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A review by the Federal Reserve B a n k o f C h ic a g o 1961 January Contents Trends on farms in District states 4 Electric power consumption — a measure of industrial activity in the Indianapolis area 7 The reverse yield gap The Trend of Business 12 2-4 rh. rend D of Business u rin g th e closing m o n th s o f 1960 eco n o m y w h ich p ro b a b ly w ill b e s u p p o rt th e g ra d u a l d ecline in o u tp u t a n d em p lo y m e n t w h ich b egan a b o u t m id y e a r c o n ing o r d ep ressin g o v er-all activity. I t is th e rela tiv e stren g th s o f th ese fo rc es w h ich tin u ed . A t y ea r en d , h o w ever, th e re w as a will stro n g consensus o f o p in io n in th e business an d financial co m m u n ity th a t th e 1960-61 co m e closest to th e m a rk . Business plant a n d equipm ent ex ad ju stm e n t w ould be no m o re severe a n d p en d itu res w h ich w ere ju st u n d e r 36 bil q u ite possibly w o u ld be co n sid erab ly m ild er th a n e a rlie r p o stw a r d o w n tu rn s. lion d o llars in 1960— 10 p e r ce n t above 1959— are re g a rd e d as alm o st c e rta in to T h e d o w n w ard p h ase o f p o stw a r b u si decline in th e c u rre n t y ear. S urveys of ness declines has b een lim ited to a y ea r o r business p la n s in d ic ate th a t th is d ro p will larg ely d e te rm in e w h ich fo re ca sts less. If th e fo reca sts fo r 1961 pu b licized be m o d e ra te , b u t p rev io u s ex p e rien c e sug in re c e n t w eeks p ro v e to be co rre c t, th e gests th a t w h en a d o w n tu rn in th is secto r p rese n t m o v e m en t will n o t be an exception. develops, in itial estim a tes u su a lly u n d e r M ost o f th e fo reca sts p o in t to an u p tu rn sta te th e e x te n t o f th e decline. C a p ita l o u t b eginning so m etim e in th e first h a lf o f lays h it a p e a k in th e seco n d q u a rte r o f th e year. H o w ev er, som e are less o p tim istic 1960 a n d h av e d eclin ed since th a t tim e. M idw est m a n u fa c tu re rs o f in d u stria l m a- in th e sense th a t n o u p tu rn is fo reseen u n til a fte r m id y e a r an d a few ex p ect no u p tu rn a t all d u rin g 1961. In retro sp e ct, it is a p p a re n t th a t th e 1958-60 u p tre n d w as n e ith e r so lo n g n o r per cent, 1957 = 100 as larg e as th e 1954-57 rise. D e m a n d did n o t p ress so closely u p o n reso u rce s o f m en an d m aterials, an d th e re w as less in crease in prices. In p a rt, th is ex p lain s w hy o u tp u t, em p lo y m en t, inco m e an d sales in th e second h a lf o f 1960 sh o w ed less ch an g e fro m th e levels in th e first h a lf o f th e y e a r th a n w as th e case in th e c o rresp o n d in g p erio d s o f 1957. A lth o u g h fo reca sts fo r 1961 v a ry in ev alu atin g th e tim in g an d stre n g th o f th e ev en tu al u p tre n d in activ ity , th e re is gen era l ag re em e n t as to th e segm ents o f th e Postw ar declines in industrial production have been limited in amount and duration Federal Reserve Bank o f Chicago Business Conditions, January 1961 c h in ery and ra ilro a d e q u ip m e n t ex p e ri million persons en ced a d o w n tre n d in o rd e rs d u rin g th e seco n d h a lf o f 1960, an d th e re w ere no in d ic atio n s at y ea r end th a t this tre n d w ould be rev ersed soon. T h e p ic tu re is n o t all u n fa v o rab le , how ever, electric a n d gas utilities an d a u to m o b ile m a n u fa c tu re rs are ex p ected to increase ca p ita l sp en d in g n ex t y ear. Business inventories are gen erally ex p ected to averag e low er in 1961 th a n in 1960. H o w ev er, as th e y e a r m oves on, in v en to ry liq u id atio n is ex p ected to give w ay to ac cu m u latio n . T h e ch an g e fro m large billion in v e n to ry d o lla r ac cu m u la tio n annual ra te in at an th e 11 Em ploym ent has eased down from midsummer peak, but not so sharply as in earlier postwar declines first q u a rte r o f 1960 to liq u id atio n at a ra te of a b o u t five billion w as the d o m in a n t ele m e n t in th e slow ing p ace o f eco n o m ic activ ity in th e y ea r ju st en d ed . In v en to rie s o f m aterials p u rc h a se d fo r fu rth e r p ro cessing by m a n u fa c tu re rs w ere red u c ed m o re th a n inv en to ries o f finished goods d u rin g th e seco n d h alf o f 1960 an d are believed to be a t relatively low levels. F o r th is reaso n p ro d u c e rs o f th ese m aterials, p a rtic u la rly steel, are ex p ectin g a larg er v o lum e o f business in th e first h a lf o f 1961 th a n w as d o n e in th e second h a lf o f 1960. Total construction activity is expected m en t in o rd e rs fro m d o m e stic p u rch a sers. G overnm ent spe n din g fo r goods an d services h as b een risin g th ro u g h o u t th e p a st y e a r a n d d o u b tle ss will rise fu rth e r in 1961. M ost o f th e in c re ase d u rin g th e p ast y e a r w as by sta te an d lo cal g o v ern m ents, b u t F e d e ra l p u rc h a se s rose a fte r m id y ear. Consum er spe n din g co m p rises a b o u t tw o -th ird s o f all sp e n d in g in th e e c o n o m y an d d eterm in e s, in co n sid erab le d eg ree, business in v e n to ry a n d ca p ita l ex p e n d itu re policies. C o n su m e r o u tla y s o n goods an d to be higher in 1961 th a n in 1960— 4 p er services to ta le d a b o u t 328 b illio n d o llars cent of d u rin g 1960— a rise o f alm o st 5 p e r ce n t G o v e rn m e n t officials. V irtu a lly all types o