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A review by the Federal Reserve Bank of Chicago Business Conditions December 1970 Contents New farm law— a step toward the marketplace 2 The Federal Reserve Systemvital and viable in the Seventies 9 Federal Reserve Bank of Chicago New farm law — a step toward the marketplace After two years of negotiations, the Agricul tural Act of 1970 was passed by Congress and signed into law on November 30. Re placing the act of 1965, the new act will be the basis for farm policy for the next three years. The Secretary of Agriculture sought a bill that would reflect the goals of the Adminis tration as well as those of the various factions within the farm political bloc. But the new law, like most legislation, may best be termed a compromise rather than a consensus. In formulating the new act, controversy centered, as so often in the past, on the degree of government support that should be pro vided for farmers. After 40 years of govern ment programs, some form of support for agriculture is generally accepted. Periodic ally, however, there is a movement to make agriculture more market-oriented. This is equated with reducing government’s role and giving farmers more freedom in production decisions. This type of program is especially appealing to government policy makers with budget constraints in mind. It is less appeal ing to congressmen from farming states and to their constituents who face the prospect of lower farm prices. The Agricultural Act of 1970, while mov ing in the direction of less government sup port and control, still provides farmers insula tion from the sometimes harsh vagaries of the marketplace. The new farm act does not depart significantly from the 1965 Food and Agricultural Act that expires this year. As under that act, farm production will be con trolled by idling cropland, and farmers’ in comes will be supplemented through direct payments and price support loans. Success o f d ire ct p a ym e n ts Direct payments to farmers for idling wheat, cotton, and feed grain acreage appear to have worked fairly satisfactorily in pre venting a buildup of excess stocks of govern ment-owned commodities. Since 1961, when direct payments to discourage production were first initiated, government stocks of wheat have been more than halved—declin ing from well over 1.3 billion bushels in 1961 to just over 600 million bushels in 1969. Corn stocks controlled by the government declined from 1.9 billion bushels to about 730 million bushels. Still, the direct payments type of program has come under criticism because of the rapid increase in payments to farmers for not producing. Especially sharp Business Conditions, December 1970 criticism springs from the extremely large payments to a few individual producers. In 1969, five operators received payments of $1 million or more each. Furthermore, about 5 percent of the farmers received 38 percent of all direct payments in 1969. Direct payments to farmers rose from $700 million in 1960 to approximately $3.8 billion in 1969—more than fivefold. The in crease in direct payments should not be interpreted as a net increase in government support of agriculture. Rather, the increase reflects a change in the form of farm income supplements. Prior to the 1960s, farmers’ incomes were bolstered indirectly through relatively high price support loans. For ex ample, the support rate for corn ranged from $1.40 to $1.62 per bushel in the 1954-57 period, compared to $1.00 to $1.05 per bushel in the 1965-69 period. Support loan rates for cotton and wheat declined similarly following changes in these programs. With the lowering of price supports on the major commodities, income supplements to farmers were maintained by boosting direct payments. As for the matter of inequitable distribu tion of payments, government farm support programs have always been commodityoriented with the largest producers receiving the most benefits. But the direct payment system makes the level of support to each individual highly visible. Formerly, large farmers received their benefits indirectly by selling at artificially high prices in the market place or to the government. A p r e c e d e n t is s e t The controversy surrounding the matter of large government payments to farmers re sulted in a compromise feature in the 1970 Agriculture Act that limits payments any one recipient may receive to $55,000 per crop. Theoretically, a grower of all three major Most farmers receive less than $5,000 in direct government payments! Percent o f to tal G o v e rn m e n t p a y m e n ts R ecip ien ts (d o lla rs) (n u m b er) Less th an 5 ,0 0 0 2 ,3 8 8 ,3 1 7 95 5 ,0 0 0 - 9 ,9 9 9 8 7 ,1 8 9 3 1 0 ,0 0 0 - 2 4 ,9 9 9 3 4,0 0 3 1 2 5 ,0 0 0 - 4 9 ,9 9 9 6 ,0 2 9 * 5 0 ,0 0 0 - 9 9 ,9 9 9 1 ,40 4 * 1 0 0 ,0 0 0 — 4 9 9 ,9 9 9 346 * 5 0 0 ,0 0 0 - 9 9 9 ,9 9 9 11 * 1 ,0 0 0 ,0 0 0 a n d o v e r 5 * H e s s th a n 1 p erce n t. |D a t a fo r 1969. crops—feed grains, wheat, and cotton—can still collect up to $165,000 in direct pay ments. In 1969, however, only two producers would have qualified. The significance of the $55,000 payment limitation may be in setting a precedent that could portend more restrictive payment ceil ings in the future. The House of Representa tives passed legislation in 1968 and 1969 to limit payments to $20,000 per producer, but the Senate did not agree. In 1970, the Senate passed a $20,000 limit but agreed to the $55,000 limit in the House bill. The $20,000 limit may