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an e c o n o m ic re v ie w b y th e F e d e ra l R e s e r v e B a n k o f C h ica g o Long-term economic strategies needed Export controls and U.S. agriculture Banking developments Index for the year 1973 december 1973 Long-term economic strategies needed 3 Shortages serve to constrain our achievable economic goals, at least in the short run, and the public m ust be aware o f those constraints if the public is to give realistic direction to policy efforts. Export controls and U.S. agriculture 6 When a major supplier, like the United States, unilaterally re sorts to export controls, it places inordinate pressures on alterna\ tive suppliers and on importers relying on a stable supply source. S u b scr ip tio n s to Banking developments 12 Index for the year 1973 15 Business Conditions are a v a ila b le t o t h e p u b lic free o f c h a r g e. For in f o r m a t io n c o n c e r n i n g b u lk m a ilin g s, a d d re ss in q u ir ie s t o R e s e a r c h D e p a r t m e n t , F e d e r a l R e s e r v e B a n k o f C h i c a g o , P. O . B o x 8 3 4 , C h i c a g o , I l l i n o i s 6 0 6 9 0 . A r t i c l e s m a y b e r e p r i n t e d p r o v i d e d s o u r c e is c r e d i t e d . P l e a s e p r o v i d e t h e b a n k ’s R e s e a r c h D e p a r t m e n t w i t h a c o p y o f a n y m a t e r i a l in w h i c h an a r t i c l e is r e p r i n t e d . Business Conditions, December 1973 3 Long-term economic strategies needed Excerpts from “Economic Policy Strategies for the 1970s,” an address by Robert P. Mayo, President Federal Reserve Bank of Chicago before the Greater Des Moines Committee Des Moines, Iowa November 29,1973 The prospects of gasless Sundays, slower highway speeds, reduced airline service, lower temperatures in homes and factories, and a less glittering Christmas have made everyone keenly aware of the “energy crisis.” Seldom has public interest and con cern with an economic issue developed so rapidly and so intensely. The implications of relative scarcities or shortages for economic stabilization policies—and here I mean the use of both monetary and fiscal policies to achieve and maintain stable prices and relatively full em ploym ent—are not simply abstract, theo retical exercises of concern to economists and the armchair policymaker. It seems clear to me that shortages of supply serve to constrain our achievable economic goals, at least in the short run, and the public must be aware of those constraints if the public is to give realistic direction to policy efforts, to have realistic expectations of the results that can be achieved, and to make realistic assessments of economic policies and economic policymakers. Unfortunately, public expectations of the performance of economic policies, even in the absence of scarcities, have been greater than those policies could be reason ably expected to achieve, attributable I am afraid to policymakers and economists who promised more than they could deliver. Since the 1930s, the intent of government policy has been to foster actively economic well-being, economic stability, and eco nomic growth. Implicit in these actions has been the belief th at national policies could solve many of our economic problems. In practice, over this period the results have been mixed, but generally successful. The basic emphasis of fiscal and mon etary policy over the past few decades has been on the management of the demand for goods and services. Nevertheless, supply considerations have n o t been ignored. We have, for example, affected supply through agricultural support programs and mini mum wage legislation, even though supply effects may n o t have been the primary or sole objective of these programs. We have also taken the existing limits of capacity growth into account in our planning. But the basic thrust and emphasis have been on influencing and affecting private and public demands for goods and services. The reasons for our lack of complete success in following this demand-oriented scenario highlight some of the difficulties that economic policy faces in a changed en vironment where supply constraints may exist to a serious degree. Clearly, there have been a number of periods in our history in which we were unwilling or unable to re strain demands on our productive potential and inflation resulted. You will recall that in the early 1960s the economy was charac terized by stable prices,but an unemploy ment rate of about 5V& percent. Demand was stimulated. The demands of the Viet nam War, with heavy pressures on man 4 power and other productive resources, plus the initiation of vast new government social programs—demands not covered by com mensurate tax increases—reduced the un employment rate to 3V2 percent by 1969. At the same time, however, inflationary pressures mounted. These expansionary policies sowed the seeds of an inflationary cycle from which we have not by any means fully extricated ourselves. During this period, we simply asked too much from this economy in terms of both public and private goods. Total supply could not adjust as rapidly as demands increased and price pressures resulted. This is another way of saying th at public expectations for the economy exceeded the econom