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A review by the Fe d era l Reserve Bank of Chicago Business Conditions 1953 N ovem ber Contents Debt, to most men and through all ages, has been a "two-faced w o rri some thing." The problems and par adoxes posed by high and rising debt are discussed in Debt— Jekyll and Hyde 4 and the current debt developments are reported in The Trend of Business 2 r p n n the E v id e n c e that o v e r -a l l b u s in e s s a c t iv it y is receding slowly from the record springtime rate continues to accumulate. Preliminary esti mates indicate that the total dollar value of the nation’s output of goods and services fell slightly in the third quarter, despite somewhat higher prices in many lines. Industrial produc tion, which had. declined in July largely for seasonal reasons, failed by several per cent to regain its earlier level in August and Septem ber. Moreover, both employment and average weekly hours worked in manufacturing indus tries failed to show their usual late summer advance, although unemployment remains near the postwar low. By far the most dramatic reversal of condi tions in recent months has taken place in the credit field. Reflecting heavy demands for credit and relatively limited availability of funds, interest rates on both long- and short term obligations rose markedly in the spring. Advances ranged from 14-% per cent, depend ing upon the type and maturity of security offered. Since the latter part o f June, however, inter est rates generally have been tending down ward, and in the past few weeks yields on short- and intermediate-term securities have dropped sharply. From the June peak to early in October, for example, market rates dropped 2 /3 of 1 per cent on 3-5 year Government securities and a full percentage point on 91 day Treasury bills. At around 1.4 per cent, the latter were at the lowest yield since 1950. What accounts for the break in security yields after the marked rise earlier in the year? One major factor appears to have been a sub stantial increase in the supply of loanable funds. 2 Business Conditions, November 1953 of business Yields on shorter-term Government securities turn sharply downward per cent y ie ld Saving by individuals in the form of time de posits, savings and loan shares, and life insurance equities has continued at a peace time record rate through the summer, and re payments on mortgages and other investments have been rising steadily. As a result, most financial institutions are faced with a large and growing volume of funds to invest. More important to the abrupt change in market conditions has been the release of sub stantial amounts of bank reserves by the monetary authorities. A reduction in member bank reserve requirements early in July freed about 1.2 billion dollars in reserves. In addi tion, purchases of short-term Government securities by the Federal Reserve since the end of April have provided about 1.5 billion dol lars in new reserves to the banking system. Lender attitudes also have contributed to the sharp fluctuation in interest rates this year. As yields were rising early in the spring, lenders naturally were somewhat reluctant to commit themselves on new loans and investments until rates had stabilized at some higher level. When yields turned down in the summer, however, it was to the lenders’ advantage to invest as close to the peak as possible, with the result that credit requests have received more favorable consideration. Certainly, the over-all demand for credit has not yet shown weakness compa rable to that suggested by the decline in interest rates, although some slackening in several important areas has been in evidence recently. Business and agricultural loans at weekly reporting banks have advanced less than sea sonally so far this fall. From early July through September, such loans had increased only 500 million dollars, as against an expansion of 1,100 million in the same period of 1952. Among industry groups borrowing substantially less since midyear than in 1952 have been food, liquor, and tobacco firms, commodity dealers, oil, chemical, and rubber producers, retail stores, and sales finance companies. In part, the smaller loan expansion so far this fall in the food lines probably reflects the higher proportion of current farm crops being placed under Government loan, the funds for which are usually supplied initially by outlying banks. This dampening influence will be re versed in coming weeks, however, as large banks purchase Commodity Credit Corporation offerings of certificates of interest in farm price support loans for addition to their portfolios. Such purchases may raise bank loan totals by around 1 billion dollars by year-end. months. Judging by the experience of banks and sales finance companies, monthly repay ments have been running about an eighth larger than at this time last year. Moreover, new credit extensions dropped slightly in July and more in August, largely in response to a moderate falling off in new car sales. Mortgage lending on residential properties has been in very large volume so far this year. Mortgage recordings of $20,000 or less (mostly on single-family homes) amounted to 13 billion dollars in the first eight months of 1953— oneeighth more than in the same period last year. Home mortgage debt is estimated to have in creased 3.3 billion dollars in the first half of this year, as against 2.9 billion in 1952. Although the dollar volume of mortgage lending will continue high, the year-to-year dif ference is likely to narrow substantially in the months ahead. Private housing starts, on