Full text of Business Conditions (Federal Reserve Bank of Chicago) : January 1975 : Review and Outlook 1974-75

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an e c o n o m ic re v ie w b y th e F e d e ra l R eserve B a n k o f Chicago




Review and outloo

1974-75

Jan u ary
1975
L IBR A R Y




Review and outlook
1974-75

Soaring prices and record in­
terest were major features in an unp r e c e d e te d a r r a y o f a d v e rse
developm ents that hit consumers,
business, agriculture, and financial
in stitu tio n s in 1974. The basic
strength o f the econom y was show n
in the fact that em ploym ent and out­
pu t were m aintained at high levels for
the first three-quarters o f the year. In
the fourth quarter, however, a severe
recession clearly was underway.
F orecasts fo r 1975 indicate
further declines in output and con­
tinued rapid price inflation. However,
more stim ulative m onetary and fiscal
policies and corrective adjustm ents in
prices and inventories point the w ay
to a recovery later this year.
A year of calamities

3

Mixed year for farmers

10

World trade patterns disrupted

14

Economic events in 1974—
a chronology

16

Government purchases
accelerate

20

Financial markets strained

23

Light in the tunnel

30

S u b s c rip tio n s to B u s in e s s C o n d itio n s are a va ila b le to th e p u b lic fre e o f ch a rg e . For
in fo rm a tio n c o n c e rn in g b u lk m a ilin g s, ad d re ss in q u irie s to Research D e p a rtm e n t
Federal Reserve Bank of C h ica g o , P. O. B ox 834, C h ica g o , Illin o is 60690.

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Business Conditions, January 1975

3

Review and outloo
A year of calamities
The U.S. econom y was struck by an un­
precedented series o f calamities in 1974.
A m ong them were the oil embargo, the
associated international liquidity crisis,
the b a la n ce-of-p a y m en ts deficit, the
chaotic demise o f price and wage controls,
widespread shortages o f materials and
components, record price inflation, record
high interest rates, a sharply falling stock
market for the second straight year, li­
quidity problems o f some prominent finan­
cial institutions, extremely poor auto sales,
a severe housing slump, the nation’s first
Presidential resignation, the adverse im­
pact o f drought and frost on m ajor crops,
cutbacks in expansion plans by the nor­
m ally stable electric utility industry, and a
new postwar high in the number o f disrup­
tive industrial disputes.
The basic strengths o f the econom y
were m anifest in the fact that output and
employment were maintained at a high
level for three quarters o f the year in the
face o f m assive adverse forces. In the
fourth quarter, however, output and
employment declined on a broad front,
shortages gave w ay to surpluses, prices o f
m any com m odities declined, and throngs
o f laid-off workers taxed the facilities o f
state unem ploym ent insurance offices. By
year-end it w as clear that the econom y was
in the throes o f a deep recession.
The United States w as not unique in
its e n co u n te r with severe econom ic
problems. Rapid inflation, unemployment,
and strikes occurred in virtually all in­
dustrialized nations. Political instability,
moreover, was widespread with changes in
leadership in Britain, West Germany,




France, Italy, Greece, Portugal, Denmark,
Israel, and Japan.

Faulty forecasts
The typical econom ic “ scenario” in
early 1974 called for a modest rise in total
output (real GNP) with an upswing in the
second half, general price inflation o f
about 7 percent, a revival in residential
building, gradually declining interest
rates, and a substantial rise in crop produc­
tion. Actual developments were quite
different. Real GN P declined in each
quarter and w as down 2 percent for the
year, price inflation exceeded 10 percent,
residential construction dropped sharply

Real output is expected to
decline again in 1975, while
inflation slows
GNP, percent change from
previous year

4 L
1966 ’67

‘ E stim ate

’68

’69

’70

’71

’72

’73

’74

’75 *

4

Consumer prices zoomed
in major industrialized nations

Federal Reserve Bank of Chicago

after an abortive recovery, interest rates
rose to all-time highs, and harvests were
reduced substantially by bad weather.
In early 1975 forecasters are less op­
timistic than a year ago. Real GNP is ex­
pected to decline again for the year as a
whole—the first two-year decline since
World War II. Price inflation is expected to
slow through the year. Once again, expec­
tations point to a decline in interest rates, a
revival o f residential construction, bumper
crops, and a general econom ic recovery in
the second half.

had far-reaching effects. The greatest im ­
pact was on sales and output o f auto­
mobiles, light trucks, and recreational
vehicles. Speed limits were cut to 55 miles
per hour and gasoline shortages caused a
reduction in the use o f vehicles for nonessential purposes. Urged by public of­
ficials (and additionally motivated by
higher prices), individuals, businesses,
and governments conserved fuel and elec­
tricity. Output o f chemicals, plastics, and
fertilizers derived from oil was curtailed.
Despite mounting pressures, the A d ­
ministration decided in late February 1974
not to institute gasoline rationing. The end
o f the oil embargo, higher fuel prices, and a
moderately lower level o f general econom ic
activity soon spelled the end o f lines at fill­
ing stations and other evidences o f oil
“ shortages.” For the year as a whole,
however, consumption o f petroleum prod­
ucts was down about 3 percent from 1973 in
place o f a normal increase o f 4 or 5 percent.
Federal controls on the price and end-use o f
petroleum products were maintained in a
modified form throughout the year.
Since World War II, total use o f energy
has increased closely in step with growth
in output. Programs to develop domestic
sources o f oil, natural gas, coal, and
nuclear energy are being pressed forward
at the cost o f m any billions o f dollars.
Associated inflationary pressures are
powerful, partly because o f environmental
restrictions.

The energy crisis ebbs

Inflation and recession

In the early months o f 1974 analysts o f
U.S. econom ic developments focused their
attention on the effects o f the embargo on
oil shipments by Arab nations and the
associated tripling o f the price o f imported
petroleum. The embargo, w hich lasted
from mid-October 1973 to mid-March 1974,
cut U.S. oil supplies by 2.5 m illion barrels
per day, about 13 percent o f consumption.
The oil em bargo and higher oil prices

Historically, rapidly rising prices have
been associated with rising employment
and declining unemployment. Over the
past decade econom ic discussions often
have centered on the “ tra d e-off’ between
inflation and unemployment. But in 1974
the United States was faced with rapid in­
creases in both prices and unemployment.
From June to December the consumer price
index rose at an annual rate o f about 11

percent, 1970 = 100




Business Conditions, January 1975

percent, while unemployment rose from 5.2
percent to 7.2 percent o f the labor force.
The reasons for the dilemma o f
simultaneous inflation and rising un­
employment are m any and complicated.
Im portant special factors in 1974 were fuel
shortages and shortfalls in crops. A more
pervasive factor, however, is the rapid and
continuing rise in labor costs per unit o f
output.
In February 1974 union leaders began
to press for 12 percent first-year increases
in com pensation. These demands were
based on a simple formula which added the
9 percent rise in the consumer price index
in the previous 12 m onths to the 3 percent
long-term average annual rise in pro­
ductivity—output per man-hour. Some m a­
jor labor contracts negotiated in 1974
provided 12 percent increases in com pen­
sation and some were even larger. The
average for m ajor contracts w as 10 per­
cent, but not all cost-of-living adjustments
are included in this figure. Gains o f 12 per­
cent or more were negotiated by m any un­
ion's in the building trades and in educa-

Food dominated the rise
in consumer prices, but
inflation was general
percent, 1967 = 100




5

Unemployment rose rapidly
to the highest level in recent years
percent

tion, despite substantial unemployment in
these fields. M any nonunion employers
raised wages substantially to keep in line
with the increases obtained by unions.
Preliminary estimates show compen­
sation per man-hour in the private non­
farm econom y to have increased 9 percent
last year. Output per man-hour, far from
rising at the historic 3 percent rate, de­
clined 3 percent for the first significant
year-to-year drop in this measure since
World War II. The com bination o f higher
compensation and reduced productivity
caused unit labor costs to rise about ^ p e r ­
cent in 1974. This compares with 5 percent
in 1973 and less than 3 percent in 1972. In­
creases in unit labor costs show up in price
increases, the other side o f the coin. Price
inflation in the private econom y averaged
over 11 percent last year.
Worker com pensation will rise sub­
stantially again in 1975. M any workers are
covered by two- or three-year contracts and
cost-of-living adjustments, or their equiva­
lents, are increasingly com m on for both
union and nonunion workers.

6

Prices and labor costs
surged due to wage boosts
and declining productivity
percent change

Federal Reserve Bank of Chicago

developments exacerbated the widespread
problem o f shortages o f materials and com ­
p on en ts th a t h a m p ered prod u ction
through a large part o f the year. M any
shortages became less severe in the third
quarter, and some com m odity prices
declined. The drop in com m odity prices
broadened late in the year as econom ic con­
ditions deteriorated.

