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A review by the Federal Reserve B an k of Chicago Business Conditions 1963 M arch Contents Trends in banking and finance 2 The European business outlook — slower growth? 5 Federal Reserve Ba nk o f Chicago in banking and finance -L -)ebt rose rapidly in 1962 as consumers, businesses and governmental units borrowed substantially more than they repaid. An ex pansion of 64 billion dollars in outstanding obligations during the year—more than in any other year except 1959 — pushed total net public and private debt past the trillion dollar mark.1 With the exception of Federal Government debt, where wars have accounted for the ma jor increments, all types of debt have shown a gradual secular rise, roughly corresponding to the over-all growth of the economy. Years when private debt has shown the largest in creases have generally been years of rapidly expanding business activity such as 1955 and 1959. This pattern reflects the demands for funds generated by consumer purchases of durable goods and houses and business ex penditures for plant, equipment and inven tories in boom periods. Although 1962 showed a gain in total production of goods and services of almost 7 per cent over the preceding year, it did not bear the earmarks of a boom year; substantial amounts of unused labor and industrial facili‘Debt figures used here are based on the net pub lic and private debt series published in the recent Annual Report of the Council of Economic Ad visers. “Net debt” excludes certain types of dupli 2 cating governmental and corporate debt. For the Federal sector, which includes agencies and trust funds, Federal holdings of Federal obligations are eliminated. For the state-local sector, debt is net of obligations held in sinking funds or by other statelocal units. Net corporate debt excludes obligations owed to other members of an affiliated system. ties remained at year-end. Nevertheless, strong activity in certain areas, such as con struction and auto buying, was reflected in associated debt forms—mortgages and con sumer credit. Nonfarm mortgages accounted for almost a third of last year’s total growth in debt. The 21 billion dollar increase in out standing mortgage debt was by far the largest on record. Consumer debt rose 6 billion— moderately less than in the record years of 1955 and 1959. Indebtedness of nonfinancial corporations rose 19 billion dollars, about evenly divided between short-term liabilities and long-term borrowing. This was a larger increase than in 1960 or 1961 but smaller than in postwar years of rapidly rising activity. Farm business showed relatively little increase in debt dur ing 1962 after a sharp 13 per cent rise in the previous year. The public sectors accounted for a quarter of last year’s debt expansion. State and local governments continued to spend more than was collected in taxes and other revenues and outstanding obligations of these units rose by a record 7 billion dollars, or more than 10 per cent. Federal Government expenditures also exceeded receipts and outstanding debt (to holders other than Federal agencies) rose 8.7 billion dollars. For the most part the 1962 increases in major types of debt extended the trends that have persisted since the end of World War II (see chart). While total debt in the economy has risen 80 per cent in the past decade, non- B u sin e ss C o n d itio n s, M arch farm mortgages and state-local obligations have nearly tripled. Farm and corporate busi ness debts have almost doubled. Consumer credit rose 130 per cent, following an even faster expansion in the early postwar years. Federal debt grew 15 per cent in the last 10 years after the modest decline from the wartime peak. Cyclical swings in Federal bor rowing have tended to move inversely with business and consumer debt as revenues re flect changes in personal and business in come, and expenditures show the effects of unemployment and other recession-sensitive programs. Despite the rapid growth of state-local obligations in recent years, the debt of these governmental units is a smaller proportion 1963 of the total than it was in 1940, prior to World War II. Personal debt, including mortgages and consumer credit, has increased in relative importance while the debt of busi ness firms has declined relative to the total. Federal debt, outside that held by Federal agencies and trust funds, accounts for about a fourth of the total, the same as in 1940. T r e a s u r y a t t r a c t s lo n g - t e r m fu n d s An active demand for U. S. Government obligations with maturities beyond five years has enabled the Treasury to continue to lengthen the average maturity of the debt without boosting long-term interest rates. This was demonstrated in both the auction sale of 250 million dollars of 25-30 year bonds in January and demand for the five and one-half year issue offered in the February refunding. G row th rates for major types of debt The winning syndicate an in 1962 continue postwar trends nounced a sellout of the long term bonds within an hour after they