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A review by the Federal Reserve B an k of Chicago Business Conditions 1963 N ovem ber Contents Trends in banking and finance 2 Stock prices and business prospects 6 Foreign trade— the United States competitive position 11 Federal Reserve Bank o f Chicago in banking and finance I^eliminary estimates indicate that the flow of private short- and long-term United States capital abroad abated sharply in the third quarter of 1963 from the record levels of the first and second quarters of the year. The de cline may be attributed in part to a series of monetary and fiscal policy actions adopted and proposed in recent months to help reduce the continuing large deficit in the United States balance of international payments. In mid-July, the Federal Reserve Banks raised their discount rates from 3 to 3.5 per cent. In addition, the ceiling on interest rates commercial banks are permitted to pay on time money—other than passbook savings— deposited for three to 12 months was raised to 4 per cent, the same ceiling as was in force on time deposits of one year and over. At the same time, the President requested Congress to impose a temporary “interest equalization” tax on United States purchases of foreign securities from nonresidents.1 The increases in the discount rate and in terest rate ceiling together with greater Fed eral Reserve emphasis on providing reserves through the discount window exerted upward pressure on domestic short-term interest rates. However, the continuing high level of domestic unemployment made it undesirable to transmit the upward pressure fully to long term interest rates. Higher long-term rates would tend to restrict investment in new domestic facilities. Raising the interest rate ceiling on time deposits contributed to higher across-the-board short-term interest rates by giving banks greater leeway in bid ding for three to 12 month deposits. On the other hand, the increased inflow of time de posits encouraged the banks to seek addi tional longer-term investments, bidding up the prices of long-term securities and tending to at least partially offset upward pressures on long-term rates. Tor a review of the proposed interest equaliza tion tax see “Foreign Long-Term Borrowing in the United States,” Business Conditions, September Since the end of June, when anticipations of an increase in the discount rate began to exert a noticeable impact on short-term inter- 1963. BUSINESS CONDITIONS S h o rt-te rm ra te s rise is published monthly by the Federal Reserve Bank o f Chicago. G eorg e G . Kaufman was primarily responsible fo r the article “ Trend s in Banking and Finance" and G eorge W . C loos fo r “ Stock Prices and Business Prospects.” Subscriptions to Business Conditions are available to the public w ithout charge. Fo r inform ation concerning bulk mailings, address inquiries to the Federal Reserve Bank o f Chicago, Chicago, Illinois 60690. 2 A rticles may be reprinted provided source is credited. B u sin e ss C o n d itio n s, N ovem ber 1963 est rates, yields on three-month Treasury bills have increased about .5 per cent to just under 3.5 per cent. At the same time the average yield on long-term Government bonds rose only slightly—from 4 per cent to 4.07 per cent—despite the additional upward pressure exerted by the recent acceleration in business activity and a large-scale Treasury refunding. The latter increased the volume of long-term securities outstanding substantially, lengthen ing the average maturity of the marketable public debt from 4 years 11 months to 5 years 3 months, the longest in seven years. Banks have bid vigorously for time de posits. At mid-October, many large banks were offering 3.75 per cent interest on three to six month negotiable time certificates of deposit, compared with the ceiling rate of 2.5 per cent three months earlier. Some banks also offered 3% per cent on six to nine month CDs, Vs per cent more than in midJuly. These higher rates attracted a consider able volume of funds. Large New York City banks increased their volume of outstanding CDs more than 400 million dollars, or almost 20 per cent, in the three months from midJuly to mid-October against an increase of only 11 per cent in the comparable 1962 period. The total increase in time deposits of indi viduals, partnerships and corporations— other than passbook savings—at large banks throughout the country was more than 750 million dollars in this period, over twice as much as a year earlier. At the same time, passbook savings, on which the interest rate ceiling remained at 3.5 per cent for deposits held less than one year and 4 per cent for over one year deposits, rose less rapidly than in the 1962 period. Higher short-term rates appear to have contributed to the slowdown in the outflow of short-term capital in the third quarter. The Sp re ad between short-term interest rates in United States and abroad narrows in recent months yield I9 6 0 1961 1962 1963 :;:Three-m onth treasury b ill rates. fTh re e -m o n th rates on U. S. dollar deposits in London. outflow is estimated to have declined to only about half that of the second quarter when re corded short-term outflows totaled over 500 million dollars. C a p ita l a ttra c te d to h ig h e st return Short-term United States capital move ments abroad generally take the form of bank loans, trade credit and investments in foreign liquid assets. Bank loans and trade credit are usually denominated in dollars—and must be repaid in dollars—while investments may be in either dollars or foreign currency. American capital is transferred abroad when net returns there are greater. Capital de nominated in dollars is generally transferred in response to interest