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A review by the Federal Reserve B a n k o f C h ica g o Business Conditions I 9 6 0 December Contents Farm prospects, 1961 5 Gold in the American economy 7 Large “holiday" reserve needs supplied The Trend of Business 14 2-5 Federal Reserve Bank of Chicago THE I3usiness trends continued mixed in the fall. Production and employment slipped further, but personal income continued to rise, retail buying improved and construc tion contracts for large jobs were in heavy volume. These developments, together with indications of rising government expendi tures, were cited by some business observers to support the view that the current adjust ment will be short and shallow. Business in ve stm e n t m oving down 2 A Department of Commerce survey re leased in late October revealed that most manufacturing firms intended to reduce in ventories during the final months of 1960. Efforts to reduce stocks on hand or to keep them from rising have restrained aggregate production all year, but moves to cut stocks appear to have been intensified. In the first quarter manufacturers’ inven tories rose 1.9 billion dollars. They increased again in the second quarter but only by 800 million dollars. The third quarter saw liqui dation to the extent of 300 million dollars. Plans called for a step-up in this rate of liquidation in the final quarter. Moreover, inventory adjustment programs are now aimed at reducing stocks of finished goods, which have continued to rise, while pur chased materials and goods-in-process have declined. The other important segment of business investment is outlays on new plant and equipment. Preliminary evidence suggests a OF BUSINESS moderate decline in capital spending between 1960 and 1961. Various firms have an nounced that their capital outlays will be reduced next year. The pervasiveness of this trend is indicated by a McGraw-Hill sur vey released in mid-November which pro jects a 3 per cent decline in total plant and equipment spending for next year. Steel, transportation equipment (other than autos and parts), building materials, textiles and railroads will cut spending 10 per cent or more according to present plans. These de clines are expected to be offset, in part, by increases in electrical machinery, motor ve hicles, utilities and a number of nondurable goods manufacturing lines. Final results, of course, will depend heavily upon the vigor Steel production has remained at sharply reduced level since midyear thousand tons I960 Business Conditions, December 1960 of general activity next year. New plants will play only a minor role in next year’s capital spending. More than ever before in the postwar period, emphasis is being placed upon cost-cutting innovations and facilities for the production of new products. Total construction contracts rise despite decline in residential work th ird -2 0 quarter p e r -1 0 cent change 0 -HO fro m year +20 ago *3 0 +40 residential Prod uctio n decline continues The gradual easing in total industrial pro duction which began in July continued into October and, apparently, November as well. Virtually all types of manufacturing in dustries have reduced output and employ ment in some degree. During November a number of important Midwest industries, including autos, televi sion and construction machinery, announced production cutbacks to reduce stocks of finished goods. Hopes for a stronger trend in machinery demand remained high but ma chine tool orders declined in the early fall and cancellations of existing orders increased. A few months ago it was confidently antic ipated that steel production would rise sub stantially in the fourth quarter. However, in late October and early November steel output was declining. It now appears that production in the fourth quarter will not exceed the 20 million tons poured in the third quarter. At the beginning of 1960 it was estimated that steel production this year would exceed the 1955 record of 117 million tons by a wide margin. Now it appears that production for the year will not exceed 100 million tons. Many steel consumers are counting upon two week delivery from the mills and im mediate availability from steel warehouses. The steel industry provides a prime example of the manner in which the inventory burden has been pushed back upon suppliers. It is believed that steel output at the current annual rate of 80 million tons is well below + 12.8 : M id w e s t total U n ite d 2.2 State s M id w e st h + 4.7 consumption. However, there is less con fidence than formerly in estimates of con sumption and the extent to which users can economize on inventory. The automobile industry, steel’s largest customer, currently is reducing production of passenger cars. Assemblies numbered 618,000 in October. Although sales were at record levels in October and early Novem ber, ample inventories in the hands of dealers have caused a reduction in produc tion schedules to less than 600,000 cars in December. H eavy construction a b rig h t spot Total construction activity was slightly lower in the third quarter than in the second, with a drop in the residential sector more than offsetting a rise in the nonresidential and public categories. But construction con tracts tabulated7by F. W. Dodge have been in large volume in recent months, indicating 3 Federal Reserve Bank of Chicago an improvement in activity for the future. In the first six months of 1960, total construc tion contracts were 7 per cent below last year in the nation and 2 per cent lower in the Midwest. In the third quarter, contracts were 2 per cent higher than last year in the nation and 5 per cent higher in the Midwest. There has been little evidence to date in dicative of a sustained improvement in the depressed home-building industry. The Com merce Department has forecast an increase of 4 per cent in housing starts nationally in 1961 over 1960. This projection is predi cated largely upon a pickup in the second