were awarded, with orders filled on a 60 per cent allotment corporate basis. Roughly half of these bonds federal were taken by insurance compa non-farm mortgage nies, pension and retirement funds and mutual savings banks—typi cally long-term holders. Commer state and local consumer cial banks took 19 per cent and dealers and brokers 16 per cent. Results of the refunding of 9.5 billion dollars of February 15 maturities showed that of the pub licly held portion (other than Federal Reserve and Treasury ac counts) 45 per cent was ex changed for the five and one-half year, 33A per cent bonds. This was surprisingly large, particu larly since holders of the maturing 1940 1962 securities had already been offered Federal Reserve Ba nk o f Chicago the chance to extend into the five-year area in the Treasury’s September advance refunding. The Treasury has created a new nonmarketable bond designed to fill the needs of persons who set up retirement pension plans under the Self-employed Individuals Tax Retirement Act of 1962. These bonds carry a 33A per cent return, similar to the regular series E and H savings bonds. However, the retirement bonds cannot be redeemed before the owner reaches the age of 59Vi years ex cept under certain hardship circumstances. P a y r o ll t a x e s h ig h e r While attention has focused recently upon proposals for income tax reductions, both employees and employers have been paying higher social security taxes since January 1. Under the 1961 amendments, contribution rates rose by Vi of 1 per cent to 3% per cent for both employers and employees. Similar increases are scheduled for 1966 and 1968, Increased social security taxes will meet expenses under current benefits and coverage by 1964 thus increasing the combined rate to 9 lA per cent on the taxable portion of payrolls. The rate for the self-employed is one and one-half times that for employees. The figures below show the effects of recent and scheduled in creases in rates per worker for those earning the maximum taxable amounts or more. 1957 1959 1960 1962 1963 1966 1968 Combined rate (per cent) 4 Vi 5 6 6V4 71/4 8V4 91/4 Maximum Total taxable payment wages per worker (dollars) 4,200 189 4,800 240 4,800 288 4,800 300 4,800 348 4,800 396 4,800 444 The rise in Federal receipts due to the most recent boost in payroll taxes is expected to be roughly 4 billion dollars for 1963. Changes in the income tax law proposed by the Presi dent were estimated to reduce taxes of indi viduals about 6 billion per year beginning in the second half of this year. However, the economic impact of the social security pro gram as a whole depends on the relation of tax contributions to benefit payments. Since 1958, income of the Old Age and Survivors Insurance and Disability trust funds combined has been somewhat less than disbursements; rapidly increasing benefit payments have more than offset higher con tribution rates. The 1961 amendment was in tended to restore the program as a whole to a self-supporting basis. Latest official Budget estimates anticipate that the new tax rates will produce receipts slightly in excess of the 16.6 billion dollars of benefit payments ex pected in fiscal 1964. The net effect of this program, therefore, is likely to offset to some extent any tax relief from other sources dur ing the year ahead. B u sin e ss C o n d itio n s, M arch 1963 The European business outlook —slower growth? ( j r o w t h of economic activity in Europe appeared to be leveling off in 1962, following the very rapid advances in several preceding years. This slackening had become evident in member countries of the European Free Trade Association (EFTA )1 in 1960 and 1961, long before it affected members of the Common Market.2 Accompanying the slowing growth rate of the chief industrial areas of Europe have been substantial declines in common stock prices; mounting pressures on profit margins in some key industries; some easing of demand pres sures; and a changing pattern of demand, with a smaller share of output going into new plant and equipment and exports and a larger share going into domestic consumption. These developments have important im plications for the United States. On one hand, any weakening of demand in Europe would likely be reflected in reduced exports from the United States while on the other it would tend to reduce the flow of American dollars to Europe for investment. The probable net effect on the balance of international pay ments of this country is, of course, uncertain. Through much of the past year the Com mon Market has exhibited little sustained growth in industrial production and during the summer months Canada was the only member of the OECD with a sizable gain. 'EFTA: Austria, Denmark, Norway, Portugal, Sweden, Switzerland and United Kingdom — also known as the “Outer Seven.” 