y’s abil ity to deliver. And public expectations for economic policy have exceeded the capa city of policy to deliver. Obviously, if we are rapidly moving toward an environment in which our popu lation growth and per capita resource de mands exceed availability, we end up with the apocalyptic conclusion of “Dooms day.” This I reject completely. Exhaustive studies have shown that there is no foresee able limitation on supplies of basic natural resources. Extreme pessimism is also un warranted because it attaches insufficient weight to the impressive array of adaptive mechanisms through which a market econ omy such as ours responds to shifting pat terns of resource scarcity. Technological change and changes in relative prices are powerful mechanisms. I do not mean to play down the short-run adjustment problem we face. But even in the short run the price mechanism can and does work. With limited supplies, price signals will activate the adjustment mechanism. And, it is within our current capabilities to provide relief and assistance to any groups in the society th at would otherwise bear a disproportionate share of the adjustments such price signals might bring about. Even if we were confident that we Federal Reserve Bank of Chicago could adjust to supply constraints we still haven’t eliminated the difficulties for eco nomic policy, and we must have realistic expectations of what these policies can de liver. First, the adjustment takes time. In the presence of shortages, policies designed to expand total output, and perhaps in crease employment through demand man agement, may work more slowly than they would w ithout supply constraints. Second, the process of adjusting supplies upward will, in a market economy, require in creases in prices for some period at least. It is the price mechanism th at communicates the demands for increased capacity, raw materials, or new technologies. Even with improvements in the speed of adjustment, it will, I fear, be difficult to achieve both of our goals of full employ ment and price stability simultaneously. It may even be impossible if we insist on de fining our short-run goals too restrictively—say 4 percent unem ploym ent and 2 percent inflation. In the presence of shortrun nonhuman resource limitations, we may n o t always be able to achieve full em ploym ent before generating price pressures on our other resources. Adaptation may simply not be that rapid. The process of achieving the goal of minimum unem ployment could put us in a future position where not only is the goal of price stability outside its range of toler ance but also where it is impossible to con tinue to achieve acceptable rates of unem p lo y m en t. The objective of economic policy controls cannot be simply to get us from where we are to where we would like to be. The optimal policy is one that brings the economy to a desired point in the “best way.” Policy actions set in motion a whole train of events that if not carefully watched can bring us to a state beyond the targeted point that is untenable. All this means simply th at our policies must be conceived within a broader time frame than in the past. Our short-run suc cesses of economic policy may not look as Business Conditions, December 1973 good as they have in the past, but over a longer time span perhaps they will be closer to what we really want. What then are the appropriate policy considerations for the remainder of this de cade? What are the alternative strategies in a changing environment? I do not pretend to have the policy answers completely and clearly identified. Most of these views will require further evaluation. Of greatest concern to me is the point I made earlier, that is, the tendency for public expectations to outrun realities in the economic sphere. This isn’t a new prob lem, but with shortages—even though cor rectable or adjustable over time—it takes on added seriousness for economic policy. If we fail to recognize th at available economic resources form a constraint upon national abilities to achieve our goals, the gap be tween expectations and realities will widen. It isn’t necessary to write a whole scenario before it becomes clear th at the wider the gap, the greater the public concern, the greater the demands for action, and the greater the likelihood of ineffectual or in a p p ro p ria te short-run economic policy actions. This does not mean th at any of us are opposed to an improved quality of life or t h a t we m u s t a d o p t an “ anti-environ m entalist” stance. But it does mean the realization th at decisions to produce public benefits impose costs. We need to weigh these costs and benefits not only for the particular program or policy action under consideration but also against all of the other programs with benefits and real re source costs. In terms of public policy, this 5 suggests the need for congressional budget ary reform, especially in putting an end to fragmented consideration of expenditures and by relating expenditures to prospective revenues and the nation’s broader needs and desires. It is essential that congressional resp o n sib ility for resource allocation be performed with the same emphasis on the total outcome th at is given to the prepara tion of the budget by the Executive