Employment and income

Controls abolished
The legislation providing authority for
price and wage controls expired on M ay 1,
1974. Prior to that date m any industries
had been exempted from controls or were
operating under more flexible rules than in
1973. Nevertheless, prices o f m any goods
and services that had been held in check by
controls rose rapidly in the weeks follow ­
ing May 1.
The nation’s experience with price and
wage controls in the program instituted in
August 1970 was judged unsatisfactory by
virtually everyone. Some critics said con­
trols should have been enforced more
vigorously, while others argued for greater
flexibility and still others rejected the
whole concept.
In retrospect, it is clear that price and
wage controls hid increases in prices that
were a cco m p lish e d indirectly. Some
materials were exported to obtain higher
prices prevailing abroad, some m anufac­
turers stopped producing low profit items,
and hoarding o f scarce materials occurred.
All o f these developments tended to disrupt
n orm al m ark et relationships. These




Civilian employment averaged over
85.9 million in 1974, up 1.5 m illion from
1973 but a much smaller rise than in either
o f the two previous years. After follow ing
an erratic path since late 1973, em ploy­
ment hit an all-time high o f 86.4 m illion in
September 1974. A very rapid drop o f 1.2
million occurred in the fourth quarter.
After-tax personal incom e rose 8.4 per­
cent last year, less than the 12.6 percent
gain in 1973, but faster than in m ost recent
years. Personal outlays increased more
than income in 1974, so the percentage o f
incomes saved was less than in 1973.

Payroll employment dropped
sharply in late 1974, ending
a three-year uptrend
percent, 1967 = 100

7

Business Conditions, January 1975

Prices paid by consumers averaged 11
percent higher in 1974, follow ing increases
o f 6 percent in 1973 and 3 percent in 1972.
The rise in consumer prices was the largest
since the 1946-47 period when World War II
price controls were removed. Food prices
were up 15 percent and fuel oil and coal
averaged 58 percent higher. With prices o f
essentials up sharply, m any consumers
curtailed outlays on autos, appliances, fur­
niture, and vacation travel. Sales o f vir­
tually all big ticket items were o ff substan­
tially in 1974, with especially large drops
in the fourth quarter. Consumer credit was
used less freely and the savings rate rose in
the fourth quarter.

Factory output falls
M anufacturing output declined 1 per­
cent last year follow ing gains o f 10 percent
in 1973 and 8 percent in 1972. From
January through September, total m anu­
facturing activity was remarkably stable.
The picture varied greatly by industry,
h ow ev er, w ith resid en tia l b u ild in g
materials and autos sharply lower than a
year earlier, while output o f business

Output of both durable and
nondurable goods declined
percent, 1967 = 100




equipment and m any consumer goods was
at record levels.
Shortages o f a wide variety o f m a­
terials and components, including virtual­
ly all metals and chemicals, hampered
production o f m any finished m anufac­
tured g ood s through the first nine
m onths—through year-end in some cases.
Strikes, more frequent than in any year
since World War II, also held back
manufacturing activity. The coal strike in
November and December, the year’s most
serious single work stoppage, forced a
reduction in steel output.
M anufacturing output in most in­
dustries dropped very rapidly in the fourth
quarter, both because o f a reduction in de­
mand for finished goods and because
businesses at all levels were attempting to
reduce inventories. In December m anufac­
turing output w as down almost 8 percent
from the N ovem ber 1973 peak. Rapidly
dwindling order backlogs indicated that
the decline in factory output would con­
tinue into early 1975.

Steel, autos, and equipment
Steel mill shipments totaled 110
million tons, only slightly less than the
record set in 1973. In both years mill inven­
tories o f finished and semifinished steel
were reduced sharply to satisfy customer
demand. Steel production would have been
even larger last year but for shortages o f
coke, scrap iron, and ore.
Auto producers assembled 7.3 million
passenger cars in 1974, down 25 percent
from the record total o f 1973 and the lowest
for a year not affected by a m ajor strike
since 1962. In the final m onths o f the year
output was at a rate o f about 6 million
units. Truck output was down about 10 per­
cent to 2.7 m illion units. Demand for heavy
trucks rem ained very strong before
plummeting in the fourth quarter.
Output o f producer goods was up 6 per­
cent in 1974. Through m ost o f the year de-

Federal Reserve Bank of Chicago

8

Business equipment output
remained strong, but motor
vehicle output plummeted

Total plant and equipment
outlays are expected to
rise more slowly

percent, 1967=100

billion dollars

‘ E stim ate

Housing and construction

mand for virtually every type o f equipment
for agriculture, construction, mining,
transportation, chem ical processing, m a­
terials handling, and metalworking was so
strong that lead times on new orders were
two or three times as long as normal. At
year-end order backlogs for heavy equip­
ment for basic industries were still large.

The value o f construction put in place
in 1974 exceeded $134 billion, only 1 per­
cent less than in 1973. After adjustment for
inflation, however, construction activity
was down 13 percent and w as at the lowest
level since 1968. Residential construction

Construction spending was down
only slightly in current dollars . . .

but was down sharply after
adjustment for inflation

billion dollars
140 "

billion dollars

120100

current dollars

-

80
60
40

20

0
1969

1970




1971

1972

1973

1973

L IB R A R Y

1974

Business Conditions, January 1975

was o ff much more than the total. In sharp
contrast, industrial construction rose sub­
stantially as manufacturers pushed ex­
pansion plans.
Housing starts dropped to 1.34 million,
compared to 2.06 m illion in 1973 and a
record 2.38 m illion in 1972. By December
the rate o f housing starts had dropped to
less than 900,000. Factory shipments o f
m obile homes, which had been maintained
near 575,000 units in both 1972 and 1973,
dropped to 375,000 in 1974, and the annual
rate late in the year was only 220,000. The
net addition to the housing stock was well
below the rate o f net household formation
in the fourth quarter o f 1974. A n easing o f




9

credit availability could be expected to help
sales o f both conventional housing and
mobile homes.
With expansion programs well un­
derway, industrial construction will prob­
ably remain at a near record level in 1975.
Electric utilities, however, have been
red u cin g con stru ction budgets since
midyear. Commercial construction prob­
ably will continue at a reduced level, es­
pecially in areas where a surplus o f office
and shopping space exists. Release o f
federal funds for construction o f water and
sewerage systems, and for various other
public works, suggests an increase in total
public construction.

Federal Reserve Bank of Chicago

10

Mixed year for farmers
Highly adverse weather conditions and
su b stan tia l losses on cattle feeding
operations dominated the farm picture in
1974. Gross farm incom e rose to a record
level, nevertheless, because o f higher crop
prices and increased marketings o f
livestock. Profits were lower, however, as a
result o f a 16 percent rise in prices paid by
farmers and the near-elimination o f
government payments. Net farm income
dropped from a record $32 billion in 1973 to
about $27 billion, but was still well above
any earlier year. Results for various farm
sectors varied widely.
Crop grow ing conditions proved to be
the worst in m any years. A sequence o f
floods in the late spring, severe drought in
the summer, and an early frost dashed in­
itial hopes for a large rise in total crop out­
put. The total crop harvest was the lowest
since 1970, with corn and soybeans es­
pecially hard hit.

Net farm income declined
as rise in expenses
offset larger receipts

‘ P re lim in a ry




The com bination o f reduced produc­
tion and continued strong demand,
domestic and foreign, caused crop prices to
average almost one-third higher than in
1973. Livestock prices, conversely, aver­
aged substantially lower because o f in­
creased marketings.