rate differentials. Capi tal denominated in foreign currency is influ enced not only by interest rate differentials but also by the risk of unfavorable move ments in exchange rates that may occur be tween the time the funds are moved abroad and the time they are reconverted into dol lars. Investors may hedge against this risk, if 3 Federal Reserve Ba nk o f Chicago they wish, by the simultaneous purchase of a like amount of United States dollars for future delivery. Such purchases are called forward cover. Hedged movements respond primarily to the net spread—commonly re ferred to as the net incentive—between inter est rate differentials and the cost of hedging or purchase of forward cover. The cost of forward cover is the difference between the cost of United States dollars for immediate delivery—the spot exchange rate —and the cost for future delivery—the for ward exchange rate. When the forward ex change rate is below the spot rate, the for ward rate is said to be at a discount. When the forward exchange rate is above the spot rate, the forward rate is said to be at a pre mium.2 When the gross interest rate spread is equal to the cost of forward cover, there is no moti vation to transfer hedged capital in response to international interest rate differentials and interest rate parity is said to exist. Although Canada raised its discount rate to 4 per cent from 3.5 per cent in August, only one month after the United States dis count rate was raised to 3.5 per cent, Cana dian short-term interest rates rose somewhat less in the three months since mid-July than rates in this country. By mid-October, the gross spread between rates on three-month 4 The 3-month forward discount or premium is often shown as a percentage to permit ready com parisons with interest rate differentials. The per centage discount or premium is computed, at first approximation, by dividing the difference between the spot and the 3-month forward exchange rates by the spot rate and multiplying by 4 to convert to an annual interest rate basis. For example, if the spot U. S. dollar-British pound sterling exchange rate were $2.80 for £ 1 and the 3-month forward rate $2.78 for £ 1 , the forward dollar would be selling at a premium equal to (.02 -r- 2.80) x 4 or 2.86 per cent. Likewise, the forward pound would be selling at a discount of 2.86 per cent. Treasury bills in Canada and the United States, which had favored Canada by about .25 per cent, was reduced to only a few per centage points. Interest rates on three-month British treasury bills remained relatively sta ble during this period and the gross spread between American and British rates narrowed from over .50 per cent in favor of British bills to less than .25 per cent. The changes are similar with respect to the incentives for hedged transactions. In mid-July the net incentive favored Canada by about .20 per cent as a result of somewhat higher Canadian short-term interest rates and a slight discount in the price of the forward Canadian dollar. Three months later, the net incentive favored Canada by less than half as much. The decline in the spread between American and Canadian interest rates was in part offset by a reduction in the discount on the forward Canadian dollar. The discount on forward British pound sterling changed only slightly in this period, but as the spread between American and British short-term interest rates declined sharply, the net incen tive to transfer capital abroad on a covered basis turned in favor of the United States. Possibly more important than the effects of interest rates on capital flows have been the effects of the policy actions in increasing confidence in the ability and willingness of this country to defend the dollar. This has served to diminish the incentive to transfer funds abroad in anticipation of a depreciation of the dollar relative to gold and other cur rencies. Sharply higher short-term interest rates have been proposed as a solution to the balance of payments problem, particularly by foreigners. T a x slo w s ca p ital o u tflo w Although Congress has yet to take final action on the proposed “interest equaliza B u sin e ss C o n d itio n s, N ovem b er 1963 tion” tax, uncertainty surrounding its adop tion has affected long-term capital move ments. Foreign borrowers and domestic lend ers alike are hesitant about entering into agreements without full knowledge of the tax cost. As a consequence, scheduling of new foreign securities has slowed almost to a standstill. Nevertheless, because the proposed tax exempts new securities registered but not sold before July 18, third quarter figures on long-term capital outflows from the United States will still show a sizable outflow. The almost complete cessation of new foreign security sales in this country may be attributed more to the uncertainty surround ing congressional approval of the tax than to the penalties of the tax itself. It has been estimated that once Congress acts on the tax proposal, regardless of the outcome, the sales of new foreign issues here will rise again al though probably not to the unusually high levels of the first half of the year. The proposed tax has also created a dual market for outstanding foreign securities. Securities sold by nonresidents frequently sell at a somewhat lower price than the same securities sold by residents. The difference in price roughly reflects the buyer’s estimate of the probability of the tax being adopted. Re cently, for example, a share of Royal Dutch Petroleum (a Dutch concern) traded on the New York Stock Exchange at $47% if the seller was a resident and at $46% if the seller was a nonresident. This difference in price is less than the amount of the proposed tax, reflecting the