branch. The old goal choice or trade-off be tween unem ployment and price stability still exists, but in a world of even short-run shortages, new difficulties are added. We will have to look more carefully beyond the short-run effects that we can achieve to the longer-run conditions we may create. More flexible fiscal policies may be a part of the answer, as would appear to be poli cies and programs to smooth out or shorten the time necessary to make adjustments. But I would be misleading you and con tr ib u tin g to excessive expectations of policymakers’ abilities if I suggested that we have all—or even most of—the answers. Our knowledge of control procedures for this type of environment is still limited but it is growing. The current and short-run prospects of our economy are a m atter of concern but not of alarm. The economy can and will adjust to the developing environment of relative shortages. It was in the process of doing so before the recent burst of pub lic awareness. And based on my earlier ex periences in fiscal policy and my current ex periences in monetary policy, I know that although it will be a difficult challenge we have the capability of meeting it. Federal Reserve Bank of Chicago 6 xport controls and U.S. agriculture Agricultural exports from the United States surged to an unprecedented $12.9 billion during fiscal 1973, 60 percent higher than the previous record in 1972, and the De partm ent of Agriculture has forecast that the value of agricultural exports will con tinue at a strong pace into 1974. In some respects, the performance of U. S. farm products in world markets in 1973 came as a welcome boost to what had been gener ally sagging exports. But this development has had some undesirable repercussions. Strong worldwide demand for agri cultural commodities in conjunction with poor crops in numerous major production areas created a domestic shortage of basic commodities and led to controversy over public policy toward agriculture. For de cades, U. S. policy has been aimed at pro moting agricultural exports. Elements of this policy have included subsidizing export shipments through concessional sales for nonconvertible foreign currency, barter arrangements, and direct dollar subsidies to exporters. In recent years, public policy has been directed toward reducing government assistance and promoting commercial dollar sales in traditional and new markets. In 1973, as strong domestic and foreign de mand collided with limited domestic sup plies to push prices of agricultural raw materials and retail foods to record-high levels, this policy of export promotion and limited export subsidies came under wide spread attack. The U. S. Government re sponded to the apparent shortages by im posing temporary export quotas on selec ted agricultural commodities. The economics of export controls The rules and guidelines of the Gen eral Agreement on Tariffs and Trade (GATT), with which the major world trad ing nations generally comply, contain lim ited provisions permitting a country to impose quantitative restrictions, such as quotas, on exports w ithout the spector of sanctions being initiated by countries in jured by the action. The conditions under which GATT permits the imposition of ex port quotas require a justification based on the national security of the exporting nation or to prevent or relieve critical shortages of foodstuffs or other essential products, provided th at all contracting countries are assured equitable shares of the international supply (GATT articles XI-2, XX-j, and XXI). Export controls take various forms. They include tariffs (not allowed in the United States),1 quotas (legislated or “voluntary”), and such subtle restrictions as differential availability of export finance credit and currency exchange controls. Ex port tariffs are often imposed by the gov ernments of developing countries as a means of obtaining revenue. Export tariffs regulate quantity by restricting the number of units sold through the rationing process of a higher price. Export quotas, on the other hand, directly control the quantity that can be exported because once the quota level is reached exports are halted— regardless of price. 1There is a constitutional question as to whether an export tax can be imposed by the U. S. Government. Article I, Section 9, of the Constitu tion reads in part “No Tax or Duty shall be laid on Articles exported from any State.” The general in terpretation has been that direct export taxes are prohibited. This provision was apparently included in the Constitution in response to Britain’s taxa tion of the Colonies’ exports and as an assurance to the states that the new federal government could not tax their exports—such taxes were a key motivating factor in the American Revolution. Business Conditions, December 1973 Export quotas Eire a routine procedure for groups th at desire to affect world price levels. Viable multinational commodity ag ree m en ts, such as the International Coffee Agreement, or the Organization of Petroleum Exporting Countries may use export quotas to regulate the quantity (scarcity or abundance) of a product on the world market, and consequently the price of the product. Such multilateral quota agreements usually have the intent of sta bilizing a