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a n e c o n o m ic re v ie w b y th e F e d e ra l R eserve B a n k o f C hicago Review and outlook 1973-74 Last year's surge in em ploym ent and output was generally anticipated, but the rapid acceleration o f inflation, wide spread shortages o f materials, and re cord short-term interest rates were not. As 1974 begins, heavy clouds dim the prospects for full-sized autos and resi dential construction. However, demand for business equipment and many con sumer goods and services remains very strong. The ongoing energy crisis im plies not only painful adjustments but also opportunities for constructive gains. I Vigorous growth marred I by inflation 3 Big rise for farm income 10 Economic events in 1973 — a chronology 15 International scene in flux 16 Government budgets near balance 20 Slower growth in money and credit 23 Energy and the outlook 31 Subscriptions to Business Conditions are available to the public free of charge. For information concerning bulk mailings, address inquiries to Research Department, Federal Reserve Bank of Chicago, P. O. Box 834, Chicago, Illinois 60690. Articles may be reprinted provided source is credited. Please provide the bank’s Research Department with a copy of any material in which an article is reprinted. Business Conditions, January 1974 3 L eview and outloo Vigorous growth marred by inflation The surge in the U. S. econom y in 1973 had been generally anticipated at the start o f the year. Total output o f goods and ser vices, adjusted for price inflation, was up 6 percent for the year—about the same as the strong gain recorded for 1972. Except for residential construction, all major sectors shared in the rise in activity in 1973. Start ing in October, Arab restrictions on oil shipments precipitated a worldwide energy crisis that was to have far-reaching effects on the economies o f virtually all industri alized nations, not only immediately, but for many years to come. The 6 percent increase in total real activity in 1973 was close to the consensus forecast at the start o f the year. Published forecasts, however, drastically underesti mated the rate o f price inflation. The gen eral view was that both the consumer price index and the GNP deflator would average about 3 percent higher, no worse than the rise for 1972. Instead, consumer prices averaged more than 6 percent higher, the largest year-to-year increase since 1951, the first full year o f the Korean War. The infla tion was paced by an explosive and unex pected rise in farm prices. Few analysts, moreover, had foreseen the strain on pro ductive capacity and the shortages o f vir tually all basic materials that developed as the year unfolded. Finally, no one had prescience o f the Arab-Israeli war, the re sulting oil embargo, and the doubling and tripling o f prices o f imported oil. Prosperity and pessimism Despite price inflation, the economic record o f 1973 was generally highly favor able. The physical volume o f output of manufactured goods was almost 10 percent larger than in 1972. Payroll employment averaged almost 4 percent higher, and un employment averaged substantially lower. Consumer purchases o f almost all major goods were at record levels in physical quantities. Housing starts were lower, but the number o f units finished and added to the supply was about the same as the 1972 record. Nonresidential construction and purchases o f producer equipment were sh a rp ly higher. Farmers’ net incomes jumped to new record levels for the second straight year. The nation’s balance o f inter national trade was in surplus after two un precedented deficit years. Mainly because P ric es a re ex p ected to rise even fa s t e r in 1 9 7 4 , w hile re a l g ro w th declines sharply gross national product, percent change from previous year 2 L ------1------1------ 1------ 1___ i___ i___ i .i i I965 '66 ‘67 '68 '69 '70 '7 1 '72 '73 '74* * Estimate. 4 o f sharply rising collections o f income taxes, federal government receipts about matched outlays after three years o f large deficits. The increase in bank deposits and credit was somewhat less than in 1972, but, except for residential mortgages, there were no significant stringencies in the availability o f funds to borrowers. In the setting o f unparalleled general prosperity in 1973, there were some loud, sour notes. Despite rising corporate pro fits—up 25 to 30 percent for the y e a r - Federal Reserve Bank of Chicago Food led th e ris e in consum er prices la s t y e a r common stock prices trended downward, and at year-end stock price averages were down almost 20 percent from the record levels o f a year earlier. The methods o f administrating price and wage controls were resented strongly by many consumers and businessmen, often for opposite rea sons. Allegations o f misconduct in high echelons o f government caused widespread apprehension. Surveys o f “ consumer sen timent” found extremely gloom y attitudes as to their future welfare. In the face o f these powerful adverse psychological fac tors, however, businessmen continued to boost appropriations for new investment projects, and consumers continued to pur chase hard and soft goods at a fast pace. Sharp reductions in consumer purchases o f standard-size cars late in the year were associated more with actual and potential fuel shortages than with general pessimism. Inflation accelerated Early in 1973, prospects appeared favorable that prices would rise no faster than in 1972. The price surge associated with the Vietnam war had peaked in 1970 when the consumer price index (CPI) aver aged 6 percent higher than in 1969. Partly because o f controls and partly because o f a sluggish econom y, the rate o f inflation ebbed to 4 percent in 1971 and to 3 per cent in 1972. As margins o f unused resources o f materials, facilities, and manpower nar- rowed in late 1972, the relatively rigid price controls o f Phase II appeared to be hampering output and distribution in in dustries where demand was strong. In midJanuary 1973, the Administration an nounced the more flexible price rules o f Phase III, which placed the system o f con trols on a more voluntary basis. Almost immediately, food prices began to rise at a faster pace. Although the jump in food prices was mainly a result o f strong demand at home and abroad at a time when some foods were in short supply, the change in the price control regulations were blamed by many. Ceilings were placed on meat prices in March 1973 at a time when it appeared that these prices would decline because o f market forces. Many consumers decided to boycott meat and many farmers decided to hold their livestock from market. Prices stayed high. In June, after a move in Con gress to legislate price ceilings, the Adminis tration declared a 60-day freeze on vir tually all prices (not wages), called “ Phase 3V6.” During the freeze, shortages o f many products, especially beef, intensified. In Business Conditions, January 1974 mid-August, Phase IV was implemented with rules similar to those in effect under Phase II. From August through December, a number o f industries were “ decontrolled” to encourage output and to discourage ex ports. These included lumber, cement, most nonferrous metals, and fertilizer. Prices surged sharply after the end o f the freeze. Agricultural prices peaked in August and declined, but remained rela tively high throughout the year. Virtually all n on food prices rose month by month. In the fourth quarter, higher prices o f pe troleum products took the spotlight with the onset o f the energy crisis. In December, the CPI was up 8.8 per cent from a year earlier. All categories except household appliances were signifi cantly higher. Food was up 20 percent. Gasoline and m otor oil was up 20 percent, rent 5 percent, and apparel 4 percent. For many families, increases in prices o f essen tial goods and services caused hardship. Some believe price and wage controls would have “ worked” if they had been administered more rigorously, with closer supervision and stronger penalties. Others are convinced that controls have made in flation even worse. All agree that recent ex perience with government management o f prices and wages has fallen far short o f success. Pressures on capacity Early in 1973, there were reports o f shortages and lengthening lead times for basic materials, components, and many finished products. The list grew larger as the year moved on until, by late summer, purchasing managers were saying “ You name it—everything is short.” Fuel supplies were tight all year, but th e problem was mitigated by slower growth in consumption associated with the mild winter o f 1972-73 and by reductions in tourist travel during the summer. When the Arab oil embargo was announced in 5 October, prospects for adequate oil sup plies were already touch and go. Most basic industries that had been plagued by excess capacity in the late 1960s and early 1970s operated at practical limits in 1973. Included were steel, nonferrous metals, coal, paper, petroleum re fining, building materials, plastics, and various chemicals. Producers o f equipment complained o f shortages o f components, especially castings, forgings, and bearings. The shortages were only partly the result o f the booming U. S. economy. Rates o f inflation were even greater abroad, and this fact together with devaluation made many U. S. products (e.g., steel scrap and so y begins) attractive at prevailing prices. Moreover, during the long period of declining or very slowly growing activity in 1970 and 1971, many industries scaled down plans to expand or modernize. Fi nally, various metal refineries, oil refineries, foundries, paper mills, coal mines, and power plants have been closed or have op erated below capacity because o f the high cost o f meeting pollution or safety stan dards. Construction o f some new facilities was delayed or cancelled because o f “ envi- P ayro ll em plo ym en t increased rap id ly u n til D ec em b er percent, 1967=100 1969 1970 1971 1972 1973 6 Federal Reserve Bank of Chicago ronmental considerations.” Large expan sion programs were underway in most o f these industries at the end o f 1973. Large gains in income After-tax personal income was up al most 11 percent last year, compared with a rise o f less than 7 percent in 1972. Sub tracting the rise in consumer prices, “ real” after-tax income was up 4.3 percent in 1973, compared with a 3.5 percent gain in 1972. Per capita after-tax income, adjusted for inflation, was up over 4 percent in 1973, not a record rise, but the largest since the mid-Sixties. As the year drew to a close, however, accelerated price inflation was eroding or reversing increases in buying power for many families. Pressures were growing for larger increases in annual worker compensation than the 7 percent rate o f advance, including