half of next year. During the third quarter substantially fewer housing permits were issued in most areas than in the same months of last year. Nationally, permits were off 19 per cent: in Chicago, 24 per cent; in Detroit, 29 per cent; in Milwaukee, 18 per cent; and in Indian apolis, 42 per cent. In most smaller centers Retail trade has not matched income gains in recent months 4 280 15.0 1957 1958 housing permits also were lower than last year, but Grand Rapids, South Bend, Keno sha and Racine reported increases. Recent strength in construction contracts has been concentrated in public utilities and public works. However, awards for manu facturing and commercial construction also have increased. Capital spending plans for next year suggest a tapering in most types of business construction although the utility and public works sectors are likely to show further improvement. Voters approved a large volume of bond issues on November 8. A n o th e r record C hristm as? Total retail sales rose to an 18.5 billion dollar monthly rate in October— a marked improvement over the 18.1 billion dollar rate of the third quarter and close to the record level of the second quarter. Strength in retail sales during October was attributable largely to increases at department stores and auto mobile dealers. The number of new cars delivered to customers in October and early November was a record. The trend of retail trade in the Christmas season will provide an indication of the seriousness of the current adjustment. De spite the drop in employment, personal in come continued to rise through October, and was 7 per cent above last year. The extent to which consumers are willing to spend this income will determine, in large degree, the pace of production in consumer goods industries in the months ahead. Re cent evidence indicates reduced buying of such hard goods as appliances and television sets. However, surveys of consumer buying intentions suggest that purchases of some of these items may soon improve. Total retail sales are generally expected to exceed the year-ago level in November and December. In 1959 these months were Business Conditions, December 1960 depressed, largely because of the steel strike which restricted the availability of new cars. Total retail sales in December of 1959, seasonally adjusted, were at a rate of only 17.5 billion dollars. This was one of the rare occasions in the postwar period when sales in the Christmas month failed to set a record. Sales during the last two months of the year will determine the success of the calen dar year for many stores. November typically accounts for 10 per cent of the year’s sales and December for 16 per cent in Midwest department stores. For some departments the November-December total is much higher—40 per cent or more in men’s fur nishings, handkerchiefs, gloves, toys and sporting goods. Farm prospects, 1961 h arm income in 1960 has climbed more than was expected at the beginning of the year, and the total for the year may exceed the 1959 level. With farm output at a record high and prices of agricultural commodities averaging only slightly below last year, cash receipts from farm marketings are now in dicated to be 34 billion dollars in the current year. Realized net income of farm operators may total about 11.5 billion. Prospects for 1961 were described recently by officials of the U. S. Department of Agriculture at the Annual Agricultural Outlook Conference as follows. D e m a n d for food and farm products is expected to be maintained in 1961 as both domestic consumption and exports will con tinue at high levels. C ash receipts from farm m arketings and realized net income of farm operators in 1961 are expected to remain close to 1960 levels. While the volume of products mar keted by farmers may increase further next year if growing conditions are average or better, prices may average slightly below the current year. Farm costs leveled off in 1960 and little change is expected in 1961. Interest pay ments and taxes rose sharply this year while expenses for livestock and feed were lower. H o g prices this fall have been more than $4 per hundredweight higher than last fall, and hog production is apparently turning upward again after a one year decline, the quickest turnabout on record. For the first half of 1961 hog slaughter will be somewhat smaller than this year, but the favorable hog-corn ratio and abundant feed supplies favor an expansion, and farmers have al ready reported plans to increase the 1961 spring pig crop. While hog prices are ex pected to drop below 1960 levels next fall, prices for next year as a whole and incomes of hog producers probably will average about the same as this year. Cattle an d calf slaughter in 1961 will in crease about 10 per cent next year, with the total meat supply reaching a new high. A severe cyclical break in cattle prices does not appear likely, barring unfavorable weather over large areas of the West, but prices are expected to continue a downward trend. 5 Federal Reserve Bank of Chicago 6 The lower grades of slaughter cattle may show more price weakness than the other classes. Next year the price decline is ex pected to average about the same as the reduction during 1960, though the down ward pressure on all classes will likely be greater in the last half of the year and could drop significantly if drought conditions de velop in the West next summer. The number of cattle on farms is expected to continue upward next year, but the recent increase in cow and calf slaughter indicates the buildup is easing off. Numbers have been increasing for three years in the current cattle cycle and are now at record levels. Feed gra in production was at a record level this year and with the large carry-over from earlier years the total supply reached a new high for the seventh consecutive year. Prices of feed grains and protein feeds are expected to average a little lower than in 1959-60. The carry-over of feed