a seasonally adjusted basis, have dropped about 20 per cent from the early spring rate, and since June have fallen below comparable 1952 levels. Consequently, since prices have changed little, the dollar volume of completions probably will be little or no larger than in the closing months of last year. Business loans at big city banks gain less than last year so far this fall m illio n d o lla rs cumulative change Consumer instalment credit has expanded 6.3 billion dollars, or about 45 per cent, since the termination of Regulation W in May 1952. Nearly 2Vi billion of this increase occurred in the first eight months of the current year. Recently, however, the growth in instalment debt has diminished significantly. In August, the increase amounted to only 200 million dol lars, as compared with gains averaging 400 million dollars in each of the five preceding 3 Debt—Jekyll and Hyde While debt creates problems both for the borrower and for the economy as a whole, it plays a vital role in transferring idle savings to those seeking use of investment funds. D e b t , in common with most everything else in the economic world, involves many puzzling and often unpleasant paradoxes. The big puz zler is this: high and rising indebtedness poses obvious threats both to the individuals in debt and to the over-all economy; yet, experience over the years indicates that periods of great prosperity are times in which debt is large and climbing and that apparently the more rapidly debt rises the more prosperous is the period. Little wonder that in all ages and to most men, debt has been a “two-faced worrisome thing.” Solving the debt puzzle is partly a matter of semantics. The emotional content of the word “debt” is quite different from that associated with the word “credit.” But the economic transaction referred to is the same— to use credit is to incur debt, and in prosperous times increasing amounts of credit are not so seem ingly paradoxical. Not all of the obstacles to solving the puzzle can be dispelled, however, by changing over to a word with a less foreboding connotation. The real catch lies in understanding the function of debt— we might better say credit at this point — in a capitalistic economy. Answers to the questions, “What is it?”, “Where is it?”, and “Why does it exist?” are a prerequisite to in formed discussion of the influences which debt wields in our changing society. W h a t is debt? Everyone knows what debt is when he owes it, but many do not recognize the debts of others when they own them. For example, few depositors regard their credits at the bank as bankers’ debts, though one may be sure that bankers do. A catalog of debt will insure that 4 Business Conditions, November 1953 we recognize it in its unfamiliar as well as familiar forms. Beyond this, listing kinds of debts will suggest the relationships involved in debt and some of its characteristics. — to consumers As individuals we are familiar with mort gages on our homes, with instalment debts for the purchase of automobiles, refrigerators, and other household goods, with charge accounts owed to retail merchants, and with personal loans to carry us over periods of unexpectedly large expenditure. In this listing we see some debt that extends over a very long period of Total debt—who owes it? time, sometimes over half of the active earning period of a man’s lifetime. Other debt falls due in so short a time that it may be little more than an accounting convenience that we use credit instead of cash. We could also note that credit is not the only way in which consumers buy houses, automobiles, and household goods. They can first save and then buy, instead of buying and then saving through debt repayment. From whom do consumers borrow to meet their needs? Only to a limited extent do they depend directly on other individuals. Princi pally, they rely on financial institutions— banks, savings and loan associations, and insurance companies. Often short-term credits are ar ranged by retailers who, at least initially, may provide credit to stimulate sales. Total debt—who owns itP — to business Businessmen probably have a greater aware ness of debt than consumers because there are few, if any, businesses that do not make important use of credit in some form or other, whereas there are a good many consumers who manage their affairs so as to avoid the con scious use of credit altogether. Businesses, like individuals, often go into debt to buy longlived goods. Some business assets, such as fac tories and various types of equipment, have an earning potential that extends far beyond the working span of a human life and are so costly that a business would lose years of profits wait ing until it could “save” enough to buy them. Businessmen also borrow a great deal of money for short periods of time. Much of this short-term credit fills time gaps between outlays for production expenses and later receipts from product sales. Thus, a farmer will borrow money to buy feeder cattle, then repay the debt months later when the finished livestock is shipped to market. Some forms of temporary debt even arise almost automatically, as when a businessman defers wage payments until pay day, waits a few days before paying his supplier for shipments, or waits until next year to pay Federal taxes on this year’s income. By and large, businessmen go to different sources for their long- and short-term needs. Corporations and farmers sell their bonds and mortgages chiefly to insurance companies and individual investors. Some of this debt also goes to banks, although business turns to banks primarily for