market’s doubts about its pas sage in the present form. Monetary and fiscal actions have a fairly prompt impact on capital movements. Effects on other components of the balance of pay ments would take place more gradually. For example, if higher short-term interest rates discourage business firms from borrowing enough to create upward price pressures on commodities, this would have a longer-term favorable effect on the trade balance. Slower increases in the prices of domestic products in comparison with foreign prices, would help to increase exports. (For a more detailed analysis of recent price trends see “Foreign Trade—the United States Competitive Posi tion” on page 11 of this issue.) It has long been noted that a country can better achieve a lasting equilibrium in its balance of inter national payments by increasing exports than by restricting capital outflows. District b u sin e ss lo a n s stre n g th e n Business loans outstanding at major banks in Seventh District leading cities rose 165 million dollars in the third quarter of 1963, well over twice as much as in the same quarter of 1962. At the same time business loans at large banks throughout the country rose less than in 1962. At the end of Septem ber, District business loans were almost 12 per cent above year-earlier levels. This rate of expansion was almost twice as fast as for the larger banks in all United States leading cities and compares with an increase of less than 8 per cent in the previous 12 month period when District loans expanded at about the national average. The recent strengthening in District busi ness loan demand is evident for almost all industry groups except retail outlets and mis cellaneous durable goods. Loans to petro leum firms, commodity dealers and chemical and rubber concerns showed particular strength, increasing 38, 30 and 19 million dollars, respectively, more than in the third quarter of 1962. Bank loans to finance com panies, which are not included in business loans, also expanded sharply, ending the quarter 50 million dollars above the year-ago level. 5 Federal Reserve Ba nk o f Chicago Stock prices and business prospects jA -fter a dull performance in the early sum mer, common stock prices surged upward and in September the most widely used indexes broke through the previous record highs reached in December 1961. This develop ment was taken as a favorable omen not only for a further rise in the market but also for general business prospects. Stock market trends long have been ac corded an almost mystical significance. Some believe changes in stock prices directly meas ure the level of business activity. Others solemnly repeat the adage, “the stock market discounts everything six months in advance.” Observers strain at personification: “What is the market trying to tell us? I think the mar ket is saying. . . .” In late summer the mes sage that the business outlook was excellent seemed to be coming through loud and clear. But a leveling of the stock indexes in October gave rise to doubts. Do market trends foretell business prospects in a useful manner? Let’s look at the record. W h y should the m a rk e t te n d to le a d ? Stock price changes were more generally accepted as a forecasting aid in the Twenties than in recent years. This was partly because the entire statistical framework for analyzing business conditions was relatively undevel oped at that time. A 1927 book, Forecasting Business Condi tions, by Hardy and Cox, observed that, 6 Perhaps the most widely accepted principle in relation to the subject of our study is the doctrine that changes in the stock market forecast similar changes in the volume and direction of business activity. The authors went on to voice considerable skepticism toward the market’s dependability as a short-run indicator. Their doubts were validated by subsequent developments. Busi ness activity began to decline a month or two before the market crash in 1929 and abortive stock price revivals in 1930 and 1931 raised false hopes of an early end to the business depression. In recent years most writers on business forecasting have concluded that changes in stock price indexes tend to lead changes in business activity but that the relationship is not stable. Nevertheless, when attempts have been made to draw up lists of statistical indi cators which customarily move in advance of general business activity an index of stock market price almost invariably is included. The rationale behind the use of stock price indexes as an indicator of future business prospects is clear enough. The major stock exchanges are among the most perfectly com petitive markets in the entire economy with many well-informed buyers and sellers. Prices of shares are determined by the deci sions that millions of individuals and institu tions throughout the world communicate to traders in the organized stock exchanges. Although some investors buy or sell on the basis of formulas, “systems” or hunches, most decisions are based upon evaluations of a vast array of detailed information on the economy and on individual business firms. Rising prices indicate that optimistic senti- B u sin e ss C o n d itio n s, N o ve m b e r 1 9 6 3 ment is predominant and that buyers are tak ing the initiative. In a falling market the opposite conditions prevail—selling pressure is relatively strong because of the growth of pessimistic attitudes. Changes in the level of stock prices tend to have a direct impact on business condi tions. First, since stock prices are widely accepted as a leading indicator, increases or decreases in the indexes may cause businesses and consumers to become more aggressive or show greater caution in spending and in mak ing investment commitments. Second, indi