world price within some agreedupon range (occasionally they take on monopoly cartel characteristics). This is typically accomplished through the alloca tion of quotas among exporting countries —and often among importing countries as well. The unilateral imposition of export quotas such as the United States imposed on oilseeds in the summer of 1973 is usually done in order to assure adequate domestic supplies at lower prices than those prevailing in world markets. Export quotas of another form have come into play since around 1960. These are the socalled “voluntary” quotas imposed by par ticular industries or by the government of an exporting country in order to avoid having an importing country impose im port quotas. For example, in 1969, under strong pressure from the U. S. Government, “vol u n ta ry ” quotas were imposed by the Japanese and Common Market steel indus tries on exports to the United States. In 1971, under similar circumstances, Hong Kong, Japan, South Korea, and Taiwan accepted voluntary quotas on synthetic and wool textile exports to the United States. Basis for export quotas The imposition of export quotas may increase the earnings of an exporting coun try if the export demand for the commodity is little affected by an increase in price—and if alternative foreign sources of supply are not available. Both conditions appear to 7 apply to agricultural commodities, at least in the short run. Imposition of quotas, however, carries a political cost for the exporting country vis-a-vis the foreign countries cut off from the supply. This cost might be felt in a loss of goodwill and possible retaliatory trade moves by trading partners, and loss of status as a reliable source of supply. In addition, by artificially re d u c in g demand—and thereby forcing down the domestic price—the exporting country runs the risk of discouraging ex pansion in domestic production of the commodity in short supply. Such a short fall could exacerbate the worldwide supply situation in the longer term , and make it all the more difficult to rescind the export quota w ithout stimulating a price rise, the avoidance of which prompted the imposi tion of the quota in the first place. Another hazard is the snowballing effect of the unilateral imposition of ex p o rt controls. As traditional importers attem pt to obtain needed supplies from alternative suppliers, the alternate suppliers may be forced to restrict exports in order to assure adequate domestic supplies at politically acceptable prices. Such condi tions obviously would seriously disrupt market conditions, to say nothing of the potential damage to political goodwill. The summer of ’73 U. S. authorities imposed export con trols in an attem pt to insure adequate domestic supplies. In mid-June 1973, the Commerce D epartm ent began to require exporters to report their export commit ments of oilseeds and grains. By late June, when the first data were in, it appeared that outstanding export commitments of oilseeds exceeded the level of supplies avail able for export prior to the new crop har vest. The tightness of the supply-demand relationship at that point had already forced domestic prices up sharply as mar ket forces reacted to allocate the short-run Federal Reserve Bank of Chicago 8 supply. Faced with these developments, brought 39 other oilseeds, oilseed products, and with the sharp advances in domestic and protein supplements under licensing food prices in general, the government’s req u irem en ts. On September 8, export position, as reflected in the President’s licenses were perm itted at 100 percent of contracted amounts, and on October 1, the speech of June 13, was that U. S. con export licensing system was revoked. sumers should not be forced to compete The imposition of controls on U. S. with foreign consumers for U. S.-produced exports of agricultural commodities was commodities solely on a price basis. The preceded by a number of interrelated simplest means of rearranging the alloca developments that accentuated the tight tion of the available supply, it appeared, ness of such supplies in world markets and was by temporarily cutting off a major put unusual pressures on U. S. agricultural portion of the m arket—that is, the export market. markets. These included: 1. The devaluation of the dollar On June 28, 1973, the Administra vis-a-vis other major currencies. tion, acting under provisions of the Export 2. Poor crops in many major grainAdministration Act of 1969, imposed an producing countries during 1972 (and embargo on the exportation of soybeans the winter and spring of 1972-73 in and cottonseed, and on their meal and oil products. On July 2, the embargo was lifted in favor of licensing con Devaluation reduced the impact of trols on soybeans, cot U.S. price in cre a se s in major foreign m arkets" to n seed , and most of their derivative products. N o . 