come to the fore again in 1973. The current $55,000 limitation, one of the most publicized features of the new act, will affect very few farmers. Moreover, it will not significantly reduce government outlays on agriculture. Only 1,100 farmers received pay ments of more than $55,000 in 1969. Of these, 950 were cotton growers in the South and West. Within the Seventh District states, only 18 farmers received government pay- Federal Reserve Bank of Chicago Direct government payments . . . billion dollars ments in excess of $55,000. All were in the leading feed grain producing states of Illinois, Indi ana, and Iowa. If the $55,000 per crop limitation had been in effect in 1969, direct payments of ap proximately $3.8 billion would have been reduced by $58 million, less than 2 percent. Lo o senin g g o v e rn m e n t re in s . . . replace high price supports dollars per bushel 4 Other provisions in the new farm act are in the direction of more freedom of choice for pro ducers, more flexible price sup ports, and less reliance on rigid formulas. The “set-aside” provision of the 1970 act is a new twist to the old scheme designed to take wheat, feed grain, and cotton acres out of production. Purportedly, it will allow the farmer greater free dom to choose the crops he wishes to grow after “setting aside” a designated portion of his acreage. Under the old program, feed grain, wheat, and cotton acreages on participating farms were lim ited to predetermined base acre age allotments (1959-60 average wheat, cotton, and feed grain acre age on the farm) less the idled acres. Thus, a farmer with a 100acre feed grain base, for example, who chose to idle 20 percent of his acreage could plant only 80 acres of feed grains, even though he might have 200 acres of cropland. The new set-aside provision will allow the farmer to plant whatever crop he wishes on his remaining acreas after idling the Business Conditions, December 1970 required acreage. Thus, a farmer is not lim ited by his base acreage allotment and may plant all his remaining crop acres to feed grains or other crop he deems most profitable. This relaxation of controls could result in sharply higher grain production and lower grain prices. There are provisions in the new act, however, which allow the Secretary of Agriculture to limit the number of feed grain acres on participating farms through 1973 to provide an orderly transition toward marketdirected plantings, should that be necessary. The removal of marketing quotas and acreage restrictions from the cotton program was another step toward less government intervention. Formerly, if in any year the U. S. cotton supply exceeded the “normal” supply, the Secretary of Agriculture pro claimed a marketing quota and established necessary acreage restrictions to control pro duction the succeeding year. A referendum was called in which two-thirds of the cotton producers had to approve the quota in order for it to be effective. Under the new act, an annual production goal will be declared by the Secretary of Agriculture as a guide for producers, but mandatory quotas, penalties, and acreage restrictions are suspended for the next three years. P a rity — less em phasis The parity concept has been a key factor in government farm programs since the 1930s. Parity—as a policy guide—is based on the premise that a bushel of corn, for example, should have the same purchasing power to day as it did in agriculture’s supposed “golden era,” 1910 to 1914. Parity carries the con notation of being fair. Farm prices are said to be at parity when the relationship between the prices of farm products and the prices of goods and services farmers purchase is the same as it was in the 1910-14 period. Government stocks lower than early 1960s billion bushels The original method of calculating parity prices maintained a constant relationship be tween prices of individual farm commodities, i.e., the relationship between the price of corn in relation to the price of hogs was frozen according to their relation in the 1910-14 base period. Several years ago this was adapted to adjust for changes in the supply and demand factors affecting indi vidual commodities. Individual farm product prices are now determined by use of an ad justed base—a ten-year moving average of prices for a particular commodity divided by the average index of prices for all farm prod ucts. This adjusted base price is then multi plied by the index of prices paid by farmers, which is still based on the 1910-14 period, to arrive at the parity price. Parity, with its emphasis on prices, does not take into account the rapid advances made in the technology of production. Mod ern technology has lowered unit costs of pro duction for many farm commodities, and it has drastically increased quantities produced. Department of Agriculture statistics indicate 5 Federal Reserve Bank of Chicago production of farm commodities increased about 127 percent from the 1910-14 period to the 1967-69 period. At the same time, the amount of inputs required to produce this output increased less than 30 percent. The result: a 77 percent increase in productivity. Most of this gain in productivity is attribu table to the mechanization of agricultural production—that has sharply reduced the amount of labor required—to the develop ment of hybrid seeds, and to the use of com mercial fertilizers. Thus, increased prices of production items purchased by farmers have been offset in varying degrees, depending on the commodity, by substantial