v er 1959. B ut sp e n d ab le in co m e w as up o f co n stru c tio n are ex p ected to rise, in clu d in g h o u sin g w hich w as th e o n ly seg even m o re. T h e d eclin e in re ta il b u y in g d u rin g th e th ird q u a rte r w as th e signal fo r h ig h er acco rd in g to estim a tes m e n t o f th e in d u stry to declin e significantly fu rth e r a tte m p ts a t in v e n to ry re d u c tio n on in 1960. P u b lic w orks, inclu d in g highw ays, p ro b ab ly w ill rise m o re th a n p riv ate c o n th e p a rt o f m a n u fa c tu re rs a n d tra d e firm s. C o n su m e r b u y in g is e x p e cted to rise stru ctio n . T h e v o lu m e o f larg e p ro jects m o d e ra tely in c o n tra c te d fo r in re c e n t m o n th s h as been im pressive, p a rtic u la rly in th e M idw est. fo recasts, at least in th e case o f n o n d u ra b le goods a n d services. F o r th e h a rd goods P ro d u c ers o f co n stru c tio n m a ch in e ry , im sector, im p o rta n t in th e M idw est, th e p ic p o rta n t in this are a, ex p ect som e im prove- tu re is m ixed. 1961, a c c o rd in g to m o st N e w autom obile sales to ta le d a b o u t ju sted , has been d eclin in g at a ra te o f a b o u t 6.7 m illion d u rin g 1960, in c lu d in g a b o u t 100,000 p e r m o n th since last Ju ly . D u rin g 5 0 0 ,0 0 0 im p o rte d m odels. T h is w as second o nly to the rec o rd 7.4 m illion in 1955. this p erio d u n e m p lo y m e n t has risen su b D eliveries o f new ca rs w ere a b o u t 15 p er ce n t h ig h e r in 1960 th a n in th e p rev io u s year. T h e d o lla r v o lu m e o f a u to sales show ed little ch an g e becau se o f m o re co m p ac t cars, less au x ilia ry eq u ip m e n t on sta n d a rd size cars a n d lo w er prices fo r used cars. A u to p ro d u c e rs e x p e ct th a t u n it sales in 1961 will be a b o u t th e sam e as in 1960. H o w ev er, p ro d u c tio n m a y be low er sta n tia lly a n d w as estim a ted to be 6.3 p er cen t o f the la b o r fo rc e in N o v em b e r. In N o v em b e r o f 1957 th e p ro p o rtio n o f the la b o r fo rce u n em p lo y ed w as 5.2 p e r cent. D u rin g N o v e m b e r th e n u m b e r o f in d u stria l ce n te rs classified by th e G o v e rn m e n t as h av in g “su b stan tia l la b o r su rp lu s” (m o re th a n 6 p e r ce n t u n e m p lo y e d ) w as in creased fro m 42 to 51. T h e ad d itio n s in clu d ed F o rt W a y n e, G a ry an d S outh b ecause the in v e n to ry o f new ca rs w as B end increased by ab o u t 4 0 0 ,0 0 0 in 1960. D istrict. Household ap p lian ce an d television p ro d u ctio n w as lo w er in 1960 th a n in co m p en sa tio n h av e co n tin u e d to ru n w ell 1959. M a n u fa c tu re rs h ad a n tic ip a te d a su b stan tial increase a t th e beg in n in g o f th e tio n la b o r sh arp ly . In th e S eventh F e d e ra l R eserve do n o t in d icate a larg e e n o u g h rise in activity to b rin g a b o u t a significant re d u c d ea le r rose th e N ew claim s fo r u n e m p lo y m e n t above last y e a r in m o st states. T h e c u rre n t te n o r of fo re ca sts fo r 1961 year. C o n su m er p u rch a ses o f these item s lagged b eh in d o u tp u t w ith th e resu lt th a t inv en to ries in in u n em p lo y m e n t. fo rce an d G ro w th co n tin u e d of p ro g ress th e in second h a lf o f 1960 p ro d u c tio n o f ap p li m e ch a n iza tio n an d tech n o lo g y m a k e p o s ances an d T V sets w as red u ced . sible increased p ro d u c tio n w ith o u t c o rre sp o n d in g decreases in u n em p lo y m e n t. N o n farm em ploym ent, seaso n ally a d T re n d s on fa rm s in D is tric t sta te s T r w o m a jo r aspects o f th e te ch n o lo g ical rev o lu tio n in ag ric u ltu re h av e b een a B etw een 1954 an d 1959 th e n u m b e r of farm s in th re e C o rn Belt states— Illinois, stead y d ecline in th e n u m b e r o f fa rm s an d In d ia n a an d Io w a— has fallen 12 p e r cen t an increase in th e av erag e fa rm size. C o n to size has tin u a tio n show n a c o rre sp o n d in g in crease to 181 o f these lo n g -tim e tre n d s has 4 5 8 ,0 0 0 w hile th e av erag e been confirm ed rec en tly fo r D istric t states acres. In tw o d a iry states— M ich ig an an d by p relim in ary d a ta fro m th e 1959 C ensus W isconsin— th e n u m b e r o f farm s d eclin ed o f A g ricu ltu re. 15 p e r ce n t to 2 4 3 ,0 0 0 , a n d av e rag e size Federal Reserve Bank o f Chicago Business Conditions, January 1961 thousand operators 600 r 3 Corn Belt sta te s-to ta l Indiona Iowa Illinois 2 Dairy Belt sta te s-to ta l Michigan Wisconsin N u m b e r o f farm operators declines but proportion working 100 days or more off the farm increases h as risen to 148 acres. H o w ev er, th e d e cline in th e n u m b e r o f fa rm s h as been lim ited to th e sm aller units. In th e D istrict th e d ividing line in th e p ast five y ears has b een a ro u n d 2 6 0 acres; th e n u m b e r below 2 6 0 acres d eclin ed w hile th e n u m b e r above th a t size in creased . A s fa rm e rs a c q u ire b e tte r m a c h in e ry an d g re a te r kno w led g e an d skill in h an d lin g o p e ra tin g costs fo r m a c h in e ry , p o w e r an d la b o r p er $ 100 o f fa rm p ro d u c ts p ro d u c e d w as a b o u t o n e -fo u rth less fo r fa rm s o f 320 acres th a n fa rm s o f 160 acres. C osts fo r fa rm s o f 5 0 0 ac res a n d 1,000 acres av e rag ed a b o u t th e sam e as fo r th e 320 ac re farm s. W ith th e ex istin g m a n a g e m e n t, kin d s o f m a c h in e