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A REVIEW BYJHE FEDERAL ANK OF Cl jfr1 nr- AY 1950 Balance Sheet of Agriculture Farm Asset Values Decline, Liabilities Continue Rise Farm asset values decreased in 1949 for the first time in more than a decade while farm liabilities continued the rise which has been under way since 1946. As a result, proprietors’ equities were reduced 5.1 billion dollars. Physical assets of agriculture on January 1, 1950, were valued at about 102 billion dollars and financial assets at slightly over 21 billion. The combined total of 123 billion dollars represents a decline from last year of 3.4 per cent; however, it is still more than two and a fifth times the prewar figure for 1940. Owner equities in these assets ap proximate 111 billion dollars, down 4.4 per cent from Jan uary 1, 1949, but 154 per cent greater than prewar 1940. In previous years asset values increased largely as a result of rising prices. The tapering off from the postwar peak reflects primarily lower market values of real estate, live stock, and stored crops. The 1949 decline of four billion dollars in real estate values was the major contributing factor in the lowering of farm assets. Seventh District declines during the same period have been somewhat more moderate. Actually some areas registered increases—generally those of exceotionally productive soil or where farm income has been relatively well maintained. Livestock values on January 1, 1950, were 13.2 billion dollars, 10 per cent less than the record of a year ago. The decline was due entirely to lower prices since actual live stock numbers increased two per cent. For the Seventh District the value of livestock fell almost one per cent more than that for the United States. Crops stored on and off the nation’s farms declined nine per cent in value. Machinery and motor equipment represent the largest offset to the decline in asset values with a 20 per cent in crease. This is to some extent a bookkeeping entry as prices of new machinery in 1949 were the highest on rec ord. The physical quantity of machinery and equipment on farms, however, increased about 11 per cent during 1949 with farmers purchasing more than replacement needs. Household equipment value increased by about three per cent. The financial assets of agriculture expanded from only five billion dollars in 1940 to a high of almost 22 bil lion on January 1,1948, and as of January 1, 1950, totaled 21.2 billion. The decrease in 1949 was almost one per cent. Deposits and currency dropped 800 million dollars or five per cent, continuing the decline started in 1948, while in vestments in savings bonds and cooperatives were up 1.5 per cent and three per cent, respectively. Information available indicates that the trend in demand deposits in country banks for the Seventh District is about the same as for the United States while time deposits declined rela tive to that for the nation. A decrease in total deposits was more evident for Wisconsin and Michigan than for other states in the Seventh District. This trend in finan cial assets of agriculture reflects very largely the changes in net income of farm operators, which reached a record high of 17.8 billion dollars in 1947, followed by declines of six per cent in 1948 and 17 per cent in 1949. All liabilities rose during 1949—real estate mortgages and non-real-estate debt each increased seven per cent— a total of 776 million dollars. Mortgage debt on the nation’s farms increased for the fourth successive year. The increase has been greater for each succeeding year, but the mortgage debt is still 17 per cent less than for the year 1940. Payments on debts have declined chiefly because of expenditures made by farmers for equipment and improvements and because of higher living costs. Farmers’ non-real-estate debt increased 434 million dollars in 1949. Excluding loans held or guaranteed by the Commodity Credit Corporation, short-term debt in creased eight per cent compared with 20 per cent in 1948. Preliminary estimates for the Seventh District show a similar increase in short-term debt. If expressed in terms of the 1940 price level, the bal ance sheet of agriculture would reflect only changes in quantity. Shown in these prices the amount of physical assets from 1940 to 1950 increased 38 per cent; financial assets excluding investment in cooperatives, 139 per cent; equities, 38 per cent; and liabilities decreased 48 per cent. BALANCE SHEET OF AGRICULTURE JANUARY 1, 1950, WITH COMPARISONS1 (Dollar amounts in millions) Item Jan. 1, 1940 Per Cent Per Cent Change Change 1940-50 1949-50 Jan. 1, 1949 Jan. 1. 19502 65,168 61,200 -6.09 +81.92 14,657 11,114 8,475 6,000 -9.87 13,211 13,390 +20.48 7,700 -9.15 6,200 +3.33 +157.37 +329.44 + 191.12 +45.03 14,800 5,024 2,036 14,000 5,100 2,100 -5.41 +1.51 +3.14 +258.97 + 1,948.19 +154.24 53,788 127,274 122,901 -3.44 +128.49 ASSETS Physical assets: Real estate....................................... 33,642 N on-real-estate: 5,133 Machinery and motor vehicles. 3,118 Crops, stored on and off farms3. 2.645 4,275 Household equipment................ Financial assets: 3,900 Deposits and currency................. 249 United States savings bonds. . . 826 Investment in cooperatives........ Total........................................... CLAIMS Liabilities: Real estate mortgages.................. Non-real-estate debt: To principal institutions: Excluding loans held or guar anteed by Commodity Credit Corporation............................... Loans held or guaranteed by Commodity Credit Corporation............................... To others..................................... 6,586 5,108 5,450 +6.70 -17.25 1,504 2,714 2,900 +6.85 +92.82 445 1,500 1,152 2,200 1,200 2,400 +4.17 +9.09 + 169.66 +60.00 Total........................................... 10,035 11,174 11,950 Proprietors’ equities........................ 43,753 116,100 110,951 +6.94 +19.08 -4.44 + 153.58 -3.44 +128.49 Total........................................... 53,788 127,274 122,901 irThe margin of error of the estimates varies with the items. Preliminary estimate. 