grains at the end of the 1961 feeding season is ex pected to increase further. Soybean production this year, although 4 per cent above last year, is below the record of 1958. Demand and supply are expected to be in close balance. Prices probably will average about the same as in the past year but with larger seasonal changes. The U. S. Department of Agriculture has suggested that larger production may be in order to provide adequate supplies for the expanding demand for soybean oil and meal. With favorable prices next spring, relative to the corn sup port price, soybean acreage is expected to increase in 1961. D airy production will be slightly above levels of recent years. Prices through March 1961 will be somewhat above year earlier. For the remainder of 1961 the level of Government price supports, to be announced before next April 1, may be an important Net farm income rose during 196 0 b i l li o n 14 d o l la r s - 1L_ I___I___I__ I___ I___l___I___I___i___ i i I i i i I i i i I . . . as farm prices and cash receipts increased b illio n d o l la r s p e r c e n t, 1 9 4 7 - 4 9 = 1 0 0 determinant of milk and butter prices. Even with no increase in support prices, cash re ceipts from farmers’ sales of dairy products in 1961 are likely to increase slightly over 1960 to another new record. However, the cost of producing milk has been rising and may prevent net incomes to dairymen from increasing. The expected decline in beef cattle prices will likely slow the decline in the number of dairy cows on farms and the increase in milk production in 1961 probably will ex ceed that in 1960. The net worth of agriculture, as an in dustry, is estimated to decline 3 per cent during 1960, the first decline since 1953. A downward trend in farm land values in most states since March is largely responsible though small declines were recorded in other farm assets, and farm debts rose. Farm debt is expected to total 25.7 billion dollars on January 1, 1961, compared with 24.3 billion a year earlier. However, debt will still be less than 13 per cent of the value of farm assets. The longer-term outlook for agriculture Business Conditions, December 1960 is dominated by the prospect of continued surpluses of major crops if it is assumed that support prices and major farm programs now in operation will be continued. Expan sion of the domestic market for farm pro ducts will depend primarily on the growth of population since the effect of rising con sumer incomes on food consumption per person is small and seems to diminish as in comes rise. Experts in the Department of Agriculture project an 11 per cent increase in total domestic use of agricultural products from 1959 to 1965. Agricultural exports are estimated to increase 20 per cent by 1965, assuming continued vigorous use of export subsidies and special Government export programs such as the “Food for Peace” proposal. Total farm output is expected to continue upward. Even with continuation of subsidies and other special Government export pro grams, Department economists concluded “. . . that by the mid-1960’s, our surplus capacity may be about the equivalent of 15 to 25 million acres of cropland . . .” considering market outlets and productive capacity as a whole. However, these econo mists noted that in recent years they have tended . . to underestimate rather than to overestimate future increases in farm output.” Gold in the Ameri can economy ^ ^h an g es in the U. S. Treasury’s stock of gold normally attract very little attention outside the Federal Reserve System and the foreign central banks which hold all or part of their official reserves in the form of gold. Since the end of 1957, however, the Treas ury’s gold stock has dropped nearly 5 billion dollars to the present level of about 18 billion, reflecting recurring deficits in our balance of international payments. In recent months the gold outflow has accelerated noticably. This, along with the spectacular gyration in the price of gold on the London market during the latter part of October, has generated widespread interest in the role of gold in the United States and the world economies and, for a time at least, caused reports on changes in gold holdings and prices to appear on the front pages of many daily newspapers. The interest in gold has been sharpened further in recent weeks as a result of the Administration’s attempts to check the flow of gold and dollars from this country. The President has directed Government agencies to cut down on dollar spending abroad wherever possible; and conferences have been held with the German, French and British Governments on the matter of sharing foreign economic aid and western defense costs. Some of the questions being asked today are: What is the function of gold in our monetary system? Why has gold been flow ing out of the country in recent years? Is the United States gold stock adequate? G old and th e d o lla r Since 1933 the dollar has not been con vertible into gold domestically. Gold coin Federal Reserve Bank of Chicago and gold certificates are not permitted to circulate as a part of the money stock. Amer icans are prohibited from holding gold in this country, except for small quantities for industrial and various other approved uses. Thus, gold plays no active role within the country as a “medium of exchange” or “store of value,” the two major functions of money. The Federal Reserve Banks, however, are required by law to maintain reserves in the form of gold certificates equal to 25 per cent of their combined note and deposit liabil ities.1The Board of Governors of the Federal Reserve System has authority to reduce or suspend the requirement temporarily. Since gold or gold certificates do not cir culate, some maintain that a reserve require ment in this form is merely a carry-over from an earlier day when gold served as a part of the domestic money stock.2 At that time notes and deposits were convertible into gold, and the world’s major currencies