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APRIL 1962 B U SIN E SS R E V IE W Balance of Payments and Monetary Policy The Long and the Short of It: Bankers are Reaching Out for Longer-Term Securities Again FEDERAL RESERVE BANK OF PHILADELPHIA BUSINESS R E V IE W is produced in the Department of Research. Clay J . Anderson was primarily responsible for the article “Balance of Payments and Monetary Policy” and J. C. Rothwell for “The Long and the Short of It.” The au thors will be glad to receive comments on their articles. Requests for additional copies should be addressed to the Department of Public In formation, Federal Reserve Bank of Phila delphia, Philadelphia 1, Pennsylvania. BALANCE OF PAYMENTS AND MONETARY POLICY* Spending, borrowing and lending, and investing are not confined within national boundary lines. Consumers and business firms in the United States buy goods and services from all over the world. We lend and invest in foreign countries; foreigners lend and invest here. We pay interest and dividends on foreign investments in this country and, in turn, receive income on funds in vested abroad. We are spending large amounts for foreign travel— much more than foreign vis itors spend here. Our Government makes large payments abroad; foreign governments make payments here. These are only a few illustrations of the multitude of transactions that crisscross national boundary lines. Some transactions re sult in receipts from, others in payments to foreign countries. International transactions have not attracted as widespread interest here as in most foreign countries. This is not surprising. Exports account for less than 4 per cent of our total output of goods and services. But foreign trade is much more important to most countries. The United Kingdom and West Germany export about onefourth and the Netherlands over one-half of their total output. Our growing concern about the bal ance of international payments has been aroused by a persistent deficit and, especially in the past few years, substantial losses of gold. I am going to deal briefly with four questions: What is the balance of payments? Why has the United States been running a deficit? * A talk by C la y J. A nd erson, E con om ic A d v ise r, Federal Reserve Bank of P hila delphia, to the Se cond Post G ra d u a te Sem inar, C e n tra l States G ra d u a t e Schoo l of Banking, C h ic a g o , Illinois, M a rc h 9, 1962. What about the impact of the Common Market? What are the implications of our balance-of-payments position for monetary policy? B A L A N C E OF P A Y M E N T S The balance of payments commonly refers to a summary statement showing a country’s receipts from and payments to foreign countries during a given period of time. A country’s international transactions are classified to show its main sources of receipts and principal types of pay ments. If payments are larger than receipts, a country has a deficit; if receipts are larger than payments, it has a surplus in its international transactions. (Of course, if transfers of gold and net changes in foreign assets and liabilities are included, receipts and payments are equal.) A simplified statement of the balance of payments of the United States in 1961 is given on page 4. Receipts Exports are by far our largest source of foreign receipts. Agricultural products, industrial sup plies and materials, and capital equipment account for a large part of our exports. Transpor tation and other services, and earnings on in vestments abroad are other significant sources of receipts from foreign countries. P ay m e n ts Our largest item of expenditure abroad is for im ported goods. There are also substantial payments for a variety of services rendered by foreign ers, and expenditures by United States tourists 3 business review UNITED STATES BALANCE OF PAYMENTS, 1961 (Billions of Dollars) Receipts Exports .................................................................. Transportation, travel, and m isce llane ou s services .. $19.9 4.8 Incom e from investm ents a b r o a d ............................. Inflow of fo re ign private lon g-te rm ca p ita l ............ U. S. G ov e rn m e n t r e c e i p t s ...................................... 3.6 0.4 1.3 Total receipts .................................................... $30.0 Payments Im ports ................................................................... $14.5 Transportation, travel, and m isce llane ou s services .. 4.7 Interest, d iv id e n d s on fo re ign investm ents in U. S. .. 0.9 Private rem ittances and other transfers ................. 0.9 O utflow of private long-term ca p ita l ..................... 2.6 Direct investm ent ................................................ $1.6 U. S. G ove rn m e n t paym ents ................................... 7.1 M ilita ry expenditures ............................................ 3.0 G o vernm en t grants, loans and aid ........................ 4.1 Total paym ents ................................................ $30.6 Basic balance: deficit ............................................ N e t outflow of short-term ca p ita l .......................... U nrecord ed transactions, errors, and o m i s s io n s ....... O v e r-a ll deficit ...................................................... $ 0.6 1.2 0.6 2.5 N ote: Detail m ay not a d d to totals because of rounding. traveling in foreign countries. In recent years, private long-term investments in foreign countries have averaged about $2.5 billion annually. Gov ernment payments to foreign countries, pri marily military expenditures and economic aid, have been large throughout the postwar period. The basic balance of payments, a term fre quently used, includes international transactions in goods and services, private long-term capital movements, and Government transactions. It ex cludes short-term capital flows, which often reflect interest-rate differentials and other tempo rary forces rather than more fundamental economic conditions. In 1961 there was a deficit of $600 million in our basic balance of payments. A net outflow of short-term capital of $1.2 bil lion, and unrecorded transactions believed to be mainly short-term capital flows brought the over all deficit to $2.5 billion. If debt prepayments by foreign governments are excluded, the total was $3.2 billion. 4 P ay m e n ts m echanism In domestic transactions only one monetary unit— the dollar— is involved in making payments and settling balances. Sales and other sources of receipts are in dollars, and dollars can be used in any type of payment. In foreign transactions there is no international monetary unit that is generally acceptable in pay ment of international transactions. There is a well-developed foreign exchange market, how ever, in international financial centers, such as New York, London, and Paris. Exporters and others with bills of exchange payable in foreign currencies can sell their bills to their bank or foreign exchange dealer. They receive dollars at the current rate of exchange. The buying banks and dealers send the bills abroad for collection and payment, thus building up their balances of foreign currencies. These balances enable banks and dealers to sell foreign currencies to importers and others needing to make payment abroad. In short, exports and other sources of receipts pro vide foreign currencies which can be used to pay for imports and other expenditures abroad. Through banks and other foreign exchange deal ers, the bulk of international transactions is settled by transfers of credit instruments and debits and credits to the appropriate accounts. W H Y A DEFICIT? A deficit in our balance of international pay ments is not something new. The United States has had a deficit every year, except 1957, since 1949. The “dollar shortage” and the “dollar gap,” which attracted so much attention in the early postwar period, vanished in the fifties. The annual deficit was not large until 1958. The small surplus in 1957 reflected primarily the surge in United States exports as a result of the Suez crisis. Beginning in 1958, the deficit soared business review BALANCE OF PAYMENTS BILLIONS OF DOLLARS years. During that time, we sold more goods than we bought in practically all major geographical sectors of the free world— Canada, Western Europe, Asia, and Africa. Trade with the Western Hemisphere other than Canada was about in bal ance— some years showing a small deficit and others a small surplus. BALANCE OF G O O D S AND SERVICES* BILLIONS OF DOLLARS 8 6 and averaged nearly $3.5 billion during the past four years. There was some improvement last year but the amount was small if debt prepay ments by foreign governments are excluded. The causes of the persistent balance-of-payments deficit cannot be pinpointed. Both receipts and payments reflect the sum of a multitude of transactions. The deficit is the result of all trans actions, not just a few. Nevertheless, it may be helpful to take a look at some major categories of international transactions to see where our strengths and weaknesses lie. Surplu s on g o o d s a n d services The United States has had a surplus on goods and services for many years. Receipts from sales of merchandise, services rendered foreigners, and income on foreign investments have substan tially exceeded payments to foreigners for these purposes. The annual surplus on goods and services since 1949 has ranged from a low of about $2 billion to a high of over $8 billion. Last year the