increases in productivity. An attempt to sever the ties between parity and farm supports in the Administrationbacked House bill was strongly opposed by members of the Senate. As a result, the con cept of parity remained alive, although di minished in importance, in the final version of the farm bill hammered out by the HouseSenate conferees. Increased efficiency boosts agricultural output 6 ‘ In clu d e s a ll item s used in a g ric u ltu ra l p ro d u ctio n . In general, the new act gives more weight to actual market price in determining the level of price supports. In the case of feed grains, cooperating farmers are guaranteed a minimum price support payment of either $1.35 per bushel for corn, or 70 percent of parity, if higher, on half the production from their feed grain base acreage. In 1973, how ever, if the 70 percent parity guarantee would result in total payments exceeding those of the previous year the amount of excess would be nullified. The price support loan floor was set at $ 1.00 per bushel for corn without refer ence to parity. M ost fa rm e rs b e n e fit little Approximately two-thirds of the individ uals counted as farmers by the Bureau of the Census benefit little from current government farm support policies. This is because they control relatively few agricultural resources. These farmers operate two-thirds of the nearly three million Census-enumerated farms,1 but receive only about a fifth of the government payments. Payments per farm in this group averaged about $440 in 1969. Obviously the majority of places and per sons counted as farms and farm operators by the Census already depend on sources other than farming for their livelihood. Indeed, in come from off-farm sources accounted for 78 percent of the family incomes of these “farmers” in 1969. Half of the operators in this group received nearly 90 percent of their income from off-farm sources. Many in this group make up the rural poor. For others, farming is a hobby or sideline. The largest one million commercial farm ers—who operate about a third of the farms in the nation and produce over 85 percent of* *A farm is defined as a place of ten acres or more with at least $50 in sales, or a place of less than ten acres with at least $250 in sales. Business Conditions, December 1970 the farm commodities —have benefited most from farm price and income support pro grams. They are also most dependent on continuance of the programs. Large-scale com mercial farmers rely on stable prices for a dependable cash flow to meet current oper ating expenses. Over half the items used in farm production are purchased from non farm sources, usually through the use of credit. In the past, when the average farm was much smaller, most of the inputs originated on the farm where used. Most im portant, family labor accounted for a much larger share of total inputs. Under these circumstances, small farmers could survive short-run price and in come fluctuations by “belt-tightening,” in effect accepting a lower wage for their labor. Many large farm in vestments were made on the assumption that farm product prices would continue to be supported. Farmland Direct government payments account for increased proportion of farm income R e a lize d net fa rm incom e 1960 D irect g o ve rn m e n t p a ym e n ts 1969 1960 (m illion d o lla rs) 1969 (m illio n d o lla rs) P aym en ts as p ercen t o f incom e 1960 1969 (p ercen t) Illin o is 589 849 18 195 3 23 In d ia n a 337 590 17 132 5 22 Io w a 708 1 ,275 21 260 3 20 M ich ig an 255 276 18 73 7 27 W isco n sin U nited S tate s 394 562 17 56 4 10 11,7 3 6 1 6,1 5 4 693 3 ,7 9 4 6 23 Majority of "farmers" rely on sources other than farming for income In co m e p er f a r m , 1969 A n n u a l fa rm p ro d u ct sale s N u m b er o f fa rm s (d o lla rs) (th o u sa n d s) Less th an 2 ,5 0 0 1,223 41 1 ,082 7,011 87 2 ,5 0 0 - 4 ,9 9 9 286 10 2 ,1 2 2 4 ,8 9 5 70 5 ,0 0 0 - 9 ,9 9 9 389 13 3 ,6 3 0 4 ,4 8 8 55 10,0 0 0 - 1 9,999 5 05 17 6,481 3,141 33 2 0 ,0 0 0 - 3 9 ,9 9 9 357 12 10,4 6 6 3,241 24 4 0 ,0 0 0 an d o ve r 211 7 2 7 ,5 0 3 5 ,4 6 4 17 Percen t o f a ll fa rm s Farm O ff- fa r m (d o lla rs) O ff- fa rm to to ta l (p ercen t) 7 Federal Reserve Bank of Chicago accounts for about two-thirds of total agri cultural assets. Farmland values are sup ported by government programs. If current programs were eliminated, land values would decline, thereby reducing the accumulated equity of all farmers. The largest landowners would lose the most. While large operators control the bulk of farm assets, they likewise hold a much greater than proportionate share of the total farm debt. A 1966 census indicated that farmers with annual farm product sales of $20,000 or more comprise only 12 percent of all farmers, but account for nearly 50 percent of total farm debt. These farmers rely on continued maintenance of farm commodity price levels to repay their debts. N e w d irectio n s The farm program that has been outlined for the next three years does not differ sub stantially from its predecessor. Nevertheless, national priorities are shifting. Problems of 8 environmental pollution, housing, labor, and poverty are in the spotlight. These problems usually are associated with urban centers. However, they are also significant issues in rural America and may well come to the fore as less government funds are allocated for farm commodity price support programs. The 1970 Agricultural Act asserts the need for developing a “sound rural-urban