Bad weather cuts crops
Early in 1974 grain producers planned
to boost production substantially. Projec­
tions based on surveys o f planting inten­
tions indicated a large expansion in total
crop acreage and probable record harvests
for most m ajor crops. A primary concern
was the apparent shortage o f fertilizer.
By late spring bad weather began to
take its toll. Drought plagued the wheat
crop, while heavy rains in the Corn Belt
substantially delayed the com pletion o f
corn and soybean plantings. In the
summer the Corn Belt was hit by drought
with resulting poor stands and slowly
maturing plants. Finally, frosts in late
September and early October prematurely
ended the grow ing season throughout
most o f the Corn Belt. Nationwide, these
conditions resulted in:
• A 1.8 billion bushel wheat harvest, up
only 5 percent despite a 21 percent rise in
planted acreage.
• A 4.7 billion bushel corn crop, down 18
percent from 1973 even though planted
acreage was up 8 percent.
• A 1.2 billion bushel soybean harvest,
down 20 percent compared to only a 5
percent drop in planted acreage.
As these developments unfolded, the
Chicago cash price for corn m oved from a
1974 low o f $2.55 per bushel in early M ay to
a high o f $3.95 in early October. Follow ing
much the same pattern, soybean prices

Business Conditions, January 1975

rose from $5.35 to about $9.00 per bushel.
Although significant contraseasonal price
declines occurred late in the year, both corn
and soybean prices were about 25 percent
above year-earlier levels at the end o f 1974.
Wheat prices, however, were substantially
below year-earlier levels.
Reduced supplies o f grain necessitate
that both dom estic utilization and exports
o f grains and soybeans must decline
sharply from the high levels o f the past few
years. Recent adjustments by livestock
producers m ay have trimmed domestic
feed grain demand about in line with
available supplies, but indications o f
foreign demand remained substantial
early in 1975. Carryover stocks prior to
the 1975 harvest will be below the re­
duced levels o f last year.
Prelim inary estimates indicate that
winter wheat plantings in the fall o f 1974
were up 6 percent to a 22-year high. Plant­
ings o f feed grains and soybeans this
spring also are expected to be higher.
Larger plantings, coupled with greater
availability o f fertilizer, equipment, and

Farm prices averaged record
high in 1974, but downtrend
prevailed most of the year
percent, 1967=100

1973




1974

11

supplies suggest record 1975 harvests,
assuming normal weather conditions.

Livestock farmers hurt
Lower livestock prices coupled with
markedly higher feed prices resulted in
losses for m any livestock producers, par­
ticularly cattle feeders and dairy farmers.
In some cases feedlot operators sustained
losses in excess o f $100 per head o f cattle
sold. Cumulative losses o f cattle feeders
since the end o f the third quarter o f 1973
are estimated at $1.7 billion, about 15 per­
cent o f their annual receipts.
The financial squeeze on livestock
producers caused a substantial reduction
in both the numbers o f cattle m oving
through feedlots and the inventory o f hogs
held for breeding purposes. Despite re­
duced feedlot activity, cattle slaughter was
up about 9 percent last year, with sharply
higher slaughter o f cow s and range-fed
steers and heifers adding to the supply.
Similarly, hog slaughter rose 6 percent
from the low 1973 level, paced by a 28 per­
cent rise in sow slaughter. Increased
slaughter boosted red meat production in
1974 near the record established in 1971.
Red meat production m ay decline
somewhat in 1975 with a sharp reduction
in pork more than offsetting an an­
ticipated rise in beef. Inventories o f hogs
and pigs are low and producers’ farrowing
intentions are down from last year. Pork
production per capita m ay decline from 67
pounds last year to less than 60 pounds, the
lowest level in 40 years. On the other hand,
record total cattle inventories suggest a
substantial increase in cattle slaughter. In­
ventories o f cattle on the range are large.
The number on feedlots is 26 percent below
the year-earlier level.
Despite higher prices, dairy farmers
a lso experienced a severe cost/price
squeeze. Milk prices received by farmers
averaged $8.31 per hundredweight during
1974, well above the 1973 level o f $7.14.

12

Nevertheless, the m ilk/feed price ratio—a
rough measure o f profitability—averaged
1.34, down from 1.47 a year ago and 1.73 in
1973. These conditions fostered heavy cull­
ing o f the dairy herds—particularly during
the first h a lf o f the year—and held down
the rise in milk output per cow. Conse­
quently, total milk production for 1974
declined slightly from the 21-year low es­
tablished in 1973.
C on su m er resistan ce to sharply
higher retail prices o f fluid milk implied a 4
percent decline in sales, somewhat more
than the decline in output. A s a result, a
larger quantity o f milk was used in
manufactured dairy products, such as
cheese, dry milk, and butter. Rising
su p p lies o f th ese products reduced
wholesale prices in the summer and
triggered large governm ent purchases to
support prices.
M ilk p ro d u ctio n th is year will
probably remain at a reduced level, even
though low prices for slaughter cow s will
lessen the incentive to cull dairy herds.
Lower production is anticipated at least for
the first part o f 1975, as high grain prices
result in altered feeding rations. Lower
feed prices and higher support prices m ay
stimulate production later in the year.

Trade restrictions imposed
Various governments imposed restric­
tions on trade in agricultural products last
year. Japan and the EC imposed several
measures to restrict beef imports, partly to
conserve foreign exchange and partly to
protect local producers faced with rising
world supplies. In April Canada placed an
import embargo on cattle and beef pro­
duced with DES, a diet supplement used in
the United States to hasten growth o f cat­
tle. The Canadian embargo w as replaced
in August by a system o f import quotas.
The United States also restricted trade
in farm products last year. In October con­
cern over the small grain harvests and an




Federal Reserve Bank of Chicago

unexpectedly large U SSR grain purchase
led to “ voluntary” export controls on
wheat, feed grains, and soybeans. In
November the United States attempted to
force a removal o f the Canadian import
quotas by im posing quotas on imports o f
Canadian livestock and products.
Despite the trade restrictions, U.S.
agricultural exports in 1974 rose 27 percent
to $22.5 billion. All o f the increase reflected
higher world prices. Moreover, reduced
shipments, in physical volume, in the sec­
ond h a lf completely offset first-half gains.
In physical volume, co m shipments were
down 9 percent and wheat shipments were
almost one-third less, but soybean exports
were 8 percent higher.
Grain exports will be down sharply in
the early months o f 1975, in physical
terms, largely because o f reduced supplies.
Higher prices, however, probably will hold
the value o f agricultural exports near yearearlier levels at least in the first h a lf o f
1975. Large crop harvests in 1975 would
boost supplies for export. Foreign demand
for current consumption m ay not recover
rapidly, but lower prices would enhance de­
mand to restore world reserve stocks.

Surging exports boosted
the trade surplus in
the agricultural sector
billion dollars
24 r

1968

1969

‘ P re lim in a ry

1970

1971

1972

1973

1974*

Business Conditions, January 1975

13

Higher food prices
Retail prices o f food consumed at home
averaged 15 percent above year-earlier
levels in 1974, only slightly less than the 16
percent rise in 1973. Increases in food
prices were particularly large early in the
year when prices o f fruits and vegetables,
dairy products, and cereal and bakery
products rose rapidly. Despite higher
prices, per capita food consumption rose to
a record high last year follow ing the slight
downturn in 1973.
Total outlays on food rose 17 percent to
$154 billion, one o f the largest increases on
record. Higher processing and distribution
costs accounted for nearly four-fifths o f the
rise, much more than in 1973.
Labor costs accounted for about 44 per­
cent o f total food processing and distribu-

tion costs. Average hourly earnings in the
food processing and distribution industry
were up more than 10 percent last year,
somewhat more than for workers general­
ly. Other factors included large increases
in costs o f rail and truck transportation,
p a c k a g in g m a teria ls, and en ergy.
Although accounting for only about 4 per­
cent o f the total marketing bill, rising
profits were also a factor.
Food prices will continue to rise rapid­
ly in 1975, especially in the first h a lf with a
slower rise possible in the second half.
Reduced livestock marketings probably
will boost average farm prices and process­
ing and distribution costs will continue to
rise. Consumers can be expected to attempt
to maintain spending on food even if
purchases o f nonfood items are curtailed.
M oreover, increased participation in
government food programs will tend to
support overall food demand.

Higher market basket food
costs reflected wider
farm-to-retail price spreads

Farm land values and debt

thousand dollars
2 .0 f

farm to retail spread

.8

.4
farm value

0
1971

1972

1973

N ote: T he m arke t basket c o n ta in s the
a v e ra g e q u a n tity of fo o d p u rch a se d
a n n u a lly p er h o u seh o ld .




1974

Farm land values continued to rise
rapidly in 1974 despite reduced net income.
N ationally, land prices were up about onefifth. For the fourth consecutive year the
appreciation in land exceeded net farm in­
come. In the district, increases in farmland
prices ranged from a low o f 14 percent in
M ichigan to a high o f 30 percent in Illinois,
according to a survey o f country bankers.
Although credit conditions were more
restrictive, rising land values and the
resulting demand for credit to finance
farm land transfers led to a 15 percent
boost in outstanding farm real estate debt
in 1974. Non-real estate farm debt also rose
rapidly. Total farm debt reached $95
billion at the end o f 1974, up $11 billion
from the year-earlier level and the largest
increase on record.