surplus exceeded $7 billion. Merchandise has contributed the major part of the United States surplus on goods and services. The excess of merchandise exports over imports averaged around $4 billion during the past five 2 0 • Includ e s investm ent incom e, m ilitary sales, p riva te remittances, and pensions. P rivate lo n g-te rm capital Individuals and business firms lend and invest more abroad than foreigners lend and invest in the United States. The net outflow of private long term capital has been considerably larger since the mid-fifties. The bulk of this outflow has been in the form of direct investments in plant and equipment. A part represents portfolio invest ment; that is, purchases of foreign securities. NET OUTFLOW— PRIVATE LONG-TERM CAPITAL BILLIONS OF DOLLARS 3 2 0 1950 '51 '52 '53 '5 4 '55 '56 '57 '58 '5 9 '6 0 '61 5 business review New loans and investments abroad result in pay ments to foreign countries; however, they later build up a return flow of receipts in the form of interest, dividends, and debt repayment. United States direct investments in foreign countries total close to $35 billion. The bulk of the investments is in manufacturing, petroleum, and mining. As to the geographical distribution, the largest amount is in Canada; but there are also substantial amounts in South American coun tries and in Europe. Direct investments in the Common Market countries total about $3 billion. G o ve rn m e n t p a y m e n ts Government payments abroad are much larger than receipts from foreign governments. Last year, payments exceeded receipts by nearly $6 bil lion, and the net outflow on Government ac count has averaged about this amount annually during the past five years. A large part of the Government’s payments abroad is for maintenance of United States troops and bases in foreign countries. Military expendi tures, which have been running about $3 billion a year, are an integral part of the nation’s de fense program. Throughout the postwar period the United States has spent large sums aiding in the recon struction and development of many foreign coun tries. In the early postwar years, Government loans and grants went primarily to European countries and Japan to assist in the reconstruc tion of war-devastated areas. Later, Government aid was shifted to help promote economic de velopment in the underdeveloped countries. Net Government economic aid to foreign countries has averaged about $3 billion annually in recent years. These payments are directly related to our exports in that about 65 cents of every dollar paid out in Government loans and grants is used for the purchase of United States goods and services. The deficit a n d g o ld In international transactions, as in domestic, we can spend more than we receive only by going into debt, or by giving up something such as gold that foreign creditors are willing to accept in payment. The initial effect of our deficit is mainly to increase bank deposits in the United States owned by foreigners. Deposits in excess of minimum working balance needs are frequently invested in highly liquid earning assets such as SHORT-TERM LIABILITIES TO FOREIGNERS BILLIONS OF DOLLARS NET OUTFLOW— UNITED STATES GOVERNMENT PAYMENTS BILLIONS OF DOLLARS ‘ Includes d e b t p rep a ym ent of $0.7 billion. 6 BILLIONS OF DOLLARS business review U. S. Treasury bills and other short-term securi ties and paper. Thus when foreigners accept dol lars in payment of deficits, our liabilities to foreigners increase and they accumulate deposits and other short-term dollar assets in the United States. Foreign holdings of short-term dollar assets total about $22.5 billion. The principal source of these foreign-owned dollar assets has been the deficits in the United States balance of payments. SHORT-TERM DOLLAR ASSETS OW NED BY FOREIGNERS December, 1961. About 70 per cent of the combined deficit since 1949 has been settled in dollars and the remainder by a transfer of gold. UNITED STATES GOLD STOCK BILLIONS OF DOLLARS What determines whether our deficits are set tled in dollars or gold? The choice rests with our foreign creditors. The largest part of our short term liabilities to foreigners is to official institu tions— central banks and governments— and to international institutions such as the Interna tional Monetary Fund. The fact that the dollar is a widely used medium of international pay ments, ability of foreign official institutions to convert dollars into gold for legitimate monetary purposes, and confidence that the United States will maintain the value of the dollar are impor tant reasons why foreigners are willing to hold dollars. Many foreign central banks hold a part or all of their monetary reserves in dollars. Some invest a part of their dollar