were linked together through gold. When the Federal Reserve Act was passed in 1913, for example, the United States and most other major nations were on a full gold standard. Their currencies were equated to a fixed weight of gold, defined as gold parity, and were freely convertible into gold. Gov ernments bought and sold gold at established prices, and there were no restrictions on the ownership of gold or its movements across international boundaries. ’Gold certificates have been issued to the Federal Reserve Banks against most of the gold held by the Treasury. The System’s legal reserve require ments approximate 12 billion dollars today, leaving a “free” gold balance of about 6 billion. •They argue that the System’s legal reserve re quirements are not an essential part of our present monetary system and should be removed to assure that Federal Reserve actions would never be ham pered by the requirement and to make the maxi mum amount of gold available for international transactions. This system had the advantage of provid ing more or less automatic regulation of the money supply in the various countries, and gold movements served as guides to and checks on monetary policy. However, indi vidual countries were subject to “runs” on their gold and consequent pressures on their bank reserves. These “runs” were of both foreign and domestic origin and often one would reinforce the other. As confidence in financial conditions deteriorated during the Twenties and early Thirties, increasing amounts of short-term capital moved from country to country seeking greater safety. In the summer of 1931, in the wake of banking collapses in Austria and Germany, foreign investors became worried about the safety of their deposits in London and began to demand gold. The ensuing runs compelled the Bank of England to suspend payment in gold in September of that year. Fears spread that the United States might follow England in abandoning the gold standard. Foreign withdrawals of gold and domestic hoarding of gold and gold certifi cates increased substantially, helping to pre cipitate a banking crisis in the winter of 1932-33. In March 1933 the United States suspended the gold standard domestically but retained an international gold exchange standard. Private domestic holdings of gold were called in, and the Treasury was given full authority to license gold exports and im ports. Internally the dollar became a “man aged paper currency,” but it continued to be convertible into gold at a fixed price ex ternally. Gold and in te rn a tio n a l paym ents In the international area gold is used as the ultimate means for settling balances with other nations. The Treasury stands ready to sell and buy gold at $35.00 per ounce, plus Business Conditions, December 1960 and minus handling charges, to Decline in total U. S. gold stock and from foreign governments, since 195 7 reflects large deficits central banks and other inter in our balance of international payments national institutions “for the set tlement of international balances 25 or for other legitimate monetary purposes.” This assures external convertibility of the dollar into gold at a fixed ratio for approved purposes. Concern about the adequacy of the United States gold stock stems principally from the fact that the 5 billion dollar outflow of gold since the end of 1957 can be directly related to large deficits in our balance of international pay ments. In both 1958 and 1959 the gold purchases deficit exceeded 3 billion dollars, 1956 1957 1958 1959 I9 6 0 and recent estimates indicate a d efic it of s im ila r m a g n itu d e for il_ J J __ I__ I__ I__ 1__ I__ I__ I__ I__ I__ I__ I__ l _ l __ I__ I__ I__ I__ I__ I__ I__ I__ U J __ I__ l_ 1960. This experience has given rise to opinion both here and abroad that the deficits may be ments to them. If all transactions are taken chronic rather than cyclical, reflecting a into account, total receipts will equal total fundamental disequilibrium in the United payments during any given period. It is States balance of payments position. If this were true, it would indicate need for basic customary, however, to refer to increases or changes in our policies affecting both receipts decreases in both our total gold stock and and disbursements in the international sector. foreign holdings of liquid dollar assets as balancing items—measures of the deficit or W h a t is a balance o f paym ents? surplus in the balance of payments. A balance of payments is a record of a If, for example, during the course of the nation’s total economic transactions with the year our payments to foreign countries for rest of the world over a given period of time. goods and services, loans and investments, Compared with conventional accounting military expenditures and Government aid statements, it is more like an income or flow exceed our receipts from exports of goods of funds statement than a balance sheet. It and services, foreign loans and investments does not show a nation’s total assets abroad in this country and our earnings on overseas or total foreign claims on assets in the investments, the difference or deficit will be United States, but it provides a summary of reflected in one or more of the following: our total receipts from other countries and (1) an increase in foreign liquid dollar hold international institutions and our total pay ings including bank deposits and short-term b illio n d o lla r s Federal Reserve Bank of Chicago investments; or (2) a decrease in the U. S. Treasury’s holdings of gold. On the other hand, if our total receipts exceed total pay ments, there will be a net transfer of dollars or gold to this country. W h a t causes a gold o u tflo w ? 