balance” and calls for reports on planning, technical, and financial assistance to rural communities. Greater reliance on marketplace allocation of resources seems appropriate for the com mercial sector of agriculture. But, it should be recognized that 40 years of government support must be dismantled slowly to mini mize capital losses and human suffering. New policies are needed to assist the re maining noncommercial farmers. Problems of these families perhaps should be viewed in the broad context of the need to provide education and job opportunities for low in come persons, rural or urban. Business Conditions, December 1970 The Federal Reserve System— vital and viable in the Seventies Remarks of Mr. Robert P. Mayo President of the Federal Reserve Bank of Chicago at the Bankers Club of Chicago on December 2, 1970 We are all aware that in this day and age the charge of irrelevancy has become almost commonplace. Our institutions are viewed by some as being outmoded, rigid, and mis directed. They are charged with being in capable of meeting the changing needs of our present society. It is said they are hopelessly inadequate as innovators. These charges do not apply to the Federal Reserve System! At least I don’t think so. Although I won’t be able to cover com pletely tonight what I judge to be the Fed’s vital and viable role in the Seventies, I hope, at least, that we can start a dialogue that will continue after this evening. O b je c tiv e o f F e d e ra l R e s e rv e policy The basic objective of the Federal Reserve System is to facilitate the achievement of the social and economic goals of our people and our government through System contributions to an appropriate economic environment. These are not, obviously, the same words that were used in the preamble to the Federal Reserve Act or in the Employment Act. But the words are meant to convey the same sense of purpose. Hopefully, they also convey the view that in this changing society we must focus on a broad view of our functions if we are to meet our responsibilities. System officials, bankers, and the general public alike must remember that the primary function of the central bank is the promotion of the public interest. But the public interest is in a state of flux, affected continuously by rapid change, innovations, and new dimen sions of sophistication. These “facts of life” have and will vastly modify our interpretation of our objective, and also how the System’s functions relate to the whole fabric of society —not just to the economic process or our financial machinery. My restatement of the System objective does not, of course, modify the three areas of specific System responsibility; namely monetary control, a smoothly running pay ments mechanism, and banking supervision. But, as I say, I feel that we should interpret these specific goals in an environment where needs are constantly changing. This means an environment where effective action may be blocked by relics of a bygone era in the form of legislation, structural rigidities, or just plain lethargy. What I’m saying is that the 9 Federal Reserve Bank of Chicago 10 goals are familiar but their implications for today are far different from what they were ten years ago. And, because today’s priorities have shifted, we must constantly rethink those priorities and the options open to us to achieve them. Each sector in the economy, of course, sees these objectives in a different light. More over, it is easy to think of methods of achiev ing each separate objective that may look promising, but yet may be mutually inconsis tent. Compromises have to be reached. The trade-offs need to be clearly understood. The paramount responsibility of the Fed eral Reserve, as the central bank of the United States, is to provide the reserve base that will allow the commercial banking sys tem to generate the appropriate total supply of money and credit. I stress the “total supply of credit” because, in this view of the central bank’s responsibility, the task of allocating the supply among would-be borrowers is left to individual bankers and other suppliers of credit interacting freely in the marketplace. In recent years, the efficiency of the allocation function has been called into question, and some changes may be due. There are two possible approaches. One is for the Federal Reserve to take a more direct role in guiding credit flows. The other is to improve the market’s ability to achieve the kind of credit and resource use that appears to be most needed. In my view, the second approach is greatly to be preferred. It de pends for its success on competition, knowl edge, and mobility of both money and people. To the extent that it cannot be made to work to the satisfaction of the majority of our peo ple, pressures will mount to steer funds in the direction of socially-desired objectives, whatever those may be at the moment. But this approach entails serious problems of possible errors in human judgment, of conflict among experts as to the proper course of action, of mushrooming government controls to make initial controls work, and of plugging loopholes that tend to render the original rules inequitable or ineffective. In what ways, then, can the Fed be ex pected to provide the environment within which banks can meet the needs of agricul ture, housing, urban areas, state and local governments, the federal government, and the international payments mechanism? The Sys tem must affect the environment through its influence on banking