overtime and other bonuses, that held fairly steady from 1968 through 1973. Consumers spent freely in 1973. Their buying power was supplemented with a 16 percent rise in consumer credit outstand ing. Consumer outlays on all goods and ser vices rose almost 11 percent, somewhat more than the increase in after-tax income. Spending on goods was up 12 percent while outlays on services, including rents, were up 9 percent. The rate o f increase from a year earlier slowed late in the year, but al most entirely because o f a drop in sales o f full-sized automobiles. Sales o f all nonautomotive stores were up 13 percent from a year earlier in December, while sales o f auto dealers were down 12 percent. Steady employment rise Payroll employment rose steadily in 1973, continuing the pattern o f 1972. In December, 76.7 million were employed at nonfarm jobs, 2.7 million, or 3.7 percent, more than a year earlier. A similar large rise had occurred in 1972, when the econom y was recovering rapidly from the somewhat depressed conditions that followed the 1969-70 recession. By far the most rapid increases in em ployment last year occurred in the durable goods manufacturing industries—including steel, autos, and machinery—which are especially important in the Midwest. But substantial gains in employment also were reported for all major categories except the federal government. Payroll employment rose slightly in December, despite reports o f large layoffs in the airline and auto in dustries associated with the fuel crisis. Many o f these workers were still on the job when the employment data were gathered in mid-month. As employment increased in 1973, estimated unemployment, until late in the year, trended downward. The national un employment rate averaged 4.9 percent, down from 5.6 percent in 1972 and 5.9 percent in 1971, but well above the 3.5 percent average estimated for 1969. For married men, the unemployment rate aver aged 2.3 percent in 1973, compared to 1.5 percent in 1969. Despite these data, other evidence suggested that labor markets were Business Conditions, January 1974 just as tight in 1973 as in 1969. Quit rates in manufacturing were as high as in the earlier year, while layoff rates were lower. Many employers reported serious shortages o f qualified workers, not only skilled workers, but also “ warm bodies.” Pressures on the labor supply, and associated high turnover rates and absen teeism, were factors in slowing gains in productivity—increases in output per man hour. Productivity for the nonfarm econ om y had increased about 4 percent in 1971 and 1972 after two years with little or no growth. Last year’s rise was signifi cantly less. 7 P a s s e n g e r c a r o u tp u t declined in th e second half, b u t eq u ip m e n t and s te e l rose percent, 1967=100 Durables lead manufacturing The 10 percent rise in the physical volume o f manufacturing activity in 1973 followed an increase o f over 8 percent in the previous year. These successive gains re flected a return to full capacity in most major industries. Manufacturing output had declined 5 percent in 1970, and had showed no year-to-year gain for 1971. Manufacturing output in 1973 was 13 percent above the prerecession level o f O u tp u t of m a n u fa c tu re d goods ro se rap id ly fo r th re e q u a r te r s percent, 1967=100 150 FRB index 140 - q u arterly averages seasonally adjusted 1971 1969. Despite this larger output, man ufacturing employment averaged 2 percent less last year than in 1969. At 40.6 hours, the average workweek in manufacturing was about the same in both years. Clearly, the manufacturing industries have achieved rem a rk a b le in crea ses in output per man-hour. Output o f durable goods was up over 12 percent in 1973, while output o f non durables rose 6 percent. Compared with 1969, however, durables were up 11 per cent while nondurables were up 17 percent. The durable goods industries with their m ore expensive, longer-lasting products always decline more than nondurables in recession periods and always rise faster when recovery is well underway. Among the major industries concen trated in the Midwest, output o f motor vehicles was up 12 percent in 1973 (in the industrial production index), steel was up 13 percent, and business equipment was up over 15 percent. All three were operating at record levels and at virtual capacity. Federal Reserve Bank of Chicago 8 C o n s tru c tio n o u tla y s rose sh arply in 1 9 7 3 , b u t m ainly because of h igher c o s ts billion dollars I4 0 public I20 - other private I00 - — 80 private residential - 60 gasoline. At year-end, auto manufacturers were straining every effort to increase out put o f compact and subcompact cars, de mand for which continued very strong. The rise in sales o f imports to a new record in 1973, in place o f an expected decline, also reflected desires to conserve gasoline. Unlike the case for autos, the truck boom continued in late 1973, especially for heavy-duty trucks. The 3 million trucks produced and sold in 1973 represented a rise o f over 50 percent from the total pro duced and sold in the prosperous year 1969. Truck manufacturers expect to re peat their 1973 successes this year. 40 Housing lags total construction 20 I9 6 5 I9 6 7 I9 6 9 I97I I97 3 Motor vehicles reach new highs The U. S. auto industry produced almost 9.7 million cars and over 3.0 million trucks in 1973, both records by wide mar gins. Deliveries o f passenger cars to U. S. customers totaled over 11.4 million last year, including almost 1.8 million imports from Western Europe and Japan. U. S. pro duction about equaled sales o f “ dom estic” cars, b u t in v e n to r ie s were substantially larger at year-end. Net imports o f autos from the Canadian subsidiaries o f U. S. auto com panies totaled about 400,000 units. Sales o f both large and small autos ex ceeded production capacity through the first three quarters o f 1973. After the introduction o f new models, however, it became apparent that most full-sized cars were not selling well, in large part because o f high consumption o f gasoline caused by pollution control devices and other factors. Sales o f full-sized cars weakened further as the year drew to a close. A sales decline already underway was greatly worsened by prospective shortages and high prices o f Construction outlays totaled $136 bil lion last year, up 10 percent from 1972. Most o f the rise reflected inflation because construction costs increased about 8 per cent, even more than in 1972. Housing starts declined sharply in the second half o f 1973, after a strong showing Housing s t a r t s declined in 1 9 7 3 as m o rtg a g e funds tig h te n e d million units Business Conditions, January 1974 in the first half, as mortgage funds tight ened. For the year as a whole, starts totaled 2.05 million, down 14 percent from the 1972 record o f 2.37 million, but about equal to 1971, the second highest year. Despite the decline in starts, the dollar value o f residential construction activity was about 8 percent larger in 1973, partly because o f inflation and partly because o f the fact that some houses started in 1972 were completed in 1973. A variety o f prob lems, particularly shortages o f cement, bricks, plyw ood, plumbing fixtures, and asphalt delayed many projects. Public construction activity was about the same in 1973 as in 1972, after adjust ment for higher costs. This was because o f econom y drives and because o f reduced needs for public structures such as schools and hospitals. Aside from the public and residential sectors, most types o f construction spend ing rose substantially in 1973. The dollar value o f manufacturing structures was up 28 percent, following three years o f de clining activity. Commercial and utility construction were both up 16 percent. Permits for new housing and contract data compiled by F. W. Dodge indicate that the construction trends o f 1973 will con tinue in 1974, at least in the early months o f the year. In the first 11 months o f 1973, contracts for manufacturing buildings were up 55 percent, commercial projects were up 19 percent, and there was a large back log o f work for public utilities and com munications systems. Prospects for strength in industrial, commercial, and utility construction in 1974 are supported by a recent government survey which indicates total plant and 9 S u rg e in p la n t and equipm ent o u tla y s is ex p ec ted to co n tin u e in 1 9 7 4 billion dollars equipment spending by U. S. businesses will be up 12 percent in 1974, compared to 13 percent in 1973. Manufacturing outlays are expected to rise 17 percent, compared to 21 percent last year. The utilities are expected to increase capital spending by about 15 percent, compared to 12 percent last year. As the year closed, the picture for re sid e n tia l construction continued to appear very dim. Savings inflows to thrift institutions, which provide the bulk o f mortgage funds, improved in the fourth quarter, but lenders were reluctant to in crease commitments for mortgage loans sig nificantly. In addition, there were wide spread complaints that prospective home buyers were “ not looking,” apparently w a it in g c la r ific a t io n o f e c o n o m ic uncertainties. 10 Federal Reserve Bank of Chicago Big rise for farm income Farmers experienced their second straight year o f unprecedented prosperity in 1973. Net income o f farm operators reached $25 billion, up more than $5 billion from the record set the previous year, and up almost $10 billion from the average for the 1967-71 period. Receipts from farm marketings in creased 35 percent in 1973, almost entirely because o f sharply higher prices. Physical supplies o f major crops were larger than in 1972, but slaughter o f cattle and hogs was smaller. Led by meat, retail food prices av eraged 14 percent more than in 1972. With a strong boost from greatly ex panded exports—especially wheat, com , and soybeans—prices o f grains and livestock soared to record levels. The composite in dex o f farm prices had averaged 126 (1967=100) in 1972, up 13 percent from 1971. The increase in 1972 had been con centrated in the second half. In early 1973, many analysts thought that increased sup plies would slow, or even reverse, the rise in farm prices and help moderate general price inflation. Experience was quite different. The composite farm price index rose spec tacularly last year. The index reached a peak o f 207 in August—62 percent above the year-earlier level. With reports o f record harvests, farm prices declined sharply after August 1973. Nevertheless, for the year as a whole, prices averaged 36 percent above 1972, and 60 percent above the average for the period 1967-71. changes in price control programs, changes in export restrictions, worldwide prosperity accompanied by rampant inflation, and shortfalls in world supplies o f certain agri cultural commodities. Sharply rising livestock prices, which led farm price increases early in the year, were temporarily checked by the im position o f ceiling controls on wholesale and retail meat prices in late March, and by a widespread consumer meat b oycott in the first week o f April. However, strong up ward pressures on livestock prices resumed by midyear when it became apparent that price controls (the Administration’s general price freeze in mid-June included all food prices) were disrupting desired increases in production and altering normal marketing patterns. Shortly after the relaxation o f controls on all food prices except beef, on July 19, public concern over meat short- l\le t fa rm incom e soared la s t ye ar, b u t m o d e ra te decline is seen fo r 1 9 7 4 billion dollars 30 25 - Why prices surged Farm price trends were spectacular in 1973, not only because o f the strong over all rise, but also because o f extremely wide fluctuations. Prices were influenced by n 19 6 5 '66 ^Prelim inary. '67 '68 '69 '70 *7I '7 2 '73P '74* *U . S. Departm ent of A griculture estimate. 