10 In the first instance a deficit in the United States balance of payments is reflected in an increase in the deposits that foreign individ uals, commercial banks and corporations maintain with American banks. Foreigners may retain these deposits as working bal ances to support trade and other activities or invest them in short-term United States securities. At times they may convert part of their dollar holdings into their domestic currency or other foreign currencies for investment abroad. In the process the bulk of these dol lars are acquired by foreign central banks and become part of their official reserves. These banks, in turn, may instruct the Federal Reserve Bank of New York to pur chase gold from the Treasury for their ac count, causing a gold outflow. As the Treasury’s gold stock has declined since the end of 1957, the gold stocks of other in dustrial nations such as Italy, France, the Netherlands, Germany and United Kingdom have risen by a roughly comparable amount. Several European central banks tradition ally use the bulk of their net foreign exchange receipts to buy gold because they prefer to maintain their official reserves in that form. Other central banks that maintain both gold and dollar reserves may use only a part of their net foreign exchange receipts to buy gold when they have sizable reserve gains arising out of balance of payments surpluses. They have the option of acquiring gold from the Treasury at the established price of $35.00 per ounce or in the London market where the price is determined by supply and demand forces. Paym ents deficit has increased Although recent estimates indicate that our balance of payments deficit increased to an annual rate of 4.3 billion dollars in the third quarter of 1960, from a 2.6 billion annual rate in the first quarter and 2.9 billion in the second quarter, at least one factor points to a basic strengthening in the United States international position. That is the substantial improvement in our trade sur plus since mid-1959. The United States is currently running an export trade surplus reminiscent of the Mar shall Plan aid period and the Suez-generated export boom of 1956-57. Since the second quarter of 1959, our exports have increased more than 5 billion dollars to a current seasonally adjusted annual rate of 20 billion dollars. Our imports, however, have tapered off slightly to an annual rate of 15 billion. The improvement in the export picture has been one of the main areas of strength in our economy during the past year. Chiefly because of the rise in the export trade surplus, this country in the third quarter of 1960 had a surplus on current account with the rest of the world equal to 4.5 billion dollars, annual rate. In the second quarter of 1959 we were running a deficit at the rate of 1.3 billion. A current account surplus means the United States is earning more than enough in its two-way trade in goods and services with the rest of the world to cover its military expenditures and private remittances and pension payments abroad. If the current account surplus has shown such a considerable improvement, why has the deficit in our over-all balance of pay ments actually increased since the first quarter? The answer rests with a substantial Business Conditions, December 1960 U. S. balance of international payments, 1 9 5 6 -6 0 1 9 5 6 1 9 5 7 1 9 5 8 1 9 5 9 1 9 6 0 lest.) (b illio n d o lla rs; re c e ip ts [ + ] , p a ym e nts [ — ]) Current account: Exports of goods and se rvice s....................... + 23.7 + 26.7 + 2 3 .3 + 2 3 .5 + 2 7 .1 Imports of goods and se rvice s’...................... - 1 9 .8 - 2 0 .9 - 2 1 .0 - 2 3 .6 - 2 3 .4 Private remittances and pensions (net) . . . . - 0 .7 - 0 .7 - 0 .7 - 0 .8 - 0 .8 Balance on current account......... + 3 .2 + 5 .1 + 1.6 - 0 .9 + 2 .9 - 2 .4 - 2 .6 - 2 .6 - 2 .0 - 2 .7 Capital account: Government loans and grants (net).............. Private U. S. capital (net): Long-term..................................................... - 2 .5 - 2 .9 - 2 .5 - 2 .2 - 2 .0 Short-term ................................................... - 0 .5 - 0 .3 - 0 .3 - 0.1 - 1 .4 Foreign long-term capital (net)2 .................... + 0 .5 + 0 .4 — + 0 .5 + 0 .5 Balance on capital account......... - 4 .9 - 5 .4 - 5 .4 - 3 .8 - 5 .8 Erro rs and om issions................................................... + 0 .6 + 0 .7 + 0 .4 + 0 .8 - 0 .6 Over-all balance: surplus (-|-) or deficit ( — ) . . - 1 .0 + 0 .4 - 3 .5 - 3 .8 - 3 .5 - 0 .3 - 0 .8 + 2 .3 + 0 .7 + 1.7 + 1.3 + 0 .4 + 1.2 + 3.1 + 1.8 + 1.0 - 0 .4 + 3 .5 + 3 .8 + 3 .5 Balancing items: Gold sales to foreigners (+ ); purchases ( — ) Increase in foreign liquid dollar holdings (-|-); decrease ( — ) ...................................... ’ In c lu d e s m ilita ry e x p e n d itu re s a b ro a d o f a p p ro x im a te ly $3.1 b illio n a n n u a lly . E x c lu d e s p u rc h a se s o f U . S . G o v e rn m e n t s e c u ritie s . N o te : B a se d on D e p a rtm e n t o f C o m m e rc e fig u re s . E stim a te s f o r 196 0 c o m p ile d b y F e d e ra l R e se rv e Ba n k o f C h ic a g o . M ilita r y su p p lie s and s e rv ic e s fin a n c e d by g ra n ts w h ic h a v e ra g e a b o u t $ 2 .3 b illio n a n n u a lly a re e x c lu d e d fro m e x p o rts and G o v e rn m e n t g ra n ts f o r a ll y e a rs . D a ta f o r 1 9 5 9 e xc lu d e s $ 1 .4 b illio n a d d itio n a l U . S . s u b s c rip tio n to th e In te rn a tio n a l M o n e ta ry Fund, o f w hic h $ 0 .3 b illio n w a s p a id in g o ld . C o m p o n e n ts may n o t b a la n c e d ue to ro u n d in g . pickup in recorded net outflows of private short-term capital, apparently in response to the pull of high interest rates abroad, and in non-recorded capital transactions. (Rather sizable movements of capital escape the offi cial reporting systems and show up only as a shift in the residual “errors and omissions” item in the balance of payments. Normally 11 Federal Reserve Bank of Chicago 12 this residual has shown net receipts, but in the first half of 1960 it showed net payments and probably included sizable capital out flows.) Recorded net outflows of long-term capital, including investment in overseas facilities by American firms, purchases