structure, bank per formance, and the availability of credit. I’m not going to talk about inflation specifically tonight. But I’m sure you’ll all agree that better control of inflation than we had in the 1965-68 era is absolutely essential to the achievement of our goal of a healthy environment for the 1970s. Nor should the absence of any comments tonight on the respective roles of commercial banks and other financial institutions be interpreted as indicating any lack of concern as to the future of banking in America. Suffice it to say that each of you has as vital a role in the future of America as you ever have had. I certainly don’t come to you tonight with a series of neat solutions to any one of the issues of the 1970s—much less solutions to all of them. The best anyone can do, as he looks into the future, is to search a wide range of possible problem areas—challenges, as I prefer to call them—and to identify the ones that are most likely to produce difficult choices in the future. There are several I would like to examine in some detail. Banking structure Among the problems faced by the Federal Reserve few are more difficult or of greater potential importance to the economy than those having to do with banking structure. Business Conditions, December 1970 Together with the Comptroller of the Cur rency, the Federal Deposit Insurance Cor poration, and the 50 state banking depart ments, the Federal Reserve is responsible for assuring that developments in banking struc ture—a term encompassing the number and size-distribution of commercial banks, their pattern of branching, and the types of activiities they conduct—are compatible with the broad goals of depositor safety, technological efficiency in banking, efficient allocation of financial resources throughout the economy, and the prevention of excessive concentra tions of economic power. The System’s specific responsibilities with respect to banking structure are spelled out in federal banking laws. In particular, I refer, of course, to the Federal Reserve Act, the Bank Holding Company Act of 1956, the Bank Merger Act of 1960, and their amend ments. Among many others, System respon sibilities include ruling on applications for mergers and acquisitions of banks by holding companies; administration of the Regulation Q ceilings on interest rates on time deposits; the determination of whether proposed new activities of banks are “so closely related to the business of banking or of managing or controlling banks as to be a proper incident thereto . . . .” Especially since the early 1950s, a major purpose of the Federal Reserve has been to encourage vigorous competition among banks within limits consistent with the safety of the banking system. Competition has been pro moted as the guarantor of good performance, assuring protection against arbitrary and un fair decisions in allocating credit among competing borrowers. The basic presumption has been that competition is best served by maintaining an adequate number of inde pendent sources of banking services in each local market. The System has bulwarked competition by preventing mergers and ac quisitions that contribute even marginally to the share of resources controlled by the larg est banking associations in markets where concentration is already high. I foresee no change in the general emphasis of the present policy in the coming decade. One major obstacle to the achievement of these goals has been the existence of state laws that restrict the Federal Reserve’s range of discretion in merger and holding company cases by foreclosing competitively preferable alternatives. For example, geographic re strictions on branching can result in the ap proval of a merger that is not in the best interests of competition. Under other circum stances, this type of merger might be denied in the hope that the bank to be acquired some how might be purchased by a bank not now competing in the same market. Similarly, home-office protection clauses in state branching laws often result in the denial of mergers promising substantial improvement in efficiency because there is no possibility of potential entry by a competing bank to offset the loss of an independent source of banking services. Although federal law has long de ferred to state law in the matter of branching, the question should be raised as to whether or not such deference precludes the attainment of anything approaching an optimal structure of banking. For the immediate future, and for some time to come, the Federal Reserve’s greatest challenges in the area of banking structure and competition will be found in its adminis tration of the new Bank Holding Company Act—expected to be enacted before Con gress adjourns its current session.1 Since 1967, banks have been forming one-bank* ’Mr. Mayo’s remarks were made prior to final Congressional action on the One-Bank Holding Company Act. !I Federal Reserve Bank of Chicago holding companies to organize or purchase subsidiaries, some of which are engaged in activities that banks, themselves, are pre cluded from by banking laws. While acknowl edging the desirability of broadening existing restrictions on bank activities, neither the Congress nor the federal banking agencies are willing to see the line between banking and commerce obliterated. Not only does the common control of purveyors and users of credit raise serious conflict-of-interest possi bilities, but the very size of the banks in volved, to say nothing of the scope of their planned