11 Business Conditions, January 1974 ages added fuel to upward price pressures. M any con su m ers were stocking their freezers. Livestock prices crested at 61 per cent above the year-earlier level in August. A lth ou g h fourth-quarter declines more than offset the summer surge, livestock and product prices remained about one-fourth above the year-earlier level at year-end. Crop prices also fluctuated widely during the year. Tight world supplies made domestic markets particularly sensitive to the vagaries o f weather, export develop ments, and governmental policies. Crop prices were at exceptionally high levels as 1973 began, partly because o f weather con ditions that delayed 1972 harvests and partly because the record movement o f agricultural exports was shifting into high gear. The government released over 40 mil lion acres from set-aside programs for planting in the early months o f 1973, and farm ers responded by increasing total planted acreage to the highest level since 1959. Nevertheless, crop prices rose almost continuously in the first half o f the year. Cold and wet spring weather across the nation delayed planting o f field crops, ham pered vegetable harvests, and frosted bud ding fruit trees, thereby helping to boost prices. World shortages o f fish meal gave further impetus to skyrocketing soybean prices. In June, the government temporari ly restricted exports o f oilseeds and highprotein feed concentrates. But this and other actions were only partially effective in restraining prices. The basic problem was that world demand for farm products was rising rapidly and supplies were tight. Like meat prices, crop prices reached their peaks in August, and then declined as bumper field crops were harvested in the fall. Nevertheless, at year-end, the overall index o f crop prices was 52 percent above the year-earlier level. Rising farm-level prices were quickly translated into higher retail food prices, despite various control measures. Food M e a t paced th e larg e in cre as e in 1 9 7 3 food prices percent, 1967=100 prices rose sharply during the first three quarters, then stabilized in the fourth quar ter. Food, which accounts for less than 20 percent o f the budgets o f most families, was responsible for about half o f the rise in the overall consumer price index. Rising consumer incomes enabled con sumers to pay higher prices for food. But price boosts also reflected limited supplies. Dollar expenditures were up sharply in 1973, but, in physical terms, per capita food consumption was down 1.5 percent— the first decline since 1965. Meat con sumption was down 6 percent and ac counted for most o f the shortfall. But con sumption o f poultry, eggs, and vegetables also was somewhat lower. The export boom U. S. exports o f agricultural com m odi ties totaled about $17 billion in 1973, 85 percent over the previous record in 1972! While a large part o f the increase reflected higher prices, shipments o f wheat were up 12 75 percent, while com was up 48 percent. Despite export controls that sharply curbed third-quarter exports o f oilseed products, shipments o f soybeans rose 9 percent for the year. Increased exports reflected strong eco nomic growth in almost all industrial coun tries. The position o f the United States as the major holder o f world supplies was strengthened by poor 1972 harvests in many other nations. Exports also were strongly stimulated by the dollar devalua tion early in the year. The negotiated sale o f agricultural commodities to the Soviet Union was an important factor in higher foreign demand, but agricultural exports were larger to all major foreign markets. Exports to Japan were nearly double the year-earlier level in fiscal 1973, while those to the European Economic Community (EC) were up by one-half. Combined, the increase in exports to Japan and the EC accounted for almost one-half o f the total increase in agricultural exports in fiscal 1973. Well-publicized U. S. Federal Reserve Bank of Chicago agricultural exports to Russia, up sevenfold in fiscal 1973, accounted for only 16 per cent o f the total increase in U. S. exports. District farmers share gains Farmers in Seventh District states ac count for more than one-fifth o f total U. S. receipts from farm marketings. The rise in their total receipts somewhat exceeded the 35 percent gain for the nation. Receipts from crops in this region were up 65 per cent, while receipts from livestock were up 27 percent. Cattle production was fairly profitable in the first half o f 1973. However, in the latter part o f the year, many producers suf fered losses because o f lower prices and higher production costs and feeding was curbed. Production was down 5 percent for the year as a whole. Prices o f choice steers rose steadily in the first half and then jumped to a record $56 per hundred pounds in August. As beef supplies im proved, this price dropped to $40 late in the year. For 1973 as a whole, prices aver aged 27 percent higher than in 1972. Profits for some cattle producers were reduced because o f higher prices paid for feed and feeder stock. Moreover, feeding efficiency was lowered in 1973 by a ban on certain feed additives, the poor quality o f the 1972 com crop, and by the substi tution o f corn for high-priced, protein-rich feed supplements. Hog production was much more prof itable last year. Because o f a 7 percent de cline in hog marketings, reduced beef sup plies, and strong consumer demand, hog prices averaged 54 percent above yearearlier levels during 1973. Prices rose very rapidly in the first quarter and again in the summer. Hog prices reached a record $59 per hundred pounds in mid-August. As sup plies picked up seasonally in September, hog prices fell sharply and stabilized at around $42 per hundredweight through the fourth quarter. Business Conditions, January 1974 13 Dairy farmers’ operating margins were very tight in 1973 until late in the year. Milk prices averaged 16 percent above 1972 levels, but feed prices rose even more. As a result, the milk/feed price ratio—pounds o f concentrate ration equal in value to one pound o f milk—fell to the lowest level since 1965. High prices curtailed the feeding o f high-protein concentrates which led to a slight reduction in milk output per cow — the first decline in nearly 30 years. Also, there was a slight acceleration in the down trend in cow numbers. These factors com bined caused a 3 percent reduction in milk production in 1973. With consumer de mand strong, stocks o f a number of dairy products fell to low levels. Several procla mations during the year temporarily re laxed import quotas for nonfat dry milk, cheese, and butter. Com and soybean farmers generally benefited the most from last year’s agri cultural boom . Despite larger supplies o f both crops, prices were well above yearearlier levels throughout the year. Booming export demand coupled with accelerated C a ttle and hog p rices held w ell above y e a r -e a rlie r levels, b u t . . . . . . p r o fit m argins on fed c a ttle plunged a f te r A u g u st dollars per head 15 0 f I00 h 15 0 ___*___*___.___.___.___.__ .__ *__ *___*___*__ i J F M A M J J A S O N D SOURCE: Iowa State University. rates o f domestic utilization carried com prices at Chicago to a peak of nearly $3 per bushel in August—more than double the y e a r-e a rlie r le v e l. S ubsequent price declines, reflecting improved worldwide production prospects, caused corn prices to fall back. The upward surge in soybean prices was checked at a high o f $12 per b u sh el near midyear. By harvesttime, soybean prices had retreated to less than $6 per bushel, compared to $3.50 a year earlier. dollars per cwt. Financial picture brighter T ...I,,,I............................... .................................. . . J M M J S 1972 N J M M J S N 1973 1 Farmers benefited in 1973 both from sharp gains in net farm income and from one o f the largest increases in land values ever recorded. According to the U. S. De partment o f Agriculture, farmland values in November were up more than 20 percent from year-earlier levels. The rise in land val ues was particularly large in Iowa. The improved financial position of farmers, along with strategies for mini mizing income tax liabilities, stimulated heavy capital spending in 1973. During the first three quarters, investment in new Federal Reserve Bank of Chicago 14 equipment was up 24 percent from the pre vious year. Unit sales o f farm tractors, rose 25 percent, and even more would have been sold but for capacity limitations o f manufacturers. While increasing their assets, farmers also increased their debts. At year-end, farm debt exceeded $80 billion, up almost 9 percent during the year. The agricultural outlook The farm sector appears poised for an other prosperous year, but not so favorable as in 1973. For the first time in 40 years, farmers will be almost completely free o f controls over prices and production. In 1974, farm prices are expected to rise in the first half and decline in the second half. For the year as a whole, prices are expected to average about the same as in 1973. Production expenses are expected to rise on a broad front, with especially large increases for fuel, fertilizer, and chemicals. Government payments will be virtually eliminated in 1974 due to new procedures C rop prices flu c tu a te d widely; p rices of m ajor crops averaged much higher dollars per bushel 12 10 8 6 4 2 0 .......I,.. .1.1.1,11IIII, IIIi In i.Im .I. i. 1,1 1linl.nlu.il m ill.1,111111il II.li i.il Inil. iliml uj J M M J S N J 1972 M M J S N 1973 established by the Agriculture and Con sumer Protection Act o f 1973. If expecta tions on receipts and expenses are realized, net farm income will be down $3 