reserves in highly liquid earning assets such as Treasury bills and AND INSTITUTIONAL TERM GOVERNMENTS bankers’ acceptances. Others hold practically all of their reserves in gold. When the latter acquire dollars a loss of gold is almost automatic. Private institutions, which hold roughly onethird of foreign-owned short-term dollar assets, need dollar working balances in conducting in ternational transactions. Willingness to hold an excess above a minimum working balance de pends on their confidence in the future value of the dollar and on the interest rate they can earn on short-term investments compared with rates available on similar investments in other coun tries with stable currencies. Now that the major currencies are convertible, interest-rate differen tials tend to generate a flow of short-term funds from international money centers with lower to those with higher short-term rates. Higher rates abroad, especially in Great Britain, have been an important reason for the net outflow of short term capital from the United States in the past two years. Ordinarily, official institutions and in ternational organizations do not shift balances from one center to another to take advantage of interest-rate differentials. 7 business review IM P A C T OF THE C O M M O N MARKET The possible impact of the Common Market on United States exports and imports and hence on our balance-of-payments position is another ques tion of considerable current interest. The European Economic Community, usually referred to as the Common Market, includes six countries: France, Germany, Italy, the Netherlands, Bel gium, and Luxembourg. The United Kingdom and Denmark have applied for admission; hence the number of members may be increased soon. One of the goals is the removal of tariff and trade barriers between member countries and estab lishment of a uniform external tariff on imports from outside the Common Market. Thus far, tariffs among Common Market countries have been reduced 40 per cent. It is much too soon to have any clear idea of the influence of the Common Market on our balance of payments. For one thing, the effect will depend significantly on the trade program adopted by the United States and the Govern ment’s success in negotiating a reduction in the Common Market’s external tariffs. It may be useful, however, to look at a few facts and some of the broader implications in order to put the problem in better perspective. Geographically, the Common Market is much smaller than the United States, but it has nearly as large a population. Its total output and per capita income are only about one-third of ours, but its exports are about the same as ours and imports are considerably larger. The Common Market countries have been ex periencing an unusually rapid rate of growth. From 1953 to 1960, total output in real terms in creased 45 per cent as compared with 26 per cent for the rest of Europe and 15 per cent for the United States. Common Market countries ac count for youghly one-sixth of our exports and 8 INCREASE IN G.N.P., 1953-1960 Real terms. PER CENT COUNTRIES* ‘ In clu d in g the U nited K in g d o m . imports. In recent years, our exports to the Com mon Market have consistently exceeded our im ports from these countries. The export surplus last year was $1.3 billion, as compared with an annual average of $1 billion for the past five years. The Common Market is likely to have diverse influences on foreign receipts of the United States. Reduction and the eventual elimination of tariffs and other trade barriers within the Common Market are tending to give producers in those countries an increasing advantage in competing UNITED STATES MERCHANDISE TRADE* BILLIONS OF DOLLARS 5 YEAR AVERAGE 5 YEAR AVERAGE MARKET— 1961 ‘ Som e exports were e xcluded from figure s for security reasons. business review with United States exporters. This advantage is an important reason for the provision in the re cently proposed Trade Expansion Act that would give the President greater authority in negotiat ing broad reductions in tariffs between the Com mon Market and the United States. Rapid growth in income and purchasing power in Common Market countries is creating an ex panding market which will tend to offset adverse effects on United States exports. It is significant also that only a small percentage of the families in the Common Market countries own automo biles and major appliances such as refrigerators, freezers, and television sets. A largely untapped market for consumer durables could afford Amer ican producers an excellent opportunity to in crease their exports. There is a widespread impression that lower costs and a slower rate of rise, especially in wages, give Common Market producers an im portant