activities, appears to some to threaten too great a concentration of economic power. Unless the law that finally emerges from the Congress is much different than expected, the Federal Reserve will be called upon to decide whether existing or proposed activities of companies owned by one-bank holding companies “are so closely related to banking or managing or controlling banks as to be a proper incident thereto.”2 It is difficult to exaggerate the importance of the Federal Reserve’s responsibilities under the proposed legislation. The Board will have to issue rul ings defining activities that are closely related to banking. Almost certainly, lengthy hear ings will precede initial rulings. Moreover, it will be necessary for the System to process individual applications for acquisitions of nonbanking subsidiaries. It is expected that the casework load of the Board of Governors and the Reserve banks might be doubled or tripled, requiring an impressive amount of recruiting and training of personnel. Whatever the actual dimensions of the task turn out to be, it is clear that the Federal Reserve will play a crucial role in determining the future evolution of the financial system. 12 2Quoted from the Bank Holding Company bill reported out of the House-Senate conference committee. I can assure you that we in the System will take a sober view of our far-reaching re sponsibilities in implementing the legislation. In te rn a tio n a l resp o n sib ilities Another area of significant interest and importance to the System, and to me person ally, is the role of the Federal Reserve in the sphere of international finance. Over the past decade, the Federal Reserve System has be come increasingly involved in international financial relations, reflecting a growing con cern about the impact of our country’s balance-of-payments deficit on the viability of an international monetary system in which the dollar has long been the focal point. The United States has run a deficit in its balance of payments almost continuously over the past 20 years. For almost a decade hardly anybody was concerned about it. In deed, the deficit in the 1950s was viewed rather with satisfaction both by the world at large and by the U. S. Government. To the individual nations abroad, our de ficit represented the means by which they could replenish their war-depleted reserves with a currency accepted throughout the world as a means of payments and a store of value. Our deficit enabled many foreign countries to move away from severe restric tions on their foreign trade which, in turn, permitted them to flourish economically— often beyond their fondest expectations. To the United States, the deficits of the Fifties were a source of satisfaction in that they enabled the government to carry out its plans for economic and military aid. In those years, the United States gave over $60 billion to other countries to lessen economic de privation and to encourage the free world to defend itself against potential subjugation by international Communism. Throughout the Fifties, the monetary pol- Business Conditions, December 1970 icy makers did not worry about the balanceof-payments problem. Formulation of mone tary policy was governed almost exclusive ly by domestic considerations—employment, prices, and growth. In the late Fifties and early Sixties, however, the situation changed drastically. With restoration of currency con vertibility the restraint on foreign investment was removed. The U. S. investor no longer had to be concerned about his ability to repatriate the proceeds of these investments. Thus, he felt free to take advantage of profit opportunities promised by the establishment of the European Common Market. As a re sult, the private capital outflow accelerated tremendously. On the other hand, the rapid growth of income in Europe, along with the reduction of trade barriers throughout the free world, enabled producers abroad to move toward large scale production and to compete more effectively against U. S. pro ducers, both in the United States and abroad. The U. S. balance-of-payments deficits increased and led to a rapid rise in the ratio of our foreign liquid liabilities to our gold reserves. Our short-term liabilities surpassed our gold stock in dollar volume in 1961. Ever since, our liabilities have been increas ing and our gold stock has been declining. These developments gave rise to concern about the ability and willingness of the United States to maintain its convertibility commit ment. The concern culminated in the 1960 “gold rush.” As you will recall, this specula tive purchasing in the London gold market was in anticipation of a U. S. revaluation of gold as a means of easing the burden of the convertibility commitment. The speculative attack was beaten back. But it became clear that U. S. national eco nomic policies had to become more intimately concerned with the country’s balance of pay ments. One result was that U. S. monetary and fiscal policy makers began to take into account balance-of-payments considerations along with the more traditionally domestic goals set forth in the Employment Act of 1946—high levels of employment, stable growth, and implicitly, stable prices. Thus, since early 1960 the Federal Reserve entered—or rather re-entered—the interna tional arena. Its activities, and the develop ment of its policies, evolved along two distinct paths: 1) the use of traditional monetary policy tools for purposes of influencing the balance of payments; 2) the