2 U . S , w h e a t, U . S . s o y b e a n m e a l, (Oils were freed from U . K . m a r k e t s __________________ _______________________ R o t t e r d a m license requirements on U . S. Ja p an ese G e rm a n U .S . Jap an ese G e rm a n d o l la r s yen m a rk s d o l la r s yen m a rk s th is date.) All export $ /b u sh e l Y /b u s h e l D M /b u sh e l $ /m t. to n Y /m t. to n D M /m t. to n contracts in force as of 1971 June 13 were reduced by J u ly 2 .0 4 729 7 .0 6 1 0 6 .0 7 3 7 ,9 0 9 3 6 7 .0 0 50 percent of the un O c to b e r 1 .9 0 1 0 1 .3 4 626 6 .3 5 3 3 ,3 7 1 3 3 8 .4 8 shipped soybeans and 40 percent of the unshipped 1972 s o y b e a n me a l . New Ja n u a ry 1 .8 2 5 .8 4 565 1 0 5 .4 2 3 3 8 .4 0 3 3 ,7 3 3 A p r il 1 .7 9 5 .6 9 546 3 5 ,3 7 2 1 1 6 .0 5 3 6 9 .0 4 licenses, good until Sep J u ly 1 .7 9 539 5 .6 7 1 2 4 .8 8 3 7 ,6 0 1 3 9 5 .8 7 tember 15 for soybeans O c to b e r 2 .5 8 111 8 .2 6 1 3 8 .6 2 4 1 ,7 3 8 4 4 3 .5 8 and October 15 for meal 1973 and cake, were issued for Ja n u a ry 3 .0 4 916 8 .6 3 2 1 9 .5 0 6 6 ,1 1 3 6 2 3 .3 8 the reduced quantities.2 A p r il 2 .8 7 762 8 .1 5 2 4 3 .2 5 6 4 ,5 8 3 6 9 0 .8 3 J u ly 4 .2 6 1 ,1 1 8 9 .8 8 5 8 0 .0 0 1 5 2 ,2 5 0 1 ,3 4 5 .6 0 O n J u l y 5, t he Office of Export Control Percent change reimposed export license J u ly 1971J u ly 19 7 2 -12 -2 6 -20 18 -1 8 requirements on soybean and cottonseed oil, and J u ly 19722 The June 13 date appar ently was used because the President made the first pub lic reference to the possibility of agricultural export controls on that date. J u ly 1 9 7 3 138 107 74 364 305 240 'I n August 1971, the United States declared the dollar inconvertible into gold, and major world currencies began "floating " vis-a-vis the dollar. In December 1971, agreement was reached whereby the dollar was devalued and major foreign currencies were revalued. In February 1973, the dollar was again devalued and major foreign currencies again began to "flo a t.” From Ju ly 1971 to Ju ly 1973, the value of the yen and mark increased, relative to the dollar, by about 36 and 49 percent, respectively. Business Conditions, December 1973 the southern hemisphere). 3. A continued upgrading of diets in markets traditionally supplied by U. S. agricultural exports. 4. Expanding trade between the United States and the USSR and China, with the emphasis on U. S. agricultural exports. 5. Mounting worldwide demand for high protein foods—especially meats an d anim al feed—coupled with a worldwide shortage of high protein fish meal. 6. Reduced stockpiles of U. S. Gov ernment-owned grains. Impact of export controls The brief duration of the U. S. export quotas (June 28 through September 8) pre vented the full impact of these actions from being felt on critical raw materials in world markets. Nevertheless, some of the impact stemming from the controls was clearly apparent. Domestic soybean prices Soybean prices e rratic under conditions of short supply dollars per bushel Jun. July Aug. Sept. Oct. Nov. Dec. ‘ Price quotations for Rotterdam are for Tuesdays; for Illinois, Thursdays (1973 data). 9 declined dramatically immediately after quotas were imposed, although prices in creased again in late July and early August. A sustained decline in prices occurred only after a record 1973 soybean crop appeared certain, and eventually stabilized at a level far below early summer. Foreign soybean prices advanced irregularly until a down turn in mid-August, also reflecting the re cord crop prospects. The most obvious of the short-run consequences was the contagious nature of agricultural export controls. Shortly after the U. S. oilseed quotas were in place, Canada imposed quotas on selected oilseeds and protein products. Argentina, Brazil, Greece, India, Israel, Pakistan, and Spain also imposed export restrictions on oilseeds or high protein crops. Had the U. S. Gov ernm ent succumbed to pressures to place export quotas on wheat and corn, the breadth of reciprocal foreign protective ex port restrictions, considering current pro duction and stock levels, would no doubt have been even greater. As it is, the European Economic Com munity (EC) embargoed exports of hard wheat (durum) and wheat products, and Argentina installed wheat quotas. Australia and Canada, both of which funnel wheat ex p o rts through government marketing boards, markedly slowed exports. A nation wide rail strike in Canada also slowed ex ports. Widespread restrictions, however, naturally increased demand pressures on the unrestricted, but limited, U. S. wheat supply earlier this year. Record wheat crops in Canada and the USSR have since relieved some of that pressure. The short-run scars from the 1973 bout with export controls apparently are not serious. One fact is quite clear, how ever: when a major supply source, like the United States, unilaterally resorts to export controls on a critical commodity, it places inordinate pressures on alternative supply sources and on importers relying on a stable supply source. With U. S. quotas Federal Reserve Bank of Chicago 10 G rains led the export surge in fiscal 19 73 Grains Feed grains Wheat unmilled and flour Oilseeds Soybeans Other oilseeds and oilseed products Other agricultural commodities Total agricultural exports (billion dollars) 1970 1971 1972 1973P N o te : 1.0 (27) 0.9 (6) 1.1 (37) 0.6 (34) 3.1 (10) 6.7 (17) 1.1 1.2 (28) 1.3 (19) 0.8 (32) 3.4 (11) (9) 7.8 (16) 1.1 (2) 1.1 (-1 3 ) 1.4 (9) 0.8 (6) 3.7 (8) 8.1 (4) 2.3 (107) 2.3 (123) 2.3 (65) 1.2 (44) 4.7 (30) 12.9 (60) F ig u re in p a re n th eses rep rese nts p e rce n t ch ang e fro m p re v io u s y e a r. ^ P re lim in a ry . now