viduals who hold stocks find that their wealth and borrowing power—using stocks as col lateral—fluctuate with stock prices and their spending may be influenced by market move ments even though they have not realized gains or losses through sales of their holdings. Third, businesses that contemplate selling stock to finance expansion and perhaps pro vide a base for additional debt may activate or postpone such plans depending upon whether stock prices rise or fall. The level of the stock market as measured by common stock price indexes has strong appeal as an economic barometer for a num ber of reasons. First, changes in prices re flect changes in investors’ evaluations of future corporate profit trends, with the aggre gate value of all common stocks thus pre sumably measuring the going concern value of all corporate business. Second, in contrast with most other economic measures, which become available a month or more after the period covered, stock price indexes are calcu lated every hour of the trading day. Third, the latest stock price indexes are readily available to all interested parties because they are re ported regularly over the “ticker,” on the radio and in virtually all major newspapers. Fourth, millions of individuals follow the market because they have a personal interest in stock price indexes as owners or potential owners of stock. Substantial changes in stock prices often have a highly speculative basis—for example, the sharp drop in September 1955 following President Eisenhower’s heart attack. But most stockholders presumably buy and sell on the basis of changes in the prospects for corporate profits (after taxes) available for dividends or reinvestment. Emphasis on profits does not invalidate the market as a barometer of business activity. For obvious reasons corporate profits tend to rise and decline with the level of business. In the early stages of a business upturn or downturn, changes in business sales bring even greater relative changes in profits be cause a substantial proportion of business costs are fixed or relatively fixed during short periods of time. After an upswing has been under way for a year or more, rising costs usually begin to catch up with or surpass the rise in sales. As a result, total corporate prof its and especially profits as a per cent of sales have tended to decline or rise before general business activity. For this reason corporate profits after taxes, along with common stock prices, appear to be a measure that often changes direction before business activity. Does the market forecast changes in cor porate profits accurately? If so, the market averages would move fairly smoothly some distance ahead of profits. But this has not been the case as the chart on pages 8-9 shows. There is also the matter of relative changes in magnitude over time. In 1962 corporate profits after taxes were nearly the same as in 1959 while industrial production was 12 per cent higher and stock prices averaged 9 per cent higher. In a longer-term comparison 1962 corporate profits were 20 per cent greater than in 1948 while industrial produc tion was up 73 per cent and the index of 7 Fed era l Reserve Ba nk o f Chicago B u sin e ss C o n d itio n s, N ove m b e r 1963 H av e ch ange s in stock prices "called business turns"? The postwar record shows many erratic movements. corporate profits after tax-billion dollars stock prices-standard 8 p o o rs - 1 9 4 1 - 4 3 = 1 0 0 s tria ) p ro d u c tio n -p e r cent, I 9 5 7 " 5 9 = 1 0 0 100 90 “ !3 0 80 “ 120 70 “ 110 2 8 70 12 60 8 - J - ju - i 5 0 4 - 10 „,i. i i i i i i i i i i, 1946 1948 1949 common stock prices had increased fourfold. The p o stw a r reco rd 8 Anyone who has observed the continuing fluctuations in stock prices realizes that it is not easy to determine when a genuine “turn” occurred in the market prior to a peak or trough in the business cycle even if the event is long past. The financial press carries highs and lows in the averages for each trading day. 1950 1951 1952 1953 Often trends are established for several days, even weeks and months, only to be reversed several times before a peak or trough in the business cycle occurs. Some who follow the market try to inter pret the highly erratic day-to-day movements. Business cycle analysts normally employ monthly averages which smooth out some random movements. Standard and Poor’s composite index of 500 industrial, rail and 1954 * * - ■*> 1955 1957 1958 utility stocks is most commonly employed for analytical purposes. How has this measure performed in relation to general business activity during the postwar period? The S & P composite index averaged 49 per cent higher in September 1963 than five years earlier. In the 60 months between these dates the index rose 36 times and declined 24 times. The longest “run” in one direction was seven months and the second longest was I9 6 0 1962 four months. Between the start of the current business expansion in February 1961 and September 1963 the index rose 17 per cent. During the period there were 19 increases and 12 declines. The longest consecutive run in one direction was only four months and the index changed direction from one month to another no less than 14 times out of a possible 31! There have been eight business cycle turns 9 Federal Reserve Bank o f Chicago 10 in the period from 1946 to date. Peaks were reached in 1948, 1953, 1957 and 1960 and troughs occurred in 1949, 1954, 1958 and 1961. In each case the change for better or worse was preceded by at least one similar movement in stock prices. But in some peri ods, particularly before the peaks of 1957 and 1960, a market decline was reversed in the months immediately before the turn in business. On