ry an d m e th o d s o f fa rm th e ir soil, p la n ts an d an im als, th e y are ing utilized o n C o rn B elt fa rm s, it a p p e a rs th a t m ost o f th e ec o n o m y in m a c h in e ry able to p ro d u c e m o re th a n fo rm e rly in costs, arisin g fro m th e ad d itio n o f m o re e a ch h o u r o f w o rk . T h u s, m a n y fa rm e rs lan d to sm all farm s, is ac h ie v ed w h en size w ith sm all acreag es h av e activ ely so u g h t rea ch es 300 to 4 0 0 acres. H o w ev er, th e ad d itio n a l la n d to fu lly utilize th e ir la b o r an d increase th e efficiency o f th e ir o v er-all av erag e fa rm in th e ca sh g rain a re a o f Io w a in 1959 w as a b o u t 2 0 0 ac res, a n d less o p eratio n s. F a rm la n d p rices ro se 33 p e r th a n 30 p er ce n t o f th e fa rm s w ere la rg e r c e n t fro m 1954 to 1959. T h e ec o n o m ic in cen tiv e to fa rm e rs to in th a n 2 6 0 acres. M a n y farm s, th e re fo re , still a p p e a r to crease th e size o f th e ir fa rm s com es fro m be in n eed o f ad d itio n a l la n d if th e y are th e possibilities o f red u c in g o p e ra tin g costs to be o p e ra te d w ith m a x im u m efficiency. an d in creasin g o u tp u t, h e n c e lead in g to T h is is in d ic ated also by th e p ro p o rtio n o f h ig h er, profit. A re c e n t stu d y in th e cash fa rm e rs w ho w o rk p a rt tim e in o th e r jobs. g rain are a o f Io w a, fo r ex a m p le , in d icates N e a rly tw o-fifths o f th e fa rm e rs in Illinois, th a t th e in v e stm e n t in m a c h in e ry a n d th e In d ia n a , Io w a a n d W isco n sin d id som e per cent of total farms with 2 0 0 acres or more of harvested cropland 0 5 10 15 corn belt 3 state totol Indiana Iowa Illinois dairy belt 2 state total Michigan Wisconsin N u m b er o f sm all fa rm s declines but number of large farms increases per cent of farms per cent of farms automobiles tracto rs: one or more tra cto rs: two or more motor trucks corn pickers grain combines milking machines milk coolers pick-up hay bailers field forage harvesters crop dryers . . . reflecting increasing levels of farm mechanization w o rk in ad d itio n to o p e ra tin g a fa rm in 1959, an d m o re th a n o n e-fifth w o rk e d at y ear. In M ich ig an th e p ro p o rtio n s w ere h ig h er, o n e -h a lf an d tw o-fifths, re sp e c su ch jobs 100 days o r m o re d u rin g th e tively. T h e e n la rg e m e n t o f farm s c a n be Federal Reserve Bank o f Chicago Business Conditions, January 1961 ac h ieved, o f co u rse, o n ly as th e to ta l n u m h ad risen 21 p e r c e n t an d p e tro le u m p ro d b e r o f farm s declines fu rth e r. ucts 14 p e r c e n t in th e C o rn B elt, a n d 14 T h e eco n o m ic p ressu res en c o u rag in g e n a n d 9 p e r cen t, resp ectiv ely , in th e d airy la rg e m en t o f farm s m a y b eco m e even stro n g e r as fa rm e rs ac q u ire m o re m a c h in states. T h ese e ry an d th e m a n u fa c tu re rs o f a g ric u ltu ra l m e ch a n ize d fa rm s o fte n specializin g in th e m a ch in e ry m a k e fu rth e r h ea d w ay in d e p ro d u c tio n o f o n e co m m o d ity h av e so m e v eloping of tim es b een in te rp re te d as in d ic atin g th a t fa rm s h av in g tra c to rs, tru c k s an d o th e r th e fam ily-size u n its are lik ely to d isa p p ea r. im p o rta n t m a ch in e s co n tin u es to increase, W hile th e e v e n tu a l effects o f tech n o lo g ica l a n d m o st o f th e n ew er m ach in e s h av e m u c h and g re a te r c a p ac ity th a n th e e a rlie r m odels. clearly , it is ev id en t th a t th e fam ily-size new types. T h e p ro p o rtio n o th e r tre n d s to w a rd ch an g es la rg e r, cannot be highly fo re see n R eflecting th e ad v an ces in te ch n o lo g y fa rm still ho ld s a co m m a n d in g p o sitio n in an d m ech a n iza tio n , fa rm e rs ’ p u rch a ses o f m a n y item s h av e in crease d even th o u g h th e D istric t. If th e re w as a tre n d aw ay fro m th e fam ily-size fa rm , th e p ro p o rtio n th e to ta l n u m b e r o f farm s h as declined. C o m m ercial fertilizer, fo r ex am p le, w as o f farm s o p e ra te d by te n a n t fa rm e rs a n d a p p lied to 6 p e r ce n t m o re c ro p la n d in C o rn B elt states in 1959 th a n in 1954, a n d to 4 p e r ce n t m o re c ro p la n d in th e d a iry states. In ad d itio n , p u rch a ses o f feed T his has n o t b een ev id en t. In fac t, th e n u m b e r o f h ire d fa rm w o rk e rs a n d th e p ro p o rtio n o f te n a n t-o p e ra te d fa rm s h av e th e n u m b e r o f h ire d w o rk e rs w o u ld rise. b o th declined. Electric p o w e r c o n su m p tio n — a m e a sure o f in d u s tria l a c tiv ity in th e In d ia n a p o lis a re a A X new series o n elec tric p o w er co n su m ed by m a n u fa c tu rin g firm s h as b een co m e reliab le in d ic a to rs of ch a n g es in ec o n o m ic activity. d eveloped fo r th e In d ian a p o lis m e tro p o li In d ia n a p o lis m a n u fa c tu rin g ac tiv ity , as ta n area an d is p u b lish ed h e re fo r th e first m e asu red by th e in d ex o f e lec tric p o w er tim e. A sim ilar series fo r th e D e tro it are a sectors o f th e tw o m e tro p o lita n areas. A s co n su m p tio n , rose 2 p e r c e n t in N o v e m b e r a n d w as ab o v e th e y e a r-e a rlie r figure. E le ctric p o w er c o n su m p tio n , a d ju ste d fo r seaso n al v a ria tio n , in c re ase d b etw e en O c to b e r a n d N o v e m b e r in th e fo o d , p rim a ry in terp retiv e ex p erien