removed, presumably the restrictions imposed by other governments gradually will be withdrawn—Canada’s oilseed restric tions are a case in point. But the brush with export controls is likely to make the future more difficult, if not directly for U. S. agriculture then for U. S. delegates at the new round of inter national trade negotiations which began September 12, 1973. Trade relations Foreign reaction to the U. S. imposi tion of export controls was sharply critical. During the early stages of the controls, Japan, the largest single im porter of U. S. oilseeds and a country highly dependent upon a steady supply of soybeans for human consumption and for conversion into animal feed, sent a delegation to Washington with the hope of obtaining assurance of continued regular supplies. Officials of the European Economic Com munity and of individual EC countries, especially France, were particularly acrid in their reactions. The EC views the U. S. imposition of export quotas on agricultural products as a curious turn, given the longheld U. S. position that the EC’s common agricultural policy severely restricts U. S. e x p o r t s to that area, (U. S. export quotas were imposed on commodities not subject to severe EC im port restrictions.) A bas i c question raised by the use of export quotas—that is, restricting access to supply —is one th at needs to be dealt with in the current r o u n d of international trade negotiations. The question is, is open access to markets, as a goal, to apply to exports, as it has to im port trade in the postwar world? A separate problem is of equally long term significance. In spite of the temporary imposition of export quotas on oilseeds and protein products, the United States will continue to push for long-term ex pansion in farm commodity exports. Even at historically high prices during 1973, U. S. farm products remained highly com petitive in foreign markets because of the dollar devaluations and the high rates of inflation abroad. But an element of uncer tainty has entered the picture, and a key question now is, what action, if any, will foreign governments take to reduce their dependency upon the United States in order to assure a regular, stable, and expand ing supply of agricultural commodities? The fact that the United States could actually find itself in a situation where sup plies of farm commodities were so tight that quotas were imposed must have been as disturbing to foreigners as it was to many domestic consumers. It is reasonable to expect foreign buyers to be searching for, and encouraging, the development of alternative sources of supply. Brazil, for example, is rapidly increasing its stilllimited production of soybeans. Britain and Japan are reported to be moving quickly toward the commercial production of a Business Conditions, December 1973 11 high protein animal feed supple Oilseed and protein meal exports* m e n t d e riv e d from petroleum are increasing in major exporting (another resource with availability countries more rapidly than production problems). Of course, alternative Production Exports s u p p ly s o u rc e s w ill n o t be U. S. Foreign Total Foreign U. S. T otal developed overnight. The United ( m illio n m e tr ic to n s ) States remains in the best position 45.7 24.7 1967 8.4 10.8 18.0 20.9 among world agricultural producers 24.7 24.8 49.6 9.9 10.8 20.8 1969 to expand production, and in 1974 25.2 53.4 13.4 24.7 1971 11.3 28.1 an expansion is anticipated. 28.7 56.9 12.3 27.3 28.3 15.1 1973e In 1974, U. S. wheat produc Percent change tion is expected to increase to 47 42.7 37.0 14.2 24.6 1967-73 80.0 13.8 million metric tons, 11 percent above the 1973 level, and feed * I n c lu d e s s o y b e a n s , f i s h m e a l , p e a n u t , s u n f l o w e r , c o t t o n , f l a x , r a p e s e e d , grains are projected to increase to c o p r a , a n d p a lm k e r n e l ( t o n n a g e in t e r m s o f s o y b e a n m e a l e q u i v a l e n t a t 4 4 p e r ce n t c ru d e p r o te in ). 191 million metric tons, 6 percent e E s t im a t e . F o r e ig n fig u r e s a s s u m e d r e s u m p t io n o f P e r u v ia n a n c h o v y f i s h above 1973. U. S. wheat exports as in g in M a r c h 1 9 7 3 w h i c h d i d n o t o c c u r . a percent of production are project 1973, it became apparent that open access ed to decline from about 76 percent to 66 had another face, that is, the freedom of an percent. The export share of feed grains is importing country to purchase goods (criti projected to remain at about 19 percent of cal or noncritical) from an exporter with production. Foreign production of feed grains and wheat in 1974 is expected to o u t u n d u e e x p o r t restrictions being imposed. Fortunately, across-the-board re increase about 6.5 percent from the 1973 strictions on exports of selected U. S. agri level. In spite of the production increases, cultural commodities were short-lived. In however, stocks of grain that will be avail October, the selective access to petroleum able at midyear 1974 in major exporting supplies by ten Middle Eastern nations pro countries are expected to be lower than at v id e d an a b ru p t and more stringent midyear 1973, indicating another year with example of the vital importance of open a potentially