short-term loans. The biggest “two-way” lenders to business are other busi nesses, which hold large amounts of corporate obligations and extend substantial trade credits to their customers. The profit motive is a critical element in business borrowing. A businessman will add to his liabilities willingly only if he expects that the extra profit he can earn with the use of the borrowed funds will exceed the debt costs. Whether the borrowing is to finance a specific expenditure or merely for working capital, the deciding factor is the prospect for increased income. — to governm ents With governmental bodies— Federal, state, 5 and local— borrowing is a different proposition. They can largely determine their own income via the taxes they impose and set their expendi tures, not to gain profits or personal satisfac tion, but to further general public welfare. The overwhelming bulk of the Federal Gov ernment’s borrowing has always been to bridge gaps between its tax collections and its ex penditures, rather than to buy particular public services or projects or to increase the Govern ment’s future income. State and local govern ment agencies, on the other hand, borrow mainly for specific capital outlay projects— highways, schools, and other public structures. The chief vehicle for governmental borrow ing is the sale of securities, of both short and distant maturities. There are the familiar U. S. savings bonds, which make up a sizable chunk of the total Federal debt. Other government securities come in assorted combinations of “payable on demand,” “payable at maturity, or when called,” “payable only to owner of rec ord,” and “payable to holder” whoever that might be. The typically high standing and at tractive combinations of terms for these securi ties have found them many homes— in portfolios of corporations, financial institutions, pension and trust funds, as well as in the safety deposit boxes of individuals and small businesses. — to financial in s titu tio n s The one remaining large group of debtors is the nation’s collection of specialized financial institutions. This may come as a bit of a sur prise, for they have just been referred to as important lenders to borrowing consumers, businesses, and governments. But the fact re mains that our financial institutions flout Polonius’ advice, “Neither a borrower nor a lender be,” for they are both, in equal degree. Their role is that of middleman, accepting the savings and in turn lending out these funds to others seeking money to build plants, buy con sumer goods, or otherwise acquire desired assets. Various savings institutions receive funds from a customer under a promise to return 6 Business Conditions, November 1953 them, upon request and subject to various con ditions. Banks, insurance companies, and, in effect, savings and loan associations are there fore in debt to their account and policy holders. In effect, they have “borrowed” the deposits of account owners and the funds used to accumu late insurance policy reserves. The “borrowing” which financial institutions do is unusual in several respects. For one thing, almost all the debt incurred has no fixed maturity, but is repaid in practice upon demand. Few other debtors would be willing to under take such an awesome obligation. For another, financial institutions “go in debt” more or less involuntarily, whenever and for whatever amounts their account and policy holders may offer. Moreover, many times an institution will both borrow and lend to the same individual, as happens when a bank makes a loan to one of its depositors. Finally, financial institutions pay for their borrowing privilege in different ways— sometimes with interest or dividends, but often with special types of service and protec tion. The attractiveness to creditors of financial institution debt is apparent, for such inter mediaries are popular recipients of “loans” from individuals and organizations the country over. Debts are assets Double-entry bookkeeping is at the root of the simplest of the paradoxes inherently asso ciated with debt— the fact that while debt is a claim on the assets and earning capacity of those in debt, it is simultaneously a part of their creditors’ worldly goods. For every buyer there must be a seller, and similarly for every liability entered on someone’s balance sheet, whether that balance sheet actually exists on paper or only in a figurative sense, someone else has an asset of equal value. For example, such debts as a U. S. savings bond, or a bank account, or a corporate bond are as much assets to their owners as is cur rency or tangible property. In the case of commercial banks and most other financial institutions, almost all assets consist of pieces Long-term debt makes up over 40 per cent of total debt S h o r t- t e r m I 200 0 L o n g -te rm deb t co n sum ers b u sin e sse s g o ve rn m e n ts 400 600 _ i_ 800 b illio n d o lla rs in clu d e s such b o rro w in g s in clu d e s such b o rro w in g s os: co n sum ers instalment credit; personal loans; policy loans; charge accounts b u sin e sse s bank loans; accounts pay able g o ve rn m e n ts Treasury bills, certificates, and notes; state and local government warrants; U. S. savings bonds ( if cashed be fo re m a tu rity ); accounts payable fin a n c ia l in stitu tio n s borrowings from Federal Reserve Banks and from Federal Home Loan Banks a s: residential mortgages railroad, public utility, and industrial bonds and notes; mortgages on rental hous ing and farm real estate Federal, state, and local government bonds; U. S. savings bo7ids (when held to maturity) of paper which