of foreign long-term securities and U. S. Gov ernment loans and grants abroad, have re mained essentially stable. As can be seen in the accompanying chart, the spread between short-term interest rates in the United States and principal European countries widened steadily in the first nine months of 1960. This reflected a leveling off in economic activity in this country on the one hand and a continued rise in the European business boom on the other. During this period the outflow of short-term capital from the United States accelerated as both foreign and domestic in vestors converted dollar balances to foreign currencies in order to take advantage of the more attractive rates abroad. United States industrial corporations and investment funds were reported to be heavy buyers of United Kingdom Treasury bills at yields approach ing 5Vi per cent. In the process the dollar balances of foreign central banks rose sub stantially. The banks have used a portion of these funds to purchase gold in London and New York, with the latter being reflected in a decline in the Treasury’s gold stock. It is interesting to note that less than a year ago interest rates in this country were higher than in most European financial cen ters. U. S. Treasury bills and prime short term finance paper offered investment yields approaching 5 per cent. These yields not only induced foreigners and Americans to keep their dollar balances invested in this country but also attracted foreign funds to New York. The above should emphasize that the re- Spread between U. S. and European short-term interest rates widens in 1960 per cent N o te : except M o n th ly a v e ra g e m a rk e t y ie ld s f o r G e rm a n y w h ic h re fle c ts e n d -o f-m o n th 3 -m o n th b ills , y ie ld s. cent increase in our balance of payments deficit is primarily attributable to non-trade items — recorded net outflows of private short-term capital and unrecorded capital transactions. These, in turn, reflect the effects of such unpredictable factors as in terest rate differentials between the New York and European money markets and the attitudes of businessmen and investors. O utloo k encouraging On balance, our present international pay ments position represents an improvement over the situation in 1958-59 when the defi cits could be directly related to a shrinkage in our export trade surplus. If the current export surplus holds, we can expect some improvement in our balance of payments, as a result of the recent easing of short-term interest rates in France, Germany and United Kingdom. This should help to moderate the outflow of short-term funds. Business Conditions, December 1960 Further areas of encouragement are: (1) the demonstrated ability of domestic business firms to make their goods more competitive with foreign merchandise and (2) the Ad ministration’s efforts to relieve the strain on our balance of payments. The President has directed Government agencies to cut down, where feasible, on overseas dollar spending, and major Western European nations have been urged to assume a greater share of the cost of extending economic aid to under developed areas and maintaining the free world’s defense position. Success in these areas is essential to correcting the funda mental problem. The Detroit-built compact cars are a strik ing example of how American industry can meet foreign competition. This country, moreover, has a considerable reserve of sur plus productive capacity to support further expansion of exports. In sharp contrast some leading export nations, notably Germany, have been losing potential export business because heavy backlogs and shortages of plant capacity and skilled labor preclude prompt delivery on orders. The German Government has proposed a substantially increased foreign economic assistance program for 1961. A fund of nearly 1 billion dollars will be established Busine ss C ond itions is published monthly by the C . Sub scriptions are available to the public without charge. For information concerning bulk mail ings to banks, business organizations and edu cational institutions, write: Research Depart ment, Federal Reserve Bank of Chicago, Box 834, Chicago 90, Illinois. Articles may be re printed provided source is credited. f e d e r a l r e s e r v e b a n k o f h ic a g o with monies from Government and private sources to provide loans and credits to under developed countries. It is understood the aid recipients will not be compelled to purchase German goods, but may use the funds to procure goods in the cheapest markets. The sharing of mutual defense costs is being re viewed with our allies, and the President has stated that discussions on this subject will be continued. Germany recently announced that it would contribute more to the cost of maintaining NATO defense installations. Thus, corrective measures are being taken to restore equilibrium to the United States balance of payments. In the meantime, our present gold stock of 18 billion dollars (nearly one-half of the free world supply) should serve to cushion possible additional drains resulting from capital movements and other unpredictable transactions. Fu tu re policies The international economic situation has changed dramatically since the end of World War II. With the help of United States foreign aid, the weak, disrupted economies of Western Europe have been rebuilt and are now productive and strong. Markets are no longer dominated by worldwide shortages of goods and services. Purchasers, freed in creasingly from dependence upon American aid, shop for price, credit terms, quality and service. The dollar shortage, which plagued many countries in the early postwar period and was confidently predicted by some ex perts to be a permanent situation, has largely disappeared. Most major industrial countries today possess sizable gold and dollar re serves. Reflecting this, their currencies are strong and freely convertible and invite foreign investment when