14

Federal Reserve Bank of Chicago

World trade patterns disrupted
Virtually all nations experienced rapid
price inflation in 1974 in the face o f slow­
downs or declines in output o f goods and
services. With sharp increases in oil prices
playing a m ajor role, policym akers were
forced to deal with m assive im balances in
international payments, much greater
than in 1972 or 1973. Poor crops, shortages
o f m any industrial materials, and widely
fluctuating com m odity prices created
further com plications. Concern over inter­
national liquidity and the viability o f
business and financial institutions also
b e c a m e in t e n s e d u rin g the year.
W idespread p olitica l instability and
changes in the governm ents o f several m a­
jor nations reflected chaotic econom ic
developments.
Perm eating the international de­
velopments o f 1974 were issues concern­
ing petroleum—its availability, its cost,
and its financing. Initial concern centered
on cutbacks in production and restrictions
on exports by members o f the O rganiza­
tion o f Petroleum Exporting Countries
(OPEC). The restrictions included an em­
bargo by several Arab OPEC members on
oil shipments to the United States, the
Netherlands, South Africa, and Rhodesia.
The embargo was initiated in October 1973
and began to be relaxed in M arch 1974. A s
production cutbacks and export restric­
tions were relaxed, the availability o f oil
was no longer an immediate problem.
Attention increasingly focused on the
surge in oil-import prices, w hich for the
United States reached an average o f about
$11.70 per barrel (customs valuation) in
August. This compared with average im ­
ported prices o f $7.30 in January 1974,
$3.60 in October 1973, and $2.70 in
January 1973. A long with the multifold in­
crease in petroleum prices came the issue o f




paying for and financing oil imports—the
complex o f issues that com m only became
known as oil funds recycling.
Prior to the oil price increases at the
turn o f the year, the United States—with
exports exceeding imports in 1973 for the
first time since 1970—anticipated another
trade surplus in 1974. Instead, as the year
progressed the United States was faced
with prospects for a trade deficit o f several
billion dollars. Countries such as Britain
or Italy were confronted with trade ac­
count deficits much larger than an­
ticipated earlier. Germany was one o f the
few oil-importing countries that recorded a
trade account surplus in 1974.

Investing oil funds—
financing oil imports
Combined, the countries o f OPEC ac­
cumulated a trade account surplus in 1974
that has been estimated as equivalent to
$60 billion from oil sales o f about $95
billion. The abrupt increase in financial
wealth and the consequent redistribution
o f world resources from oil-importing coun­
tries to oil-exporting countries becam e the
focal point o f international econom ic and
monetary activity during the year. A n im ­
m ediate problem was faced by oil
importers—how to finance the additional
billions o f dollars worth o f oil imports.
Soon thereafter, oil exporters, m any o f
them with small populations and limited
needs for imports, had to make difficult
decisions on how to utilize the sudden in­
flux o f billions o f dollars worth o f oil fund
receipts.
Various means were employed by the
oil-importing countries to finance oil
d eficits. C on sortia bank loans and
governm ent-to-governm ent loans were

15

Business Conditions, January 1975

used e x te n s iv e ly . T he International
M onetary Fund (IMF) established a
special oil facility with funds obtained
primarily from loans by oil-exporting
countries. Oil exporters also m ade grants
and loans to developing countries. Other
arrangements included bilateral trade
agreements between oil exporters and oil
importers.
OPEC countries sought investment
outlets on a large scale, primarily in short­
term securities in the United States, the
E u ro-cu rren cy markets, and Britain.
Smaller amounts were placed in other
countries, both developed and developing,
and in international institutions such as
the W orld Bank. Through year-end,
relatively few funds had been placed either
in longer-term debt instruments or in
equities.

International reserves
were profoundly affected
by higher-priced oil

‘ In c lu d e s data fo r ten O PE C m em b e rs;
A lg e ria , E quador, In d on e sia , Iran, Iraq,
K u w a it, Lib ya , N ig e ria , S audi A ra b ia and
V enezuela.
“ End o f D e ce m b e r data, e x c e p t fo r
end o f N o ve m b e r data fo r Iraq and S a u d i A ra b ia .




M any industrial countries, especially
Japan and the Western European coun­
tries, provided incentives to increase ex­
ports in 1974. Partly, this w as to help pay
for higher-priced imports, oil, and other
commodities, and partly to offset saggin g
domestic demand. These efforts had
limited success because o f falling dem and
for imports in m ost developed countries.

International monetary reform
The International M onetary F und’s
Committee o f 20 w hich had been form ed in
1972 and charged with developing the
framework for a new world m onetary
system reported at m idyear that “ . . . in
view o f present uncertainties related to in­
flation, the energy situation and other un­
settled conditions, it is not appropriate to
attempt to determine the full details o f all
a sp e cts o f th e fu tu re international
m onetary system, m any o f w hich can
better be decided in the light o f future
developm ents.”
Several interim arrangements were
put in operation by the IMF, however, in­
cluding the oil facility designed to assist
members in financing the initial im pact o f
higher petroleum costs. Further, the valua­
tion o f the international reserve asset SDR
was tied to a basket o f 16 currencies, rather
than solely to the U.S. dollar. In addition, a
set o f general principles was established to
guide central banks in the appropriate
m anagem ent o f floating exchange rates so
as not to aggravate international ex­
change problem s o f other countries. To
m onitor the operation and adjustm ent
process o f the m onetary system, a new 20member IM F interim committee w as es­
tablished.

Trade balance shows deficit
U.S. m erchandise exports rose 38 per­
cent in 1974 to $98 billion, while im ports
rose 45 percent to $101 billion. The

Federal Reserve Bank of Chicago

16

Business Conditions, January 1975

1974— a chronology

Economic events

AU G 2 0 Financial press carries reports of
many firms shifting to LIFO to cut taxes.

OCT 2 9 Phillip E. Coldwell joins the Federal
Reserve Board.

A U G 2 6 The Treasury sells 3-month bills at a
record 9.91 percent yield. (See Dec. 20.)

N O V 5 Elections give Democrats large ma­
jorities in Congress.

M A Y 10 Franklin National Bank omits divi­
dend due to foreign exchange losses.

AU G 2 8 The Bell System sells 40-year bonds
at a record 10 percent.

N O V 12 The coal strike begins. (See Dec. 9.)

M A Y 2 4 First Mortgage Investors omits a
dividend, reflecting the financial difficulties of
many REITs.

SEP 4 The Federal Reserve Board eliminates marginal reserve requirements on longerterm CDs.

J A N 2 Nixon signs bill to reduce speed limit
to 55 mph.

M A Y 2 Minimum wage rises from $1.60 to
$2.00 per hour.

J A N 3 Federal Reserve Board reduces mar­
gin requirements on stock purchases from 65 to
50 percent.

M A Y 8 William Simon succeeds
Shultz as Secretary of the Treasury.

J A N 18 The Federal Energy Office says that
the Arab oil embargo is fully effective.
J A N 29 All U.S. controls on foreign in­
vestments are suspended.
J A N 31 Independent truckers begin 11-day
strike to protest high fuel prices and reduced
speed limit.
FEB 21 The AFL-CIO Executive Council
decides on a 12 percent target for wage boosts.
FEB 28 Nixon says “no gas
despite lines at gas stations.

rationing”

M A R 8 The International Bauxite Associa­
tion is established as an aluminum ore cartel.
M A R 8 Henry C. Wallich joins the Federal
Reserve Board.
M A R 13 The Dow industrials close at 892, the
high for the year. (See Dec. 6.)
M AR 18 Arab oil embargo is lifted.
A P R 4 Shortages ranging from “abrasives
to zinc” are reported.
A P R 12 The United Steel Workers agree to a
pattern-setting three-year pact providing for a
40 percent increase in wages and benefits.
A P R 15 Thrift institutions report savings
losses as “disintermediation” returns.
A P R 24 Consolidated Edison omits a divi­
dend for the first time in its history, reflecting
the financial squeeze on electric utilities.
A P R 25 The Federal Reserve discount rate is
raised from 7.5 to 8 percent.
A P R 30 The Economic Stabilization Act ex­
pires, ending general price and wage control
authority; the Committee on Interest and
Dividends expires.




17

George
»

r

J U N 4 Various electric utilities are reported
to be deferring expansion projects.

SEP 9 Purchasing managers report no rise
in new orders in August, first time since
January 1971.

J U N 2 6 Germany’s Bankhaus Herstatt col­
lapses with worldwide repercussions.

J U L 5 Emergency Livestock Credit Act
guarantees loans to hard-hit farmers.
J U L 12 Usury ceiling on Illinois home
mortgages is raised from 8 to 9.5 percent until
July 1, 1975.
J U L 12 Congressional Budget and Impound­
ment Control Act of 1974 becomes law. (See Dec.
11, 1974.)
J U L 16 The Labor Department reports more
strikes than at any time since World War II.
J U L 18 Reports indicate machinery output
slowed by shortages of major components.
J U L 2 3 The Federal Financing Bank sells its
first debt.
J U L 2 4 Citicorp sells $850 million of in­
novative variable rate notes.
A U G 9 Gerald Ford becomes President as
Nixon resigns.
A U G 12 The Department of Agriculture says
drought will hurt the crops.
A U G 2 0 Industry sources report very weak de­
mand for major appliances, except freezers.