3Crops on farms and held in warehouses as security for CCC loans. SOURCE: Bureau of Agricultural Economics. U. S. Department, of Agriculture. Current Mortgage and Housing Developments Financial Arrangements Dominate Home-Building Outlook The housing boom ranks as one of the most important factors supporting current high levels of business activity, both in the Midwest and in the nation generally. It is to be expected, therefore, that considerable interest would be evidenced in questions concerning it. The one-fourth per cent reduction in FHA interest rates, combined with increases in the percentage of appraised value covered by mortgage insurance under the new housing act, seem certain to have significant effects upon future housing and mortgage developments. How long can this boom be expected to last? How important is mortgage finance in determining the future levels of effective housing demand, and what are the pros pects for financial arrangements favorable to a continuing boom level of building? Will the newly-enacted Housing Act of 1950 stimulate or dampen apartment building? Are construction costs now stabilized and are home buyers and mortgage lenders convinced that a new long-run price structure for homes has been established? Will the relative position of residential construction in the Seventh Federal Reserve District, in comparison with the rest of the na tion, continue the improvement observed during the last six months? Answers to these and related questions are of particular importance to Midwest home builders and mortgage lenders. A national total of one million or more new houses per year for the next several years would go far toward sup porting an extended high volume of general business. Al though direct expenditures for housing construction com prise only about three per cent of the gross national product, there are important subsidiary effects from this kind of activity. New homes must be furnished, and this requires heavy outlays for furniture, floor coverings, and draperies. Increased demands for major household appli ances and fixed home equipment also are created. A large volume of residential construction also is ac companied by development of raw land. This calls for substantial expenditures for streets, sewer systems, water and gas mains, telephone and power connections, and schools and other community facilities. Whether a home-building total of a million a year or more will be continued through 1950 and perhaps into future years depends in large part upon availability of mortgage credit. In the main, postwar residential con struction has been financed on a low equity, high loan basis. About half of all dwelling units started in 1949 were financed under FHA and VA programs which gen erally carry long maturity mortgages covering 80 per cent or more of the cost. Despite the very large aggregate holdings of liquid assets by individuals, it appears that a substantial fraction of the families needing housing fa cilities either are not in possession of sufficient liquid asset holdings to make substantial equity payments or are unwilling to use their assets in this way. Effective housing demand, it appears, must rely heav ily upon the continued making of mortgages on high loan-to-value ratios. Moreover, the willingness of many lenders to make a marginally important volume of such loans is conditioned by Government programs for insur ing or guaranteeing a part of the risk on these loans, as is evidenced by the chronic requests on the part of vari ous pressure groups to have these provisions liberalized and extended. CURRENT HOUSING BOOM Approximately three and one-half million permanent nonfarm homes have been built since the end of the war. A high proportion of these—83 per cent—are single family structures, and nearly all of them—98 per cent— were privately financed. The period 1923-1926 produced almost exactly the same total of new dwelling units as the four years 1946-1949, but the greater emphasis on rental units during the earlier building boom resulted in a small er fraction—59 per cent—of the units being built as single-family structures. Public housing was not a factor in the boom of the 1920’s, since no public units were con structed prior to 1935. Perhaps the most interesting postwar year from the standpoint of residential developments was 1949, in which substantial increases in starts during the last half of the year upset earlier expectations. During the general busi ness decline of early 1949 most observers—including the official forecasters in the U. S. Departments of Commerce and Labor—felt that building volume for the year would be somewhat below 1948’s total. Starts during the first half of 1949 were disappointing by comparison with the same months of 1947 and 1948. These estimates of fu ture prospects, however, fell short of the actual perform ance which turned out to be of record proportions—an estimated 1,025,000 dwelling units. This all-time high volume was in small part the result of a doubled volume of publicly-financed dwelling units, but in much greater part it reflected liberalized financing terms which were legislated during July and the revival in general business confidence which developed as the year progressed. An important factor contributing to the record num ber of starts in 1949 was the trend toward construction of cheaper dwelling units on the part of many builders. The willingness of builders to cater to the less than $10,000 market combined with the liberal financing ar rangements and increased emphasis on multi-family units explains most of the unseasonally large number of hous ing starts of last fall and winter and the early months of 1950. A further influence causing the high volume of last Page 1 year was the apparent belief—particularly on the part of many potential home buyers having substantial liquid asset holdings—that prices and construction costs had stabilized and might move upward and that there was no use waiting for them to drop to lower levels (see Chart 1). This sector of housing demand, which is difficult to ana lyze and quantify, may well continue into the future months as a strong supporting force toward a high level of housing activity, and is, of course, less dependent upon liberal financing terms. An important aspect of all postwar home building is the tendency toward very small single-family homes and “efficiency” apartments. This development has been essen tially in response to high building costs and legal limita tions upon mortgage insurance, since by this means the price of the “house” can be kept within loan limits. Also, the secular trend toward smaller families during the decade of the 1930’s meant that much of the housing de mand preferred this smaller housing unit. Postwar birth rates and population developments, however, indicate a reversal of this earlier trend toward smaller families with the result that current housing need is more heavily in the three-bedroom category. Home builders will be required to use considerable ingenuity in supplying this potential market for larger houses within a price structure that such families can afford. Many mortgage lenders are deeply concerned over the postwar emphasis upon very small dwelling units. It is generally agreed that with the exception of the “green lumber period” most houses built during the postwar years conform to high structural standards. Nevertheless, great concern is voiced in some financial quarters about the adequacy of these very small houses for living needs. With present day high mortgage loans and long maturi ties, lenders must consider not only