several occasions, most noticea bly in 1946 and 1962, there were relatively sharp changes in the market that were not followed by comparable changes in business activity. Assuming a change of 5 per cent or more to be a “swing” in the monthly average of the Standard and Poor’s composite index, there have been 11 declines in the market and 13 rallies since 1946 as compared with only four business cycle troughs and four peaks. In retrospect the sharp drop in the market in 1962—21 per cent from March to June with no appreciable recovery until Novem ber—presents one of the most noteworthy false signals provided by the stock price in dexes. Forecasts of a decline in general busi ness activity became widespread in October 1962 just at the time that a renewed upswing was about to begin. Only one other postwar decline in stock prices— as measured by changes in monthly averages—was as severe as that of 1962. Be tween May and November 1946 the compos ite index dropped 21 per cent. This develop ment, however, was followed by two years of vigorous expansion in business activity dur ing which time the index never approached its 1946 high. A different sort of false signal was offered by the stock market in 1957 when the Stand ard and Poor’s index rose 12 per cent be tween February and July. The latter month afterwards was accepted widely as the peak of the business expansion. The same story was retold, although less emphatically, in 1960 when the market rose 4 per cent be tween March and June although May 1960 later was accepted as a business peak. R e a d in g the m a r k e t’s m e ssa g e Historical comparisons of trends in com mon stock prices and business activity reveal no clear or dependable pattern. Since the early postwar period, stock prices have risen far more than most broad measures of activ ity and many zigs and zags in the market have not had counterparts in business fluctuations. In short, if the market is “trying to tell us something” about short-term business pros pects, we have not yet learned its language. In the long run, on the other hand, stock market prices measure public confidence in the future of American prosperity. Market appraisals of the worth of business firms, in dividually and collectively, comprise a vital part of our economic intelligence. The Two Faces o f Debt A new booklet e n title d The Tw o Faces of Debt has recently been p u b lish e d by the Federal Reserve Ba nk o f Chicago. It presents a d e sc rip tio n o f the role o f debt in o ur economy and the d is trib u tio n o f debt am ong m a jo r g ro u p s o f debtors and c re d ito rs. Copies o f th is booklet, as w e ll as M odern Money Mechanics—a w o rk b o o k on deposits, currency and bank re se rve s, a re a v a il able to banks, b u sin e ss o rg a n iza tio n s and educational in s titu tio n s fro m the Research D e p a rtm e nt, Fe d e ra l Reserve Bank o f Chicago, Box 8 3 4 , Chicago, Illin o is 6 0 6 9 0 . B u sin e ss C o n d itio n s, N ovem b er 1963 Foreign trade— the United States competitive position (_>un United States exports be increased enough to eliminate the deficit in its balance of international payments? This possible remedy is given high priority in American international economic policy. Businessmen are urged to seek out additional export opportunities and Congress has authorized expansion and improvement of insurance and financing facilities that aid private exports. But many persons call attention to the fact that this country now exports nearly 5 billion dollars more of goods each year than it im ports and many observers express doubts that this surplus can be boosted substantially. Others not only believe that boosting exports is the most desirable attack on the balance of payments problem but also that this approach has good prospects of succeeding. One view — reiterated recently by the Brookings Institution, a privately endowed research organization — is that European wages and prices will continue to rise fairly rapidly and that this will go a long way toward ending, possibly in five years, the deficit in the United States balance of pay ments.1 The Brookings study also assumes a faster rate of economic growth in the United States, both relative to its own record in re cent years and relative to the growth rate in Western Europe in the years ahead. While there are plausible reasons for making these 'Such deficits, which have occurred almost every year since 1950, result from the fact that the United States spends, lends, invests and gives away abroad more than foreigners spend, lend and invest in this country. assumptions, placing major emphasis on continued inflation abroad to provide a solu tion to our balance of payments problem leaves us in the awkward position of relying on the failures of others in order to solve our own problems. Whether these assumptions, and the conclusions based upon them, prove to be correct will be determined largely by the answer to a more basic question: is the competitive position of the United States strengthening relative to that of its major world trading competitors? Prices a n d w a g e s risin g Prices and wages have advanced during the last few years in both the United States and Europe. But in the United States, consumer prices rose less rapidly than in France, Ger many, Italy and Britain. This has been true even if allowance is made for changes in offi- Prices and wages, 1962 Consumer prices Hourly W holesale earnings in prices manufacturing (1958 = 100) United States. . . 105 100 France.................. 119 113 133 Germ any............. 109 103 140 Ita ly ...................... 109 101 132 United Kingdom. 110 107 127 SO URC E: OECD, Genera Statistics Monthly Bulletin of Statistics, July 1963. 