N O V 2 0 Auto makers announce layoffs and
capital outlay reductions as sales slump.
N O V 2 7 FDIC insurance coverage is raised
from $20,000 to $40,000.

SE P 10 FNMA auction of commitments
produces a record 10.6 percent yield.

»

N O V 2 9 Many textile firms report layoffs.

SEP 18 Natural gas suppliers
sharp cutbacks to industrial users.

J U L 3 The fed funds rate averages a record
13.5 percent in the previous week.
J U L 3 Major banks raise their prime rates to
a record 12 percent.

N O V 13 Federal Reserve Board approves a
restructuring of reserve requirements to en­
courage longer-term time deposits.

announce

D EC 6 The Dow industrials close at 578,
lowest since October 1962. (See Mar. 13.)

SEP 19 Builders report funds for residential
and commercial construction all but dried up.

D EC 6 The Federal Reserve Board author­
izes banks to issue six-year investment cer­
tificates yielding up to 7.5 percent.

SEP 23 A very early frost hits crops in the
northern Cornbelt.
SE P 2 5 The Federal Reserve Board es­
tablishes a higher discount rate on loans to
member banks requiring exceptionally large
assistance for long periods.
SEP 2 7 The President’s “ Economic Summit”
meeting is attended by 800 delegates.

D EC 9 The Federal Reserve discount rate is
reduced from 8 to 7.75 percent.
D EC 9 The Comptroller of the Currency says
150 banks are under scrutiny.
D EC 9 Coal production resumes at some
mines. (See Nov. 12.)

OCT 6 President Ford obtains cancellation
of large grain sales to USSR.

D EC 11 Congress exercises its new power
over Presidential impoundment of funds by re­
jecting most proposed spending cuts.

OCT 7 Voluntary export controls are placed
on grains and soybeans.

D EC 19 Oil companies are reported to be
cancelling plans to expand refining capacity.

OCT 8 The Comptroller of the Currency
declares the Franklin National Bank insolvent.

D EC 20 The Treasury sells 3-month bills to
yield 6.96 percent. (See Aug. 26.)

OCT 8 President Ford’s program to fight in­
flation includes a 5 percent tax surcharge.

D EC 20 Congress approves the Trade Reform
Act permitting new international trade
negotiations.

OCT 11 Businesses report that shortages
suddenly have given way to surpluses.

D EC 2 4 Long lines are reported at unemploy­
ment offices.

OCT 15 Heavy layoffs are announced by
appliance producers.

D EC 31 American citizens can buy gold, first
time in 40 years.

18

resulting $3 billion deficit reversed a $1.4
billion surplus recorded in 1973. This
deficit reflected higher prices for imported
oil. The physical volum e o f oil imports was
down slightly from 1973, but the total cost
rose from $8 billion to almost $25 billion as
prices averaged more than three times as
high.
Without the sharp rise in oil prices, a
substantial trade surplus probably would
have been achieved last year. Crude oil and
petroleum products accounted for onefourth o f total imports, compared with 11
percent in 1973. A large share o f the rise in
other exports and imports also reflected
higher prices.
Exports rose last year on a wide front.
The value o f exports o f industrial supplies
and materials w as up 55 percent, and
that o f nonautom otive capital equipment
was up 40 percent. These two broad
categories have accounted for about 60 per­
cent o f U.S. exports in recent years. The
value o f exports o f consumer goods,
agricu ltu ral commodities, and motor
vehicles also rose substantially.

U.S. nonpetroleum trade
increased sharply in 1974
billion dollars




Federal Reserve Bank of Chicago

Exports and imports o f services and
earnings on investments also are im por­
tant in the nation’s balance o f payments.
While complete data are not yet available
for 1974, it appears that the United States
had a surplus on services and on earnings
on investments, although not so large as
the deficit on merchandise.

Trade reform
The “ Trade Reform A ct o f 1974,” pass­
ed late in the year, became law in January
1975. A major provision authorizes the
P r e s i d e n t to e n te r m u l t i la t e r a l
negotiations directed toward reductions in
tariffs and in non-tariff trade barriers. The
law also provides for preferential reduc­
tions o f selected tariffs on goods from most
developing countries (OPEC members are
a major exception) and permits the con ­
ditional extension o f most-favored-nation
tariff status to additional countries—
primarily the USSR.
Government assistance to firms, in­
dividuals, and communities suffering
economic injury resulting from a relaxa­
tion in trade barriers is expanded by the
act. The President also is granted greater
discretion in retaliating against “ unfair”
trade practices o f other countries. The new
act provides the President with increased
flexibility in charting U.S. trade policy, but
the Congress retains veto power over
selected administration trade decisions.

International finance
Various restrictions on international
transfers o f funds were removed or relaxed
in major western countries early in the
year. The Federal Reserve System ’s V olun­
tary Foreign Credit Restraint Program
restricting foreign investments o f fin an ­
cia l institutions and the Commerce
Department’s Foreign Direct Investment
Program restricting investment o f nonfin a n c ia l firm s were terminated in

Business Conditions, January 1975

January. The Treasury Department’s In­
terest Equalization Tax discouraging in­
vestments in foreign securities by U.S.
residents was effectively terminated when
the tax rate was reduced to zero in January
1974. The tax was allowed to lapse at
midyear when the law on which it was
based was not renewed.
Intense uneasiness developed in finan­
cial circles around midyear concerning the
state o f bank liquidity in leading industrial
countries. Substantial losses were incurred
in foreign exchange transactions by
several international banks. In response,
the governm ents o f m ajor countries—
including the United States, the United
Kingdom , Germany, and Switzerland—
imposed regulations restricting foreign ex­
change dealings by banks a n d /or required
detailed reporting o f bank positions in
foreign currencies.
International banks were heavily in­
volved in the placement o f oil funds during




19

the year. T h eir a ctiv itie s included
facilitating investments o f oil funds and
the negotiation o f multinational, mul­
tibank loans to governments to assist in
financing balance-of-payments deficits.
U.S. banks also greatly expanded their role
in financing foreign trade, with outstand­
ing bankers’ acceptances financing thirdcountry trade almost quadrupling to $10.1
billion as o f December 31, 1974, up from
$2.7 billion a year earlier.
The international banking sector of
the Chicago banking community ex­
panded further in 1974. By year-end, 19
state licenses for branches o f foreign
banks had been approved for the Chicago
“ L oop” area, up from four a year earlier.
Three additional applications were pen­
ding at the end o f 1974. The number of
Chicago-based Edge A ct banking sub­
sidiaries conducting an international
banking business increased from three in
1973 to six in 1974.

Federal Reserve Bank of Chicago

20

Government purchases accelerate
Purchases o f goods and services by federal,
state, and local governm ents exceeded
$308 billion in 1974, up 12 percent for the
fastest rise since 1967. A s in the private
sector, prices and salaries (“ services”
purchased by governm ents are largely
salaries) paid by governm ents rose rapid­
ly. Little, if any, increase in total spending
occurred after adjustment for price in­
creases. Few new program s were im ­
plemented and some were curtailed or post­
poned at the federal and the state and local
levels.
Federal purchases rose 9 percent to
$116 b illio n , while state and local
purchases rose 13 percent to $192 billion.
Federal purchases were 8.3 percent o f
GNP, virtually the same as in 1973 when
this ratio was the lowest since 1950. State
and local purchases were 13.8 percent o f
GNP, continuing the steady rise from 5 per­
cent o f GNP just after World War II. Over
one-fifth o f all state and local outlays are
now financed through federal grants-inaid. These grants support a wide variety o f
functions, especially education.
As usual, defense spending dominated

Inflation drives up
federal purchases
billion dollars
0
20
40
60
80
1--------1
--------- 1
--------- 1
--------- r-

purchases of
goods and
services in
1958 dollars

purchases of
goods and
services in
current
dollars




100 120
--1------1
-

direct federal purchases accounting for $79
billion, or 68 percent o f the total. Although
defense purchases were up 6 percent from
1973, they merely returned to the level o f
1969. Last year’s rise was largely ac­
counted for by salary increases for military
personnel and expenses required to com ­
plete the transition to an all-volunteer
arm ed service. T h e armed services
numbered 2.2 m illion in the second h a lf o f
1974, down from a peak o f 3.6 m illion in the
autumn o f 1968. The last draftees were dis­
charged in November.
Federal civilian employment averaged
2.73 million, up 2.6 percent from 1973. State
and local employment averaged 11.56
million, up 4.3 percent. Federal em ploy­
ment returned to the 1970 level, after three
years o f declines, while state and local
employment averaged almost 18 percent
higher than in 1970.