to $5 billion from the high level o f 1973. Crop plantings in 1974 will be encour aged by high prices, elimination of all setaside requirements in the various farm programs, and the unusually large amount o f field preparations accomplished this past fall. Analysts expect plantings to rise by around 12 million acres, provided weather conditions are favorable and fuel and fertil izer supplies are adequate. This would represent a 4 percent increase from 1973 and a 12 percent increase from the 1968-72 average. Available supplies o f soybeans are well above last year, while supplies o f com are lower. Consequently, prospective price re lationships between com and soybeans are likely to encourage a shift in acreage from soybeans to com . Livestock prices are expected to rise in the first half o f 1974 because o f reduced supplies. Placements o f cattle in feedlots were sharply below year-earlier levels dur ing the latter part o f 1973, reflecting poor profit margins. Feedlot placements are ex pected to rise in early 1974, but significant year-to-year increases in beef slaughter are not anticipated until the second half. Pork supplies also probably will be be low year-earlier levels through most o f the first half o f 1974. Farrowings may increase if feeding margins remain favorable. As in the case o f beef, however, sizable increases in hog slaughter supplies are not likely until after midyear. Food prices are expected to rise on a broad front in the early part o f 1974. Prices o f meat, dairy products, and pro cessed fruits and vegetables all appear headed upward because o f short supplies. Price increases probably will be small com pared to 1973, however, and there is reason to hope that a period o f relative stability will begin before midyear. Economic events in 1973 — a chronology January 1 European Economic C om m u nity is expanded to in clude B ritain, D enm ark, and Ireland. January 5 Freeze on new com m itm ents for subsidized housing. January 11 The D ow industrial index closed at a record 1052. January 12 Phase I II liberalizes wage and price controls. July 1 July 5 January 12 Acreage set-aside requirements ended fo r wheat. January 18 M ajor oil companies place customers on allocation. January 29 Peace in V ietn am announced. January 2 9 Officials see prospects for reduced inflation as " e x ceedingly favorable.” February 2 Acreage set-aside requirements reduced fo r feed grain program. February 5 Purchasing Managers Association reports shortages of m any materials and components. February 12 The do llar is devalued by 10 percent relative to other m ajor currencies. March 2 Foreign exchange markets closed because o f massive sales of dollars. March 15 Sales ordered from strategic materials stockpiles. March 19 European exchange markets reopen w ith rencies in "jo in t flo a t." EC cur March 19 A to m ic Energy Commission says nuclear power is needed to avoid dependence on M iddle East oil. March 26 The Joint Econom ic C om m ittee recommends return to stricter wage/price controls. March 2 9 A p ril 5 Ceilings established on prices of beef, pork, and lamb. Mississippi floods worst in 3 0 years. A pril 19 Federal Reserve grants seasonal borrowing privileges to m em ber banks. A pril 26 C ID issues guidelines fo r tw o -tier prim e rate. May 1 Treasury revises prospective deficit downward because of higher receipts. M ay 1 M ay 16 U. S. oil im po rt quotas ended. Fed's Regulation Q ceilings suspended for all large CDs. May 16 Three percent marginal reserve requirement announced fo r large CDs over specified base am ount. M ay 17 "W atergate C om m ittee " begins hearings. June 4 July soybean futures hit $ 1 2 per bushel, up from $ 3 .5 0 a year earlier. E xport controls placed on steel scrap. July 5 Interest rate ceilings raised for savings and smalldenom ination tim e deposits, and suspended for four-year, $ 1 ,0 0 0 m inim um accounts. Export controls extended to 41 farm commodities. July 13 Federal Reserve "swap lines" with banks reactivated and expanded. foreign central July 18 beef. Price freeze ends fo r health care and all foods except July 19 A ll acreage set-aside requirements eliminated for 1974. August 12 General price freeze ends and Phase IV begins. August 17 Chicago branches of foreign banks authorized by the Illinois Foreign Banking O ffice A ct (effective October 1). Septem ber 7 Marginal reserve requirements on CDs raised an additional 3 percentage points. Septem ber 9 Soybean, cottonseed export controls relaxed. Septem ber 10 Thirteen-w eek Treasury bills sold at 9 .0 2 per cent, fo r an investment yield of 9 .3 5 percent. October 1 Rem aining agricultural export controls removed. October 2 M andatory allocations ordered on oil products. October 6 Egypt and Syria attack Israel. October 15 N ew law requires interest ceilings on tim e deposits of less than $ 1 0 0 ,0 0 0 . October 16 Posted price of Arab crude oil raised 70 percent. October 17 A rab nations announce reductions in oil shipments. October 2 2 Cease fire arranged in Arab-lsraeli war. October 2 5 F ertilizer industry exempted from price controls. October 2 6 In ternational trade surplus for the third quarter was the largest since 1965. November 1 Airlines reduce scheduled flights. November 7 President outlines steps for fuel conservation. November 16 Alaskan pipeline bill signed. December 5 Th e D ow industrials closed at 7 8 8 , low fo r the year. (See January 11.) December 6 Price controls end for 4 0 nonferrous metals. December 7 Marginal reserve requirements on CDs reduced by 3 percentage points. December 10 6 .0 percent. Rates on U . S. savings bonds raised from 5.5 to June 13 S ixty-day price freeze announced, called "Phase 3!4." December 12 oil usage. Federal Energy O ffice announces regulations for June 2 8 Export restrictions placed on soybeans, oilseeds. December 17 Daylight Saving T im e enacted (effective 1-6-74). June 2 9 German m ark is revalued by 5.5 percent. December 2 4 Arab nations announce an additional 100 percent increase in posted prices for crude oil. June 2 9 Increase o f .5 percentage point announced fo r reserve requirements on m em ber bank demand deposits over $ 2 m illion. December 29 Large layoffs planned by auto firms, airlines. 16 Federal Reserve Bank of Chicago International scene in flux International developments last year, as in 1972, were dominated by adjustments to correct imbalances in the international ac counts o f major trading nations. Prolonged surpluses for some nations and chronic deficits for others had forced the abandon ment o f fixed exchange rates in August 1971. The industrialized nations then be gan a cooperative effort to formulate a new and more effective system. These efforts continued through 1973. Market forces associated with imbal ances in international accounts, rather than a preconceived plan, determined the nature and sequence o f adjustments in 1973. A c celerated price inflation on a worldwide scale worked to keep foreign exchange mar kets in turmoil. At various times, specula tive activities exerted a powerful influence. In October, the shock o f the Arab oil em b a r g o , which suddenly intensified the world energy crisis, altered the existing structure o f international trade and finance to a marked degree. Large sums were transferred from cur rencies considered to be candidates for de valuation to currencies that were deemed likely to appreciate. These pressures first converged on the weak Italian lira and the strong Swiss franc. Confronted with a large outflow in late January, the Italian authorities termi nated their commitment to maintain a rela tively fixed exchange rate for the lira. Italy D o lla r values of fo re ig n c u rre n c ie s jum ped, bu t declined n e a r y e a r-e n d percent Foreign exchange markets It was apparent early in 1973 that the rea lig n m en ts o f international currencies agreed to at the Smithsonian Institution in December 1971, and implemented in 1972, had failed to accomplish their purpose. De spite devaluation o f the dollar, the U. S. for eign trade deficit in 1972 was over $6 billion, more than three times the trade deficit for 1971, which had been the first such deficit o f th e c e n t u r y . M oreover, some foreign countries that had revalued their currencies relative to the dollar because o f chronic sur pluses, continued to run large surpluses in early 1973. These developments caused for eign exchange market participants to antici pate additional currency realignments. . . . -L-. ■ ■ . ............... —» . ■ ■ ■ -j M J 1972 S D M J S D 1973 Note: Data are w eekly averages of daily o f fered rates in the U. S. m arket as a percent above or below central rates as established by the De cember 1971 Smithsonian agreement. The Canadian dollar is the percent above average m arket rate in January 1972. Business Conditions, January 1974 adopted a “ two-tier” exchange rate system o f the type maintained by France and Bel gium since 1972. On one tier, funds ob tained from current transactions could be converted at a rate that was officially main tained at a relatively fixed rate relative to other currencies. On the other tier, pay ments on capital transactions were con verted at a rate that “ floated” in response to supply and demand. Contrary to Italian experience, the Swiss were confronted with massive inflows o f speculative funds in anticipation o f an upward revaluation. Abandoning efforts to maintain fixed exchange rates, the Swiss decided to allow their currency to float. After the floating o f the Italian and Swiss currencies, speculative funds flowed to Germany and Japan. These transfers be came so heavy that on February 9 foreign exchange markets throughout the world were closed. After intensive negotiations, in tern ation al monetary authorities an nounced, on February 12, that the U. S. dollar would be devalued by 10 percent against major European currencies and the Japanese yen would be set afloat. When ex change markets reopened, the yen rose 16 percent above its previous dollar parity. Despite the drastic actions, speculative activities soon resumed. In early March, the e x ch a n g e markets were closed again, and w ere n o t reopened until mid-March after so m e new steps had been agreed to. The mark was revalued by 3 percent, and mem bers o f the European Economic Community (EC) adopted a “ joint float.” Under this ar rangement, the currencies o f Belgium, Den m ark , F rance, Germany, and the Nether lands o f the EC—plus nonmembers Norway and Sweden—were maintained by their au thorities within plus or minus 2.25 percent margins relative to each other, but were al lowed to float relative to all other curren cies. By the end o f March, therefore, ef forts to maintain fixed exchange rates for major currencies by official intervention had been abandoned for the time being. 