interest rates are at attractive levels. Meanwhile, many under developed and primarily raw materials ex- 13 Federal Reserve Bank of Chicago porting nations are still handicapped by low reserves and recurring balance of payments deficits. With the change in world conditions now clear to all, the United States is in the process of reshaping its policies. It appears that more emphasis will be placed on extending aid to low income countries and that other lead ing industrial nations will be urged to play a greater part in this task as well as in main taining the free world’s defense position. These new policies should help to achieve the essential goals of restoring equilibrium to the United States balance of payments and fostering continued healthy growth of the free world economy. Large "holiday” reserve needs supplied T J_he nation’s banks are currently experi Thus, the absorption of bank reserves due 14 encing the usual heavy demand for currency and credit associated with the holiday season. Every year, between Thanksgiving and Christmas, currency in circulation increases by more than 600 million dollars, reflecting the public’s greater use of “pocket” money for Christmas shopping, gifts of money and other holiday expenditures. Commercial banks obtain this additional currency from the Federal Reserve Banks. Payment for it reduces the reserves of the commercial bank ing system unless offset by Federal Reserve action. The season also brings increased demand by bank customers, both businesses and in dividuals, for short-term financing. As loan volume expands, deposits rise, and banks need more reserves to meet their legal re serve requirements against the additional deposits. The pre-Christmas increase in re quired reserves normally amounts to at least 400 million dollars, but may be greater if business is expanding rapidly. to currency outflow and deposit expansion usually amounts to between 1.0 and 1.5 billion dollars. Besides these seasonal factors, however, there are other developments that may cause declines in bank reserves. The most important is an outflow of gold. Bank reserves decline when the Treasury sells gold, because buyers pay for the gold by writing checks against their deposits at commercial banks. As these checks are presented for payment through the clearing process, the reserves of the banks are reduced. This year the gold outflow caused a heavy drain on bank reserves. From mid-September until Thanksgiving this outflow averaged more than 100 million dollars per week. One function of the Federal Reserve Sys tem is to provide banks sufficient reserves to assure their ability to satisfy purely seasonal cash and credit demands. At the same time, System operations may offset the reserve effects of gold outflows to the extent these are incompatible with the monetary needs Business Conditions, December 1960 of the domestic economy. The volume of reserves pro The Federal Reserve System has provided vided by System action may, of large amounts of bank reserves to cover course, be either larger or smaller fourth-quarter needs this year than the total amount being cur rently absorbed, depending on general economic conditions. During times of rapid business expansion and full employment of resources, the System may pro vide a somewhat smaller amount of reserves in the interest of re straining possible inflationary pressures. This fall, on the other hand, there has been slack in some segments of the economy, and uncertainty has dominated the business outlook. In this en vironment reserves have been provided to assure that banks are able to meet the credit needs that would be associated with a faster pace of business, as well as ■"Includes cha ng es in T r e a s u r y c u rre n c y , T r e a s u r y cash and d e to offset those absorbed by sea p o s its w ith th e R e s e rv e Ba nks, m em ber bank b o r r o w in g , a ll o th e r sonal forces and gold outflows F e d e ra l R e s e rv e a c c o u n ts n o t s h o w n s e p a ra te ly and e x c e ss re s e rv e s . (see chart). N o te : T h e cha ng es s h o w n in th e u p p e r b a r f o r each y e a r a b s o rb Between the end of September bank re s e rv e s , and th o s e in th e lo w e r b a r s u p p ly re s e rv e s . In d iv id u a l fa c to rs may ha ve d iffe r e n t e ffe c ts in d iffe r e n t p e rio d s d e p e n d in g and Thanksgiving, Federal Re on th e d ire c tio n o f th e c h a ng e , e .g ., g o ld in flo w s s u p p ly re s e rv e s serve open market purchases of w h ile g o ld o u tflo w s a b s o rb them . T h e d a ta f o r th e y e a rs 1 9 5 6 -5 9 Government securities supplied a re changes in w e e k ly a v e ra g e s fro m th e la s t w e e k in S e p te m b e r to th e la st w e e k in D e c e m b e r. C h a n g e s f o r 1 9 6 0 a re e stim a te s more than a billion dollars of based on a c tu a l c h a n g e s th ro u g h m id - N o v e m b e r p lu s n o rm a l bank reserves. As sellers of these se a so n a l c ha ng e s and p ro je c te d g o ld o u tflo w . N o a llo w a n c e is securities deposit the proceeds in made f o r p o ssib le c ha ng e s in F e d e ra l R e s e rv e h o ld in g s o f G o v e r n m ent s e c u ritie s d u rin g D e c e m b e r. their bank accounts, reserves in crease. In addition, changes in the reserve requirements of member banks, as provided in legislation adopted in July 1959, have been timed to November 24, all vault cash became reserve supply a large amount of reserves during eligible, but at Country banks, which hold this period. As a result of the most recent most of the vault cash, the reserve effect amendment to the reserve regulations, an was partially offset by a concurrent increase estimated 1.3 billion dollars of reserves in the percentage of demand deposits which became available in two steps: (1) effective must be held in reserves; and (2) effective 15 Federal Reserve Bank of Chicago December 1, reserve requirements against demand deposits of Central Reserve