Federal receipts and outlays
Total federal outlays include a wide
variety o f nonpurchase expenditures that
are not included in the federal governm ent
sector o f gross national product. N on­
purchase expenditures have accounted for
an increasing portion o f total federal out­
lays since 1953. Since 1969 they have ac­
counted for more than one-half the total,
and in 1974 they exceeded 60 percent o f the
total.
Federal outlays in 1974 totaled almost
$299 billion, an increase o f $34 billion over
1973. O f this increase, $24 billion went for
nonpurchase expenditures and $10 billion
for purchases o f goods and services.
Federal nonpurchase expenditures are
m ainly transfer payments to persons,
g r a n t s - i n - a i d to s t a t e a n d lo ca l
governments, and interest. Social security

Business Conditions, January 1975

21

State and local finance

Federal payments to
individuals increasingly
exceed defense outlays
billion dollars
0
20
40
1 ------------- 1
----------------1 -

60

80

100

120

~ i ---------------- 1
---------------- 1
---------------- 1

transfer
payments to
individuals

defense
spending

paym ents alone took $70 billion o f the $114
billion o f federal transfer payments to per­
sons during 1974. Individuals received an
11 percent increase in social security
b e n e fits la st year. O ther tra n sfer
paym ents to persons include veterans’
benefits and unemployment insurance.
The m ost recent m ajor change in
social security legislation linked the level
o f benefits to the consumer price index. As
a result, an increase in benefits o f almost 9
percent is scheduled to become effective in
July 1975. In a related development income
subject to social security taxes was raised
to $14,100 on January 1,1975, an increase
o f $900.
The federal deficit (National Income
Accounts basis) was about $7.6 billion in
1974, up from $5.6 billion in 1973 and sub­
stantially smaller than the $17.5 billion
recorded for 1972. Government programs
for dealing with the m ajor problems of
recession, inflation, and energy shortages
are not established in detail, but tax reduc­
tions and increased outlays are virtually
certain. Prospects for lagging receipts—
reflecting both a declining econom y and
probable tax reductions—and increased
spending point to a very large federal
deficit in 1975, probably the largest since
World War II.




Total outlays o f state and local
governments (about 90 percent are for
purchases o f goods and services) have in­
creased about 11 percent each year for the
past decade. Last year these outlays reach­
ed $206 billion. The total would have been
larger were it not for the fact that the
federal governm ent took over payments to
the blind and to certain other types o f dis­
abled individuals during the year.
Revenues o f state and local govern­
ments increased less in 1974 than in 1973,
partly because o f the slowing o f the
economy, but also because m any state and
local governments used federal revenue
sharing funds to reduce taxes. A common
form o f tax relief was the reduction o f
property taxes for senior citizens, the
blind, and disabled. No new federal
p r o g r a m s to a id state and lo ca l
governments were initiated in 1974, and
some existing program s were constrained
by Presidential impoundment o f funds ap­
propriated by Congress.

State and local government
surplus narrowed in 1974
billion dollars

22

As 1975 began, the com bination o f the
business slowdown and continued infla­
tion suggested that expenditures o f state
and local governments would continue to
grow faster than revenues. Legal re­
quirements will force m any o f these
governments to cut outlays or raise taxes
to achieve balanced budgets, and others
will attempt to do so to avoid increasing
their debts.
Stringent conditions are not universal.




Federal Reserve Bank of Chicago

Several states again are considering tax
cuts because o f accumulated or anticipated
surpluses, follow ing the trend o f 1973 and
1974. M ost states, however, are imple­
menting or are considering tax increases
for the first time in several years. Local
governments have less tax flexibility than
state governments. M any cities and coun­
ties have announced freezes on hirings and
some have laid o ff personnel in recent
months.

Business Conditions, January 1975

23

Financial markets strained
While the gross national product was 8 per­
cent larger in current dollars in 1974 than
in 1973, net funds raised in the credit
markets declined slightly. The m oney
supply (M]_), defined as demand deposits
plus currency in the hands o f the public,
rose 4.5 percent in the 12 months ending in
December, compared to 6 percent in the
previous 12 months.
With the supply o f loanable funds
limited, strong demands for credit, es­
pecially from business, pushed short- and
long-term interest rates to record highs. In
the fourth quarter, reduced econom ic ac­
tivity com bined with easier monetary
policy caused interest rates to decline.
Faced with the need to finance rising
investments in inventories and fixed
assets at inflated prices, the business sec­
tor raised substantially more funds last
year than in 1973. Nevertheless, m any
firms encountered a cash squeeze and
were forced to take steps to pare expenses
and investments. The volume o f credit
channeled to the household sector was
lower in 1974 as residential construction
and purchases o f durable goods declined.
State and local governments required
about as much financing as in 1973, while
federal cash borrowing was up almost 50
percent. Borrowing by federal agencies
assisting housing increased significantly.
Total federal agency borrowing again ex­
ceeded direct Treasury borrowing.
A s in earlier periods o f credit restraint,
savings flow s shifted from deposit-type ac­
counts to direct market investments in
search o f higher yields—a process known
as “ disinterm ediation.” A s a result,
savings and loan associations and mutual
savings banks were hard put to honor com ­
mitments to make m ortgage loans. The
com m ercial banking system was less




affected by disintermediation because ma­
jor m oney market banks were able to sell
large certificates o f deposit (CDs) exempt
from rate ceilings. Savings inflows im­
proved in the fourth quarter, both at thrift
institutions and at commercial banks.

Money, credit, and short-term rates
A s 1974 began, most interest rates
were below their 1973 peaks. Further
declines, especially in short-term rates,
were generally expected. Forecasts of
declines in interest rates, widely publicized
as late as M arch and April, were believed
to be consistent with projections, accurate
in retrospect, o f continued sluggish
econom ic activity throughout the year.
These expectations failed to m a­
terialize as the Federal Reserve, in its con­
cern with inflation, refused to provide the
reserves necessary to accommodate the
very heavy credit demands. Monetary
policy in 1974 was focused on the achieve­
ment o f quantities o f m oney and credit
judged consistent with stable economic
growth. As a result, interest rate de­
velopments were related m ainly to two
factors—the strength o f current credit
demands and investors’ views about the
future rate o f inflation. The Federal
Reserve continued to supply the liquidity
necessary to cushion the im pact o f tem­
porary disturbances in the financial
markets. But, an expansion in money and
credit sufficient to keep interest rates
stable in a period o f rapidly rising expen­
ditures could only fuel inflation which, in
turn, would ensure even higher interest
rates in the long run.
With the end o f the oil embargo and
rapid price acceleration, credit demands
rose sharply and M^ expanded at an an-

24

nual rate o f more than 9 percent in
February and March. Although later revis­
ed downward, at midyear estimated sec­
ond-quarter growth was at a 7 percent an­
nual rate, for a five-month pace near 8 per­
cent. Bank loans to business rose at a 24
percent seasonally adjusted annual rate in
the first half.
As these developments unfolded, the
System allowed m oney market conditions
to tighten in order to moderate the rate of
monetary growth. The basic discount rate
was increased from 7.5 to 8 percent in
April, and short-term market interest rates
rebounded to new record levels. The prime
lending rate o f the large com m ercial banks
moved to a record 12 percent in July, and
formulas calculated by some banks in­
dicated an even higher rate. Yields on 3month Treasury bills approached 10 per­
cent in the summer, and the federal funds
rate (paid on borrow ings by one bank from
another) reached 13.5 percent.
Money market pressures were inten­
sified beyond the degree sought by the
Federal Reserve by news o f liquidity
problems o f various banks, other financial
institutions, and business firms, both here
and abroad, and problems created by inter­
n a tio n a l flo w s o f oil-related funds.
A ssu ra n ce b y the F ederal Reserve
authorities that moderate bank deposit ex­
pansion would be supported and that in­
dividual temporary liquidity problems
would be alleviated by the “ lender o f last
resort” helped to ease these tensions and
interest rates receded from peak levels in
the late summer.
Although the m oney market had eased
markedly by September, third-quarter
growth in M^ was quite sm all—less than 2
percent annual rate when measured
between June and September and about 3.5
percent if the third-quarter average is com ­
pared with the second-quarter average.
The broader measure o f money, M^ (which
includes commercial banks’ savings and
time deposits other than large negotiable




Federal Reserve Bank of Chicago

Growth in money and bank
credit slowed in 1974
percent

16 12

-

8

-

4 -

04L
1969

1970

1971

1972

1973

1974

Note: M i = d a ily average o f c u rre n c y + d e ­
m and de p osits held by the p u b lic . M2 = M i +
tim e d e p osits o th e r than n e g o tia b le c e rtific a te s
o f d e p o sit over $100,000. Bank C re d it = L o a ns
(in c lu d in g those sold to a ffilia te s b u t e x c lu d in g
d o m e stic in te rb a n k loans) and in ve stm e n ts at
all co m m e rcia l banks.
C hanges are seasonally a d ju ste d a n n u a l
rates, last m on th o f p e rio d relative to last m o n th
o f p re ce d in g period.