ce w ith th ese d a ta is m e tal a n d th e e le c trica l an d n o n e le c tric a l a c q u ired , it is believed th a t th e y w ill b e e q u ip m e n t m a n u fa c tu rin g w as first p re se n te d in o u r issue o f A p ril 1959. T h e elec tric p o w er series reflect ch anges in activ ity in th e m a n u fa c tu rin g in d u strie s but tra n sp o rta tio n index o f electric p o w er co n su m p tio n in eq u ip m en t an d ch e m ic al sectors. In c o n trast, m a n u fa c tu rin g activ ity in th e U n ite d In d ian a p o lis w as dev elo p ed by w eighting the p o w er c o n su m p tio n d a ta fo r ea ch in d u stry w ith a m e a su re o f “ v alu e ad d e d p e r k ilo w att h o u r” so th a t differences in declined slightly in th e States, as m e asu re d by th e in d ex o f in d u stria l p ro d u c tio n , d eclin ed b etw een O c to b e r an d N o v em b e r. In d ia n a p o lis output T h e co n su m p tio n o f elec tricity closely parallels th e cyclical ch an g es in th e o u tp u t o f ind iv id u al in dustries. H o w ev er, th e re latio n sh ip b etw een in d u stria l p o w er in p u t an d m a n u fa c tu re d p ro d u c t v aries greatly am o n g in d iv id u al in d u stries, a n d th e ag g re gate o f electric p o w er co n su m ed by all in dustries in a m e tro p o lita n a re a w ould be m isleading as an in d ic a to r o f in d u stria l the relativ e am o u n ts o f p o w er co n su m ed by in d iv id u al in d u stries w ould no t clo u d th e in d icatio n s o f cyclical ch an g es in o u tp u t. A co m p ariso n o f th e w eig h ted to ta l of electric p o w er c o n su m p tio n by m a n u fa c tu rin g firm s in In d ia n a p o lis w ith th e m a n u fac tu rin g p o rtio n o f th e U n ite d S tates in d u stria l p ro d u c tio n in d ex reveals so m e in te re stin g differences. Since 1950 th e av e r age a n n u a l in crease in In d ia n a p o lis po w er co n su m p tio n h as b een a b o u t 6 p e r cen t w hile n a tio n a l m a n u fa c tu rin g o u tp u t has p ro d u ctio n w ith o u t som e ad ju stm e n t. F o r increased a b o u t 4 p e r c e n t p e r y ear. In each d o lla r o f o u tp u t th e p rim a ry m etal d ian ap o lis elec tric p o w er c o n su m p tio n m ay o v ersta te so m e w h at th e g ro w th in o u tp u t in d u stry , fo r exam p le, uses o v e r n ine tim es as m u c h electricity as th e m a c h in e ry in in th a t m e tro p o lita n a re a o v er th is lo n g er d u stry an d o v er seven tim es as m u c h as p erio d o f tim e. T h e h ig h e r ra te o f g ro w th th e tra n sp o rta tio n eq u ip m e n t in d u stry . T h e in in d u stria l p o w er use reflects, in p a rt, Th e e le c tric p o w e r d a ta used in th is a rtic le w e re su p p lie d b y th e D e t r o it E d iso n and In d ia n a p o lis P o w e r and Lig h t C o m p a n ie s— tw o o f six e le c tric u tilitie s in th e S e v e n th F e d e ra l R e se rv e D is tric t n o w re p o rtin g o r a fte r a tim e lag o f s e v e ra l m o nths. Th e d a ta , in d u s tria l c o lle c te d e sta b lish m e n ts fro m e le c tric g e n e ra tin g u tilitie s power fo r and th e ir o w n use, w ill be used to im p ro v e th e a c c u ra c y o f c u r s o o n to b e g in re p o rtin g m o n th ly e le c tric p o w e r sa le s re n t p ro d u c tio n in d e x e s. M o n th ly s ta tis tic s on p h y sic a l b y in d u s try . T h e s e vo lu m e o f o u tp u t a re n o t a v a ila b le f o r a ll s e c to rs o f u tilitie s a re a ls o c o o p e ra tin g in a n a tio n a l p ro g ra m to d e v e lo p c u rre n t m o n th ly d a ta on our e le c tric p o w e r c o n su m p tio n b y in d u stry . a b o u t 4 9 p e r c e nt o f th e m o n th ly in d u s tria l p ro d u c tio n Th e e le c tric p o w e r s ta tis tic s p ro g ra m no u n c e d lish e d in by R e se rv e w a s f ir s t a n Industrial Production: 19 5 9 Revision th e B o a rd S y ste m in of Ju ly G o v e rn o rs 1 9 60. of S tu d ie s of th e pub F e d e ra l a nnua l and c o m p le x m a n u fa c tu rin g econom y, and c u rre n tly in d e x is e stim a te d fro m m a n -h o u rs d a ta . T h e e stim a tio n o f p ro d u c tio n b a se d u p o n m a n -h o u rs re q u ire s a d ju s t m ent f o r p ro d u c tiv ity c ha ng e s, and th e re s u lts a re n o t a lw a y s s a tis fa c to ry . E le c tric p o w e r, as an im p o rta n t th a t th e in d u s tria l c o n su m p tio n in p u t in som e in d u s trie s , may p ro v id e a b a sis f o r b e tte r o f e le c tric p o w e r c lo s e ly p a ra lle ls p ro d u c tio n in many e stim a te s o f p h y sic a l o u tp u t. T h e e le c tric p o w e r d a ta m o n th ly d a ta in d u s trie s . But in d ic a te th e n a tio n a l m o n th ly fig u re s c u rre n tly n o w b e in g c o lle c te d s h o u ld im p ro v e th e a c c u ra c y o f a v a ila b le in c lu d e p o w e r consum ed by a num b e r o f firm s th e e x istin g n a tio n a l o u tp u t in d e x e s as w e ll as p ro v id e o th e r tha n m a n u fa c tu rin g e sta b lish m e n ts, a re n o t su b re lia b le in d ic a tio n s o f c ha ng e s in o u tp u t in d iv id e d a re a s. by kind of in d u s try and a re a v a ila b le o n ly in d iv id u a l Federal Reserve Bank o f Chicago Business Conditions, January 1961 th e increased use o f electricity fo r air c o n su ch as ch em icals, m a c h in e ry an d electrical d itio n in g an d lighting. It also reflects the eq u ip m en t, c o n tin u e d p arallels o n ly in b ro a d o u tlin e th e o u tp u