competitive advantage. It is extremely difficult to get a reasonably accurate comparison of production costs in different countries; how ever, material recently prepared for the Joint Economic Committee of Congress does not indi cate that our exporters are at a significant dis advantage in this respect. Total wage costs in creased less in the United States from 1953-1959 than in four of the Common Market countries. The increase in France was slightly less than in the United States, and data were not given for Luxembourg. The 27 per cent increase in total wage costs in the United States was considerably below the increases in West Germany, Belgium, the Netherlands, and Italy, which ranged from a low of 37 per cent for Belgium to a high of 55 per cent for Germany. The United Kingdom had an increase of 48 per cent. A more significant indicator from the stand point of competition is wage cost per unit of output. During the period 1953-1959, wage costs per unit of output increased 12 per cent here as compared with increases of 20 per cent in the United Kingdom, 18 per cent in the Netherlands, 7 per cent in Germany, and decreases in Italy and in Belgium. Large productivity gains enabled Italy and Belgium to reduce wage costs per unit despite substantial increases in total wages. A recent survey by the National Industrial Confer ence Board of American manufacturers with plants abroad indicated that lower productivity and higher non-wage costs frequently offset or more than offset the lower money wage rates in foreign countries. The other side of the coin is the effect of the Common Market on United States imports. A mutual reduction of tariff and trade barriers would tend to stimulate our exports to the Com mon Market, but it would also make it easier for Common Market producers to sell in the United States. A large part of our imports is in tropical and semi-tropical products not produced here, and raw materials and other products used in further production. Imports that do compete with do mestic industry often stimulate progress and the development of new products. The automobile in dustry is a recent example. A growing volume of imports spurred domestic manufacturers to bring out small cars to compete with the foreign com pacts. Thus far, American compacts have been competing successfully with foreign cars of the same class. A vital factor influencing our ability to com pete with the Common Market, in addition to tariff negotiations, is the behavior of costs and prices. A rising cost-price spiral in the United States would tend to price our producers out of world markets, resulting in an increase in imports and a decrease in exports. 9 business review W H A T ARE THE IM P L IC A T IO N S FOR M O N E T A R Y P O L IC Y ? Finally, what are the implications of our balanceof-payments deficits for monetary policy? Solving our balance-of-payments problem re quires an over-all program of which monetary policy is only a part. The Government has taken a number of steps to try to bring foreign receipts and payments into balance. A broader program of export credit insurance, more information about sales opportunities abroad, greater em phasis on the need for holding the line on costs and prices to help keep American producers com petitive are among the measures designed to en courage exports. Other steps have been taken to reduce foreign payments, such as lowering the duty-free allowance of returning United States tourists from $500 to $100, attempts to get other countries to assume a larger share of foreign aid, and increased emphasis that purchases re quired under our foreign aid programs be made in the United States. Where does monetary policy fit into the over all program? There are several things that mone tary policy can do. One implication is obvious. In using monetary policy to foster high levels of production and em ployment, and sustained growth we must be care ful to avoid inflation. A rising cost-price spiral would have a double-edged effect on the balanceof-payments deficit; it would reduce our foreign receipts and increase payments. A second and closely related implication for monetary policy derives from the large volume of short-term dollar assets held by foreigners. Willingness of foreigners to continue to hold re serves and working balances in dollars will de pend on their faith and confidence in the future value and stability of the dollar. Loss of confi dence could induce large-scale withdrawals of 10 dollars and gold. If this embarrassment is to be avoided and if the dollar is to continue to serve as the world’s leading international reserve cur rency, it is imperative that the value of the dol lar be protected and foreign confidence preserved by sound monetary and fiscal