CDs as well as the com ponents o f M]^) and
bank credit also leveled o ff as time deposit
inflows slowed and restrictive bank lend­
ing policies began to affect loan volume.
Continuation o f the slow third-quarter
expansion rates in the aggregates w as not
considered consistent with the econom y’s
longer-run needs, and the System con­
tinued to m ove cautiously to a more accom ­
modative posture.

25

Business Conditions, January 1975

The m oney supply and bank deposits
grew at a som ewhat faster rate in the
fourth quarter than in the third quarter. By
year-end the federal funds rate had
dropped back to 8.5 percent, and m ost other
short-term market rates were near the
levels prevailing at the start o f the year.
The Federal Reserve’s discount rate was
cut to 7.75 percent in December and to 7.25
percent in early 1975.

Long-term rates also rise
T h e v o lu m e o f co rp o ra te debt
securities sold publicly was twice as large
in 1974 as in 1973. Movements in long-term
interest rates generally followed the
pattern o f short-term rates, but, as usual,
with a lag and with smaller fluctuations.
Heavy m arketings o f securities pushed
rates to record levels in the late summer
with top-rated issues bearing yields o f over
10 p ercen t on fiv e- to seven-year
maturities. M any corporate issues were
postponed or canceled.

The spread in yields between top-rated

corporate securities and lower-grade issues
was especially large in 1974, and this
spread widened as the year proceeded. This
reflected concern over the financial health
o f firms especially hard hit by inflation,
high interest rates, and declining profits
and sales. Some firms were unable to sell
new securities on acceptable terms and
some issuers o f com m ercial paper found
that they could not place their notes with
investors.
The volume o f tax-exempt municipal
issues sold w as about as large in 1974 as in
1973. Yields on m unicipals reached their
highs for the year in December at over 7
percent. Proposed new municipal issues
were postponed at various times during the
year because o f adverse market conditions.
Although the volume o f mortgage
loans declined in 1974, rates on new
m ortgages set record highs. Nationally,
r a t e s o n new c o n v e n tio n a l hom e
m ortg a g e s a v era g ed 9.8 percent in
September. In some states these rates were
well over 10 percent. Usury ceilings held
rates at lower levels in some states, but

Most interest rates had receded
from record levels by year-end
percent

percent

Note:

Market rates are monthly averages of daily fii




26

these laws also had the effect o f restricting
the flow o f m ortgage funds. M ortgage rates
eased moderately late in the year.

Smaller rise in bank loans
Commercial bank loans increased
about 11 percent last year, about 40 percent
less than in each o f the two previous years.
(These com parisons exclude loans to other
domestic commercial banks.) Moreover,
the pace o f loan expansion slowed marked­
ly as the year progressed.
Loans to business borrowers rose very
rapidly in the first eight m onths o f the year
but at a much slower rate thereafter. Infla­
tion increased needs for funds to finance
inventories and receivables o f m anufac­
turers and trade firms. In addition, de­
mand for loans from public utilities, real
estate investment trusts (REITS), finance
companies, and foreign banks was un­
usually strong. In some cases these
borrowers were forced to turn to the banks
because o f difficulties in selling securities
or commercial paper.
Real estate loans rose less than 10 per­
cent in 1974, after rising 20 percent in each
o f the two previous years, and rose at an
annual rate o f only 5.6 percent in the se­
cond half. Consumer instalment loans rose
at a much slower pace than in 1973 because
o f the slump in sales o f automobiles and
other durables.
The slower growth in bank loans in the
second h alf resulted, in part, from more
selective lending policies, reflecting both
urgings o f the m onetary authorities and
the desire o f banks to improve their liquidi­
ty and asset quality. More restrictive lend­
ing practices were evident in the fact that
large banks allowed an unusually large
spread to develop between their prime lend­
ing rate and the market rate on commer­
cial paper—an alternate source o f funds for
some firms. At year-end, 90-day commer­
cial paper rates were down to about 9 per­
cent, but most large banks still posted a




Federal Reserve Bank of Chicago

10.5 percent prime rate. The slow ing in the
rise o f bank loans also reflected declines in
demand from some industries with reduced
volumes o f activity and the repayment o f
bank loans with the proceeds o f security
sales.

Bank sources of funds
Time and savings deposits in 1974
again provided the m ajor source o f bank
funds. However, time and savings ac­
counts, other than CDs in denom inations
o f $100,000 or more, rose only moderately
because these deposits are subject to in­
terest rate ceilings and higher yields were
available on m oney market instruments.
All certificates o f deposit o f $100,000 or
more have been exempt from interest
ceilings since M ay 1973. A s a result, m ajor
banks selling CDs were able to compete
freely in the m oney markets for funds to
support loan expansion in contrast to
earlier periods o f m onetary restraint.
The net increase in negotiable CDs
outstanding in 1974 was almost $29
billion, a new record. In the summer the
rates paid on prime CDs reached a high of
12.25 percent, and some banks paid even
more. Because funds could be obtained by
selling CDs, banks made relatively little
use o f “ nondeposit” sources o f funds such
as Eurodollars and sales o f assets to bank
holding companies, both important in
1969.
Commercial banks acquired some
funds by sales o f Treasury securities in the
second half. Their holdings o f other
securities, m ainly municipals, continued
to rise, but at a slow pace.
Throughout the year m any banks
supplemented their resources through
purchases o f federal funds and through
sales o f Treasury and U.S. agency
securities under repurchase agreements.
F or w eekly re p o rtin g b a n k s these
liabilities averaged about $12 billion
higher in 1974.

Business Conditions, January 1975

M em ber b a n k b o rro w in g s from
Federal Reserve banks reached a record
total o f almost $4 billion outstanding in
late summer. A substantial portion o f this
amount reflected a loan to the troubled
Franklin N ational Bank, eventually ac­
quired by another bank. Exclusive o f this
loan, member bank borrowings ranged
between $1 billion and $2 billion until De­
cember, when outstandings declined to the
lowest level in more than two years.

Regulations and guidelines
A m en d m en ts to Federal Reserve
regulations and other actions taken by the
Board o f Governors during 1974 were
m ainly related to monetary policy, bank li­
quidity problems, and the uneven impact
o f tight m oney on flow s o f credit to various
sectors o f the economy.
Regulation A, governing lending to
member banks by Federal Reserve banks,
was amended in September to permit the
application o f a “ special” discount rate,
higher than the basic rate, to member
banks requiring exceptionally large as­
sistance over prolonged periods. The
special rate was set initially at 10 percent—
2 percentage points above the basic dis­
count rate. The purpose o f the special rate
is to limit any rate advantage for long-term
assistance when the basic discount rate is
below market rates.
A n October amendment to Regulation
A permitted loans secured by residential
m ortgages at the lowest discount rate. Pur­
suant to the authority granted in the
Em ergency Home Purchase A ct o f 1974,
Federal Reserve banks were authorized to
make advances on the security o f residen­
tial m ortgages at the discount rate
applicable to loans secured by eligible
collateral as defined in the Federal Reserve
Act, which had previously excluded long­
term loans.
Member bank reserve requirements
(Regulation D) were restructured to en­




27

courage the issuance o f time deposits with
longer maturities and thus improve bank
liquidity. Supplemental or “ m arginal”
reserve requirements were removed. These
had been applicable to large time deposits
and certain other obligations above a base
amount since early 1973. The basic require­
m ent on time deposits with initial
maturities o f less than 180 days was in­
creased from 5 percent to 6 percent, except
for the first $5 m illion to which a 3 percent
requirement continued to apply. On time
deposits issued to mature in 180 days or
more the requirement was reduced from 5
percent to 3 percent. In addition, the re­
quired ratio o f reserves to demand deposits
over $400 m illion was reduced from 18 per­
cent to 17.5 percent. These changes, on
balance, released more than $1 billion o f
reserves in the fall when seasonal needs
were increasing and made additional
funds available to m ost member banks.
Early in the year the Board submitted
to Congress a proposal to require all types
o f financial institutions whose deposits are
used by the public in m aking payments to
hold reserves in accord with a specified
schedule. Very small nonmember in­
stitutions would be exempted under the
plan. The m ajor purpose o f the proposal
was to im prove monetary control and
reduce the competitive disadvantage borne
by member banks as a result o f monetary
action. The proposal did not result in any
legislative action in 1974.
Regulation Q, governing deposit in­
terest rates, w as amended to encourage
longer-maturity deposits and enable banks
to compete more effectively for them. As of
December 23, member banks were per­
mitted to offer up to 7.5 percent on “ invest­
ment certificates” in minimum denomi­
nations o f $1,000 maturing in six years or
more. Parallel action taken by other super­
visory authorities set a 7.75 percent ceiling
on similar certificates issued by thrift in­
stitutions.
In connection with legislation that in­