are evidence that someone has borrowed from them on a short- or a long-term basis— notes, bonds, mortgages. Our dynamic expanding economy is based on the continuous production of more and new kinds of goods and services. This process requires a high rate of investment and, in turn, large savings— savings that are promptly chan neled into productive and profitable uses. Sometimes the saver and investor are one and the same— as, for example, when an indi vidual uses his savings to pay for the construc tion of a house, or a business finances its plant and equipment expenditures with its retained earnings. This procedure was typical of the days when most Americans were farmers or small businessmen, reinvesting in their farms and businesses any earnings over and above those debt D e p o s it -t y p e debt in clu d e s such “ b o rro w in g s” f in a n c ia l in stitu tio n s T a x - lia b ilit ie s b u sin e sse s as: bank deposits; savings and loan association shares; cash value of life insurance pol icies; dividends left with life insurance companies in clu d e such "b o rro w in g s ” a s: acci’ued corporate income tax needed to support their families. Today, however, most of us are employees, not proprietors, and much, though by no means all, investment is made by individuals and firms without enough ready cash to finance expan sion of their production facilities. Thus, the accumulation of personal savings and the ex penditure of these funds for investment pur poses are frequently separate and distinct processes, performed by separate and distinct persons or groups. Thus, it is essential to have convenient, well-established ways of transferring unspent funds of savers to businesses, govern ments, or individuals seeking the use of funds. The tra n s fe r function o f debt In this country, savings can be put to work in a number of ways. Savings in the form of 7 cash balances in checking accounts may be exchanged for stock (equity shares) in business concerns. In this way savers become part own ers of the business and share in its earnings and losses after prior claims have been met. Or they may directly lend their accumulated funds to others, in return for interest and the borrow er’s promise to repay the debt sometime in the future. That is, savers exchange their cash or bank deposits for a less liquid debt asset that yields an income, but must ordinarily be re converted into cash or a checking account bal ance before it can be spent or reinvested. Most often, savings indirectly find their way into investors’ hands, with banks and other financial institutions acting as middlemen be tween the savers and users of investment funds. All of these methods of putting savings to work, aside from the purchase of stock, involve the creation of debt and are vital branches of the economy’s “transport system” for savings. guard for the funds entrusted to them, although it is supported by a number of additional pro tective arrangements, such as the spreading of funds over a wide number of undertakings, the maintenance of an equity cushion to absorb debt defaults, governmental supervision of operations, and governmental insurance and guarantees of some loans held by institutions as well as a large share of their deposit liabilities. Thus, both individual savers and the finan cial middlemen to whom they may entrust a portion of their savings are desirous of keep ing much of their funds under the protective cover which debt affords. In these circum stances, users of funds, who may have to seek out money wherever it can be found, will nat urally be inclined to accommodate such desires by offering debt rather than equities. Those who need outside funds often find it easier and cheaper to obtain them through channels of debt, either directly from savers or indirectly through financial intermediaries. Less ris k In a system such as ours today, it is inevitable that debt totals be relatively substantial. To the average saver, debt is in many respects a more attractive repository for his funds than are riskier, though possibly more rewarding, equi ties. The majority of savers place a high premium on keeping their savings safe, liquid, and conveniently available. Only the debts of others can have these attributes in high degree, and only certain forms of debt at that. A number of debt vehicles tailored to these saver desires have been developed over the years. The most common are the host of financial institutions which dot our economic landscape. They specialize in making promises to repay funds left with them, in exact dollar amount, immediately upon request. To insure their ability to deliver on such promises, they in turn must invest funds received in assets readily disposable at or near par value, which for the most part means high-grade debt obli gations of businesses, governments, and indi viduals. Such prudence is their prime safe 8 Business Conditions, November 1953 Debt and money Debt can do more than simply transport idle funds to places where they are desired. It is also the means by which entirely new funds are created, funds that may be required for a pros perous, expanding economy. The banking system is the mechanism that accomplishes this “money creation.” Today, most purchases are paid for by checks drawn on bank demand deposits. Practically, therefore, demand deposits have become accepted as money. But they are also bank debts, liabilities of a bank to its depositors. How do these bank deposit liabilities arise? Usually they are in curred when a depositor brings in cash or a check on another bank which the recipient bank can collect