t su b stitu tio n of electricity fo r o th e r in p u ts such as lab o r, co al a n d gas. p ro d u c tio n in In d ia n a p o lis ch an g es in D e tro it a n d th e U n ite d S tates. B ut it is th e cyclical a n d n o t th e long- T h e reaso n fo r th is is th a t th e co m p o sitio n ru n c o rresp o n d e n ce betw een electric po w er o f In d ian a p o lis o u tp u t w ith in e a c h o f these co n su m p tio n and in d u stria l p ro d u c tio n secto rs differs fro m th a t o f o th e r areas. th a t is o f m a jo r im p o rta n c e . T h e m o re T h e ch em ic al in d u stry in In d ia n a p o lis is ra p id g ro w th o f electric p o w er co n su m p tio n ac co u n ts fo r som e o f th e a p p a re n t o rie n te d to p h a rm a c e u tic a ls; th e m a c h in e ry in d u stry , to e q u ip m e n t fo r m o ving m a differences in cyclical ch an g es; how ever, terials o r tra n sm ittin g p o w er m ech an ically even a fte r tak in g this in to co n sid eratio n im p o rta n t differences rem a in . T h e m ost an d to c o n stru c tio n eq u ip m e n t; a n d th e electrical m a c h in e ry in d u stry , to c o m m u n i significant w as th e g rea ter cyclical stab ility catio n s eq u ip m en t. T h e differences in th e o f th e m a n u fa c tu rin g secto r o f th e In d ia n sev erity o f th e 1954 a n d 1958 recessions in apolis eco n o m y . In In d ian a p o lis, as c o m p a re d w ith th e n a tio n ’s ex p erien ce, are reflected in th e stru c tu re 1954 th e decline in m a n u fa c tu rin g activ ity in In d ian a p o lis w as little m o re th a n a p au se in g ro w th ; in 1958 th e falling off in m a n u fa c tu rin g activ ity w as less th a n in th e natio n . In term s o f the d u ra tio n a n d tim in g o f cyclical changes, th e n atio n a l a n d In d ia n apolis p a tte rn s w ere m u c h th e sam e in th e e a rlier p erio d . In 1958 th e In d ian a p o lis cycle w as a b o u t th re e m o n th s sh o rte r th a n th e n atio n al cycle an d lagged th e ch an g es in m a n u fa c tu rin g o u tp u t n a tio n a lly b o th in term s o f th e p e a k an d tro u g h . o f In d ian a p o lis m a n u fa c tu rin g as w ell as in th e tim in g o f tech n o lo g ica l a n d o th e r changes. T h e 1954 leveling in activ ity in In d ian a p o lis, fo r ex a m p le , w o u ld h av e b een even less n o tic ea b le h a d it n o t b een fo r a stru c tu ra l sh ift in th e p h a rm a c e u tic a l in d u stry in th e a re a th a t resu lted in a m a rk e d d ecline in elec tric p o w er co n su m p tio n by th a t in d u stry . T h e g re a te r stab ility o f m a n u fa c tu rin g in In d ian a p o lis, as c o m p a re d to th e n atio n , reflects th e g re a te r im p o rta n c e o f n o n d u r able goods m a n u fa c tu rin g in th a t area. Industrial differences T h e co m p ariso n o f elec tric p o w er use in A ctiv ity in th e ch e m ic al an d fo o d in d u s In d ia n a p o lis’ tra n sp o rta tio n eq u ip m e n t in tries, in p a rtic u la r, b o th n a tio n a lly a n d in d u stry , heavily w eighted by a irc ra ft p a rts p ro d u ctio n , w ith th e sim ilar series fo r In d ia n a p o lis did n o t d ec lin e as m u c h as differences did d u rab le goods m a n u fa c tu rin g . B ut th e fo o d a n d ch e m ic al in d u strie s in 1957 a c b etw een th e tw o tra n s p o rta tio n e q u ip m e n t c o u n te d fo r a b o u t 16 p e r c e n t o f to ta l sectors fro m 1950 to 1957. H o w ev er, since 1957 th e p ro d u c tio n o f p assen g er c a r an d tw o in d u stries m a d e u p o v er 25 p e r ce n t tru c k p a rts has in creased in th e In d ia n o f m a n u fa c tu rin g apolis a re a , an d activ ity in th e tra n s p o rta tion e q u ip m e n t in d u stry h as show n w id er sh o rtn ess o f th e d eclin e in In d ia n a p o lis activity in 1958 resu lted in p a rt fro m th e swings, sim ila r to th o se in D etro it. In o th e r m a jo r in d u stria l categories, — con tin u ed on page 11 D etro it illu strates significant n a tio n a l o u tp u t w hile in In d ia n a p o lis th ese o u tp u t. S im ilarly, th e 9 Federal Reserve Bank o f Chicago Business Conditions, January 1961 relatively b e tte r p e rfo rm a n c e o f th e n o n d u ra b le goods sector. T h e m a k e u p o f th e In d ia n a p o lis e c o n o m y w as also th e cau se o f th e la te r b o tto m ing o f to ta l m a n u fa c tu rin g activ ity in 1958. P ro d u c tio n o f n o n elec trica l m a c h in e ry n a m a n u fa c tu rin g . In In d ia n a p o lis, ac co rd in g to th e elec tric p o w er series, o u tp u t o f n o n elec trica l m a c h in e ry re a c h e d its low p o in t in Ju n e reflecting in p a r t th e g re a te r im p o rta n c e o f sp ecialized in d u stria l m a c h in e ry in th e In d ia n a p o lis th a n in th e tio n a lly rea c h e d its low p o in t in M ay, a n a tio n a l m o n th la te r th a n th e low p o in t fo r to ta l o u tp u t in In d ia n a p o lis, co n sistin g p rim a rily ec o n o m y . E le c tric a l m a c h in e ry o f electrical eq u ip m e n t, ra d io p a rts a n d in m ost m e tro p o lita n cen ters. television c o m p o n e n ts re a c h e d a low in M ay 1958, o n e m o n th la te r th a n electrical T h e m a n u fa c tu rin g se cto r o f an y d iv ersi fied local e c o n o m y u su ally p u rch a ses m a n y m a ch in e ry o f its raw m a te ria ls fro m so u rces o u tsid e th e a re a a n d sells m o st o f its o u tp u t to firm s an d in d iv id u als o u tsid e th e a re a. I t is