policies. A third implication, now that the major cur rencies are convertible, is that international in terest-rate differentials, especially short-term rates, should be considered in formulating mone tary policy. Short-term funds have become sensi tive to differences in interest rates. Relatively low short-term rates in the United States during the past two years resulted in increases in foreign borrowing here and substantial outflows of short term capital. The Federal Reserve was thus confronted with objectives calling for conflicting actions— ample reserves and low interest rates to promote re covery and facilitate sustained growth, but rela tively high short-term rates were needed to slow or at least not aggravate the outflow of short term funds and loss of gold. In an attempt to achieve both objectives, the Fed pursued an easy money policy but supplied reserves in ways that would exert minimum downward pressure on short-term rates. Under legislative authority pre viously granted, member banks were permitted to count vault cash as reserves. The Fed also supplied a large volume of reserves by purchas ing intermediate and longer maturities of Gov ernment securities, putting the direct downward pressure on intermediate- and long- rather than short-term rates. Fortunately, the United States has a total gold stock of $16.7 billion, providing a $5 billion cushion of excess reserves. A cushion of excess reserves has enabled Federal Reserve authorities to direct monetary policy toward achievement of domestic economic goals even though techniques business review employed in supplying reserves were adapted to the needs of the balance-of-payments situation. C O N C L U D IN G REMARKS In closing, there are four points I should like to emphasize. First, our balance-of-payments deficit persists because it springs from deepseated causes. The surplus on goods and services is not large enough to cover the net outflow of private long-term capital and Government payments required in the foreign military and economic aid programs. Second, in our current economic environment, the deficit does not generate important self-cor recting market forces. It can be eliminated only by discretionary action on a broad front. If steps already taken prove inadequate, more drastic action will be required. Third, the Common Market is not just a strong competitor. It is an area of rapidly rising income; and let us hope our Government will be able to negotiate a trade program that will give our ex porters reasonable access to this growing market. Finally, in using monetary policy to help achieve sustained growth in output and employ ment, we should not overlook the importance of reasonable price stability. Rising prices would tend to price our products out of the world market, intensify our balance-of-payments prob lem and, if long continued, might undermine confidence in the dollar and lead to large with drawals of dollars and gold. THE LONG AND THE SHORT OF IT: BANKERS ARE REACHING OUT FOR LONGER-TERM SECURITIES AGAIN June 22, 1961-—The banker settled back in his high leather chair and began to speak: “We learned our lesson during the last two periods of business recession and early recovery— in 1953-1954 and 1957-1958. Loan demand was off and we started buying longer-term securi ties with higher interest rates. It was the only thing we could do to bolster sagging profit mar gins. Then— bam!-—the business recovery got up a head of steam, interest rates rose, and we had to sell our long and intermediate securities at a discount in order to meet a rising loan demand. But we learned. During the 1960-1961 recession, we put most of our money in short-terms.” March 20, 1962—The banker tapped his ball point pen on the desk for emphasis: “Profit margins are under pressure again. Sag ging loan demand and rising interest rates on time and savings deposits are forcing us to go after higher-yielding, longer-term securities. It’s the only way we can meet higher costs and still make a decent report to stockholders at year’s end.” The above are typical comments from typical bankers explaining the shift in investment policy which has occurred at many banks in the past few months. From an emphasis on shorter-term securities, manifest during the most recent busi ness recession and for several months thereafter, bankers now are nodding more and more ap provingly at intermediate- and longer-term issues. This raises some interesting questions: (1) how do the timing and magnitude of the present portfolio adjustment compare with similar phases of past business cycles, (2) why the current in terest in longer maturities, (3) will the present 11 business review CHART 1 “OTHER” SECURITIES— WEEKLY REPORTING MEMBER BANKS INDEX (TROUGH = 100) effort