development of new tools to deal with the problems arising from the balance-of-payments deficit. As I have already suggested, balance-ofpayments objectives were added to the al ready established goals of monetary policy. This merely increased the possibility of mu tually inconsistent and unattainable objec tives. What the task finally boiled down to was an attempt to find a satisfactory middle ground between the opposing forces of do mestic considerations and balance-of-payments considerations. With a sluggish do mestic economy in the early Sixties, the scale in this trade-off inevitably tipped in favor of domestic considerations. But because of balance-of-payments considerations, expan sionary policies were pursued with sufficient moderation to result in the maintenance of a relatively stable price level through the early 1960s. This paid dividends. Stability of our price level relative to that of our foreign competitors enabled us to maintain our com petitive position in the world markets. This alone contributed to improvements in the trade account. In addition, through “opera tion twist,” the Fed tried to discourage inter national short-term capital outflows believed to be sensitive to short-term interest rate dif- 13 Federal Reserve Bank of Chicago 14 ferentials, and to encourage domestic invest ment by selling bills and purchasing bonds presumed to depend upon the long-term interest rate level. By late 1965, the domestic economy began to show signs of overheating and monetary policy gradually swung to tightness. We moved into a period where the domestic and international objectives were in obvious har mony, but also a period where the success of continuing policies to contain inflationary trends were still in doubt. In my book, fiscal policy failure in that period far outdistanced the shortcomings of monetary policy. The fact remains, however, that the severe inflationary pressures we ex perienced had an adverse influence on our balance of payments, specifically the trade account. Our trade surplus, which rose steadily between 1960-64, virtually disap peared, largely as a result of sharp increases in imports prompted by our overheated economy. We have seen some improvements this year. But the problem of finding a healthy balance between the domestic and interna tional objectives of national policy will re main a challenge for us at the Fed. We know that the U. S. economy cannot prosper with out a viable trade and financial relationship with the outside world. Similarly, for years to come, the outside world must depend heavily on a healthy dollar—backed by a viable U. S. economy—for its continued growth and prosperity. The Federal Reserve has made important contributions in dealing with the strains con fronting the international monetary system. The development, and imaginative use, of a network of mutual credit lines between cen tral banks—the so-called swaps—have been one of the major defenses we have developed to deal with speculative pressures on the monetary system. These and other arrange ments are an outgrowth of intensive partici pation by the Federal Reserve in international consultations with other central banks. Out of these consultations have emerged such concrete measures of international coopera tion as the Gold Pool Arrangements in the early Sixties, the General Agreement to Bor row that strengthened the facilities of the IMF, and last year’s IMF special drawing rights that hold promise of a better function ing international monetary system. We have a long way to go in solving the problems encountered in the monetary rela tionship among nations. In the years to come, the continuously changing kaleidoscope of challenges presented by the problems will require imaginative building upon the base of mutual cooperation among monetary authori ties. I expect to participate actively within the framework of the Federal Open Market Com mittee in the search for solutions acceptable to independent nations in our interdependent world. The international challenges that we at the Chicago Fed shall be facing in the next decade arise from our position as a leading regional bank. Our Seventh Federal Reserve District leads the nation in the export of manufactured and agricultural goods. We have corporations that have been real trailblazers in the development of multinational business—one of the most significant de velopments on the international scene during the past decade. With this increasing international orienta tion of Midwest industry has come a pro found transformation of banking in our district. Our banks have responded with gusto to the growing international banking needs of their customers. While in the early Sixties, international banking facilities were offered at only a few Midwest banks— and in many Business Conditions, December 1970 instances in name only—at the beginning of the Seventies, we have 24 banks with signifi cant loans abroad. Our banks have estab lished 20 overseas branches. Ten Edge Act subsidiaries have been set up for purposes of undertaking equity investment abroad. Nu merous other arrangements—such as repre sentative offices, ownership participation in foreign banks, and an enlarged network of correspondent relations with foreign banks— have firmly established Midwest bankers as a progressive group. These developments have entailed new challenges in virtually all functions at the Chicago Fed. Our examination, discount, re serve analysis, and research departments all have had to respond to the