sensitive, th e re fo re , to ch a n g es in th e n a tio n a l ec o n o m y a n d in tu r n tra n sm its th e effects o f th ese ch an g es th ro u g h incom e m a n u fa c tu re rs g en e rally bu t p ro b ab ly closely p ara llelin g th e low p o in t o f n atio n al o u tp u t in th e p a rtic u la r types o f p ro d u cts m o st im p o rta n t to In d ian a p o lis. V a lu e of the electric pow er series W h en th e s tru c tu ra l differences am o n g th e In d ian a p o lis, D e tro it and n a tio n a l an d sp en d in g th ro u g h o u t th e lo cal e c o n om y. If th e in te ra c tio n s b etw e en lo cal an d econom ies a re co n sid ered , it ap p e a rs th a t n a tio n a l cy clical b e h a v io r a re k n o w n , a th e electric p o w er series is a u sefu l in d i c a to r o f c u rre n t ch a n g es in th e o u tp u t o f m o re in fo rm ed in te rp re ta tio n o f p ro b ab le local re p e rc u ssio n s o f n a tio n a l business ch an g es is possible. m a n u fa c tu re d p ro d u c ts. T h e elec tric p o w er series is n o t a su b stitu te fo r o th e r reg io n al series, su ch as b a n k d ebits, em p lo y m e n t M o reo v er, th e stu d y o f cy clical b eh a v io r in th e m a n u fa c tu rin g se cto r o f lo c al e c o n o r d e p a rtm e n t sto re sales. E a c h o f these has its ow n uses in id en tify in g ch an g es in om ies m a y p ro v id e ev id en ce o f g e o g ra p h i p a rtic u la r secto rs o f th e local eco n o m y . ad v a n ce o r obso lescen ce in m a n u fa c tu rin g . T h e electric p o w er series p ro v id es in fo r m a tio n , n o t prev io u sly av ailable, on th e stru c tu re o f business cycles a n d th e ch an g es in p ro d u c tio n in m a n u fa c tu rin g , th e key “ b re a d w in n e r” in In d ian a p o lis as cal differences in ra te s o f tech n o lo g ica l It leads also to a b e tte r u n d e rsta n d in g o f im p act o f business an d g o v e rn m e n t policies on a given c o m m u n ity . Th e re v e rse y ie ld gap T h av e ex p ect a h ig h e r re tu rn fo r th e assu m p tio n yielded m o re th a n h ig h -g ra d e bo n d s such tr a d itio n a lly , co m m o n stocks o f g re a te r risk. U n d e r o rd in a ry c irc u m as G o v e rn m e n t secu ritie s.1 In v e sto r assess stan ces eq u ities are re g a rd e d as risk ie r in vestm en ts th a n b o nds. T h e ir p rice s and m e n t o f th e co m p ara tiv e risk fa c to r is th e key to this re la tio n sh ip : in v esto rs n atu ra lly T or purposes of comparison, the yield on common stocks is determined by the dividend/price ratio while the yield on bonds represents yield to maturity. yields are d e p e n d e n t on ea rn in g s p e r sh a re w hich in tu rn are su b ject to m a n y v ariab les th a t c a n n o t read ily be p re d ic te d — u p s an d dow ns in business activity, ch a n g es in tax rates an d G o v e rn m e n t re g u la to ry policies, Federal Reserve Bank o f Chicago Business Conditions, January 1961 te ch n o lo g ical d ev elo p m en ts a n d c o m p e ti per cent, 1953= 100 tio n fro m o th e r firm s b o th d o m e stic a n d fo reign. T h e o w n er o f a h ig h -q u ality b o n d , o n th e o th e r h an d , feels assu re d o f a defi n ite yield o v er th e life o f th e issue a n d p a y m e n t in full a t m a tu rity . T h e c h ief risk is d e fa u lt an d , fo r o b lig atio n s issued by e sta b lished g o v ern m en ts, m inim al. th is is co n sid ered The g a p em erges In 1958 th e sp rea d b etw een e q u ity a n d b o n d yields b eg an to n arro w . By th e e n d o f 1959 lo n g -term g o v ern m e n t b o n d s in m o st W estern c o u n trie s gen erally y ielded m o re th a n co m m o n stocks. T h e n ew rela tio n sh ip w as d escrib ed as th e rev erse yield gap. E m e rg e n ce o f th e rev e rse yield gap ste m m ed fro m a w orld -w id e b o o m in co m m o n sto ck p rices th a t p u lle d eq u ity yields G e rm an stock market boom has paced worldwide advance in equity prices Prices are m onthly a v e ra g e s fo r M arch, June, Septem ber a n d December. United States, Sta n d a rd & Poor's Com posite; Canada, Dom inion Bureau of dow n, an d a g en e ral rise in in te rest rate s o n bonds. T h e sto c k m a rk e t b o o m re flected a b asic im p ro v e m en t in in te rn a tio n a l co n d itio n s: p ro d u c tio n an d tra d e h a d p ic k ed u p b risk ly a n d th e rese rv e p o sitio n p a te d deficit in th e F e d e ra l B udget. M e a n o f m o st E u ro p e a n c o u n trie s h a d stre n g th en e d m a teria lly , fa c ilita tin g fre e r c u rre n c y w hile, b o n d p rices d rifte d d o w n w a rd a n d in te rest rate s tig h ten e d in resp o n se to co n v ertib ility an d a g en e ral rela x atio n o f m o u n tin g cre d it d em an d s. By th e e n d o f tra d e restrictio n s. T h e rise in in te rest rates, fo r th e m o st p a rt, resu lted fro m th e in a full p erc e n ta g e p o in t m o re th a n equities. Statistics; United Kingdom, a n d Netherlands, Inter national M o n e ta ry Fund; Germany, Federal Sta tis tical Office. 