the structural qual ity of the building but also its usefulness as a dwelling unit. Many of them feel that in certain areas the fourroom single-family detached house and the efficiency apartment already have been overbuilt. This, however, would not be taken to mean that a substantial market for more adequate dwelling units might not exist in these areas. boom nationally but that nonresidential construction has maintained its expected comparative position. To some extent this was to have been expected in view of the great er relative importance of manufacturing in this section and the heavier population growth in other parts of the nation, such as the South, Southwest, Pacific Coast, and such Eastern cities as New York, Baltimore, and Wash ington. The greater emphasis upon manufacturing in the Seventh District appears to have resulted in a consid erable net in-migration of workers whose housing needs are very great but whose incomes and asset holdings are not sufficient to buy homes. This is especially true of the Negroes who migrated to Midwest cities during the war and many of whom have remained. Among the District’s principal cities, only Detroit has had a housing boom large enough to rank it with the lead ing cities of the nation. Two reasons seem to account for Detroit’s record: (1) the area experienced a considerable population growth over the last two decades and, there fore, had a greater backlog of demand and (2) builders there have been more successful in achieving a low-cost house. Average cost per new house in Detroit during 1949 was about $8,300 compared with about $10,800 in Chi cago, or 23 per cent less. Wage rates and general prices in the two cities are more comparable. It is particularly to be noted that apartment building still is lagging in major Midwest cities. Available data in dicate that in the District’s two largest industrial areas— Chicago and Detroit—rental-type housing comprised only 17 per cent of all housing built during 1949 in the former, and seven per cent in the latter. Of the 15 major metro politan areas in the nation for which data are available, none shows as small a proportion of rental-type units as these two. During the last few months of 1949 and early 1950, heavy commitments in Chicago under Section 608 of the National Housing Act indicate that steps were being taken to alleviate this shortage of new rental-type strucCHART I RESIDENTIAL CONSTRUCTION COSTS UNITED STATES, 1939-49 (I939-IOO) SEVENTH DISTRICT BUILDING TRENDS During the second half of 1949 and the first quarter of 19S0 the volume of both mortgage recordings and housing starts in the Seventh Federal Reserve District increased relative to their previous position in the nation. Throughout the last half of 1949 more than 18 per cent of the dollar volume of new housing construction in urban areas was authorized in Seventh District States as com pared with approximately 15 per cent in the earlier post war period. Nonfarm mortgage recordings, however, reg istered less than a one per cent relative gain—from 16.7 per cent to 17.4 per cent—possibly indicating that real estate activity in existing homes did not increase pro portionately with new building. It commonly has been observed that residential build ing in the Midwest has failed to keep pace with the Page 2 ^ RESIDENCES RTOn I Mr.N BUILDINGS I o, rtU I Cl_3 AND OFFICE SOURCE: U 8 DEPARTMENT OF COMMERCE (E.H BOECKH AN0 ASSOCIATES) tures in the District’s largest city. Most of these com mitments will be built during the current year. However, greatly increased building of multi-unit structures, both in Chicago and in other major cities of the District, will be required if a “reasonable” balance between new rental facilities and new single-family houses is to be approached. In 1940 rental-type structures comprised 70 per cent of all existing dwelling units in Chicago. In Detroit the pro portion was 47 per cent. Under the previously existing Section 608, FHA could insure 90 per cent of the entire project cost if the cost per apartment did not exceed $8,100. Even these liberal terms did not stimulate much activity in the Seventh District until the last few months of Section 608’s life. Section 207 as now amended permits FHA to insure 90 per cent of the first $7,000 of appraised value per unit and 60 per cent of the next $3,000. These provisions obviously will entail larger equity outlays by the owner and seem un likely to be attractive in the face of competition from controlled-rental buildings. CAPITAL MARKET TRENDS The supply of capital available for mortgage and most other consumer financing needs has increased substantial ly during the last 18 months. This increase reflects pri marily the lessened commercial and industrial demands for funds after the completion of most postwar expansion plans and contracted requirements for working capital resulting from the end of the price inflation. However, the increased supply of capital funds stems in part from expanded savings in the form of insurance reserves and pension and retirement fund balances, as well as a con tinued rise in time deposits and savings and loan share accounts. It is in answer to these supply and demand factors that basic interest rates have followed a general, though not always continuous, downward course in the last year, a trend which will be furthered by the re duced FHA rates. The underlying change in the capital market has re sulted in an increased availability of funds for mortgage lending purposes. During late 1947 and early 1948 heavy demands for funds in the capital markets resulted in a rise in yields on both corporate and municipal bonds, as well as rising interest rates on loans. In this competitive market, mortgage loans—particularly the four per cent loans guaranteed by the Veterans Administration—were considered by many financial institutions as noncompeti tive investments, and in fact the market for this paper came close to drying up completely. It was commonly said at that time that home-building prospects were in jeopardy because of the low rates on guaranteed mort gages. The subsequent decline in demand for funds and the concomitant increase in the supply of available capi tal now has changed that situation, and numerous finan cial institutions both large and small have become more interested in four per cent loans. However, in the home mortgage field costs of acquisi tion, servicing, and reserves for bad loans are very high, and, therefore, the net return which can be expected from a four per cent mortgage is little better than the return from a Government or corporate bond. A recent study of mortgage costs by the National Bureau of Economic Re search revealed that acquisition, servicing, and reserve costs total 1.33 per cent for the mortgage portfolios of commercial banks and 1.5 per cent for insurance com panies. This