17 In April and early May, the weighted average price o f major currencies in terms o f dollars had tended to stabilize at a level 10 percent above the Smithsonian parities. Later in May, however, major currencies again began to rise relative to the dollar. By midyear, the average dollar price o f these currencies had increased an additional 10 percent. The uptrend in these exchange rates was marked by very sharp day-to-day fluctuations. The joint float became in creasingly difficult to maintain, partly be cause o f growing differences in internal economic conditions among EC countries. Germany, with a vigorous econom y, a large and g ro w in g trade surplus, and the strongest EC currency, revalued again by 5 percent in late June. In July, the Federal Reserve System joined central banks o f other major nations in periodic interventions in foreign ex change markets. The Federal Reserve nego tiated with 14 major central banks and the Bank for International Settlements to in crease reciprocal lines o f credit (“ swap lines” ) from $6 billion to almost $18 bil lion. Under these arrangements, the Federal R eserve b o r r o w e d foreign currencies needed for intervention. Minor speculative flurries occurred during the remainder o f the year. But con certed efforts o f central banks in dealing with abrupt fluctuations in the foreign ex change markets provided an environment in which a system o f more flexible exchange rates could operate despite differing eco nomic conditions in individual countries. Starting in November, the dollar appre ciated rapidly relative to other major cur rencies, largely because sharply higher oil prices and uncertain supplies were expected to have a smaller impact in the United States than in other industrialized countries. The U. S. balance o f payments Two devaluations followed by further depreciation o f the dollar through the Federal Reserve Bank of Chicago 18 U.S. tr a d e su rp lu s es in 1 9 7 3 w e re th e f ir s t since e a rly 1 9 7 1 billion dollars q u a rte rly d a ta seasonally adjusted I II III I97I IV I II III IV I97 2 I II III IV* 19 7 3 *Based on October-N ovem ber figures. workings o f the floating exchange rate system sharply reduced the foreign cur rency cost o f U. S. goods in world markets last year. These reduced foreign currency prices coupled with worldwide prosperity produced a rapid improvement in the U. S. trade account in 1973, especially after the first quarter. In 1973, the United States had a small merchandise trade surplus, compared to a record $6 billion deficit in 1972 (census basis). The value o f U. S. exports was up more than 40 percent last year. Agri cultural exports paced the rise, but exports o f industrial raw materials, consumer goods, and capital equipment also showed large gains. U. S. imports were up about 25 per cent in 1973. Very substantial gains were reported for industrial materials, capital goods, agricultural products, automotive products, and consumer goods. Almost 25 percent o f the total in crease in imports consisted o f crude oil and refined oil products. The value o f petro leum imports was up about 70 percent from 1972, partly because o f higher prices, but also because o f an increased volume facilitated by a gradual relaxation o f oil im port quotas in the first half o f 1973. Arab restrictions on oil exports reduced U. S. im ports o f Middle East oil late in the year. A large part o f the rise in U. S. ex ports in 1973 reflected higher prices. Measured by the Department o f Com merce’s unit value index, prices o f U. S. ex ports, led by agricultural products, aver aged 13 percent higher than in 1972. But the rise in physical volume was more than 25 percent, and for nonagricultural com modities the larger volume accounted for over two-thirds o f the value increase. In contrast to exports, the increase in the value o f imports in 1973 was due largely to higher prices. Except for fuel, which in creased in volume throughout most o f the year, the volume o f imports was only slightly higher in 1973 than in 1972. The improvement in the U. S. trade account in 1973 was reflected in other A f t e r y e ars in d e fic it, th e U.S. balance of p a ym ents im proved m arked ly in 1 9 7 3 billion dollars I II III 1971 IV I II III 1972 IV I II III 1973 IV Business Conditions, January 1974 measures o f the nation’s international eco nomic performance. The “ basic balance,” which includes long-term capital flows as well as goods and services (but excludes volatile short-term movements o f capital), showed a $1 billion surplus for the first nine months o f 1973, compared to an $8 billion deficit for the same period a year earlier. A large inflow o f funds for direct investment in the United States, and for purchases o f U. S. securities, contributed to the swing. Apparently, the basic balance continued in surplus in the fourth quarter. Hopes had been high that a trade surplus and a payments surplus could be achieved again in 1974, but sharply higher prices for imported oil and prospects for slower eco nomic growth in Europe and Japan cast a shadow on optimistic projections. Foreign banks in Chicago The Illinois Foreign Banking Office Act, approved in August 1973 and effective October 1, permits foreign banks to estab lish state-licensed branches in Chicago’s “ L o o p .” By year-end, seven large foreign banks had filed applications for Chicago branches with the Illinois Commissioner o f Banks and Trust Companies, four licenses had been issued, and one branch had opened for business. Licensees and applicants for branches include some o f the largest and best-known foreign banks. Already licensed are the National Westminster Bank and Barclays o f the United Kingdom (the latter’s office opened on La Salle Street in November); the Banco Commerciale Italiana; and the Swiss Bank Corporation. Applications were p e n d in g at year-end for the Banque Nationale de Paris, the Banque de l ’lndochine (France), and the National Bank o f Greece. In addition, several Japanese banks 19 have e x p re s s e d in te re s t in Chicago branches. Branches o f foreign banks in Chicago had been preceded in recent years by statechartered affiliates. Such banks had been established by the Dai-Ichi Kangyo Bank and the Bank o f Tokyo (both Japanese) and the Banco di Roma. A ls o reflectin g the cosmopolitan development o f the banking industry in Chicago are the Edge Act subsidiaries established, or in the process o f organi zation, by U. S. banks headquartered else where. The Edge Act o f 1919 authorizes the Federal Reserve Board to charter and regulate corporations to engage in an inter national banking business. These corpora tion s may trade in foreign exchange, fi nance international trade, and make foreign loans. They may hold time and demand de posits o f foreign residents and o f U. S. resi dents when these deposits are directly re lated to international transactions. Unlike b a n k s, th e y may acquire equity invest ments in foreign corporations. Five Edge Act corporations have been approved for Chicago. Three in operation include sub sidiaries o f the Bank o f America and the Crocker National (both o f California) and the First National City Bank o f New York. Subsidiaries o f the Chase Manhattan and the Bankers Trust (both o f New York) also have been approved. Banks headquartered in the Midwest have steadily broadened and deepened their facilities and capabilities to engage in inter national activities. Such services provided by local banks are now complemented increasingly by Chicago offices o f foreign banks and o f domestic banks headquar tered in financial centers o f the East and West Coasts. These developments reflect the expanding involvement o f the Midwest in international trade and finance. Federal Reserve Bank of Chicago 20 Government budgets near balance Purchases o f goods and services by federal, state, and local governments totaled almost $280 billion in 1973, up 9 percent from 1972. The gross national product (GNP), which includes all spending on goods and services, increased more than 11 percent in 1973. For the fifth straight year, total gov ernment purchases increased less than GNP. Government purchases accounted for 21 percent o f GNP last year, down from 23 percent in 1968, but about equal to the proportions recorded in the years 1961-66. F ed era l government purchases in creased only 3 percent in 1973 to $107 billion, with most o f the rise in nondefense spending. Defense spending was about $75 billion, almost exactly the same as in 1972, and below the $78 billion reached in 1968 and 1969. The size o f the armed forces was reduced slightly in 1973 and equipment purchases were lower, but rising costs, mainly reflecting pay increases and reenlist ment bonuses, offset these factors. The 1 9 7 3 in cre as e in fe d e ra l purchases lagged th e in crease fo r s ta te and local u n its billion dollars 0 I0 0 200 300 T--------- 1--------- 1--------- 1--------- 1--------- 1 Aside from defense, federal purchases o f goods and services largely consist o f wages and salaries and civilian construction. Federal civilian employment, which aver aged 2.62 million in 1973, was almost ex actly the same as in 1972. Mainly because o f higher salaries, federal purchases of goods and services for nondefense purposes reached $33 billion last year, up about $2.5 billion. Purchases by state and local govern ments, with a strong assist from federal grants-in-aid for various programs, in creased 13 percent in 1973 to about $170 billion. In most years since World War II, federal purchases o f goods and services ex ceeded combined purchases o f states and municipalities. Starting in 1968, however, state and local purchases have exceeded federal purchases every year, and by a widening margin. In 1973, federal expen ditures were only 8 percent higher than in 1968, while state and local expenditures were up almost 70 percent. State and local employment has continued to increase year-by-year and in 1973 it averaged 11 million, almost 400,000 more than in 1972. While federal civilian employment averaged 4 percent less in 1973 than in 1968, state and local employment averaged 21 percent higher. ______ I97 I federol 11972 Federal outlays and receipts ^H |l973 state and local total Total federal outlays include large amounts that are not counted as purchases o f goods and services. On the national in come accounts basis, total federal outlays were about $265 billion last year, up 8 per cent from 1972. (The national income ac count concept o f federal outlays and re ceipts differs somewhat from the more commonly cited “ unified budget.” ) Non- Business Conditions, January 1974 T o ta l fe d e ra l o u tlays again in creased much fa s te r th a n purchases billion dollars 0 I0 0 T----r purchases of goods and services 200 — i— 300 —i 1971 1972 1973 other outlays total outlays 21 It had been