broadening hori zons of our banks. But our mission is broader than just accepting the challenges. We envi sion our job to be more aggressive than that. We must provide leadership and encourage ment to bank and industry alike in this area of endeavor. Recognizing the vital role that efficient international banking plays in healthy growth, we plan to encourage expansion of international banking in our district to the limits of our ability. As a first step in this direction we intend to begin publication of a weekly international letter. We know that Midwest banks, busi nesses, and the public have a pressing need for timely and accurate information on inter national economic developments. We have developed a number of sources of informa tion both here and abroad, and in our inter national letter we hope to share with you the information available to us. We want to participate with our banks in finding solutions to problems they encounter in their effort to grow to full-service interna tional operations. We are fully cognizant of the importance of these international relation ships to the Midwest and to the nation—in deed, to the world at large. Obviously, I have only scratched the sur face on issues and areas for our concern. I’ll end here, nonetheless, with the hope that I can continue this dialogue with each of you. Any attempt to cover a topic of such breadth in a single speech is foolhardy. But I do hope that you leave with the view that the System is very much alive, kicking, and relevant. As for myself, I intend to do everything possible to see that we accept the challenge provided by the changing environment. A fundamental reappraisal of many of our current policies and regulations is definitely in order. As you look back over this decade from the vantage point of 1980, I am confident you will find that the Federal Reserve Bank of Chicago has played a vigorous role in meeting the greater responsibilities arising from our tran sition into what may be called our post industrial economy. 15 B U SIN ESS C O N D IT IO N S is p u b lish e d m o n th ly b y the F e d e ra l R ese rve B a n k o f C h ic a g o . D ennis B. S h a rp e w a s p r im a rly resp o n sib le fo r the a rtic le " N e w fa rm la w —a step to w a rd the m a rk e tp la c e ." S u b scrip tio n s to Business Conditions a r e a v a ila b le to the p u b lic w ith o u t c h a rg e . For in fo r m atio n co ncern ing b u lk m a ilin g s , a d d re s s in q u irie s to the R esearch D e p a rtm e n t, F e d e ra l R ese rve B a n k o f C h ic a g o , B o x 8 3 4 , C h ic a g o , Illin o is 6 0 6 9 0 . A rtic le s m a y be re p rin te d p ro v id e d source is c re d ite d . P le ase p ro v id e the b a n k 's R esearch 16 D e p artm e n t w ith a co p y o f a n y m a te ria l in w h ic h a n a rtic le is re p rin te d . ¥ Vi. K,‘Siness Conditions j i a review by the Federal Reserve B ank of Chicago Index for the year 1970 Month Pages January June March 10-16 2-4 12-16 February October 11-15 7-11 A g ricu ltu re an d fa rm fin a n ce Agriculture—Strong in 1969, excess capacity continued...................................... Farm equipment prospects.......................................... Farm finance in a period of high interest rates........... Farm mortgages The impact of tight credit...................................... Food prices level off.................................................. New farm law A step toward the marketplace.............................. December 2-8 October 2-6 B a n k in g , cre d it, an d m o n e ta ry policy Bankers liberation Equal opportunity in the money market............... The Federal Reserve System Vital and viable in the Seventies........................... Housing, production, and finance............................. Needed, adaptable home mortgages........................... The one-bank holding company History, issues, and pending legislation............... Tight credit and the banks 1966 and 1969 compared...................................... December March April 9-15 5-11 13-16 July 2-16 May 4-11 Month Pages August November August January October November February March 2-7 9-15 7-12 2-10 12-15 2-8 2-5 2-5 Econom ic conditions/ g e n e ra l Consumption trails rising incomes............................. Models as economic tools............................................ More working wives, fewer children......................... The 1960s—lessons for the 1970s............................. Paying for pollution control........................................ Recovery in corporate profits.................................... The trend of business.................................................. The trend of business.................................................. The trend of business Continued strength in capital goods..................... The trend of business Impact of the truck strikes...................................... The trend of business Inventory growth ahead.......................................... April 2-9 May 2-3 September 2-7 February April June June September 6-10 10-13 10-16 5-10 7-12 In te rn a tio n a l econom ic d evelo p m e n ts The EEC and U. S. agriculture.................................... Foreign trade—the uneasy surplus........................... Measuring the U. S. Balance of Payments................. Perspective on the Seaway.......................................... U. S. trade—pressures for restriction.........................
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