tight supply situation. access to supplies. What’s in store? The conflict boils down to political expedience as opposed to economic ratio nale. The rule book of international trade, Based on the experience of export the General Agreement on Tariffs and Trade, controls imposed during 1973, a central question concerning international trade is has only limited provisions concerning re now beginning to be raised. In an in stricted access to supply in international trade. It is of considerable importance that creasingly interdependent world, what in ternational provisions can be established the “Tokyo R ound” of trade negotiations, now in the preliminary stages, consider that guarantee open access to markets? rules of trade aimed at achieving and en Until the summer of 1973, the term forcing open access of supply. “open access” was generally interpreted as freedom of exporting countries to ship g o o d s to importing countries w ithout Jack L. Heruey undue im port restrictions. In June-July Federal Reserve Bank of Chicago 12 anking developments Business loans lose steam Bank loans to commercial and industrial borrowers declined during the first six weeks of the fourth quarter following record-breaking expansion for the first three quarters of 1973. Normally, business credit demands are heaviest in the fall when funds are needed to finance the processing of agricultural products and a build-up in inventories for the holiday season. The recent weakness in bank loan de mand reflects both the slowing pace of the business expansion and the elimination of an abnormal rate structure that made bank loans attractive relative to other short-term sources of credit throughout the first nine months of the year. About 40 percent of net funds raised by corporate business in the financial markets was in the form of bank loans in the first nine months, com pared with just over 25 percent in 1972 and 30 percent in 1969. At the large week ly reporting banks, the nine-month rise in commercial and industrial loans (including those transferred to affiliates) was 20 per cent nationally and 30 percent in the Seventh District. This huge expansion in bank loans to businesses has dwarfed the 1969 experience, and despite the contrac tion early in the fourth quarter, it appears that the relative gain for the year probably will exceed any year since 1950. Rate spread a factor The atypical behavior of business loans at commercial banks thus far in 1973 is clearly related to the relationships be tween the interest rate on bank loans, which is set by the lending bank, and the rate that must be paid in order to sell short-term promissory notes (commercial paper) to investors, a rate that must be competitive with other returns available in the money market. Many large, well-known corporations can choose between these two routes in satisfying their short-term financ ing needs, and the choice is largely deter mined by relative costs. These costs include more than just the nominal interest rate payable on the obligation—for example, the compensating balance required by a bank and the costs of issuing and servicing commercial paper. Historically, the spreads between the prime loan rate—the basic rate a bank charges its most creditworthy customers— and rates on various categories of com mercial paper tend to vary within a fairly narrow range over time except when banks wish either to attract or repel loan business or when commercial banks as a group are under pressure from public policy to lag behind rising market rates. Business Conditions, December 1973 A longer-term comparison of the prime loan rate prevailing at the nation’s major banks and the average rate quoted by dealers on four- to six-month commercial paper shows that the prime generally has been above the paper rate except in tight money periods. This spread was modestly negative for brief periods in 1969-70 but, on a monthly basis, fluctuated within a positive range of 5 to 140 basis points from the spring of 1970 to February 1973. The development of a negative spread of more than 60 basis points late last winter reflect ed efforts by the Committee on Interest and Dividends, in connection with the Ad m inistration’s price control policies, to re strain the price of credit, especially to small businesses. This gap between bank loan charges and the cost of borrowing in the market led to a more than $9 billion in crease in business loans of big banks in the first quarter, a period when there is nor mally little or no net gain. This was ac companied by a $3 billion decline in o ut standing dealer-placed commercial paper. In April, many large banks adopted a “tw o-tier” prime that enabled them to gradually adjust the “large borrower rate” to the m arket rate. Prime rate adjust ments became more frequent and the spread narrowed but remained negative. A bout the same time, many banks adopted more restrictive lending policies and tight ened nonprice lending terms to stem the flood of business loan demand rooted in strongly expanding economic activity. For the second and third quarters together, business loans at the large banks expanded by another $9 billion, while commercial paper remained level. Only in late Septem ber, after the prime reached 10 percent, did the sharp decline in