40 +272 3,260 2,531 6,085 +228 + 99 +294 19 imprinted with magnetic ink. The test proved up to two hours a day of computer time effective and, as planned, the equipment took and has written a number of its own pro its place on the check collection production grams. line. In October we added a second system and The Bank and Public Relations Department the department now processes 170,000 checks a took on several new activities in 1961. They were: day on its electronic equipment. a series of pamphlets explaining our The success of our electronic check handling economy for the “ mass” reader; participation in installation is due, in large measure, to the a series of public service television programs; cooperation of district banks, most of which now are preprinting checks in magnetic ink. preparation to make a movie about the Federal Reserve System. About 60 per cent of all the checks we receive In other departments, discounts and advances are now preprinted and the percentage is rising to member banks fell to $564 million from all the time. The Data $2,712 million in 1960. Issues of saving bonds its own Processing electronic Department installed computer in May, 1961. At present it is doing over 60 different jobs for the various departments of the Bank. The Research Department, for example, uses exceeded redemptions for the first time in several years. Fewer pieces of currency but more coins were counted in 1961. Additional statistics on Reserve Bank opera tions are shown on page 26. NEW RELEASE Forecasts for 1962. The Department of Research has compiled and analyzed a number of predictions made by businessmen, economists and Government officials. This compilation includes a summary of forecasts for the econ omy as a whole and particular sectors of the economy. The more important indicators are presented in chart form. Copies of this release are available on request from the Bank and Public Relations Department, Federal Reserve Bank of Philadelphia. 20 DIRECTORS AN D OFFICERS A t the election held in the fall of 1961, Frank R. Palmer was re-elected as a Class B director by the banks in Group I for a term of three years from January I, 1962. Eugene T. Gramley, President of the Milton Bank and Safe Deposit Company, Milton, Pennsylvania, was elected for a like term by banks in G roup 3 to serve as a Class A director. He succeeds. O. Albert Johnson. The term of Henderson Supplee, Jr. as a Class C director and his service as Chairman of the Board of Directors expired at the end of 1961. The Board of Governors of the Federal Reserve System appointed Willis J. W inn to succeed him as a Class C director for a three-year term. Mr. Winn is Dean of the W harton School of Finance and Commerce, University of Pennsylvania. During 1962, Walter E. Hoadley, previously Deputy Chairman, will serve as Chairman and David C. Bevan as Deputy Chairman of the Board of this Bank. By appointment of the Board of Directors, Howard C. Petersen, President of the Fidelity-Philadelphia Trust Company, Philadelphia, Pennsylvania, will continue to represent the District on the Federal Advisory Council during 1962. W ith the approval of the Board of Governors of the Federal Reserve System, the Board of Directors reappointed Karl R. Bopp as President and Robert N. Hilkert as First Vice President for terms of five years beginning March I, 1961. Roy Hetherington, an Assistant Cashier, retired on M ay 31, 1961 and Philip M. Poorman, Vice President in charge of fiscal agency oper ations, on June 30. Norman G. Dash, previously an Assistant Vice President, was made a Vice President, effective July I. He succeeds Mr. Poorman as senior officer of the fiscal agency function. 21 DIRECTORS AS OF JANUARY 1962 Term expires December 31 Group C LASS A 1 FREDERIC A. POTTS President, The Philadelphia National Bank, Philadelphia, Pennsylvania 1962 2 J. M ILTON FEATHERER Executive Vice President and Trust Officer, The Penn’s Grove National Bank and Trust Company, Penns Grove, New Jersey 1963 3 EUGENE T. GRAMLEY President, Milton Bank and Safe Deposit Company, Milton, Pennsylvania 1964 CLASS B 1 FRANK R. PALMER Chairman, The Carpenter Steel Company, Reading, Pennsylvania 1964 2 R. RUSSELL PIPPIN Treasurer, E. I. du Pont de Nemours & Company, Wilmington, Delaware 1962 3 LEONARD P. POOL President, Air Products and Chemicals, Inc., Allentown, Pennsylvania 1963 C LASS C WALTER E. HOADLEY, Chairman Vice President and Treasurer, Armstrong Cork Company, Lancaster, Pennsylvania 1963 D A V ID C. BEVAN, Deputy Chairman Vice President, Finance, Pennsylvania Railroad Company, Philadelphia, Pennsylvania 1962 W ILLIS J. W