in cash. The deposit of the cus tomer at the recipient bank is upped, but the public’s total holdings of cash and deposits in other banks are reduced by a like amount. The nation’s total money supply remains unchanged. When a bank makes a loan or buys a secu rity, however, it is a different story. The bank D ebt in the consumer balance sheet Assets Liabilities and Net Worth Consumers' debt Debt of others due to 3 other consumers due from : other consumers J businesses businesses c o rp o ra te b o nd s and m o rtg a g e s Federal Government (FNMA governments m o rtg a g e s) F e d e ra l financial in stitu tio n s s ta te - lo c a l <— com m ercial banks m u tu a l sa v in g s banks financial institu tio n s *— and sa v in g s and loan a sso c ia tio n s co m m e rc ia l bank d ep osits instalment credit and residential mortgages lif e in su ra n c e com panies m u tu a l sa v in g s d e p o sits and sa ving s and loan s h a re s c a sh value o f life in su ra n c e p o lic ie s Total debt assets + cash, business equities, tangible personal property, and real estate Total Consumers' assets accepts its customer’s note or security and in exchange gives him an equivalent increase in his deposit account. Nobody else loses a de posit. Consequently, the total of cash and deposits— the money supply— is increased. Money has been created. If this were all there was to the process, of course, everybody would be getting into the banking business. Actually, the operations of our far-flung hanking system siphon away the $ 9 0 billion Total liabilities + consum ers' net worth Total Consumers' liabilities and net worth fruits of money creation from any individual bank. Few people borrow money to keep it idle. Usually a borrower will quickly write checks on his new deposit to make some in tended payments. In the normal course of events, the persons he pays will redeposit these checks in their own banks. This sort of transfer is even more rapid when the bank buys a security, for the seller typically requests imme diate transfer of the funds to his own bank. In 9 either case, the newly created deposit has not disappeared, but it has shifted from the orig inal bank to others. When this happens, the original bank must be able to lay its hands on cash or its equivalent to pay out to the other banks. As a practical matter, therefore, any one bank cannot afford to add to its loans and investments (creating new deposits in the process) by an amount greater than its excess holdings of cash reserves. D ebt What cash is “excess” depends upon a num ber of factors. Generally speaking, a bank need keep cash equal to only a moderate fraction of the deposits made by customers with cash or checks on other banks for usually, as one such deposit is drawn down, some other customer is bringing in additional funds for deposit. Thus, if a bank receives a big bulge of cash and checks for deposit, it may safely regard a sizable portion of the funds so received as “excess” in the business balance sheet Liabilities and Net Worth Assets Businesses' debt Debt of others due from : due to : consumers consumers c o rp o ra te bonds and m o rtg a g e s other businesses other businesses Federal Government Federal Government accrued corpora te ta x lia b ilit ie s financial institu tio n s financial in stitu tio n s 'c o m m e rc ia l deposits at c o m m e rc ia l b a n k s banks m utua l s a v in g s banks m u tu a l s a v in g s life in su ra n c e com panies banks Total debt assets $ 180 billion + business plant and equipment, farm land and equip ment, inventories, and equity in other businesses Total Business (and farm) assets 10 Business Conditions, November 1953 $ 2 5 0 billion business . toons, mortgages, and bonds Total liabilities + business and farm net worth Total Business (and farm) liabilities and net worth and make loans and create new deposits in a comparable amount. Once those created de posits shift to other banks and the lending bank transfers its excess cash resources in payment, its ability to create new money is exhausted. But this is not true for those banks receiving that transferred cash and deposit. They simi larly need keep as cash reserves only a fraction of the funds placed with them, and they too can lend the remainder, creating new deposits in the process. As this chain of action grows and spreads through the entire banking system, more and more “new” deposits are “created.” The maximum amount of this deposit expan sion is determined by the portion of deposited funds which is kept as cash reserves. At pres ent, national and state authorities require banks to maintain reserves equal to about one-fifth of their demand deposits. Mathematically this permits the banking system as a whole, in meet ing borrowers’ demands for credit, to create about 4 dollars more of deposit money for each dollar of cash reserves. That the overwhelming bulk of our money supply consists of bank deposits rather than hard cash or paper cur rency attests to the importance of this process. The volume of money in the economy and the speed with which it changes hands has an obvious influence on the tempo of economic activity. A money supply which is constricted by scarcity of the reserves which the banking system needs to create deposits may make it impossible to finance some projects. An easily expansible money supply, on the other hand, can encourage a larger volume of business, higher prices for the same volume, or both. Dangers — re a l . . . While moderate injections of new money are helpful lubricants for an expanding economy, it is easy to flood the economic mechanism and