means that the net return on a four per cent mortgage would be between two and one-half and three per cent, a range within which there are still many com petitive investments carrying less risk. It is sometimes taken for granted that a financial in stitution carries no risk whatever on a guaranteed or in sured mortgage loan. However, this is not strictly true since less than half of all outstanding mortgage money is on loans covered by insurance or guarantee. Virtually all mortgage lenders make many loans of the conventional type, that is, with neither guarantee nor insurance. Very naturally, each lender will be concerned with the possible effects of new construction upon the property values sup porting his existing portfolio. Equally important with risk of ultimate loss is the factor of delay which would almost certainly accompany a period of widespread mortgage foreclosures. Neither VA nor FHA has gone through such a period, and, there fore, the problems of processing large numbers of claims in a falling market are not known. The mere action of foreclosure, however, is time consuming, and there can be little question that the processing of claims in large num bers would necessarily be slow. In addition to these fac tors, foreclosure proceedings must be undertaken in most cases by the lending institution, and it is they who would reap the adverse public relations inevitably accompany ing such a process. In view of these factors, it is understandable that lend ers would consider the long-run worth of the loan, irre spective of Government guarantee or insurance. In other words, most lending institutions could not follow the policy of making any and all mortgage loans simply be cause they were eligible for Federal insurance or guaran tee. Rather, these lenders—who usually have a keen feel for the effective demand in their own localities—prefer to make only such loans as show promise of soundness, both from the standpoint of the long-run value of the property itself and also the ability of the mortgagor to meet his amortized payments. It is within this framework that present day mortgage lending is carried on, and it is because of these considera tions that the Federal Government has found it necessary to establish a market through FNMA for loans which it already guarantees. Looking toward the future it is prob ably safe to say that the Government will find it neces sary to continue this mortgage-buying agency into the fu ture years if still more liberalized credit arrangements are to be the principal support for high-level residential construction. OUTLOOK UNDER NEW HOUSING ACT Although the prospect for mortgage lending and home building in the Seventh District, as in other parts of the Page 3 nation, will be clouded until final interpretation of the recently-passed Housing Act of 19S0, the current year gives promise of exceedingly high mortgage and home building volume. First quarter starts are estimated to be nearly 60 per cent higher than the total for the first three months of 1949. Scattered reports indicate that specula tively built homes which were started last fall and now are reaching completion are finding a ready market. Con tinued strength in this market should result in a volume of homes built for sale at least equal to that of last year. Public housing volume is expected to reach about 80,000 units in 1950, and this, of course, will swell the over-all total of dwelling units built, although it will have no di rect effect upon mortgage volume. Recent estimates by the U. S. Department of Com merce place the still-existing national backlog of housing demand at a figure between one million and two and onehalf million dwelling units. Since 5-6 hundred thousand new houses per year are required to satisfy the “normal” increment of families needing shelter, these estimates of backlog indicate a two to five year span during which a million houses per year might be demanded. Such esti mates necessarily are rough and depend upon such im ponderable factors as the desire of doubled-up families to have living quarters of their own and the number of houses needed to provide an “adequate” vacancy ratio. Nevertheless, they do offer evidence that a high volume of new housing demand will exist provided the price and financing arrangements are mutually acceptable to the buyer and the financing institution. Confirming the likeli hood of basic demand strength, recent announcement by the Federal Reserve Board states that about one million consumers indicate intentions to buy new homes in 1950. The newly-passed legislation seems likely on balance to stimulate further easing of mortgage credit. Along with the rate drop it calls for still easier terms for single family construction and home purchase, but somewhat tighter provisions for apartment construction, although this may not become evident immediately because the “bank” of commitments carried over from Section 608 about equals all starts under this section during 1949. A total of approximately four billion dollars of additional housing credit is authorized by the new Act, and in some cases these authorizations are for entirely new programs. Perhaps the most significant development affecting the total volume of rental-type housing is the expiration of Section 608, National Housing Act, and the newly-en acted amendments to Section 207. Whereas it was for merly possible for promoters of apartment building proj ects to obtain insurance on virtually all of the construc tion cost by building of “efficiency” apartments, it will be necessary under new commitments for the builder to sup ply a substantial amount of equity money. This equity investment will total about 20 per cent of the project cost if the average cost per unit is $10,000 and if FHA apprais als approximate actual construction costs. To the extent that appraisals are below construction cost a greater pro portion of equity money would be needed, but the Act is so drawn as to encourage apartments averaging less than $10,000 per unit. Page 4 Since there is a specific attempt in the newly-passed law to encourage construction of homes having 3-4 bed rooms, there is some possibility that this large potential market may be tapped to a greater extent in the present year. Persons building homes containing three bedrooms may obtain insured mortgages covering 95 per cent of the first $8,500 of appraised value, and this provision may make home building financially feasible for numerous families who were previously unable to go ahead. The Federal National Mortgage Association will con tinue to buy mortgages, which are insured by FHA or guaranteed by the Veterans’ Administration, up to the new limitation of 2.75 billion dollars of total holdings. Because of the limitation this year’s total purchases prob ably will be smaller than the nearly one billion dollars used in 