IN N Dean, Wharton School of Finance and Commerce, Philadelphia, Pennsylvania 1964 22 OFFICERS AS OF JANUARY 1962 KARL R. BOPP President ROBERT N. HILKERT First Vice President RALPH E. H AAS Assistant Vice President JOSEPH R. CAMPBELL Vice President G EO RGE J. LAVIN Assistant Vice President and Assistant Secretary W ALLACE M. C ATANACH Vice President HENRY J. NELSO N Assistant Vice President N O R M A N G. DASH Vice President HARRY W. ROEDER Assistant Vice President D A V ID P. EASTBURN Vice President M U RD O C H K. G O O D W IN Vice President, General Counsel and Assistant Secretary JOSEPH M. CASE Chief Examining Officer HAROLD M. GRIEST Examining Officer JAM ES V. VERGARI Vice President and Cashier JACK H. JAM ES Examining Officer RICHARD G. W ILG U S Vice President and Secretary LEONARD M ARKFORD Examining Officer EVAN B. ALDERFER Economic Adviser G. W ILLIAM METZ Examining Officer CLAY J. A N D E R SO N Economic Adviser JACK P. BESSE Assistant Cashier JO HN R. BUNTING, JR. Business Economist W ILLIAM A. JAMES Personnel Officer EDW ARD A. AFF Assistant Vice President W ARREN R. M OLL Assistant Cashier HUGH BARRIE Assistant Vice President FRED A. MURRAY Director of Plant ZELL G. FENNER Assistant Vice President RUSSELL P. SUDDERS Assistant Cashier HERMAN B. HAFFNER Genera! Auditor ST A T E M E N T OF CONDITION FEDERAL RESERVE B A N K OF PHILADELPHIA End of y e a r ( 0 0 0 ’s omitted in d ollar figures) A SSET S G o ld certificate reserves: G o ld certificate a c c o u n t ............................................... Redemption fund— Federal Reserve n o t e s ..................... Total go ld certificate r e s e r v e s ................................... $ 90 6 ,9 5 9 7 1 ,5 1 7 $ 1 ,0 5 5 , 7 1 2 66 ,2 51 $ 97 8 ,4 7 6 $ 1 ,1 2 1 , 9 6 3 Federal Reserve notes of other Federal Reserve B a n k s ........ O the r cash ...................................................................... Loans and securities: Discounts and a d v a n c e s ............................................... United States G overnm ent s e c u r it ie s ............................. 4 3 ,6 3 5 1 2 ,8 5 2 4 2 ,5 1 9 1 0 ,7 9 3 2 ,1 8 5 1 ,6 5 8 ,9 6 3 4 ,1 9 2 1 ,5 4 5 ,0 1 2 Total loans and s e c u r it ie s ......................................... $ 1 ,6 6 1 ,1 4 8 $ 1 ,5 4 9 , 2 0 4 Uncollected cash items .................................................... Bank p r e m is e s .................................................................. All other a s s e t s ................................................................ 4 3 9 ,4 4 3 3,521 1 3 ,5 9 0 4 1 2 ,3 2 4 3,791 1 2 ,0 4 4 $ 3 ,1 5 2 , 6 6 5 $ 3 ,1 5 2 ,6 3 8 $ 1 ,8 9 0 , 0 7 4 $ 1 ,8 6 7 ,3 2 3 8 2 9 ,2 3 7 1 0 ,6 9 6 1 5 ,3 7 0 3,211 83 1,788 2 7 ,0 3 8 1 2 ,6 2 6 5 ,7 0 0 Total assets ............................................................ LIABILITIES Federal Reserve notes ...................................................... Deposits: M e m b er b ank reserve a c c o u n t s ..................................... United States G o v e r n m e n t ............................................. F o r e i g n ........................................................................ O the r deposits ............................................................ Total d e p o s i t s .......................................................... $ 85 8 ,5 1 4 $ 87 7 ,1 5 2 D eferred a vailability cash i t e m s ....................................... All other liabilities .......................................................... 32 3 ,8 0 8 3,34 7 3 3 4 ,9 7 1 1 ,6 9 7 Total liabilities ........................................................ $ 3 ,0 7 5 ,7 4 3 $ 3 ,0 8 1 , 1 4 3 $ $ C A P IT A L A C C O U N T S C ap ital paid i n ............................................................ Surplus ........................................................................ Total liabilities and capital a c c o u n t s ......................... Ratio of g o ld certificate reserves to deposit and Federal Reserve note liabilities com bined ................................. 24 1960 1961 25,641 51 ,2 81 2 3 ,8 3 2 4 7 ,6 6 3 $ 3 ,1 5 2 , 6 6 5 $ 3 ,1 5 2 , 6 3 8 3 5 .6 % 4 0 .9 % EARNINGS AND EXPENSES FEDERAL RESERVE BANK OF PHILADELPHIA ( 0 0 0 ’s omitted) 1961 1960 E arnin gs from: United States G overnm ent s e c u r it ie s ............................. $ O the r s o u r c e s .............................................................. Total current e a r n i n g s ............................................... 