hoped in mid-1973 that the approximate balance of federal outlays and receipts in 1973 would be repeated in 1974, although, o f course, at a higher level for both. Ramifications o f the Arab-Israeli war and the associated energy crisis will raise expenditures from earlier estimates. Any worsening in the general economy will tend to reduce receipts. Another development that will raise outlays in 1974 is the legislation enacted at year-end that will boost social security pay ments by 7 percent in April and by an additional 4 percent in July. To help pay for these increases, the wage base for social security taxes was raised from $10,800 to $13,200, effective in January 1974. State and local governments purchase outlays are dominated by transfer payments (including social security and unemployment compensation), which rose 15 percent in 1973 to about $95 billion. This large rise mainly reflected the 20 percent boost in social security payments, effective in October 1972. Next most important are grants-in-aid to state and local govern ments, which rose 9 percent to $41 billion, and interest, which rose over 17 percent to about $16 billion. Total federal revenues about matched outlays in 1973, following large deficits in each o f the three previous years. The ap proximate balance o f outlays and receipts reflected larger-than-anticipated increases in personal and corporate income taxes, especially the latter. Over $22 billion was paid in refunds on personal income taxes in 1973, mainly in the spring. This figure was about $7 bil lion more than normal because o f changes in the withholding schedule that became ef fective in January 1972. Apparently, in dividual taxpayers still have not reduced their withholding deduction to compensate for this factor, and refunds probably will be even larger in 1974 than in 1973. Total outlays by state and local governments approached $184 billion in 1973. F ederal tr a n s fe r paym ents have exceeded defense o u tla ys since 1 9 7 1 percent of total outlays 50 r I9 6 7 I9 6 8 I9 6 9 I970 I97I I972 I973 * Federal governm ent transfer payments to persons, which totaled about $ 9 3 billion in 1973, include social security and medicare payments, all federal retirem ent paym ents, railroad retirem ent benefits, veterans benefits, and several other small programs o f paym ents to individuals. 22 Over 90 percent o f this represented pur chases o f goods and services. Pay increases for employees account for a substantial portion o f the rise in total state and local outlays. Other expenses also increased. Ex penditures for school systems, the largest single element in state and local budgets, have increased at a slower pace in recent years reflecting smaller enrollments in the lower grades. But outlays on law enforce ment, safety, and welfare have continued to rise rapidly. Receipts o f state and local govern ments totaled $195 billion in 1973. The n et surplus (national income accounts basis) was almost $11 billion, somewhat less than in 1972. After setting aside pen sion reserves, land purchases, and other similar items (excluded from the national income accounts definition o f expendi tures) state and local governments had an operating surplus o f about $2 billion in 1973. Many state and local governments re duced tax rates last year, in contrast to the Federal Reserve Bank of Chicago steady increases in past years. Federal grants-in-aid provided state and local gov ernments with about $41 billion, over 20 percent o f their total revenues. About $6 billion o f these grants were in the form o f general revenue sharing. State and local government finance may feel a double impact from the oil shortage during the coming year. Motor fuel taxes supply significant revenues, and these will be directly affected by reduced sales. Moreover, many local governments, particularly school districts, will have to pay sharply increased fuel bills. Slowing o f the growth o f the overall econom y may impose new strains on state and local finance in 1974 if outlays grow more rapidly than revenues. The overall surplus position is likely to decline in 1974, and operating budgets will probably show a deficit in the aggregate. The 1972-73 trend o f using federal revenue-sharing funds to re duce state and local tax rates probably will not continue. Business Conditions, January 1974 23 Slower growth in money and credit Federal Reserve policy actions in 1973 were designed to slow the expansion o f money and credit in order to moderate price inflation while permitting continued growth in real activity. Bank loans and in vestments, the money supply, and con sumer-type time and savings deposits rose less rapidly than in 1972. With credit growth restricted and loan demand strong from most sectors, short-term interest rates rose to the highest levels in this century. Funds raised in the money and capital markets by all borrowers—individuals, busi nesses, and governments—totaled about $175 billion in 1973. This was about 6 per cent more than in 1972, and the smallest percentage increase since 1969, also a year o f credit restraint. Expansion in commer cial bank loans and investments accounted for an estimated 42 percent o f total funds raised. This compares with 45 percent in 1972 and 19 percent in 1969. Savings and loan associations and other thrift institu tions provided a smaller proportion o f total funds in 1973, mainly because o f the diver sion o f savings to higher-yielding money market instruments in the second half. Business loans at banks rose by a rec ord amount in 1973, but sales o f corporate securities declined. Consumer credit also rose at a record pace last year, but residen tial mortgages outstanding increased rela tively less than in 1972. Federal borrowings were reduced in 1973 because o f the smaller budget deficit. State and local gov ernments, on balance, had budget sur pluses, although smaller than in 1972, but their net security issues were also smaller. Record increase in bank loans Bank credit grew very rapidly in the first half o f 1973 but slowed markedly in the second half. For the year as a whole, loans and investments at all commercial banks including loans sold to affiliates rose by about $71 billion, or 13 percent, com pared with the postwar record increase of 15 percent in 1972. Loans accounted for virtually all o f the increase in loans and in vestments. Total loans rose at a 30 percent seasonally adjusted annual rate in the first quarter. The annual increase in loans was 18 percent—about the same as the very large increase in 1972. Bank portfolios o f real estate and consumer loans, which had risen very sharply in 1972, continued to expand rapidly, although the pace declined in the final quarter. Business loans dominated bank credit growth last year, rising 21 percent, com pared with a rise o f less than 12 percent in 1972. Demand for bank credit by commer cial and industrial firms was unusually strong through mid-August. In part, this re sulted from increased working capital needs associated with the business expansion. In addition, through most o f the year, bank loans were a relatively cheap source o f funds to large borrowers that normally cover a substantial portion o f their short term financing needs by selling commercial paper in the open market. Increases in bank lending rates were restrained by the guide lines set by the Committee on Interest and Dividends (CID), while open market rates were left free. The effects o f the abnormal rate struc ture were most pronounced early in the year. Business loans expanded at a seasonal ly adjusted annual rate o f almost 40 per cent in the first quarter. In that period, outstanding commercial paper declined by more than $3 billion, offsetting about onethird o f the dollar rise in bank loans. Given the rate constraint, it was difficult for 24 banks to control the volume o f loan take downs o f commitments generated through the aggressive efforts o f loan officers in the previous two years o f slack loan demand. In early April, the heads o f the federal bank supervisory agencies sent letters to all large banks urging them to review their loan commitment policies and to maintain records by which the appropriateness o f these commitments could be judged. This was the first o f several efforts to persuade banks to restrain overall credit expansion while giving adequate attention to the needs o f local customers, including smaller business firms. Many banks, at the suggestion o f the CID, adopted a “ two-tier” prime rate. Un der this arrangement, banks were able to adjust, at least partly, loan charges to large national borrowers to money market inter est rates while holding down charges paid by smaller firms except as justified by in creases in costs to the bank. The “ big prime” posted by the major banks moved in 16 steps o f a quarter point each from 6 percent at the start o f the year to 10 per cent by late September. Nevertheless, for most o f the year, the prime rate was below related market-determined rates. In the fourth quarter, the growth in business loans was little more than the ex pected seasonal trend. A major factor ac counting for reduced demand for bank loans after September was the decline in commercial paper rates relative to bank lending rates. In addition to shifting back to the paper market for short-term funds, many large corporations increased their sales o f securities in the last quarter. For the year, however, corporate offerings o f long-term securities, including common stocks, were about one-fourth smaller than in 1972. As usual in a period o f monetary re straint, commercial bank holdings o f U. S. Government securities declined in 1973. Many banks liquidated Governments to provide loanable funds, but the net reduc Federal Reserve Bank of Chicago tion in total bank holdings o f federal debt also reflected smaller Treasury cash bor rowing. By contrast, bank portfolios o f non-Treasury securities rose in 1973, al though by less than in either o f the two previous years. A relatively large portion o f net acquisitions o f these securities were obligations issued by federally-sponsored agencies. Offerings by these institutions were more than three times the 1972 total. Outstanding obligations o f the Federal Home Loan Banks alone rose by more than $8 billion. Large security sales by these in stitutions helped finance advances to mem ber savings and loan associations whose ability to meet heavy mortgage com m it ments was impaired by shifts o f funds from deposit-type accounts to higher-yield mar ket investments. Sources of bank funds Both demand deposits and personal savings-type deposits rose less rapidly in 1973 than in 1972. Nevertheless, these sources provided roughly $35 billion to commercial banks. In order to meet strong loan demand, the nation’s major banks also bid aggressively for money market