1949. Nevertheless, the probable effects of the new legal limit are not entirely apparent, since Fannie Mae’s success in selling mortgages now in its portfolio makes possible a greater buying program in 1950 than would be indicated by the fact that only 250 million dol lars of additional funds were voted to the agency. Whether the Seventh District will continue to improve its relative position in home building, as compared with the nation as a whole, during the present year depends importantly upon the volume of rental-type units which are built. Although the expiration of Section 608 may have a longer-run dampening effect upon apartment building, commitments made prior to the expiration seem likely to assure a much larger total of rental units than were built last year. This prospect, in addition to the ex pected volume of single family construction, seems likely to increase the Midwest’s standing in the national hous ing totals. NONFARM HOUSING STARTS AND MORTGAGE RECORDINGS UNITED STATES, 1939-49 DWELLING UNITS STARTED 12,000 STARTS Business Inventories and the Business Cycle No Heavy Liquidation Likely in *50 % By the beginning of the second quarter the nation’s business was well on its way toward a fulfilment of the “good first half” prophecies of last December. Whatever difficulties lie ahead, prosperity has not been threatened seriously so far in 1950 by the type of inven tory liquidation evident last year. In fact, one basis for the favorable trend in production early in the year was the reduced level of inventories held by manufacturers and trade firms. The coal and steel strikes, cautious in ventory policies, and high consumer spending during 1949 had worn stocks down to a point where reordering was necessary in many lines to rebuild inventories to meet adequately anticipated sales volume. On the other hand, no important over-all inventory increase is likely. Trade firms are continuing to buy carefully, believing that most prices have not yet undergone sufficient read justment. INVENTORIES SLASHED IN 1949 * » Overcautious inventory policy in the first half of last year threatened to turn a moderate dip in business activity into a full-scale downturn. From 1945 through 1948 business inventories rose steadily as a result both of higher prices and larger physical volume. In January of 1949 total inventories on a seasonally adjusted basis reached 58.5 billion dollars, an all-time peak. By the end of the year they had declined 4.7 billion dollars, or eight per cent. About the same proportional decline occurred in physical industrial output during 1949. Well into 1949 manufacturers, retailers, and whole salers marked time, allowed their stocks to run off, and waited to determine whether a real depression or a sub stantial decline in prices would develop. However, con sumers continued to buy, showing no desire to retrench in the expectation of any serious trouble ahead. Retail sales were remarkably steady at high levels all during 1949. The total for the year was 128 billion dollars, off less than two per cent from 1948, and physical volume was somewhat higher. Over 5.1 million automobiles and about 2.8 million television sets were produced and absorbed by the markets. Sales of household appliances, clothing, and shoes, which had been hit earlier than busi ness generally, began to revive. Demand in 1949 was no longer a matter of war-in duced backlogs or a need to “fill the pipelines.” Instead, general business activity rested on a firm base of consumer demand and income far above prewar levels. By mid summer of last year many firms were finding their stocks inadequate, and new orders began to increase. Six months of attrition had carried inventory depletion further than could be justified by sales prospects. Lags in the restock ing process, plus the effects of important strikes in the fall, caused inventories to continue to decline through the remainder of 1949. INVENTORY CHANGES AND BUSINESS CYCLES Inventory changes can have a dramatic effect upon general business conditions. The downturns of 1920 and 1937 were, to say the least, aggravated by unwarranted accumulations of stocks and their subsequent liquidation. After the first world war merchants scrambled for goods with the hope of achieving speculative gains. This activ ity plus high levels of consumer demand caused prices to rise to unprecedented heights. When prices fell sharply in 1921 they carried the wreckage of many enterprises down with them. In 1936, a revival of business confidence brought an overexpansion of inventories. This unstable type of busi ness expenditure came to an end in the middle of 1937 and the process was reversed. Goods were sold from in ventory and production was cut back. Many observers referred to the situation as an “inventory recession.” When inventories are rising the net additions are an increase in the demand for goods beyond current con sumption. Usually, the desire to increase stocks comes at the same time that retail trade is brisk. The result is greater upward pressure upon prices, and as they rise a speculative motive for further inventory accumulation is introduced. When inventories are falling they are reacting to the expectations that sales at the retail level are going to drop off. Additional goods are offered on the market when they can least easily be absorbed. An inventoryprice-deflation spiral results, for at the same time less money is being placed in the income stream through the productive process. Inventory decisions influence prices and, in turn, are influenced by them. Changes in inventories lag about six months behind changes in sales. There are two main reasons: (1) in ventory accumulation or decline is influenced by the momentum of the productive process and the level of out standing orders, and (2) price changes are immediately reflected in sales but not in inventory book values. This lag was evidenced in previous business crises. In 1930, in ventories did not turn down until the second quarter. In 1932, sales picked up near the end of the year, but inven tories continued their downward course until mid-1933. In 1948, total business sales reached their peak in Sep tember, but inventories continued to rise into Tanuary of 1949. Businessmen constantly make decisions which are based upon an evaluation of the economic outlook, and these very decisions have an important effect upon actual developments. Capital expenditures are usually given foremost attention in discussions of the effect of business Page 5 plans and attitudes upon the cyde. There is an unfor Businessmen’s inventory decisions are largely influ tunate tendency to underestimate the importance of in enced by anticipated sales, but there are a number of ventory policy. Outlays on capital goods and inventory other factors which must be considered. What are the accumulation both involve