to buy longer-term issues unduly impair bank liquidity? T IM IN G A N D M A G N IT U D E In their efforts to increase yields, bankers* have concentrated especially on “other” securities— a classification consisting chiefly of municipals and corporates. As may be seen in Chart 1, banks ac *The term s " b a n k " and " b a n k e r " are used th rou ghout to mean w eekly reporting banks, except as otherw ise ind icate d. cumulated these securities rapidly as the economy ebbed into the recessions of 1953-1954, 19571958, and 1960-1961. In the two earlier periods, holdings began to level off six to eight months after the recession trough at around 5 to 9 per cent above the trough level. In the 1961— 1962 up turn, however, holdings of these securities are still rising at a rapid clip 12 months after the low point of the recession. Latest available data place CHART 2 UNITED STATES GOVERNMENT NOTES AND BONDS— WEEKLY REPORTING MEMBER BANKS INDEX (TROUGH = 100) 12 business review the 1961-1962 upturn, on the other hand, banks kept their holdings of notes and bonds relatively stable for the first five months after the trough, then increased them sharply. In the past three months, note and bond holdings have begun to drift downward, but are still above levels associ ated with past recessions. Chart 3 shows changes in the maturity distri CHART 3 WEEKLY REPORTING MEMBER BANK HOLDINGS OF UNITED STATES TREASURY NOTES AN D BONDS Change from June 1961 to February 1962. MILLIONS OF DOLLARS + 9.6% 1500 1000 $1482 500 + 1.5% 0 AFTER 5 YEARS I $8511 WITHIN 1 YEAR -5 0 0 1 TO 5 YEARS $1036 -1 0 0 0 23% “other” securities 18.5 per cent above the 1961 recession trough. Bank holdings of United States Treasury notes and bonds tell another story. These securities were added rapidly to bank portfolios during the two previous downturns, and a little less rapidly during the 1961 recession (as shown in Chart 2 ). During the 1953-1954 and 1957-1958 upturns, banks cut their holdings of notes and bonds sharply three months after the cycle trough. In bution of bank holdings of notes and bonds dur ing the period of rapid accumulation between June, 1961 and February, 1962. As may be seen, the accumulation was chiefly in the oneto five-year sector, the after-five-year area show ing a marked decline. This would seem to indicate that bankers are not prepared to go too far out in the maturity spectrum, at least in their hold ings of Governments. But why should banks be buying longer-term securities at this stage of the business upswing? The answer to this question may be found by ex amining several factors influencing the manage ment of bank portfolios in recent months. W H Y THE INTEREST IN LO N G E R -T E R M SECURITIES? First of all, loan demand has not lived up to ad vance billing. As may be seen in Chart 4, loans CHART 4 LOANS ADJUSTED— WEEKLY REPORTING MEMBER BANKS INDEX (TROUGH = 100) 13 business review at weekly reporting member banks since the re cession trough have held well below the 1954 level and are now about in line with the 1958 trend. This growth in loans has been slow relative to expectations and relative to the ability of the banking system to lend. Coupled with increasing costs, the slack demand for loans has put pres sure on bank earnings. To relieve this pressure, many banks have purchased higher-yielding, longer-term securities. Another reason why banks have been buying longer-term issues concerns the recent revision of the Federal Reserve System’s regulation on in terest rates member banks may pay on time and saving deposits. Effective January 1, 1962, the rate ceiling was raised to 3% per cent payable on savings deposits and on time deposits and certificates of at least six months, and 4 per cent on like deposits held for more than a year. Pre viously, the rate ceiling on all deposits was 3 per cent. Under this provision, many banks have raised rates. The additional expense incurred has encouraged banks to seek out higher-yielding, longer-term securities to add to their portfolios. As a third factor, one might suspect that part of the emphasis on longer-term issues is in re sponse to the forecast by some bankers that the present business expansion will not be sufficiently brisk to produce inflationary pressures. If this is the case, the reasoning goes, the supply of funds may be adequate to meet loan demand without any upward pressure on interest rates, with the consequence that bond prices might not decline much. Another factor of importance in bank deci sions to buy longer-term securities is the relatively large holding of liquid, though lower-yielding, short-term Treasury bills. As shown in Chart 5, CHART 5 UNITED STATES TREASURY BILLS— WEEKLY REPORTING MEMBER BANKS BILLIONS OF DOLLARS 14 