bring about an inflationary situation. Bank deposit creation can proceed as long as banks have more than enough cash reserves to meet legal requirements and have opportunities to add to their loans and investments. Such addi tional debt assets may arise from new bor rowing requests or they can be drawn from the existing pool of loans and investments held by non-bank investors. These processes, and par ticularly the latter, are commonly called “monetizing” debt— that is, selling it to banks in exchange for new bank deposits, thus in creasing the money supply. Obviously, the pos sibilities for debt monetization are greater, the larger the stock of debt which the economy accumulates. The problem of Federal debt monetization has been particularly acute since the end of World War II, because of the huge increase in Federal obligations necessary to finance the war. Only in the past few years has it been brought under control— partly because other developments eased active inflationary pressures and partly because the Federal Re serve System became free to use its various powers to limit the reserves available to banks. But the threat of inflation is not the only dilemma raised by a large and rising debt in a prosperous period. Another is the fact that under these conditions a substantial share of business— many house, auto, and appliance sales and much of the inventory build-up— is facilitated by the fact that it is easy to borrow money to finance these purchases. The issue is, can we sustain prosperity without constantly increasing dosages of credit, which threaten inflationary outbursts? Then, too, what if the boom fades? Since people do not find it easy or sound to borrow in bad times, sales on credit may slump badly. Meanwhile, existence of old debts will make a recession a period of net debt repayment, narrowing the spendable remainder of incomes. To what levels will spending on cur rent production drop under these influences? Part of the answer to these crucial questions depends upon how well debtors and creditors can manage their present debt positions in ad versity, part on how well agencies responsible for maintaining stability can do their jobs. . . . o r fanciful The fact that debt is so necessary to our D ebt in the government balance sheet (Federal, s ta te , and l o c a l ) Assets Liabilities Debt of others Governments' debt due fro m : securities held by consumers FN M A consumers m o rtg a g e s businesses c o rp o ra te in c om e ta x lia b ilitie s businesses state-local holdings of Federal securities Federal Government financial in stitu tio n s financial institu tio n s comm ercial bank d e p o sits ----- c o m m e rc ia l b a n k s ■“ m u tu a l s a v in g s b a n k s and sa v in g s and loan a s so c ia tio n s life in su ra n c e c o m p a n ie s Federal Reserve Banks Total debt assets $ 5 0 billion $ 2 5 0 billion Total liabilities + public property including military hard goods + invested to preserve "the American way of life" Total Government assets = Total Government liabilities economic life, but seems so loaded with ominous threats, casts it in the role of a paradox to many people. Sometimes, however, this paradox draws force, not from any real threats, but from people’s deep-seated moral attitudes about the “wrongness” of being in debt. For individuals, thrift has always been a virtue and thriftlessness— often represented by going into debt— a vice. These attitudes frequently are a product of confusing what can be done by 12 Business Conditions, November 1953 individuals and businesses on their own hook and what all consumers or all businesses or even the whole economy can do in the aggregate. As individual consumers we know that, if our income exceeds our spending, we grow in financial strength whereas, if our spending ex ceeds our income, we face an eventual day of reckoning. This is so since we must repay or refinance these debts, and it is not always wise or even possible to refinance individual debts at the discretion of the debtor. In the aggregate, however, there is no par allel necessity to reduce total outstanding debt, and reduction of aggregate debt is frequently not desirable. We have already seen that, inas much as the saver usually is not the actual user of the funds, a large share of total invest ment must be accompanied by debt transac tions. Too, we have seen that all debts are assets as well as liabilities, that repayment of bank-created debt reduces total assets as well as liabilities, and that a reduced money supply can be an unsettling influence on the economy. And as we know from our own experience as consumers and businessmen, going into debt does not always mean prodigality. Often there is a choice as to whether to pay for a given expenditure by reducing purchases of other items, by cutting savings, or by borrowing, and often there are distinct advantages to borrowing. For example, when we borrow to purchase a home or to develop a business, we receive in the present the returns which the money used to service the debt might have secured for us only in years to come. Far from indicating thriftlessness, borrowing to buy a residence often results in the home-owner’s saving far more, via repaying the debt and increasing his equity in the house, than he would save in any other way. Furthermore, many a profitable business venture and much investment in new products and processes would not have been possible were not the necessary credit available. As we approach the trillion-dollar mark in in debtedness, we can feel with some degree of con fidence that this does not brand us as a nation of