great increases in business prospects for price changes? It is always desirable to spending in boom times. On the way down, capital ex have inventories at high levels when prices are due to rise penditures, however far they may be reduced, still pro and at a minimum when deflationary tendencies are vide some positive stimulus, but inventory accumulation strong. Is supply expected to be tight in the future? Re gives way to net liquidation. When inventories are al tailers’ stocks rose rapidly in 1942 in view of prospective lowed to run off, the depressing consequences may be wartime shortages. A similar situation existed last Octo enormous. Sales exceed production, and the effect is ber, when steel users increased their orders because the similar in some respects to a large net increase of imports strike appeared imminent. Over the past decades businessmen have learned a from abroad. In 1930, the first year of decline after the prosperity good deal about inventory management. Trade firms have of the twenties, spending on producers’ durable equip managed to conduct their activities with a constantly de ment (an important part of capital spending) was 1.5 bil creasing ratio of stocks to sales. In 1940, retail sales were lion dollars less than in 1929. When the inventory liqui at about the 1929 level, but inventories were only 80 per dation in 1930 is added to the net accumulation of 1929, cent as large. In 1939, sales for all business were 6.6 times the total is 1.8 billion. Inventory changes were evidently inventories. During recent years this ratio has been about more important in furthering the depression in its early eight to one. This steady trend toward faster inventory stages than the drop in spending on producers’ goods. A turnover is the result of a number of factors: (1) better more striking example is offered by the 1937-38 down control through perpetual inventory methods and other turn. In 1938, producers’ durables again dropped 1.5 bil improved techniques, (2) faster and more reliable service lion dollars, but inventory spending declined 3.1 billion, from suppliers, (3) better sales forecasting, (4) greater or almost twice as much. Last year, producers’ durables caution on the part of management, and (5) insufficient fell only one billion dollars, but the cut in inventory working capital in the hands of trade firms. The trend toward smaller inventories per unit of spending reached the impressive total of 8.8 billion. The sales is highly desirable. There is nothing to be gained fact that this change in business spending could be ab by keeping inventories themselves at a high level. It is sorbed without disastrous results is an optimistic com the fluctuations that must be avoided if inventory levels mentary on the inherent stability of the economy today. are not to affect the business cycle, and changes are less In the postwar period, speculative inventory accumu lation did not reach serious proportions, and stocks never troublesome if they are kept low in relation to sales. became very heavy when compared to sales. Any tenden However, if a merchant’s stocks are inadequate in quan cy for inventory reductions last year to start business tity or variety, sales may be lost. Retailers in Midwestern activity snowballing downward was offset by high con cities and in the nation tended to underestimate demand sumer income and spending which did not decline ap all during 1949. In December of last year it was neces sary to place rush orders for all sorts of commodities to preciably. satisfy higher demand than had been anticipated. Manufacturers’ inventories are less subject to manPROBLEMS OF INVENTORY MANAGEMENT CHART Inventories are a serious problem for individual firms as well as for the economy as a whole, and poor inventory management is an important cause of business failure. One-third of the gross working capital of all corporations consists of inventories. They amount to 25 per cent of total assets of manufacturers, and nearly 40 per cent of total assets of trade firms. At the end of 1949, total busi ness inventories were valued at 53.8 billion. Of this amount manufacturers held 57 per cent, wholesalers 17 per cent, and retailers 26 per cent. The inventories of manufacturers, the largest group, are also, unfortunately, the most volatile. Durable goods industries, of special importance to the Seventh District, account for almost half of the total for all manufacturing. Illinois, Michigan, Indiana, and Wisconsin, while repre senting only 17 per cent of the nation’s population, pro duce over one-third of all machinery, electrical equip ment, metal products, and transportation equipment. These industries accounted for two billion of the total de cline in all manufacturing inventories of 3.3 billion dollars last year. Page 6 I MANUFACTURERS PRODUCTION AND INVENTORIES OF DURABLE GOODS (SEASONALLY ADJUSTED, 1946-49) INVENTORIES BILLIONS OF DOLLARS PRODUCTION INVENTORIES l II I I I M I I I I I I l I II I * BASED UPON 1936* 39 AVERAGE. SOURCES. US. DEPARTMENT OF COMMERCE AND BOARD OF GOVERNORS OF THE FEDERAL’RESERVE SYSTEM * ♦ CHART 2 TOTAL BUSINESS INVENTORIES (SEASONALLY ADJUSTED. 1948-50) 3ILLI0NS Of DOLLARS BILLIONS OF DOLLARS 0-00 under which the cost of sales is charged with the latest purchase, eliminates extremes of recorded profits and losses caused by inventory price changes. While LIFO tends to smooth out fluctuations in business profits as shown on financial statements, it really covers one fiction with another. The basic problems of inventory manage ment are still present, and the ability of a firm to weather sharp price declines is largely unchanged. From one standpoint, LIFO may be said to have harmful effects, since it tends to reduce taxes when inflationary pressures are uppermost and increases them in periods of business decline. The practice may actually encourage speculative inventory management, since part of the tax penalty is removed. LESS INVENTORY TROUBLE IN THE FUTURE? AUG. SEPT. OCT. NOVt DEC. SOURCE. U S. DEPARTMENT OF COMMERCE agerial control than are those of trade firms. Instead of merely buying and selling goods, the manufacturer adds value to raw materials and produces something different. His stocks are divided into three portions: raw materials, goods in process, and finished goods. When materials are once placed in the productive process, manufacturers’ in ventories are apt to continue to grow even though sales fall off. The situation is simplified if production is to order rather than for stock, but even here cancellations and merchandise returns may result. FINANCIAL EFFECTS All lines of business experience serious financial prob lems when inventories are rising. From 1946 through 1948, funds required by corporations to carry larger inventories at steadily rising prices amounted to 26.4 billion dollars, or 60 per