funds through sales o f negotiable certificates o f deposit (CDs). Outstanding negotiable CDs o f $100,000 or more at the nation’s major banks rose $23 billion in the first three quarters. Some o f this was allowed to run o ff in the fall as loan growth slowed and the imposition o f marginal reserve require ments increased the cost o f funds from this source. Nevertheless, at year-end, CDs totaled $64 billion—an increase o f almost $20 billion for the year and equal to more than one-fourth o f the net increase in total bank credit. In 1969, CDs declined by $12 billion, or about 50 percent. The banks’ ability to expand deposits last year was maintained as a result o f changes in the Federal Reserve’s Regula tion Q governing maximum interest rates payable on deposits. Ceilings on large- Business Conditions, January 1974 denomination CDs maturing in 90 days or more were suspended in mid-May. (Ceilings on shorter-maturity CDs had been sus pended since mid-1970.) Ceilings on pass book savings and smaller time deposits were liberalized in early July. These amend ments made it possible for banks to remain competitive with other types o f invest ments for business and consumer deposits. As market interest rates rose, the rates that had to be paid in order to sustain de posit growth, coupled with CID guidelines a im ed at holding down bank lending charges, reduced bank profit margins. These developments induced more restric tive lending policies. Moreover, as the cost o f funds in the money market soared above bond yields, the incentive to acquire securi ties was reduced. Both o f these factors con tributed to the slower growth o f bank credit in the second half o f the year. Because banks continued to have access to money markets in 1973, they raised only about $3 billion net from “ non deposit” sources. These sources, including bank borrowings from foreign branches, and sales o f loans either to their own hold ing companies or to other nonbank affil iates, were tapped extensively in 1969 when severe deposit outflows occurred. An important source o f funds for the major money market banks was the pur chase o f federal funds—overnight loans from other banks. For a group o f about 50 large banks that report these transactions to the Federal Reserve, net daily purchases rose to almost $15 billion in mid-Decem ber, compared with about $10 billion in the peak week o f 1972. Interbank lending does not add to the resources o f the bank ing system as a whole, but it transfers funds from selling banks to buying banks. For in dividual banks, the choice between “ buying deposits” and obtaining funds through other channels is largely determined by relative costs. These relative costs are af fected by contract interest rates, reserve re quirements, and other factors. 25 Rate ceilings and reserve requirements Changes in Regulation Q made by the Federal Reserve Board in 1973 were ac companied by similar actions by the Fed eral Deposit Insurance Corporation and the Federal Home Loan Bank Board which, re spectively, set ceilings on rates paid by in sured nonmember banks and savings and loan associations (S&Ls). Adjustment o f rate ceilings reduced, but did not entirely pre v e n t, “ disintermediation” —outflows of funds to market instruments. Before ceil ings on large CDs with maturities o f 90 days or more were suspended on May 16, related market rates had moved above the ceiling on these instruments, and only very short-maturity CDs (30 to 89 days), al ready free o f ceilings, could be sold. This created problems for bank managements and placed heavy upward pressure on mar ket interest rates in the under-90-day area. In mid-June, the Federal Reserve Board, in an attempt to slow the expansion o f bank credit, increased reserve require m en ts (under Regulation D) on largedenomination CDs and bank-related com mercial paper from 5 to 8 percent on amounts in excess o f a specified base. (Banks with less than $10 million in out standings were exempt.) This increased the cost o f these funds and tended to make credit more expensive. Large nonmember banks were urged to voluntarily increase their reserves by a like amount. An addi tional 3 percent marginal reserve on large CDs was imposed from early October until mid-December. On June 21, the 20 percent reserve requirement on Eurodollars above each bank’s reserve-free base was reduced to 8 percent, but with a provision for the base to be phased out. Also in June, reserve requirements were applied to funds ac quired through sales o f “ finance bills” (working capital or “ ineligible” accep tances). These actions, overall, increased the cost o f money market funds to banks, but also placed the various instruments on 26 Federal Reserve Bank of Chicago a more uniform footing. In July, reserve requirements on demand deposits over the first $2 million at each member bank were increased by one-half o f 1 percent. A new schedule o f maximum rates payable on savings and time deposits other than large CDs was announced at the start o f the third quarter. It permitted banks to increase rates paid on passbook savings and various maturity categories o f time deposits up to four years by a range o f .25 to .75 percent. Rate ceilings were removed en tirely on deposits o f at least $1,000 with maturity o f four years or longer at both banks and thrift institutions (so-called “ wild card” certificates). Higher rates offer ed on the ceiling-free deposits helped to stem the transfer o f funds from banks into direct market investments. Most banks were soon paying 7 to IV? percent on these instruments. To reduce competition, bank issues o f ceiling-free deposits were limited to 5 percent o f each bank’s total time and savings deposits. Higher rates notwithstanding, thrift institutions reported substantial net out flows in August and September, in large part reflecting shifts o f personal funds into Treasury bills. Yields on new three-month bills were above 9 percent at their peak. In response to the unfavorable S&L experi ence and reduced availability o f mortgages, Congress passed legislation requiring resto ration o f the ceilings on all consumer-type deposits. Effective November 1, ceilings on four-year, $1,000 minimum deposits were set at IV a percent for banks and IV? percent for S&Ls. Limits on outstandings were re moved. By this time, market rates had eased and deposit flows had improved. Thrift institutions reported net inflows o f funds through year-end. Nevertheless, most savings institutions remained very cautious in making new commitments. Monetary aggregates Preliminary data show that demand deposits and currency held by the public (M i) rose 5 percent from December 1972 to December 1973, compared with 8 per cent in the previous year. The broader mea sure, M2 , which includes time deposits other than CDs in addition to demand de posits and currency, rose about 8 percent Expansion of m o n e ta ry a g g re g a te s w as s lo w e r percent per annum 8 - IH IIH 1971 IH IIH 1972 IH IIH 1973 Note: Changes based on seasonally adjusted daily average amounts in December and June. M-| = currency + demand deposits held by the public. M 2 = M-] + tim e deposits other than CDs over $ 1 0 0 ,0 0 0 . CP = member bank deposits + bankrelated commercial paper + nondeposit sources. RPD = reserves available to support private non bank deposits. Business Conditions, January 1974 last year, also less than in 1972. The expan sion in M i was concentrated in two periods—in the second quarter and again toward year-end. The Federal Reserve System influ ences trends in monetary aggregates mainly through actions that affect the volume o f reserves o f member banks. As in 1972, the Federal Open Market Committee chose the growth rate in reserves available to support private deposits (RPDs) as its short-run guide. Changes in this measure were be lieved to be closely associated with changes in M i and M2 . RPDs rose about 9 percent in 1973, slightly less than in 1972. RPDs include reserves supporting large CDs as well as private demand and consumer-type time balances. Changes in the composition o f deposits between time and demand, shifts between banks with different average p e r c e n ta g e reserve requirements, and changes in the marginal requirements on CDs all tended to alter the relationship be tween RPDs and the monetary aggregates. Because o f the heavy use o f CDs to acquire loanable funds in 1973 and because o f the imposition o f the marginal reserve require ments on these liabilities, the growth pat tern o f RPDs resembled that for bank credit more than that for either M i or M2 . Member bank borrowing Advances to member banks by the Federal Reserve banks rose very rapidly in the early part o f 1973 and remained at his torically high levels through the rest o f the year. Daily average borrowings reached a peak o f over $2.5 billion in the last week o f August, compared with a high o f $1.7 bil lion in the 1969-70 period o f monetary re straint. In the final quarter, outstanding borrowings ranged from $1.2 billion to $1.5 billion, still well above the levels pre vailing in the two previous years. A new factor affecting the volume o f borrowing was an April amendment to Regulation A, implementing the “ seasonal 27 borrowing privilege.” Qualifying banks (de fined as banks subject to significant and persistent drains o f funds resulting from re curring seasonal loan and demand patterns, and that do not have reliable access to na tional money markets) were given the privi lege o f borrowing from Federal Reserve banks in predetermined amounts for speci fied time periods. This arrangement was in tended to help such banks better serve their communities. Nationwide, “ seasonal bor rowing” reached a peak o f less than $200 million in August, declining to less than $50 million by year-end. A major reason for heavy member bank borrowings was the fact that the cost o f these funds was relatively low. More over, the amount o f reserves made available through Federal Reserve open market op erations was limited under the restrictive monetary policy. A series o f increases brought the discount rate to an all-time high o f 7V6 percent on August 14, up from 4lA percent in early January. Nevertheless, the discount rate was more than 2 percent age points below the federal funds rate dur ing most o f the year. Because use o f the discount window over a prolonged period o f time is deemed inappropriate, however, banks were kept under pressure to repay their indebtedness. This encouraged the adoption o f restrictive loan policies that helped to slow credit expansion. Interest rates Demand for short-term funds was so strong in 1973 that interest rates rose to unprecedented levels. At its late-summer peak, the three-month Treasury bill rate was above 9 percent, more than double the level o f a year earlier. Major banks were paying