113 and U. N., Federal Reserve Bank o f Chicago 12 cial values of currencies. France’s prices volume changes in many different commodi probably rose somewhat more than they ties. Nevertheless, based upon available in would have in the absence of the 17 per cent formation, it appears that export prices, in devaluation of the French franc in December terms of dollars, rose in the United States, 1958, and Germany’s prices may have been Germany and Britain, and fell in France and held down somewhat by the upward revalua Italy from 1958 to 1962. Import prices de tion of the German mark in March 1961. clined in each of the five countries. Both export volume and import volume in 1962 Wholesale prices were stable here but ad vanced in the Old World—though only were larger for each country than in 1958. nominally in Italy. There is no consistent pattern between price changes and volume changes. For ex The relative price stability in the United ample, although prices (unit values) of ex States must be attributed in large part to the ported goods rose somewhat more steeply in ample capacity in major industries and a Germany than in the United States, Germany measure of restraint in wage settlements and was able to boost its exports substantially fringe benefits. These settlements, of course, more. And although German import prices are related to the over-all job market and have been influenced by the relatively high fell less than those in the United States, Ger level of unemployment. many’s imports rose at a faster rate. On the It does not necessarily follow from the other hand, Italy, whose prices declined most on both sides of the trade ledger, ranked first above, however, that the United States ex port position has improved in proportion. in gains in both exports and imports. In all the countries, export prices rose For export and import prices, which are important factors affecting the quantities of American goods de manded by foreigners and the quantities of foreign goods de Export-im port prices and volume, 1962 manded by Americans, do not Export Export Import Import necessarily move in step with the prices® volume prices'* volume broad gauge price indexes. This is (1958 = 100) especially true for a country like 117 United States.............. . . 103 96 127 the United States whose exports 96 95 144 150 France.......................... and imports are a much smaller Germany...................... . . 104 144 97 171 fraction (8 per cent) of gross na 211 93 198 90 Ita ly................................ tional product than is the foreign 122 United Kingdom......... . . 103 116 97 trade of most other industrial 159 Common M a rke t. . . . . . 100 147 95 nations (30 to 40 per cent). European Free Unfortunately, the available 97 125 136 Trade A re a ............ . . 102 evidence that pertains more di “Expressed in United States dollars in order to reflect revalua rectly to exports and imports also tions of national currencies against the dollar. Index figures not is less than adequate, largely be strictly comparable because o f varying procedures used by countries in compiling indexes. cause of difficulties in represent SO URC E: IMF, International Financial Statistics and U. N ., Monthly ing in one or a few numbers Bulletin of Statistics, July 1963. the composite effects of price and B u sin e ss C o n d itio n s, N ovem ber 1963 relative to import prices and the rise in im port volume generally outpaced the advance in export volume. The only exception to this is France, where export and import prices moved nearly in step but import volume was up less than export volume. A convenient way to measure the relative strengths of exports and imports is to let the ratio of import volume to export volume of each country be equal to one for the base year (1958). Import-export ratios, 1962 (1958 = 1.00) F r a n c e ....................................... 0.96 United K in g d o m .....................1.05 Italy ..........................................1.07 United States ......................... 1.09 G e r m a n y ...................................1.19 Of the five countries compared, France was the only one whose export volume rose faster than import volume from 1958 to 1962. The foregoing data suggest a few conclu sions. First, relatively small percentage in creases in the fairly comprehensive measures of domestic wages and prices do not assure a country a favorable standing in the prices and the volume of goods exported. This is partly because the commodity composition of total exports differs from that in the whole sale and consumer price indexes. Prices and wages rose considerably more in France than in the United States, but it was able to boost its export volume by about three times as much due partly to its currency devaluation in December 1958. The fact that France’s import volume advanced only a little less, despite higher franc prices of its imports after devaluation, may be largely attributable to the new trading opportunities which arose as the members of the Common Market be gan to reduce their tariff barriers on January 1, 1959. In contrast, Germany’s export ex pansion was slowed and its import growth boosted by the upward revaluation of the mark in March 1961. Second, a fall in import prices relative to export prices tends to favor growth in im ports relative to exports. In the case of the industrial countries considered here, the rela tive growth of imports reflects an improve ment in their terms of trade vis-a-vis the countries whose major exports are raw ma terials. In other words, prices of their exports tended to rise relative to prices of their im ports. The shifts in these price ratios, 195862, for the main regions of the world were: United States and C a n a d a ..............106 Common M a r k e t.............................. 105 European Free Trade A r e a ......... 