business review bank holdings of Treasury bills recently leveled off almost 50 per cent above the 1961 recession trough, much higher than in the two other periods shown. In fact, it is likely that, despite in creased bank interest in longer-term issues dur ing business recovery, holdings of Treasury bills rose more than enough to shorten the average ma turity of bank investment portfolios. Very re cently, the extensive purchases of municipals may have produced some lengthening in the average maturity. In short, banks have relatively high holdings of short-term Governments. Many banks are ex periencing rising costs and are disappointed in the trend of loan demand. Thus, they are willing to reach out for higher-yielding, longer-term securities to add to their investment portfolios. But one further question remains to be explored: Will the present efforts to buy longer-term securities unduly impair bank liquidity? THE STATE OF B A N K LIQ U ID ITY An answer to the above question is subject to many imponderables. What will be the future de mand for loans? What volume of reserves will be made available to the banking system in com ing months? Such questions, of course, cannot be answered with any degree of certainty. Yet it is possible to get some idea of the relative vulnerability of banks to future liquidity pressures by taking a look at their present and past liquidity position. Chart 6 shows an estimate of all member bank holdings of short-term Government securities as a percentage of total deposits during the period 1953-1962. The last point plotted (February, 1962, 12 months after the 1961 recession trough) shows that member banks held short term Governments of over 10 per cent of their total deposits. Twelve months following the 19531954 and 1957-1958 recession troughs, all mem ber banks had a short-term Government-total deposit ratio of less than 5 per cent, or one-half of the present figure. Thus the liquidity position of member banks by this measure is high compared to recent years. If the many bankers who have forecast a rela tively mild loan demand in future months are indeed correct, liquidity pressures might not even approach those felt in past business upturns. If they are wrong, as forecasters sometimes are, bankers may find themselves repeating the open ing quotation in this article. CHART 6 RATIO OF SHORT-TERM UNITED STATES GOVERNMENT SECURITIES* TO TOTAL DEPOSITS— ALL MEMBER BANKS 1953-1962 PER CENT 15 FOR THE RECORD... B IU IO N S Third Federal Reserve District MEMBER BANKS 3RD F.R.D. United States Per cent change $ Per cent change Factory* Department Storef Check Payments Employ ment Payrolls Sales Stocks Per cent change Feb. 1962 from Per cent change Feb. 1962 from Per cent change F e b.1962 from Per cent change Feb. 1962 from SU M M A R Y 2 mos. 1962 Feb. 1962 from mo. ago year ago year ago Feb. 1962 from mo. ago year ago 2 mos. 1962 from year ago LO CAL CHANGES mo. ago M ANU FA C T U RING Electric power consumed...... Man-hours, total*............. .. Employment, total.................. W a ge income*..................... - 2 0 0 0 3 + 14 + 17 + 3 + 1 + 8 0 + 4 + 3 0 + 14 + 10 + 3 0 +23 + 14 + 8 + 9 + + - + 4 + 6 + + C O N S T R U C T IO N ** C O AL PRODUCTION -1 9 - 7 + TRADE*** Department store sales........... Department store stocks.......... - — 1 + 8 B A N K IN G (All member banks) Deposits............................. Loans................................. Investments.......................... U.S. Govt, securities............. Other............................... Check payments.................... 2 1 0 1 1 1 0 — 18t + - * 7 + 4 + 5 + 3 + 4 + 8 + 10 + 10 + 4 +20t +23t 1 1 ’ Production workers only. ••Value of contracts. •••Adjusted for seasonal variation. year ago mo. ago year ago year ago mo. ago year ago -2 0 0 + 1 - 1 - 2 + 2 -1 9 + 7 4" 6 +10 + 8 + 16 + 8 2 + 16 Lehigh Valley. . . + 1 + - 2 Lancaster........ + 2 + 3 0 0 5 + - 1 - 1 +14 -1 7 + 10 - 0 5 +n + It 0 0 0 + 1 -1 0 + + 6 -1 5 +12 6 Philadelphia. . . . 0 + 1 — 1 + 6 - 5 - 2 0 + 12 -1 5 + 19 0 + 5 + 1 + 17 - 4 - 1 - 4 + -1 7 +14 0 + 2 + 1 +10 — 6 — 2 — 3 1 + 2 Scranton......... + 8 + 7 + 11 + 9 + 16 + 11 Trenton.......... - W ilkes-Barre... + 1 - 4 + 12 + 1 2 — 2 ... 0 + 1 t20 Cities JPhiladelphia + 1 + 3 + 10 — 4 + Wilmington. . . . ot mo. ago Reading.......... 6 PRICES Consumer............................ mo. ago +13 + 15 + 3 + 2 + 8 year ago Percent change Feb 1962 from 0 - 1 - 2 + 2 York.............. 0 - 2 — 1 + 3 + 9 - 3 + - 7 4 — 16 — 3 — 2 3 — 5 — 22 + 11 4 - 5 — 8 + 0 + 7 -1 4 1 - +14 9 — 35 + 5 6 + 7 — 14 + 1 0 •Not restricted to corporate limits of cities but covers areas of one or more counties. fAdjusted for seasonal variation.
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