spendthrifts. Rather, it mirrors more than anything else our large accumulation of savings and high levels of investment, the present-day separation of savers and users of money, and the preferences for sheltered abodes for sav ings. The role that debt plays is not a simple one, for the distribution— and creation— of funds have many ramifications within modern economics. By-products of debt changes can be the aggravation of inflations and recessions. Distorting pressures can develop, too, from more devious influences not weighed here, such as the “burden” of debt on various borrowers and the pyramiding of indebtedness from repet itive transfers of existing assets. There is need for discussion and analysis of these widespreading effects, from which to draw guidance for actions which may minimize the hurts and maximize the benefits that debt can produce. But one basic fact stands forth: debt exists and will continue to do so, and it performs useful economic functions in its existence. What is required is not its abolition, but rather its intelligent supervision. The debt picture today In a society as complex as ours, the ability and willingness to borrow or to lend differ widely among individuals and organizations. As a result, while the total of liabilities must be equal to the sum of all debt assets for the econ omy as a whole, this need not be true for any individual or group. For some consumers and businesses, the debts they owe exceed the debts owed them; for others, their debt assets surpass their liabilities. In the accompanying charts, the debt of five conventional economic groups or interests in our society is cross-classified on the basis of who owns it and who owes it. In four of the five groups— for consumers, businesses, finan cial institutions, and governments— the figures are totals of the debt assets and liabilities of many individual units. The fifth category— the Federal Reserve System— although including the operations of the twelve regional Reserve Banks, is a single unit. While the charts exclude intra-organization debt— for example, Federal securities owned by Government trust funds or bonds of a cor porate subsidiary held by the parent company — they do include debt owed to wholly separate economic units within each group. For exam ple, the data contain items such as residential mortgages held by consumers, corporate-owned 13 bonds of other corporations, state and local governments’ holdings of Federal securities, as well as bank deposits of life insurance com panies and savings and loan associations. Of these intra-group debts, those of businesses are by far the most important, yet they are small relative to the total debt of the sector. Consumers la rg e st c re d ito r group Consumers are the nation’s big creditor group— either in the amount of their gross holdings of debt assets or in terms of their net holdings after deduction of their own debts. Debts owed to individuals totaled 340 billion dollars at the end of 1952, about 40 per cent of all outstanding obligations. Almost 80 per cent of all consumer held debt assets are of a very liquid type, that is, assets held at financial institutions— bank deposits and life insurance policy reserves— and government bonds. Debts owed by consumers amounted to nearly 90 billion, but this was only one-fourth the size of their total claims. In contrast to their debt assets which, in the main, can be converted into cash at will, about 60 per cent of their obligations are of a fixed long-term nature. Tw o groups net d ebtors Businesses and government— Federal, state, and local— are the large net debtors in the economy, balancing the over-all creditor posi tion of consumers. Although the obligations of business and government groups total close to 250 billion each, governments are net debtors to a much greater extent than are businesses. The Federal debt, of course, dwarfs that of all state and local bodies. The debt held by the public— that is, outside of government agencies and trust funds— amounted to 222 billion at the end of 1952, the biggest share being held by consumers and commercial banks. The Fed eral Government’s relatively modest claims on other sectors consist primarily of business tax liabilities, CCC loans, FNMA mortgages, as well as loans to states and local governments. Business owes its biggest debt to financial 14 Business Conditions, November 1953 institutions— 85 billion dollars, or over onethird of all business liabilities. The debts of businesses are divided almost evenly between long- and short-term obligations. Their debt assets are predominantly short-term claims on consumers and other businesses and deposits at financial institutions. For business, as for other sectors, debts are not the only assets and liabilities that appear on the balance sheet. Debt owned by corpora tions is over two-fifths of their total assets, and their debt obligation about 60 per cent of their total liabilities and net worth. The bulk of their assets and liabilities are not claims payable in money under terms of a contract. They are, on the asset side, tangible assets, such as plant, equipment, and inventory, and ownership of other firms and of patents, good will, and the like, and on the liability side, their capital or net worth— the owners’ interest in the business. Similarly, consumers have nondebt assets— homes, durable and nondurable goods, and in tangibles such as job tenure and security— and nondebt liabilities— their net worth positions. Only in the case of the Federal Government, where the bulk of the debt was incurred to finance war and purchase war