cent as much as capital out lays during the same period. The decline in corporate security issues from 1948 to 1949 is largely accounted for by the fact that most firms no longer needed large sums for working capital to carry inventory increases. The commercial and industrial loans of the weekly reporting banks are strongly influenced by inventory trends. From 1946 through 1948, this loan category rose by 9.3 billion, or 100 per cent, while total business inventories gained 28.1 billion, or 92 per cent. In 1949, these loans dropped 2.5 billion, or 13 per cent, while inventories dropped eight per cent. Many corporations which do not ordinarily depend upon commercial banks used bank loans in 1946 and 1947 to satisfy their greatly increased need for work ing capital. Aside from creating problems in financing inventories, rising prices cause profit figures to be inflated as a result of inventory gains. Profits from this process are partly fictitious, since the gains cannot be converted into cash unless the inventory is liquidated. The last-in-first-out method of inventory valuation, What can be done to mitigate the effects upon the cycle of extreme fluctuations in business inventories? Violent over-all price changes are somewhat less likely than in the past because of agricultural price supports and high rigid industrial cost patterns. New processes to synthesize certain commodities such as alcohol, rubber, and detergents have added considerable stability to the prices of related goods. Industries such as meat packing or those dealing with fats, oils, and other agricultural products will continue to be vulnerable although certain commodities can of course be hedged. Sellers could probably contribute to a smoothing of sales and production totals by offering to reimburse cus tomers if prices decline by a certain date. A fair propor tion of inventories are financed by bank credit, and bank lending officers can help prevent extreme movements either up or down by wise lending policies and sound advice to customers. Part of the inventory problem is a result of inade quate information on which to base decisions. Business managers should be able to compare the situation in their own firm with all the firms in their industry and other related industries. For example, when finished goods in ventories start to back up in the hands of manufacturers, there is a signal to go easy on new accumulations. If this tendency can be observed soon enough, some of the ex cesses of inventory accumulation can be avoided. When stocks to sales ratios indicate an undersupply of goods, it is likely that additional goods can be acquired without undue risk. Newly revised statistical material useful for inventory analysis was recently made available by the Department of Commerce. Total sales and inventories of manufactur ing, retail, and wholesale establishments broken down by type of enterprise on a seasonally adjusted basis are cur rently being published each month in the Survey of Cur rent Business. Department of Commerce statisticians had determined that the older series understated business inventories in the postwar period. Supplementing the in ventory and sales data is the series on manufacturers’ new orders which the Department of Commerce offered in December, Page 7 Retail Credit Survey—1949 Credit Buying Sustains Retail Sales Both cash and charge account sales receded from the preceding year’s levels in all lines of trade with the ex ception of cash transactions for automobiles. The largest decline in cash sales occurred at furniture stores, while the greatest reduction in charge account sales was ex perienced by the household appliance store group. A marked shift in consumer buying from nondurable to durable goods coupled with an increase in the relative importance of sales credit during 1949 were the most noteworthy findings of the annual survey of more than 1800 credit-granting retail establishments in the Seventh Federal Reserve District. Each of the nine lines of trade covered by the survey experienced an expansion in credit sales relative to cash sales. This trend was especially pro nounced at the retail outlets for furniture and household appliances, with credit sales accounting for approximately three-fourths of total volume during the year. The strength of instalment sales during 1949 mod erated a decline in total net sales for most of the lines of trade. At least part of the upsurge in demand for durable goods may be attributed to an increased emphasis on in stalment selling through widespread advertising of eased credit terms. While these long-term transactions were important in sales of furniture and automobiles, they were most significant at household appliance stores, with an increase of one-fifth in dollar volume and the largest expansion in relation to total sales. Automobile dealers reported a total net sales increase of 16 per cent during 1949. This was the only kind of business included in the survey which experienced a high er level of sales than in 1948. Declines in sales of the other retailers ranged from 12 per cent for jewelry stores to two per cent at household appliance stores. To some extent these sales declines reflected moderate reductions in prices. RECEIVABLES SUBSTANTIALLY HIGHER Increased year-end receivables were reported by all types of stores except women’s apparel. Moreover, the ratio of receivables to total sales for the year was higher than for 1948 in all lines of trade. This drop in liquidity of outstandings reflected the increasing relaxation in credit terms which characterized retail sales during 1949. Jewelry stores reported over one-half of their instalment accounts uncollected at the end of the year, while depart ment and furniture stores also were in relatively less favorable positions than at the end of 1948. Furthermore, outstanding balances on a generally lower charge account sales volume were repaid somewhat more slowly than in any year since the war. STOCKS REDUCED IN VOLUME Inventories at the end of last year were generally lower in dollar volume than at the same time in 1948. SALES RECEIVABLES, AND INVENTORIES OF CREDIT-GRANTING RETAIL BUSINESSES st-wat rn»TmTT Transaction Per centage Change from 1948 r'T-Tkr'TMT Percentage of Total Sales 1949 1948 Automobile Dealers Sales during year: DUCPRA/r TlTCTRIPT Per Percentage centage of Change Total Sales from 1948 1949 1948 Automobile Tire and Accessory Stores Per centage Change from 1948 1Q1R.1Q4Q Percentage of Total Sales 1949 1948 Department Stores Per centage Change from 1948 Percentage of Total Sales 1949 66.9 13.3 19.8 100.0 67.3 15.8 16.9 100.0 -7.9 -7.3 +9.4 -6.5 41.6 51.0 7.4 100.0 42.3 51.4 6.3 100.0 -8.1 -3.4 +2.1 -5.8 56.7 58.3 -18.3 23.1 9.1 8.4 +6!9 60+ +1.8 Instalment1............................................ +117.3 +33.8 9.7 5.4 2.4 9.3 3.4 2.1 +7.4 +49.1 +12.9 13.4 22.8 8.6 11.7 17.7 7.1 +0.9 +28.5 +8.6 21.8 47.6 11.6 20.9 +5.5 +28.6 +24.9 26.4 13.0 10.8 -1.8 Household Appliance Stores -10.0 3.9 3.8 -8.7 5.0 4.8 Accounts receivable at end of year: Sales during year: Cash......................................................... Charge account..................................... Total.................................................... Accounts receivable at end of year: Charge account1................................... Inventories, retail at end of year1.... 10.0 Men's Clothing Stores Jewelry Stores Page 8 1949 | 1948 -11.7 -5.2 55.3 39.2 5.5 57.5 38.0 4.5 100.0 26.6 17.1 56.3 100.0 +11.8 -8.1 22.6 36.0 24.2 -0.3 +48.2 +6.2 13.6 22.3 6.6 12.9 16.8 5.7 3.1 3.2 -9.3 W omen a Apt>arel Stores -3.1 3.6 3.8 32.1 -15.9 -17.2 +21.0 -2.1 25.8 26.6 47.6 100.0 30.0 31.5 38.5 100.0 -14.5 -12.3 -6.5 -11.6 44.3 24.0 31.7 100.0 45.9 24.2 29.9 100.0 -14.2 -2.6 +5.0 -9.8 58.2 32.6 9.2 100.0 61.7 30.4 7.9 -11.4 -8.5 -12.0 56.3 37.0 6.7 56.9 36.2 6.9 +15.8 +33.3 +29.4 15.4 33.7 20.2 11.0 30.6 15.3 +4.5 +4.1 +4.2 27.4 57.4 24.9 23.0 51.4 21.1 0.0 +4.2 +1.2 20.4 30.8 9.5 19.9 31.0 8.5 -2.7 -0.2 21.3 20.4 20.0 19.0 -14.2 4.0 3.6 -4.8 1.9 2.1 +1.7 3.7 4.2 -8.0 5.4 5.4 am ass s e Percentage of Total Sales Hardware Stores Furniture Stores +15.8 -2.4 +37.4 +16.5 Charge account..................................... 1948 Per centage Change from 1948 100.0 Although men’s clothing stores showed slightly heavier inventories, all the other kinds of businesses reduced stocks on hand from one per cent at automobile dealers to as much as 14 per cent at household appliance stores. In many cases the reduction in inventories more than kept pace with the decline in sales volume, and as a re sult over half of the lines of trade reported a more rapid rate of turnover than a year earlier. The rate of turnover, however, was lower for men’s clothing, hardware, and jewelry stores. REVIEW BY KIND OF BUSINESS Automobile Dealers again experienced a substantial rise in total sales, although the increase was smaller than in the preceding postwar years. Stocks tended to increase somewhat as production reached a new peak, although the last quarter factory shutdowns due to steel shortages and model changeovers limited the output of new cars and forced inventories down. The expiration of Regulation W at midyear enabled dealers to offer more liberal credit terms, thereby leading to an appreciable expansion in in stalment sales and outstandings. Total sales of Automobile Tire and Accessory Stores dropped during 1949 from the high level of the preceding two years to approximately the 1946 volume. The bulk of the decline occurred in cash sales, but credit sales also were down somewhat from the 1948 high. Accounts re ceivable continued to increase, thereby indicating slower collections. For the first time since the Retail Credit Survey of 1942, total sales of Department Stores failed to surpass the dollar volume of the previous year. This decline re sulted from lower initial mark-ups, substantial markdowns, and buying down by consumers. In order to meet the competition of specialty stores for durable goods sales, department stores engaged in intensive advertising of instalment terms. Despite the continued high-level building of new homes with a correlated demand for furnishings, total sales in Furniture Stores for the year as a whole declined slightly. Apparently in anticipation of price declines dur ing the earlier months of 1949, consumers delayed their purchases of housefurnishings. Merchants allowed stocks on hand to move accordingly lower, and thereby main tained a fairly constant inventory turnover. Although Hardware Stores offer stable lines of “hard” goods to the consumer, business is transacted primarily on a cash and charge account basis. A decline in total sales was somewhat mitigated by the more active credit volume, although more than one-half of the total was in the cash segment. Uncollected credit account balances were somewhat higher in relation to sales. In an attempt to stem the decline in total net sales from the 1947 high, Household Appliance Stores have been stressing instalment sales to an increasing extent. These sales accounted for 48 per cent of the total busi ness in 1949. exceeding the 1941 peak. Reporting stores nearly doubled the amount of instalment paper which they sold last year. These stores showed the greatest drop in inventories on a year-to-year comparison owing to a strong upsurge in consumer buying during the final months of 1949. Despite promotional tie-ups with manufacturers, both cash and credit sales of Jewelry Stores continued the de cline of the preceding year. To some extent uncertainty regarding the future status of the excise tax probably caused consumers to defer purchases of jewelry. A con tinued increase in receivables during the year reduced the ratio of sales to receivables to the lowest point in the last eight years. Sales of Men’s Clothing Stores fell to a level below that of 1946. These declines may be attributed in some degree to adjustments from the distorted and abnormally high demand of the immediate postwar years. Instalment sales and receivables increased nominally from the pre ceding year. There were no radical style changes in Women’s Ap parel during 1949. Lacking this stimulus, sales dropped to the lowest level in the last four years. Inventory turn over ratios remained unchanged, however, since stocks declined sharply during the year partly as the result of lower prices. RECENT TRENDS IN RETAIL TRADE The upturn in retail sales evident in the last quar ter of 1949 has continued into the first part of 1950. Du rable goods sales have gathered momentum and are still eclipsing soft goods totals. Both furniture and appliance sales have been substantially above year-ago levels, the former probably representing an actual increase in unit totals. The traditional effectiveness of Easter as a spur to apparel sales has not produced an increase in sales volume for the spring of 1950. The latest figures for de partment stores reveal that women’s clothing sales have been abating from last year’s level. Men’s wear sales, while showing a decline for January and February, how ever, turned upward in March. Note: Copies of a more detailed analysis, including comparisons by city trading areas in the Seventh District, may be obtained on request to the Research Department Federal Reserve Bank of Chicago, P. O. Box 834, Chicago 90, Illinois RETAIL CREDIT SALES, 1949 SEVENTH PERCENTAGE INCREASE DEPARTMENT MEN'S STORES STORES FURNITURE OR DECREASE STORES CLOTHING JEWELRY -?■ -sBHHHIH STORES Y/////A+« HOUSEHOLD APPLIANCE STORES HARDWARE AUTOMOBILE OVER 1948 FEDERAL RESERVE DISTRICT STORES DEALERS AUTO TIRE AND ACCESSORY STORES ■■■ SEVENTH FEDERAL IDWA T ILL ■ INO RESERVE DISTRICT
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