1959 lo n g -term G o v e rn m e n t b o n d s yield ed creased cre d it d em an d s asso ciated w ith th e In th e U n ite d K in g d o m th e yield lines h ig h level o f business activ ity in m o st w estern in d u stria l co u n tries an d , to a lesser cro ssed in A u g u st 1959 as th e sto ck m a rk e t ex ten t, fro m steps ta k e n in th o se co u n tries rise o f business activ ity an d p ro sp e c ts o f a C o n serv ativ e v ic to ry at th e polls in th e fall. to restra in in flatio n ary pressu res. In th e U n ite d S tates th e rev erse yield g ap a p p e a re d in A u g u st 1958 as th e ec o n o m y seem ed w ell o n th e ro a d to r e co very fro m th e 1957-58 recession. T h e b o u n d e d ah e a d in resp o n se to a c o n tin u e d A t y ear e n d th e rev e rse g ap h a d w id en ed to a full p o in t in fa v o r o f bo n d s. T h e E conom ist o f L o n d o n said th e situ atio n sto ck m a rk e t c o n tin u e d to rise, reflecting m a rk e d “ . . . a big b re a k w ith tra d itio n an d c a u tio n .” th e stren g th o f th e business rec o v ery as well as g row ing in v esto r c o n c e rn a b o u t yield gaps h ad w id en ed to a p p ro x im a te ly 1 inflation, to u c h e d off by th e la rg e antici- p e r cen t a n d 4 p e r cen t, resp ectiv ely . O n ly In C a n a d a a n d W est G e rm a n y , rev e rse 13 in th e N e th e rla n d s w as th e tra d itio n a l re latio n sh ip b etw een com m on sto ck an d lon g -term b o n d yields m a in ta in e d b u t by a tio n al in v esto rs— m u tu a l fu n d s, in su ran c e co m p an ies a n d pen sio n fu n d s— in creased steadily. D u rin g very slim m arg in . in creasin g A new era o f investm ent? E m e rg e n ce o f th e rev erse yield gap raised m a n y p erp le x in g q u estio n s fo r in vestors. D id it h era ld a new e ra in invest m e n t o r co u ld it still be re g a rd e d as a tra d itio n a l d a n g e r signal? H o w w ould in vestm en t decisions be affected? D id it have significance fo r m o n e ta ry an d fiscal policy? Som e investors o n b o th sides o f th e A tla n tic w ere o f th e o p in io n th a t reverse yield gaps m ig h t c o n tin u e fo r som e tim e p erio d , in te rest in in v esto rs show ed in v e stm e n t o p p o r tu n ities in foreign sto ck m a rk e ts. A s sh are p rices rose a n d yields d eclin ed in th e U n ite d S tates d u rin g th e seco n d h a lf o f 1958, m a n y A m e ric a n in v esto rs fo cused th e ir atte n tio n u p o n E u ro p e . A m e ric a n b uying b ecam e an im p o rta n t fa c to r in th e ru n -u p in G e rm a n a n d D u tc h sh a re prices in th e la tte r p a rt o f 1958 an d e a rly m o n th s o f 1959. G e rm a n ch e m ic al an d elec trica l e q u ip m e n t firm s a n d th e D u tc h in te rn a tional co m p an ie s— U n ile v er, R o y al D u tc h of P etro le u m an d P h ilip s L am p — w ere b o u g h t equities. In v esto rs in creasin g ly h ad co m e to heavily. By th e su m m e r o f 1959 A m eric an fav o r th e ho ld in g o f eq u ities as a m ean s o f a n d G e rm a n investors, th e L o n d o n press sh a rin g in th e benefits o f eco n o m ic grow th, as w ell as hed g in g ag ain st p ossible infla equities. tio n . In v esto rs also felt th a t eq u ities h ad less cyclical risk, now th a t n atio n al gov Investor reassessm ent of equities in view of th e im m en se p o p u la rity ern m e n ts h ad co m e to assum e g re a te r re rep o rted , w ere active b u y ers o f B ritish sponsibility fo r m ain ta in in g high levels o f By th e en d o f 1959 it w as a p p a re n t th e rev erse yield g ap h a d b eg u n to ex ercise a e m p lo y m e n t an d m in im izin g th e im p a ct o f business recessions. In th ese circ u m sta n ce s fin an cial cen ters. T h e re w ere re p o rts o f investors w ere w illing to ca p italize c o m m o n stock earn in g s a t h ig h e r m u ltip les an d sw itching fro m sto ck s to b o n d s by large in v esto rs in b o th L o n d o n a n d N ew Y o rk . d ecided influence in m a jo r in te rn a tio n a l ac ce p t lo w er yields. P ric e-ea rn in g s ratio s In th e U n ite d S tates in O cto b e r, inves in th e U n ite d S tates in c re ase d n ea rly th re e fold d u rin g th e last d ec ad e— fro m th e low to rs ru sh ed to su b scrib e to th e T re a s u ry ’s level o f seven tim es ea rn in g s at th e end o f 1949 to 19 tim es ea rn in g s a t th e e n d o f 1959— w hile d iv id e n d yields fell fro m notes m a tu rin g A u g u st 1964. T h e issue w as p o p u la rly k n o w n as th e “ M agic F iv e s.” 7 p er cen t to ju st o v e r 3 p e r cent. stro n g th ro u g h th e first h a lf o f 1960 as M a rk e t an alysts 14 this ta lk e d 2 billion d o lla r cash offering o f 5 p e r ce n t T h e pull o f high in te rest ra te s c o n tin u e d o f a possible investors b ec am e less su re a b o u t th e ec o w orld-w ide sh o rtag e o f eq u ities relativ e to n o m ic o u tlo o k . A su b stan tia l sell-off in th e dem an d . F ew new eq u ity issues cam e o n to sto ck m a rk e t en su ed as in v esto rs so u g h t m a rk e ts as c o rp o ra tio n s fo r ta x an d o th e r reaso n s p re fe rre d to m e et th e ir cash needs w ith reta in ed earn in g s a n d d e b t financing. M eanw hile, sto ck b u y in g by larg e in stitu safety a n d possible ca p ita l g ains in b o nds. T his sh ift in ex p e ctatio n s co u p led w ith an easing o f in te rest rate s h a d re d u c e d th e rev erse yield gap in th is c o u n try to less th a n Federal Reserve Bank o f Chicago Business Conditions, January 1961 per cent yield 8 per cent yield 8 6 United States . ^ s ^ c o m m o n stocks 4 ----------- ------------------------------- « » » 1 » » ■__ 1 1 1 1 __ 1 l - JL. L, 1 t i 1 1_I— 1— 1— L-J— i i 1 I Canada com m on stocks 4 long-term governments long-term governments 2 0 6 2 t 1- per cent yield 0 per cent yield per cent yield Yields represent m onthly a v e ra g e s— unless other w ise noted— fo r M