almost 11 percent on federal funds and short-term CDs, and were charging their prime customers 10 percent on short term business loans. In late September, bill yields and commercial paper rates dropped sharply, apparently because o f expecta- Federal Reserve Bank of Chicago 28 tional factors. These expectations were not validated by other developments, however, and short-term rates rose again. Although the August peaks were not regained in most areas, various factors caused fluctuations in short-term rates through the balance o f the year. These included liquidation o f U. S. debt by foreign central banks whose trade positions had deteriorated, interruption o f Treasury financing caused by the delay in raising the federal debt ceiling, and wide spread uncertainties related to the energy shortage. At year-end, most money market rates, although 1 to 2 percentage points below their 1973 peaks, were near the highs o f 1969. Movements in long-term rates were much less spectacular than movements in short-term rates in 1973. New issues o f high-grade corporate bonds were yielding about 7 percent in late 1972. These rates moved up to about 8 percent in the sum mer and remained near that level to yearend. Even higher levels had been reached in late 1969. Rates on tax-exempt municipals were relatively stable throughout the year, somewhat above the 5 percent level. Rates on long-term Treasuries averaged about 60 basis points higher in 1973 than in 1972. Home mortgage rates moved up gradu ally in the first half o f 1973 and then in creased sharply in the summer as the sup ply o f mortgage funds was curtailed. Effec tive rates on new mortgages reached 9 to 9.5 percent in states without usury ceilings. In addition, downpayments were raised and credit standards were tightened. Where ef fective usury ceilings existed, as in Illinois, availability o f mortgage funds was reduced further. District banking Credit growth at banks in the Seventh Federal Reserve District outpaced the rapid expansion o f bank credit nationally. De posit growth, however, was close to the na tional trend. As a result, district banks re- S h o r t-te r m in te r e s t r a te s s e t reco rd s, b u t m o st lo n g -te rm ra te s rem ained below th e ir 1 9 6 9 highs 1969 1970 I97I I972 I973 Note: M arket rates are m onthly averages of daily figures. I969 1970 I97I I972 1973 Business Conditions, January 1974 Loan expansion w as s tro n g th ro u g h o u t th e d is tr ic t large banks* percent change based on last Wed. in Dec. 0 10 20 30 United States Chicago Detroit Indianapolis Milwaukee Des Moines United States Illinois Michigan Indiana Wisconsin 29 statements each week was 23 percent, re flecting exceptionally strong expansion in Chicago in the first half. Loan composition Commercial and industrial loans at large district banks increased more than 30 percent in 1973—twice as rapidly as in 1972. These loans accounted for half o f the rise in all loans. Real estate and consumer instalment loans increased almost as fast as in 1972. Real estate loans rose 12 percent in 1973, compared to almost 14 percent in 1972. By contrast, in the 1969 period o f high interest rates, real estate loans in creased only 5 percent, following a 15 per cent gain in 1968. Some o f the $1 billion increase in bank loans to nonbank financial institutions in 1973 represents additional funds that flowed into mortgages through mortgage companies. Iowa •D a ta fo r the largest banks in m ajor cities include loans sold to affiliates but exclude sales o f federal funds to and loans to other commercial banks. lied more heavily on nondeposit sources o f funds than banks elsewhere. Virtually all o f the expansion in mem ber bank credit was accounted for by loans, which rose $10 billion, or 21 percent. Holdings o f U. S. Treasury securities de clined almost $1 billion, offsetting about two-thirds o f the dollar gain in holdings o f municipals, agencies, and other securities. Portfolios o f non-Treasury securities rose 10 percent, compared to 7 percent in 1972 but less than the 16 percent average annual increase in the five previous years. The gain in loans matched the gain in 1972—the strongest recorded since 1965. Loan growth at large banks was more rapid than at small- and medium-sized banks. In cluding loans sold to affiliates, the gain at the 55 large banks that report detailed Tim e d e p o sits rem ained m ost im p o rta n t so urce of funds fo r d is tr ic t m em ber banks 1966 '67 '68 '69 '70 '71 '72 '73 N ote: Data are averages of Wednesdays in December. *Nondeposit sources, including net pu r chases o f federal funds from other banks. 30 Loan composition at smaller banks that do not report this breakdown weekly is not yet available for the end o f the year. In the first half o f 1973, however, gains in the major types o f loans at these banks equaled or exceeded the first-half 1972 gains. Real estate loans and business loans each rose about 8 percent at these banks in the first half o f 1973, and consumer loans (both instalment and single-payment) in creased 9 percent. Agricultural loans were up about 8 percent, compared to 4 percent for the first half o f 1972. Financing asset expansion District member banks financed the 1973 growth in bank credit mainly with interest-bearing liabilities. Collected de mand deposits averaged only IV2 percent higher in December 1973 than the previous December at large city banks, and 5 per cent above December 1972 at other mem ber banks. The gain in time deposits at smal ler banks was less than 10 percent, compared to 14 percent in the previous year. Time deposits at large banks increased $ 4 .2 b illio n , or 17 percent. This gain in cluded an increase o f more than $3 billion in large CDs. After marginal reserve require ments were imposed in June, however, the increase in outstanding CDs slowed appre ciably. The higher cost o f CD funds and Federal Reserve Bank of Chicago expectations that interest rates would de cline made the federal funds market a more attractive source o f funds. By November, net purchases o f federal funds by district money market banks were more than double the first-quarter average. In the effort to retain personal savings d e p o s its , many banks introduced the higher-rate, four-year, $1,000-minimum de posits. As o f October 31, 72 percent o f dis trict member banks were offering such de posits, and outstandings amounted to $1.5 billion. Much o f this total resulted from shifts within the same banks from other types o f accounts. At the large banks, pass book savings and all other small-denomina tion accounts o f individuals and businesses increased less than $800 million for the year as a whole. Member bank borrowing from the Federal Reserve Bank o f Chicago averaged $250 million daily in 1973, compared to $40 million in 1972. Large banks borrowed about $200 million per day in the first quarter, but the average for the last three quarters was about $100 million. Loans to smaller banks rose steadily until August, the peak month o f seasonal borrowing un der the new seasonal borrowing privilege. More than one-third o f all district members were accommodated at the discount win dow at some time during 1973—the largest number since the early days o f the System. Business Conditions, January 1974 31 Energy and the outlook Even prior to the Arab oil embargo in October 1973, there was a widespread view that econom ic growth would slow marked ly in 1974. Residential construction, pas senger cars, and recreational vehicles were headed down and there was little hope for an early reversal. Formal projections o f economic aggre gates published near the turn o f this year have been generally similar. Real growth for 1974 is expected to be zero to 2 per cent, down from 6 percent in 1973, while prices are expected to rise even more than last year. Residential construction, fullsized cars, and all activities related to travel and recreation are expected to be sharply lower, while nonresidential construction and business equipment are expected to be substantially higher. Exports o f most goods are expected to continue to rise faster than imports, but higher oil prices jeopardize the fa v o r a b le tra d e balance so recently achieved. Almost all forecasts see the econ om y weakest in the first half o f 1974, with real activity down very slightly, followed by a recovery in the second half. Two successive quarterly declines in real GNP are widely accepted as marking “ a recession.” Normally a recession is charac terized by declining demands throughout the private econom y. But many activities that are expected to decline or grow more slowly in 1974 will reflect shortfalls in sup plies. Under these circumstances, forecasts o f the general econom y have less meaning than usual for consumers, businesses, and financial institutions. Forecasts looking a year or more ahead should never be regarded as immut able blueprints o f the future. Vital develop ments in 1973, such as the rate o f price inflation, the strength o f consumer pur chases o f durable goods, the extent o f the capital spending boom , the degree o f im provement in the balance o f trade, the very sharp rise in short-term interest rates, and the severity o f the fuel crisis were not fore seen in the “ consensus forecast.” Seldom before has there been such a sharp contrast in the prospects for major sectors o f the econom y. Early in 1974, it appeared that steel, nonferrous metals, plastics, cement, and many other materials released by declining sectors would be em ployed readily elsewhere. Reemployment o f manpower released by declining sectors, however, is hampered by limited mobility o f the work force. This raises the spectre of a cumulating “ regular” recession, a possi bility which will be closely watched by monetary and fiscal authorities. The energy crisis has its obvious “ losers,” such as large cars, recreational ac tivities, petroleum refining and distribu tion, airline travel, and highway construc tion. But there are also many “ winners,” such as small cars, “ do-it-yourself” activi ties, petroleum drilling and exploration, coal mining, nuclear power, railroads, and urban transport. In January 1974, official statements indicated that the fuel shortfalls would be appreciably less than had been feared. In part, this was because o f the rapid ad justments made by consumers, businesses, and governments. The United States has a far better energy situation than most other industrialized nations, as was reflected in the recent strengthening of the dollar. Nevertheless, for years to come, the problems o f production and efficient use of energy will have a high priority in private and public planning. Many necessary ad justments will be painful and lengthy, but ingenuity and sound planning will merit large rewards.
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