5 3 ,9 5 4 $ 180 6 1 ,8 4 3 879 $ 5 4 ,1 3 4 $ 6 2 ,7 2 2 $ 8 ,1 1 9 $ 7 ,5 9 4 N et expenses: O p e ra tin g e x p e n se s* .................................................. C ost of Federal Reserve c u r r e n c y ................................. 624 691 Assessm ent for expenses of Board of G o v e r n o r s ............ 364 384 Total net e x p e n s e s .................................................. $ 9 ,1 0 7 $ 8 ,6 6 9 Current net e a r n i n g s ........................................................ $ 4 5 ,0 2 7 $ 5 4 ,0 5 3 $ 200 $ Ad d itions to current net earnings: Profit on sales of U.S. G overnm ent securities ( n e t ) .......... Transferred from reserves for contingencies ( n e t ) .......... — All o t h e r ...................................................................... Total a d d i t i o n s ....................... ................................. 1 $ 140 824 201 — $ 964 Deductions from current net earnings: M isce lla ne ous non-operating expenses ......................... 1 7 Total d e d u c t io n s ...................................................... $ 1 $ 7 N et additions .................................................................. $ 200 $ 957 Net e a rn in g s before paym ents to U.S. T r e a s u r y .................. $ 4 5 ,2 2 7 $ 5 5 ,0 1 0 D ivid end s paid ................................................................ 1 ,4 7 2 1,3 9 9 Paid to U.S. T reasury (interest on Federal Reserve notes) . . . . 4 0 ,1 3 6 5 1 ,5 8 5 Transferred to or deducted from (— ) S u r p l u s ................... $ 3 ,6 1 8 $ 2 ,0 2 5 * After deducting reimbursable or recoverable expenses. 25 VOLUME OF OPERATIONS FEDERAL RESERVE B A N K OF PHILADELPHIA 1961 1960 1959 1 8 1 ,1 0 0 2 6 ,3 0 0 1 6 ,2 0 0 732 1 7 6 ,7 0 0 2 5 ,0 0 0 1 7 ,2 0 0 707 1 7 3 ,6 0 0 2 4 ,2 0 0 1 7 ,9 0 0 718 677 149 2 6 0 ,3 0 0 4 7 6 ,2 0 0 1 544 317 698 145 2 9 5 ,0 0 0 45 1 ,2 0 0 2 529 326 742 133 2 9 9 ,2 0 0 4 9 1 ,1 0 0 2 505 328 406 419 353 8 ,6 5 0 1,11 9 7 ,8 7 2 6,65 7 1,0 4 3 7,53 6 6 ,7 6 6 953 $6 4,600 5 ,8 6 6 274 166 $ 6 4,500 5,131 283 150 $6 4 ,3 0 0 4 ,9 7 4 287 157 3 6 ,3 9 5 9 0 ,6 7 6 1,78 3 55 564 2,2 4 0 851 3 4 ,7 0 7 87,251 2 ,0 7 2 54 2 ,7 1 2 2 ,1 8 2 861 3 3 ,2 6 7 6 9 ,8 2 6 2 ,0 7 4 52 6 ,2 6 2 1,981 842 1 0 ,9 9 8 1 0 ,5 5 7 12,771 405 377 156 386 405 142 382 531 128 N u m b er of pieces ( 0 0 0 ’s omitted) Collections: O r d in a ry c h e c k s * ....................................... . . G overnm ent checks (paper and c a r d ) .............. Postal m oney orders ( c a r d ) ............................. N on -cash it e m s ............................................... C le a rin g operations in connection with direct sendings and wire and g ro u p clearing p la n s * * . . . . Transfers of funds ............................................. C urren cy c o u n t e d ............................................... C oins counted ................................................... Discounts and ad va nce s to member b a n k s ............ D ep osita ry receipts fo r withheld t a x e s ................. Postal receipts (remittances) ............................... Fiscal a g e n c y activities: M a rk e ta b le securities delivered or redeem ed . . . S a v in g s bond transactions— (Federal Reserve Bank and agents) Issues (including re-issues) ......................... Redem ptions ............................................. C ou p on s redeem ed (G overnm ent and agencies) . . . 6 ,7 5 6 D o lla r am ounts ( 0 0 0 , 0 0 0 ’s omitted) Collections: O r d in a ry c h e c k s * ........................................... G overnm ent checks (paper and c a r d ) ............. Postal m oney orders ( c a r d ) ............................. N on -cash i t e m s ............................................... C le a rin g operations in connection with direct sendings and wire and g ro u p clearing p l a n s * * ........ Transfers of funds ............................................. C urren cy c o u n t e d ............................................... C oin s counted ................................................... Discounts and ad va nce s to member b a n k s ............ D ep ositary receipts fo r withheld t a x e s ............... Postal receipts (re m itta n c e s)............................... Fiscal a ge n cy activities: M a rk e ta b le securities delivered or redeem ed . . . S a v in g s bond transactions— (Federal Reserve Bank and agents) Issues (including re-issues) ......................... Redem ptions ............................................. C ou p on s redeem ed (G overnm ent and agencies) . . . * Checks handled in sealed packages counted as units. * * Debit and credit items. 26