arch, June, Septem ber a n d D e cember. Co m m on Stock yields: United States, Stan d ard & Poor's; Canada, M o ss, Law son & Co., Ltd. (b e gin n in g o f month); United Kingdom, Finan cial Times; Germany, Federal Statistical Office; Netherlands, Rotterdam sche Ban k (end of month). Reverse yield g a p s emerge in leading W e ste rn countries as the spread between common stock and bond yields n a rro w s h a lf a p e rc en ta g e p o in t b y D e c e m b e r 1960. th e N e th e rla n d s w as a b o u t th e o n ly p lace P a rallel d ev elo p m en ts h a d re d u c e d th e C a n a d ia n rev erse yield gap to less th a n a w h ere lo n g -te rm G o v e rn m e n t b o n d s still q u a rte r p o in t b y th e th ird q u a rte r o f 1960. T h e N e th e rla n d s p rese n te d a n in te re st yield ed less th a n c o m m o n stocks. A s sh a re p rices ro se a n d yields d eclin ed d u rin g 1959, in resp o n se to h ea v y fo re ig n in g co n tra st to d ev elo p m en ts in th e U n ite d S tates an d C a n ad a . D esp ite a ste ad y rise in buying, D u tc h in stitu tio n a l in v e sto rs w ho business activ ity in th e N e th e rla n d s d u rin g 1959, lo n g -term in te rest ra te s in th e D u tc h to w ard eq u ities lig h ten e d th e ir co m m o n sto c k p o rtfo lio s a n d b o u g h t b o n d s. T h is flow o f fu n d s in to th e b o n d m a rk e t w as all- e c o n o m y re m a in e d fa irly stab le a t slightly m o re th a n 4 p e r cen t. A t th e e n d o f 1959 h av e a tra d itio n a lly ca u tio u s a ttitu d e im p o rta n t in e n a b lin g th e G o v e rn m e n t a n d o th e r agencies to b o rro w su b sta n tia l sum s ing in p a rt th e efforts o f m o n e ta ry a u th o r at relativ ely low rates. In G e rm a n y th e rev e rse yield gap sto o d tiveness o f eq u ities as an inflatio n hedge a t n early 4 p erc en ta g e p o in ts in fa v o r o f an d a ttra c te d m a n y in v esto rs to h ig h -y ield bon d s a t th e en d o f 1959. A ttra c tiv e yields o n bonds, th e c e n tra l b a n k o b serv ed in its ing d eb t securities. T h e ca p ita l g ain ap p e al o f equities w as fu rth e r d a m p e n e d a n d th a t o f b o n d s au g m en te d , by g ro w in g u n 1959 a n n u a l re p o rt, h a d h elp ed to m o d e r ate th e ad v a n ce o f eq u ity p rices since th e seco nd h a lf o f 1959. In th e seco n d q u a rte r o f 1960, how ev er, th e G e rm a n sto ck m a r k et surged ah e a d reflecting, in larg e m e as u re, in v esto r a n ticip a tio n o f h ig h e r c o rp o r ate profits an d d iv id en d p ay o u ts u n d e r p ro p osed revisions to th e G e rm a n C o m p an y A ct. M eanw hile, in te rest ra te s co n tin u ed to rise as th e G e rm a n e c o n o m ic b o o m gain ed m o m e n tu m , a n d by S ep te m b er th e reverse yield gap h a d w id en ed to 4.7 p e r centage points. O nce ag ain ; how ev er, th e gap ap p e ars to be ex ertin g a n o tic ea b le influence in th e G e rm a n m a rk e t. F o re ig n d e m a n d fo r G e r m a n eq u ities has d ro p p e d off co n sid erab ly ities to h a lt inflation, re d u c e d th e a ttra c ce rta in ty a b o u t th e bu sin ess o u tlo o k in th e U n ite d S tates, C a n a d a an d , m o re rec en tly , th e U n ite d K in g d o m . O ne resu lt h as b een a c o n sid erab le n a r ro w in g in re c e n t m o n th s o f th e sp re a d b e tw een yields o n eq u ities a n d b o n d s in th e U n ite d S tates, C a n a d a an d B ritain . R everse yield gaps in these m a rk e ts m a y w iden ag ain if in v e sto rs’ e x p e ctatio n s sh ift in th e d irec tio n o f ren ew ed inflatio n o r vig o ro u s ec o n o m ic gro w th . O n th e o th e r h a n d , th e reverse yield gap m a y d isa p p e a r a n d be succeed ed by yield p a tte rn s w h ich h av e long been held to be “ n o rm a l.” T h e ex p erie n ce o f th e p a st y e a r in d ic ates anew th a t rela tiv e yields ca n go th ro u g h large an d G e rm a n investors, it is rep o rted , are sw ings in resp o n se to ch a n g es in investors show ing in creased in te rest in h ig h er-y ield ex p e ctatio n s a n d th e im p a c t o f fiscal, d eb t m a n a g e m e n t a n d m o n e ta ry policies o f ing d eb t securities. P e rh a p s o f g re a te r significance, G e rm a n in d u stria l c o rp o ra go v ern m en ts. tions are finding it m o re a ttra c tiv e to raise new c a p ita l th ro u g h issuance o f new shares in stead o f bonds. (T h e v o lu m e o f b o n d financing has v irtu a lly d rie d u p .) T h ese new eq u ity offerings sh o u ld h elp to ease th e th in n ess o f th e G e rm a n sto c k m a rk e t w hich has been su c h an im p o rta n t fa c to r Business C onditions is published monthly by the F e d e ra l R e se rv e B a n k o f C h ic a g o . Subscrip in th e p o stw a r rise in G e rm a n sh a re prices. tions are available to the public without charge. Significance of reverse yield gap business organizations and educational institutions, For information concerning bulk mailings to banks, W h a t co n clu sio n s m a y be d ra w n fro m write: Research Department, Federal Reserve Bank th e fo regoing? T h e e m erg en c e o f rev erse yield gaps in m a jo r in te rn a tio n a l financial of Chicago, Box 834, Chicago 90, Illinois. Articles ce n te rs has help ed to ch eck th e w orld-w ide 16 ad v a n ce in co m m o n sto ck p rices d u rin g m ost o f 1960. H ig h in te rest rates, reflect may be reprinted provided source is credited.
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