2Common Market: Belgium, France, Italy, Lux embourg, Netherlands and West Germany — also known as the “Inner Six.” Within the Common Market the economic performance has varied from country to country; since 1960 Italy has shown the most robust rise in activity, followed by France, Germany and the Benelux countries, with the latter falling short of the area’s average growth in production. As it has become increasingly evident that some of the European countries have, in varying degrees, lost some of their earlier push, a number of prominent international economists have advocated the adoption of more expansionary economic policies in Europe. But a general concern over rising costs has led other policy makers to favor greater monetary and fiscal restraint. L e a d in g e x a m p le s The Federal Republic of Germany was the first of the six Common Market countries to achieve a vigorous and sustained rate of eco nomic growth. Between 1953 and 1961 Ger many’s industrial production advanced more than 8 per cent annually; in 1962, however, it rose only about 4 per cent. Rapid growth prior to 1962 had greatly reduced the country’s sizable manpower re serve and by the late Fifties the German economy had begun to rely increasingly on an inflow of workers from Italy and other Euro pean countries with labor surpluses. The tightened labor market, accentuated by the cutoff of the supply of East German workers, was accompanied by sharp increases in wage rates which recently have exceeded gains in productivity. 5 Federal Reserve Ba nk o f Chicago Consequently, profit margins in important German manufacturing industries have come under increasing pressure and the rate of in vestment in new plant and equipment has fallen off markedly. The first half of 1962 saw an increase of less than 4 per cent in investment in new facilities, while between 1958 and 1961 such investment had risen at a rate of somewhat over 10 per cent a year. As a result of the continuing rise in costs and the 5 per cent boost in official value of the German mark in early 1961, the excep tionally large German export trade surplus has declined substantially since the third quarter of 1961. While German exports con tinue to be very competitive in world mar kets, imports have risen considerably. Be tween 1958 and 1960 the consumer price index rose at an annual rate of just over 1 per cent, climbed 2.5 per cent in the ensuing year and an estimated 3.5 per cent in 1962. Although German economic growth slowed appreciably during the past year, re cent monetary and fiscal policies have had the net effect of restraining domestic demand. The maintenance of domestic price and ex change rate stability is a foremost objective of governmental policy. The Bonn Government has hinted that, if unions and employers do not reach “sensible” wage agreements, it will consider adopting tighter procedures for wage negotiations. Industrial production, selected areas Common Market EFTA 1958......... . 144 119 120 102 113 1959.......... . 153 125 129 116 125 Although not evident in the annual figures, United To ta l Canada States O EC D b (1 9 5 3 = 1 0 0 ) though the rise in this country was exaggerated somewhat since activity was rising from a re cession level in 1958. 1960......... . 171 134 130 119 132 industrial production declined some time dur 1961......... . 182 136 134 120 135 ing either 1960 or 1961 in all OECD areas 1962 *.. . . . 193 140 146 131 145 except the Common Market. Per cent change, 1958-62 34 The low in Canada was reached during the third quarter 18 22 28 28 of 1960, in the United States during the first quarter of 1961 and in the EFTA during the The data in the table indicate that between 1958 and the third quarter of 1962 industrial fourth quarter of 1961. Also, the recession was most pronounced in the United States production rose most rapidly in the Common with industrial production dropping 7 percent; Market (34 per cent) and less rapidly in the but it fell only 4 per cent and IV 2 per cent in EFTA (18 per cent) and in Canada 122 per cent). Canada and the EFTA, respectively. Production in the OECD grew at the same During the entire period since 1953, indus rate (28 per cent) as in the United States al trial production in the OECD increased 45 per *Third quarter, seasonally adjusted annual rate. bOECD, the successor o f the Organization fo r European Economic Cooperation (OEEC), includes both the Common Market and the EFTA countries as well as a few other European countries, the United States and Canada— 20 countries in all. 6 cent o r at an average annual rate of about 4 per cent. W h ile production in the United States fell significantly short of this, produc tion in the Common Market rose at an annual rate of about 7V2 per cent. B u sin e ss C o n d itio n s, M arch In France, pockets of unemployment have emerged in recent months, owing to the in flux of a sizable number of refugees from Algeria and the release of servicemen follow ing termination of the Algerian War last spring. These are expected to be absorbed readily if the French economy continues to grow vigorously. An over-all rise of 6 per cent in production is projected for 1963, or slightly more than the increase last year. However, there are acute shortages of skilled workers in several key industries, and this has contributed to mounting wage-price