City banks were reduced to make them equal to those of Reserve City banks.1 These changes, as they affect the three classes of banks, are summarized below: (million dollars) At Central Reserve City banks, through: Additional vault cash allowable 150 Reduction in reserve requirements on demand deposits from 17Vi to 16**% 250 400 At Reserve City banks, through: Additional vault cash allowable 380 At Country banks, through: Additional vault cash allowable 900 L e s s , increase in reserve re quirements on demand deposits from 11 to 12% -3 8 0 520 Total reserves made available 1,300 This is likely to be augmented by some rise in the total amount of currency in bank vaults during the holiday period. Based on 16 This amendment to the Board’s Regulation D, governing member bank reserve requirements, con stitutes the final step in the implementation of legislation enacted by Congress in July 1959 for the purpose of making reserve requirements more equitable among individual banks. The law pro vided, among other things, that the Federal Reserve Act be amended to (a) fix identical reserve re quirements for Central Reserve and Reserve City banks and (b) eliminate any formal distinction between Central Reserve and Reserve City banks by July 28, 1962. The law also authorized the Board of Governors to make vault cash eligible for inclusion in required reserves. The first step in carrying out this legislation was taken in December 1959, when member banks were allowed to count part of their vault cash as reserves. A further step was taken in August to increase the amount of allowable vault cash. the experience of other recent years, the reserves already provided appear ample for the pre-Christmas needs, especially when the probable expansion in Federal Reserve float is taken into consideration. (Float rep resents an automatic extension of Federal Reserve credit as banks clearing checks through the Federal Reserve are given credit for cash items still in process of collection from the drawee banks.) Float always rises over the holiday period with the higher volume of checks and occasional mail delays. However, there are a number of factors which may cause the current season to differ from other recent years. First, deposit expansion may absorb a larger volume of reserves than usual. De posits were slow to respond to easier mone tary policy in the summer and early fall, but have been showing larger gains recently. The net effects, however, will depend on how the deposit growth is distributed among banks. Compared with last year, fewer re serve dollars will be required to support the same volume of deposit growth at New York and Chicago banks due to lower require ments; but Country banks will need more reserves per dollar of deposits. In addition, gold outflow may continue to cause a heavier drain on reserves than usual. Finally, because of the large and wide spread initial impact of reserve requirement changes, the resulting reserves may be used less rapidly than those provided by open market purchases. If reserves should appear redundant for current needs, they can, of course, be absorbed by Federal Reserve actions. Changes in reserve requirements are frequently supplemented with open mar ket operations since the latter are capable of achieving greater precision in the amount and timing of the release or absorption of bank reserves. Business Conditions a review by the Federal Reserve Bank of Chicago In d e x f o r th e y e a r 1 9 6 0 Automatic check clearing on the threshhold! April, 4-6. Banking in the 1950’s, March, 14-16. Large “holiday” reserve needs supplied, December, 14-16. Loan ratios rise further, September, 16. Sharp rise in debt increases demand on capital and credit markets, February, 12-15. Business finance Charge-offs on business loans, 1957-59, August, 9-12. Terms of home mortgage loans, June, 714. Consumer credit and savings The economy’s changing money needs, July, 5-10. Government issues attract personal sav ings, January, 8-12. Instalment debt continues rapid climb, August, 5-9. New fashions in consumer lending, Janu ary, 5-7, 12-14. Savings institutions shift investment port folios, April, 6-10. Economic conditions, general Labor resources in the Sixties, July, 10-16. Projecting economic growth, May, 11-16. Strikes and recessions—effects on con sumer buying, January, 14-16. The trend of business, January, 2-4; Feb ruary, 2-4; March, 2-5; April, 2-4; May, 2-4; June, 2-5; July, 2-5; August, 2-5; September, 2-4; October, 2-6; November, 2-5; December, 2-5. Who are the “unemployed?”, February, 4- 7, 15-16. Farm finance and agriculture Farmers and farm surpluses, April, 10-16. Farm prospects, 1961, December, 5-7. The hog cycle in perspective, February, 7-9. Hogs boost farm income outlook, June, 5- 6. Industry, trade and construction America’s capacity to produce, November, 10-15. Bank debits— a measure of local business activity, September, 5-9. Business growth in the Midwest, October, 6- 10 . E a s te r s p a rk s r e ta il sa le s rise , M a y , 4 -6 . T h e g ro w th o f c o n s u m e r se rv ic e s , N o v e m b e r, 5 -1 0 . M a n -h o u r s a n d e le c tric p o w e r c o n s u m p tio n in th e D e tr o it a r e a , M a rc h , 1 0 -1 4 . International economic conditions G o ld in th e A m e r ic a n e c o n o m y , D e c e m b e r, 7 -1 4 . M id w e s t in d u s trie s a d ju s t to s h iftin g w o rld tr a d e p a tte r n s , O c to b e r , 1 0 -1 6 . T h e o u tlo o k f o r U . S. fo re ig n tr a d e , S e p te m b e r , 9 -1 5 . T h e S e a w a y — y e a r o n e in re v ie w , M a y , 6- 11. Public finance D e b t e x p a n s io n slo w s, J u n e , 1 5 -1 6 . F e d e r a l a g e n c y s e c u ritie s , A u g u s t, 1 2 -1 6 . M id y e a r B u d g e t re v ie w , N o v e m b e r , 1 5 -1 6 . T h e n e w B u d g e t, F e b r u a r y , 1 0 -1 1 . U p tr e n d in r o a d b u ild in g d u e to re s u m e , M a rc h , 5 -1 0 .
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