market rates, generated in part by expectations of a weaker econo my, restore the positive spread. The rever sal was so abrupt, in fact, that it imposed a greater-than-normal penalty on bank loans. Many borrowers switched back to the paper market, and in October, dealer paper 13 Bank prime lagged market ra te s until autumn percent I 1.0 4 - 6 mo. commerciol paper Commercial paper/prime rate" spread widens basis points 100 - I O O 11 11 I I I I I I I i l l 111 I I I i I I I 11111111II1111 1111111 I I I I I I I I 11 V i 111 1969 1970 1971 1972 1973 ‘ Monthly average rates. The predominate large-business prime rate charged by major banks was weighted by business days in the month. e x p an d e d by nearly $3 billion—about double the contraction in business loans. Subsequent downward adjustment in the prime rate and a partial rebound of market rates restored a more normal spread by early November, and this condition is likely to minimize shifts between these two sources. If it persists, bank loan trends in the months ahead will be more reflective of the overall demand for short-term business credit. The outlook for bank loan demand is clouded by prospective energy shortages, and by the degree to which corporations will go to the capital markets both to fund o u tsta n d in g short-term obligations and planned increases in capital expenditures. Corporate bond issues have been mod erate in 1973, as increased earnings added to liquidity and many corporate treasurers stayed short in the hope that funding could Federal Reserve Bank of Chicago 14 Pattern of loan growth was similar for most major industrial groups Percent change in co m m e rcia l and in d u s tria l loans o f large d is tric t banks w ith o rig in a l m a tu ritie s o f 1 year o r less Jan.-Sept. M a n u fa ctu rin g M etal and m a ch in e ry F ood, liq u o r, tob acco O th e r m a n u fa c tu rin g & m in in g +57 + 28 + 64 O ver 1 year O ct. Jan.-Sept. O ct. -1 0 -1 3 -1 0 + 18 + 47 + 39 + 2 - 1 - 1 Trade +23 + 1 + 29 + 2 U tilitie s +66 -1 0 + - C o n stru ctio n +33 - 5 + 64 Services + 13 + 3 + 14 + 3 Foreign + 16 - + 42 + 26 Acceptances -7 1 + 3 A ll o th e r +25 - 8 +271 + 4 +32 - 6 + 31 + 2 Total 4 9 - 1 -1 3 - Note: Based on reports of 18 large Seventh District banks. Excludes loans sold to affiliates. be done later at lower cost. Issues of bonds and equities together accounted for less than one-fourth of total external corporate financing in the first three quarters. When short-term rates declined in early 1970, long-term corporate bond yields softened initially but, under pressures generated by a huge volume of new issues, rose to their peak levels in that cycle almost six months later, while business loans declined. If capi tal expenditures planned for next year are not cut back significantly, heavier reliance on the bond market can be expected. But because credit, though costly, has remained available to business in 1973, unlike the 1969 experience, the necessity for busi nesses to issue long-term obligations ap pears less urgent in 1974 than it was in 1970. Some district dimensions The nine-month rise and subsequent weakness in business loans were relatively more pronounced in this district than na tionally. Reports by the largest district banks on loans classified by borrower cate gories show a similar profile for all the ma jor industrial groups, with strong increases through late summer followed by a level ing-off or decline thereafter. But as of midNovember, net dollar gains were substan tially above the year-ago period in all ex cept the construction and service groups. The contraseasonal decline in loans to food processors since mid-August reflects paydowns on the large increases placed on the books three to six months earlier, partly in connection with last summer’s surge in commodity prices, that have more than off set borrowing to cover normal fall credit needs. The recent declines at district banks were concentrated in short-term loans, ex cept in the construction sector. While total loans of the largest banks declined almost $350 million during October, term loans— outstanding loans with original maturities longer than a year—rose $100 million. 15 Business Conditions, December 1973 Index for the year 1973 Month Pages Banking and credit Banking developments* Small bank portfolio b e h a v io r........... Bank holding companies: an overview ABCs of figuring interest ................... March August September 3-10 3-13 3-11 January April May July October November December 3-31 3-12 3-12 3-10 3-15 3-13 3-5 Economic conditions, general Review and outlook—1972-73 ................ Economic growth strains capacity . . . . Motor vehicles lead the u p s u rg e .............. Agriculture—midyear review and outlook I n f la tio n ...................................................... More on inflation ...................................... Long-term economic strategies needed. . International economic trends The expanded Common Market . . . Export controls and U. S. agriculture March December 11-16 6-11 Government finance Growth of government spending Paying for government spending February June *Banking developments is a regular feature of Business Conditions. 6-15 3-12
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