28

creased insurance coverage per account
from $20,000 to $40,000 and to $100,000 for
public time and savings accounts, the
Board amended Regulation Q to permit
member banks to accept savings accounts
o f governmental units and to pay the same
rate as thrift institutions (7.75 percent) on
time deposits o f less than $100,000 o f
governmental units.
Under conditions o f severe restraint
on overall credit expansion, a m ajor public
policy concern in 1974 was the allocation o f
a v a ila b le cred it a m o n g com p e tin g
demands. Because o f existing credit lines
and loan agreements and access to the
money and capital markets, large national
corporations were generally able to obtain
adequate financing despite increasingly
restrictive bank lending policies. Other
sectors, especially residential building,
were seriously weakened because avail­
able credit supplies were sharply curtailed.
In recognition o f the problems facing com ­
mercial banks in allocating funds am ong
customers, the Federal Advisory Council, a
group o f 12 leading bankers that meets
periodically with the Federal Reserve
Board, formulated a statement setting
forth suggestions as to the m ost ap­
propriate uses o f loanable funds. The
Council emphasized the need to meet work­
ing capital and investment needs o f
basically sound businesses and to provide
equitable credit distribution to the homebuilding and consumer sectors. Loans for
acquisitions and speculation were deemed
unsuitable. This statement was forwarded
by the Board to all member banks in midSeptember to serve as a guideline for lend­
ing policies.

Seventh District banking
Credit expansion at district member
banks fell short o f the high growth rates o f
the previous two years but was slightly
greater than the national pace. Excluding
interbank loans but including loans sold to




Federal Reserve Bank of Chicago

affiliates, total loans and investments of
district member banks rose 9 percent in
1974, compared to 15 percent in 1973. A s in
other recent years, bank loans expanded
more rapidly (11 percent) than total bank
credit. H oldings o f U.S. Treasury securities
declined 3 percent, while holdings o f other
types o f securities, primarily obligations of
states and political subdivisions, rose 7
percent—less than in other recent years.
In keeping with the national pattern,
credit expanded more rapidly at large
banks than at small- and medium-sized
banks. Loans at large district banks that
submit weekly condition reports increased
13 percent for the year, despite a fourthquarter decline. The largest percentage
increases—each up more than 20 percent—
were recorded for agricultural loans, loans
to nonbank financial institutions, and
commercial and industrial loans. Gains in
consumer instalment loans and real estate
loans were the slowest since 1971, while
loans on securities declined from a year
earlier. Loan expansion varied greatly
among these banks by areas, ranging from
less than 5 percent in Des M oines and
Detroit to 19 percent in Chicago. Virtually
all o f the 1974 gains in Chicago, Detroit,
and Milwaukee were recorded during the
first half o f the year.
Loan growth at smaller district banks
that do not report loans by type was a little
over 8 percent, with gains ranging from 5
percent in M ichigan to more than 12 per­
cent in Iowa. First-half data on loan com ­
position at all district banks other than
large weekly reporting banks indicate
slower growth than a year ago for all m ajor
types o f loans. Real estate loans were up 6
percent, a slower rate o f expansion than in
either the first or second h a lf o f 1973. Firsthalf gains in both consumer loans and
agricultural loans were around 3 percent.
In 1973 agricultural loans posted annual
gains o f 19 percent, and consumer loans
were up 14 percent. Commercial and in­
dustrial loans at these banks increased

Business Conditions, January 1975

29

Variations in rates of
loan expansion in the
district were similar to. . .

the patterns of growth in
time and savings deposits
LARGE BANKS
percent change based on
last Wed. in Dec.
-0 + 4
8
12
16 20 24 28
-----------1-----------1
-----------1-----------1
-----------1
-----------•
i----------- 1

LARGE BANKS*
percent change based on
last Wed. in Dec.
0
4
8
12

16

20

United States
United States
Chicago

Chicago

Detroit

Detroit
Indianapolis

Indianapolis

Milwaukee
Milwaukee

DesMoines

DesMoines

OTHER MEMBER BANKS
0
4
8
12
16
1
-------- 1
----------- 1-------- 1
---------- r-

20

OTHER MEMBER BANKS

United States
Illinois
Michigan
Indiana
Wisconsin
Iowa

‘ Data for the largest banks in major cities
include loans sold to affiliates but exclude
domestic commercial interbank loans.

almost 9 percent in the first h a lf o f 1974,
about 1 percentage point below the firsth a lf 1973 gain but twice the pace recorded
for the second h a lf o f 1973.
Collected demand deposits were vir­
tually the same on average in December
1974 as a year earlier, and district banks,
therefore, had to rely on interest-bearing
funds to finance the increase in loans and
investments. Time and savings deposits at
all district member banks increased 14 per­
cent with large banks up 17.5 percent and




0

4

8

12

16

20

24

28

1 ------- 1
------------1
----------1------------1
-----------------1
------------1 1
------

United States
Illinois
Michigan
Indiana
Wisconsin
Iowa

other banks up 9.6 percent. Excluding
large CDs, time and savings deposits at
large banks rose just over 4 percent.
Deposit inflow s at large banks were
augmented by increased use o f such non­
deposit sources o f funds as net purchases
o f federal funds, securities sold under
repurchase agreements, other borrowings,
amounts due their own foreign branches,
and loans sold to affiliates. Funds from
these sources increased 15 percent or $1.2
billion, one-third as much as in 1973.

30

Federal Reserve Bank of Chicago

Light in the tunnel
Early in 1975 the dow nsw ing in the
economy retained strong momentum. U n­
employment m oved to the highest rate
since before Pearl Harbor, and few
employers were recruiting. Consumer con­
fidence was at a low ebb and even families
not directly affected by unemployment
were spending cautiously. M any business
firms were cutting prices a n d /o r cutting
production to reduce inventories. Capital
expenditures were still rising, but price in­
flation accounted for most o f the gain and
m any com panies were reevaluating expan­
sion plans in view o f declining demand
and falling profits.
Monetary policy became more stimu­
lative in the fourth quarter o f 1974, and
further steps toward ease were taken in
early 1975, including successive cuts in the
discount rate and a reduction in reserve re­
qu irem en ts on demand accounts o f
member banks. Meanwhile, federal spend­
ing was accelerating partly because o f in­
creased payments to the unemployed and
partly because deferred program s, e.g.,
water pollution control, were reactivated.
B oth the A d m in istra tion and Con­
gressional leaders were advocating sub­
stantial tax reductions for both consumers
and businesses. The prospects o f an ex­
tremely large federal deficit in fiscal 1976
was not likely to deter m assive use o f fiscal
policy to reverse the econom ic downturn.
The decline in activity has been ac­
companied by adjustments that will help
promote a recovery, as in earlier dow n­
turns. Prices o f m any commodities, com ­
ponents, and finished goods have declined
from the inflated levels reached in 1974.
Shortages that had hampered m any ac­
tivities have largely disappeared. Funds
for m ortgages and other purposes have




become more available at lower rates.
Production in some industries has been
below final demand in recent m onths. All
p ostw a r re ce ssio n s h a ve been pre­
dom inantly inventory recessions which
were necessarily limited in duration
because stocks o f goods must be m ain­
ta in ed at levels adequate to serve
customers’ needs.
The opening paragraph o f this issue o f
Business Conditions enumerates a long
list o f calamities that struck the U.S.
econom y in 1974. The likelihood o f such a
confluence o f unfavorable developments
again in 1975 seems remote. The severity o f
the current decline in activity has en­
couraged com parisons with the Great
Depression o f 1929-33 when total output
declined by more than h a lf and the un­
employment rate rose from 3 to 25 percent.
The analogy, however, is not appropriate.
The experience o f the 1930s led to the
creation o f institutions and policies—later
refined and expanded—that were intended
to limit any future econom ic decline. In­
cluded are deposit insurance, m ortgage in­
su ran ce, m ortgage amortization, un­
employment compensation, social securi­
ty, medicare, vastly expanded private pen­
sions and insurance, enhanced powers o f
the Federal Reserve and other financial
agencies, farm incom e supports, and great­
ly improved statistical tools, all factors
helping to alleviate distress and moderate
declines in income, output, and em ploy­
ment.
Finally, there is the almost universal
determination to use the full power o f the
federal government to m aintain a viable
private economy. A cruel lesson w as learn­
ed in the Great Depression and its like will
not be seen again.

31

Business Conditions, January 1975

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