105 Latin A m e r ic a ................................. 96 Africa ................................................. 90 Middle E a s t ...................................... 89 SOURCE: o f Statistics, U.N., M on th ly July 1963. Bulletin Third, the greater relative increase in the foreign trade of Germany, Italy and France, despite greater percentage increases in wages and prices, reflects the high rate of growth of trade within the Common Market. The smaller relative increase in foreign trade of the United States reflects the slower rise of demand in Latin America and Canada, which are important United States markets. Another possibility for gauging a country’s “exporting strength” is to express its export (import) surplus as a per cent of its total merchandise trade during a given period. For the five countries considered, the results are given in the table on page 14. The two countries with an export surplus in 1958 (United States and Germany) were still net exporters in 1962, though by a some what smaller margin. Countries with an im port surplus in 1958 (France, Italy, United Kingdom) were still net importers in 1962— 13 Federal Reserve Ba nk o f Chicago in 1958; in the United States the rise was about one-eighth. But because of their low starting point, representative European wages in 1962 were on the whole still only W a g e s , ou tpu t a n d prices from one-fifth to two-fifths of the comparable American average, and in absolute (rather The most basic ingredient of international than relative) terms the gap widened from competition, of course, is comparative pro duction costs. While relative movements of 1958 to 1962. Fringe costs, which are not included in the production costs are affected by many things, wage data, are often a sizable share of total possibly wages loom largest. But while better labor costs, and the relative importance var information is available for wages than for ies widely from country to country. In Italy, most other industrial costs, the implications fringe benefits are almost equal to “regular” of wage trends for shifts in competitive strength are not easily appraised. Hourly earnings. In France they account for about two-thirds and in Germany for about half, earnings in manufacturing do not reveal but in the United Kingdom fringe benefits whether or not the cost gap between United are only about one-seventh of regular earn States and European goods that are interna ings. The comparable ratio in the United tionally traded narrowed in relative terms States is about one-fifth. between 1958 and 1962. A rising wage trend Combined hourly and fringe payments in might be reinforced, or offset, by movements major Western European countries range of fringe costs, changes in output per man from approximately one-fourth (Italy) to hour and other factors. one-third (Germany) of the comparable On an hourly basis, manufacturing work United States total. Including fringe benefits ers in major European countries in 1962 has the effect, therefore, of narrowing the earned on average about one-third more than range of differences in total hourly wage costs in Europe while at the Total trade flo w s and trade surpluses same time bringing the average E u ro p ean Export Ratio of surplus to Value of (import-) surplus value of foreign trade foreign trade hourly wage costs J958 J962 1958 1962 1958 1962 closer to the United (millions) Iper cent) States figure. Such a United States broad, multi-country 4,533 5,173 38,115 14.5 13.6 (d ol.)............. 31,307 average, of course, — 4.5 — 1.0 France (fr.). . . . 45,070“ 73,450“ — 2,050“ — 750 conceals large differ 7.5 3.8 Germany (m.). . 68,810“ 102,040“ 3,860 5,150“ ences. This is also true — 11.0 — 13.0 Italy (L.)............ 3,621 b 6,701b — 399 b — 869 of country averages, United Kingdom which gloss over dif — 6.1 — 6.4 8,441 — 430 — 543 (stg.).............. 7,066 ferences among re “ Figures given in billions, with two decimal places only. In converting to millions, a gions, industries and ze ro has been added. firms. Nevertheless, b Billions. SO URCE: IMF, International Financial Statistics, July 1963. wage d i f f e r e n c e s by an even larger margin—except France which had nearly eliminated her import sur plus. 14 B u sin e ss C o n d itio n s, N ovem ber 1963 Since the extent to which an in crease in production per man hour offsets the increase in wages Other nations Difference as per cent Hourly earnings varies, changes in wage cost per in manufacturing from U. S. of U. S. unit of output also differ between 1962 1958 1962 1958 1962 1958 countries. For example, in the in $2.39 United S ta te s... $2.11 dustrial sector (mining, construc .50 $1.73 $1.89 18 21 .38 France................. tion and manufacturing) gains in 26 34 .54 .81 1.57 1.58 Germany............ output per hour in France and 1.9916 17“ .35 .40a 1.76 Ita ly..................... Germany between 1954 and 1961 37 41 .99b 1.33 1.40 .78a United Kingdom offset roughly half the increase in a 1961 (1962 figures not available). wage cost per hour, hence unit b Males. wage cost rose by somewhat more N o te : Figures are dollar equivalents o f payments received by (all) wage than one-third. In the United earners in their national currencies. Conversion into dollars at end-of-year exchange rates. States and Italy, on the other SO URC E: U. N., Monthly Bulletin of Statistics, July 1963. hand, output per hour advanced at nearly the same rate as wages, among leading European industries are far resulting in only a very small rise in labor less pronounced than the gap between these cost per unit of output in these countries. In industries and their United States counter the United Kingdom unit cost rose at a rate almost equal to Germany’s, although the two parts. In 1960, for example, average hourly components of unit cost advanced much less earnings and fringe benefits in the chemicals rapidly. and machine tool industries in European It is of great consequence to industry on countries tended to cluster around the equiva both sides of the Atlantic how the major lent of $1; for workers in the United States employed in these industries, the average was determinants of unit labor costs will move in the principal trading nations. If wage costs in more than $3 an hour. Europe increase on average 8 per cent per Any meaningful appraisal of relative unit year while output per man-hour advances costs must take into account production per only 4 per cent, and if at the same time Amer hour as well as wages. Although reliable data ican wage costs increase 4 per cent per year are scarce and problems of interpretation are while output per man-hour increases 3 per numerous, there can be no doubt that wide cent, Europe’s competitive position will differences exist, both in absolute levels of worsen on balance. output per man-hour and in the trend of Any estimate of future changes in com changes in these levels, both among the Euro pean countries and between them and the parative output per man-hour among various countries—if anything more than an exten United States. For example, it is estimated sion of recent trends—must take into account that gross production per man-hour in manu many things. Commercially useful inventions, facturing increased from 1954 to 1960 by for example, may increase production per well over 30 per cent in Germany, nearly 30 man-hour faster in one area than another. per cent in France, but slightly less than 20 per cent in Italy, the United Kingdom and the The economic integration of the European Economic Community (EEC) and of the United States. C o m p arative w age earnings in manufacturing 15 Federal Reserve Ba nk o f Chicago European Free Trade Association (EFTA) —not to mention similar efforts in the less developed countries of Latin America and Africa—might possibly help Western Europe to keep unit wage costs in check. But com petitive improvements on this score could be offset by the effects of the new United States tax incentives (accelerated depreciation and tax credit provisions recently enacted) de signed to spur a higher rate of capital invest ment in this country. The currently proposed reduction of corporate income tax rates would tend to have similar effects. Inflationary pressures in Europe are still another uncertainty. They have lately gener ated increased interest in public policies on wages and prices and resulted in adoption of programs to restrain these pressures. C on clusion s a n d o u tlo o k 16 On the basis of presently available infor mation, it is difficult to evaluate the competi tive position of the United States in interna tional trade. There is some indication that the United States competitive position vis-avis other major trading nations declined somewhat from 1958 to 1962, despite the stability of wholesale prices in this country. In recent months, however, several coun tries—especially France and Italy—have ex perienced a rapidly rising trend in hourly labor costs. If it continues, it may well lead to a strengthening of the competitive position of the United States, but statistics on exports and imports in 1963 hardly suggest that such an improvement has already occurred. Labor remains in relatively short supply in Europe, while it is relatively abundant in the United States. This should help to maintain stable prices here. In years past, as the econ omy has moved close to full employment, an accelerated rise of wage rates and prices has followed. It may be necessary, therefore, to develop wage-making arrangements which permit the country to approach full employ ment without incurring cost-inflating wage increases. The United States as well as Eur ope has shortages of particular skills, as edu cation and training have lagged behind changing technological requirements and changing consumer demands. The growth trends in the labor force in Europe and the United States will diverge during the remainder of this decade. It has been estimated that by 1970 the European Economic Community’s labor force will be only 5 per cent larger than it is now, while the working population will be 17 per cent greater in the United States and 7.5 per cent larger in the United Kingdom. Even if the rate of population increase in Europe should rise above its 1 per cent annual average of recent years and approach the 1.7 per cent annual increase in the United States, it would be many years before the effects of the accelerated trend showed up in the labor force. In the meantime Europe, like the United States, may expect some addition to the industrial labor supply resulting from the shift of manpower “from farms to fac tories.” Whether the momentum of this movement, already significant in the late Fifties, can be maintained in the Sixties will depend in part on how the area’s hard foughtout agricultural policy is finally implemented. In the broadest view, some facets of pro spective developments in other industrial countries will tend to favor a net gain in the United States competitive position in world markets in the Sixties. But the evidence is not clear enough to assure that this will be the outcome, and it is unlikely that the sizable deficit in the balance of international pay ments of the United States can be resolved by attention to exports alone, important as that is.
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