materials, does debt overwhelm the balance sheet unless, of course, we are prepared to place a money value on preservation of the nation. Financial in s titu tio n s in balance Since financial institutions function as mid dlemen between savers and users of funds, a financial institution usually acquires a debt asset to match each additional debt liability, leaving its claims and obligations approximately in bal ance. Thus, banks and savings and loan asso ciations attempt to employ the funds which they acquire or can create to the fullest extent possi ble, within the limits set by law and traditional banking practices. Life insurance companies, as receivers of individuals’ savings in the form of premium payments, also attempt to invest their funds in earning assets to the fullest possible extent. This balance is clearly illustrated in the chart below. Financial institutions’ debt assets — loans and investments plus commercial bank deposits at the Federal Reserve Banks— totaled 270 billion dollars, as compared with obliga tions of 260 billion dollars. Commercial banks account for 60 per cent of the totals, and life insurance companies another 24 per cent, with the mutual savings institutions holding the remainder. Paper currency occupies a unique place in our present system. The 29 billion dollars in circulation at the close of 1952 were liabilities of the Treasury and the Federal Reserve System to the bearers of the currency and, similarly, debt assets to those holding it. In practice, D ebt in the financial institution balance sheet Assets Liabilities and Net Worth Financial Institutions' debt Debt of others due fro m : consumers — instalment commercial banks credit and m utual savings banks and residential, savings and loan associations mortgages life insura nc e companies held by due to : consum ers c o m m e rc ia l bank d e p o sits — m u tu a l sa ving s bank deposits and savings and loan a sso cia tio n shares cash value o f life insurance policies businesses ________ c o m m e rc ia l banks business loans, m utual sa v in g s banks and mortgages,\ savings and loan associations and bonds owned by life insura nc e c om p anies businesses c o m m e rc ia l banks m u tu a l s a v in g s b a n k s deposits at governments governments bank d e p o sits to com m ercial banks — > to m utual savings banks and savings and loan associations, to life insurance companies other financial institutions other financial institutions Federal Reserve Banks re s e rv e d e p o s its Total debt assets $ 2 7 0 billion $ 2 6 0 billion Total liabilities + currency, p la nt, and real estate Total Financial Institution assets financial in stitu tio n s' net worth Total Financial Institution liabilities and net worth 15 How economic groups share in the 860 billion dollar total U. S. debt Distribution among economic groups N et debt position Gross debt position Consumers Business Government Financial institutions Federal Reserve System Consumers +260 own 345 owe 85 10 10 65 15 85 185 60 0 0 Business — 80 own 170 owe 250 15 65 75 75 25 25 55 85 0 0 Government -1 9 5 own 50 owe 245 • 85 25 25 10 10 15 100 25 Financial institutions + 10 own 270 owe 260 60 185 85 55 100 15 5 5 20 0 Federal Reserve System + 5 0 0 0 0 25 0 20 0 0 own owe 25 20 • •Less than 2.5 b illio n dollars. Figures in b illio n d ollars, as of December 31, 1952. A ll figures rounded to the nearest 5 b illio n. Note: Data presented in the table are partly estimated, and based on the follow ing concepts and definitions: businesses include corporations, unincorporated enterprises, and farms; nonprofit associations and pension and trust funds are included w ith consumers; a ll debts are taken at their par or face values; data fo r demand deposits are based on bank records and therefore include bank check flo a t; likew ise, business debt is based on business records and therefore includes trade float. however, currency, of which seven-eighths is Federal Reserve notes, is considered by the bearer not as a debt asset that will be redeemed by the borrower at some specified time, but rather as a very special type of tangible asset. Paper currency now plays the role in our econ omy that gold played when it was free to circulate. market and discount policies and its powers to set requirements for bank reserves, the Federal Reserve System can influence the amount of new debts incurred and the transfer of existing debt. By continually adapting its policies, the System aims to guide the nation’s debt flows in accordance with the changing needs of a grow ing and prospering economy. Role o f the Federal Reserve Economic growth demands a continuing flow of savings into investment uses. A large part of the stream of accumulated and bank-created funds must pass through debt channels to reach those in a position to employ the funds. Some of these channels are simple and direct, others constitute an intricate network of transactions. The Federal Reserve System can to some extent alter the direction and dimension of these chan nels through its ability to influence credit ex pansion or contraction. Through its open 16 Business Conditions, November 1953 Business Conditions is published monthly by the f e d e r a l r e s e r v e b a n k o f Ch ic a g o . Sub scriptions are available to the public without charge. For information concerning bulk mail ings to banks, business organizations, and edu cational institutions, write: Research Depart ment, Federal Reserve Bank of Chicago, Box 834, Chicago 90, Illinois. Articles may be re printed provided source is credited.
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