pressures. Retail prices have been rising about 4 per cent annually. Incomes, reflecting higher wages and increased social insurance payments, have risen at an even faster pace and, therefore, production is shifting some what from the filling of foreign orders to the satisfaction of domestic consumer demand. Italy has been the fastest growing economy in the European Common Market in recent years. Between 1959 and 1961 industrial production rose at an annual rate of about 13 per cent. For 1962 a further rise of about 10 per cent was anticipated. Moreover, pros pects for the current year appear good, al though uncertainty in the business sector re garding the outcome of forthcoming national elections could exercise a restraining influ ence. While there are still substantial numbers of unemployed in southern Italy, many lack the skills and training required by industrial firms, a problem common to other countries as well. In some industries labor shortages now exist and large wage increases are com monplace. This has intensified pressures on business profit margins and could cause some cutbacks in the rate of business capital invest ment. From 1959 to 1961 consumer prices increased an average of about 2 per cent annually, but last year the price index moved 1963 Industrial production has grown rapidly in the Common Market countries index, 1953 = 100 200r 1953 1958 1959 1960 1961 1962 up at least twice that amount. (Spain has aroused growing interest in the last few years. Beginning in 1959 the country embarked upon an extensive program of dis mantling rigid controls over the economy, in cluding many import restrictions, which may succeed in restoring the country to economic health. If her application to join the Common Market is accepted, Spain may achieve vigor ous economic growth.) Britain's economy apparently is expanding less rapidly than those of its chief competi tors in Europe. After rising gradually since the early part of 1962, British industrial pro duction declined sharply in October but was followed by a small recovery in November. The over-all gain for the year is believed to be less than 1 per cent, although British con sumer prices advanced about 4 per cent. In 7 Federal Reserve Ba nk o f Chicago mid-January the unemployment rate had inched up to 3.6 per cent of the work force— the highest in Britain since 1947. Over the last two years there has been little change in the size of Britain’s foreign trade balance. The reversal of the business advance in Britain followed in the wake of a rather sobering atmosphere in negotiations concern ing Britain’s bid to join the Common Market. Investment in new plant and equipment has dropped off sharply despite credit becoming more readily available and the government further liberalizing investment and deprecia tion allowances. An inquiry made toward the end of last year by the Federation of British Industries revealed that a further reduction of capital expenditures by private industry was in prospect. Conclusion A slowdown of business activity in several European countries last summer led the Com mon Market to launch a study of measures to be used, if necessary, to counteract a re- Consum er prices rose further in major European countries in 1962 8 cession. The proposed actions include tax cuts, heavier government spending and deficit financing. However, most of the member gov ernments apparently believe that prompt im plementation is necessary. For the most part the slowdown has been merely a reduced rate of rise and appears to have resulted largely from labor shortages rather than inadequate demand. European markets for consumer goods are still expand ing rapidly. In 1962 private consumption in the Common Market for the first time ad vanced more rapidly than capital investment. It would appear that the upward pressures on wages and prices in countries such as Italy, France and Germany could be relieved somewhat by a more plentiful supply of goods. Labor shortages cannot be eliminated quickly, although recourse to more capitalintensive manufacturing processes will tend to relieve this pressure in the long run. Tariff reductions by the Common Market countries would be one means of providing a prompt increase in supply of goods and would be regarded by their world trading partners— perhaps primarily the United States—as superior to monetary and fiscal restraint as an anti-inflation weapon. Such reductions would not only increase the sup ply of goods for consumption but also those needed for the further mechanization of pro duction; in addition, this would help the in dustrial countries with unused labor and plant capacity (for example, the United States and England) to accelerate their own growth of production. It is hoped, therefore, that pend ing the start of tariff negotiations with the United States, under the Trade Expansion Act of 1962, the Common Market authorities in Brussels will see the possible widespread benefits of helping to bring about a further liberalization of international trade.
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