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February 21,1975 The international sector of the U.S. economy has performed remark ably well this past year, considering the massive impact on the domestic economy of inflation, recession and the oil-price upsurge. In the face of a $16.8-billion rise in oil-import costs, this sector registered a $2.0billion export surplus in the GNP accounts in 1974— the second strong year in a row, after 1972's record $6.0-billion deficit. Excluding petroleum products, the trade bal ance improved sharply during the year, on the basis of a 39-percent increase in exports of goods and services. A much slower pace is in the cards for 1975, but the foreigntrade sector should remain strong nonetheless. Last year's sharp rise in the export trade, which came on top of an identical 39-percent increase in 1973, attests to the beneficial effects of dollar devaluation on the nation's trade balance. Still, the dollar has weakened in recent months, drop ping about 4 percent in tradeweighted value from last Septem ber's level, as a reflection of the deterioration in the trade balance caused by the oil-im port increase, and more importantly, the deteri oration in the overall balance of payments caused by substantial fi nancial outflows. Interest rates have fallen throughout the industrial world because of the universal re cession and easier monetary pol icies, but the decline has been even greater in this country than else where, thereby prompting outflows 1 of funds in search of higher rates. These developments have masked the strong underlying tone of the U.S. balance of payments created by the unprecedented export boom. Textbook illustration This improvement stands out in strong relief when the trade data are adjusted for the effect of rising prices. Between 1972 and the third quarter of 1974, the physical volume of exports jumped more than 30 percent compared with only a 5percent expansion in import vol ume. On the export side, all major categories except farm products rose by a sizable amount, with non food consumer goods leading the list. On the import side, by contrast, only the capital-goods and rawmaterial categories expanded over this period, while most consumergoods categories actually declined. This is a textbook illustration of the combined impact of dollar deval uation and domestic recession. Following 1972's bath of red ink, the nation recorded net exports of $3.9 billion in 1973 because of the sharp expansion in export volume relative to imports. Last year's performance — $2.0 billion net exports — was weaker despite a continued increase in export volume and an actual de cline in import volume. The reason for this shift was a deterioration in the nation's terms of trade. The ad verse effects of devaluation on the terms of trade had been offset in 1973 by a 55-percent rise in farm export prices, but last year the terms (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. of trade declined at a 15-percent annual rate (January-September) because of the soaring prices of pe troleum and other raw-material imports. This and other factors had caused most observers last fall to predict a fairly substantial trade deficit for 1975, but stronger fourth-quarter statistics have cast a rosier hue over the outlook. The earlier pessimistic projections were heavily influenced by the third-quarter upsurge in oil imports and the record deficit re- ’ suiting from it. Later developments cast a new light on the third-quarter figures, however, especially since it seemed that the increase in oil im ports was simply filling an inventory gap created by the oil embargo. Many uncertainties While we can now be more confi dent about the overall strength of the foreign-trade sector— and confi dent also about the economy's abil ity to adjust to the higher price of petroleum— we still must take into account a number of unknowns in 2 assessing the prospects for 1975. Heading the list of uncertainties is the question of worldwide inflation, although many observers are be coming increasingly optimistic on this score. A slowdown in the price trend is possible because of such factors as a decline in money-supply growth from the two-digit neigh borhood in the first several years of the decade to a somewhat slower pace between mid-1973 and late1974. For example, Germany's M, growth rate slowed from 11.4 to 5.1 percent over this 1973-74 period, and U.S. money growth slowed from 7.2 to 5.5 percent over the same time-span. A major uncertainty is the future price of oil and the economic im pact of whatever energy program arises out of the AdministrationCongressional dialogue. Similar un certainty concerns the future of farm exports, which increased more than 25 percent in 1974 but are widely expected to decline in 1975. Again, there is the question of the future strength of the dollar, which has been the beneficiary of central-bank support in recent weeks after its four-month-long decline. The prob lems of forecasting are compounded by the failure of regression equa tions based on historical importexport data to fit more recent data. This failure is not surprising, how- ever, considering not only the im pact of worldwide inflation but also the numerous supply shifts which have occurred in the markets for internationally traded goods, espe cially oil and food. Slower growth of trade Given all these difficulties, a rough estimate of the future shape of the foreign-trade sector can still be made. Assume, for example, that the U.S. experiences slightly less infla tion in 1974 than other OECD coun tries^ -10 percent versus 12 percent — — and that real GNP declines 2 per cent here while rising 2 percent among the nation's major trading partners. These estimates can be multiplied by their respective price and income elasticities (based on historical data) to provide estimated changes in the volume of imports and exports, and can then be con verted into dollar estimates by ap plying appropriate rates of price change. On the import side, these calcula tions would yield a 4-percent de cline in volume and a 15-percent rise in prices of all imports (except oil) for 1975. If we assume that oil imports will be stable in volume but rise 10 percent in price, we would then obtain total imports of $152.6 billion— about 11 percent above the 1974 figure. On the export side, our 3 calculations would yield a 5-percent rise in volume and a 10-percent rise in prices of exports (except food). If to this we add a 20-percent decline in value of food exports, in line with the general expectation of farm an alysts, we would obtain total exports of $153.0 billion— almost 10 percent above the 1974 total. Net exports in the GNP accounts thus would total $0.4 billion for the year. Despite the roughness of these esti mates, they suggest what could be expected in an environment charac terized by slow (or negative) growth of real GNP, a slackening in the universally high rate of inflation, and a slackening also in the oil-price up surge. In this situation, a modest trade surplus could be achieved with the projected increases of 11 percent in imports and 10 percent in exports. However, in strong con trast to last year's rapid increases of 43 percent in imports and 39 per cent in exports, these estimates suggest that the effects of dollar devaluation and of a massive world wide boom are now wearing off. Nicholas Sargen U O } § U |L |S E /V \ • LjEJfl • U O § 9 J O • E p E A 9 N . O l ] E p | MEMEH • E IU JO J!|E 3 . EUOZUy • B>|SE| V *# !le 3 'O D S p U E J J U E S isL ON llWHHd a iv d BDVISOd s n 1IVW SSVID lS d ld BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (D ollar amounts in m illions) Selected Assets and Liabilities Large Commercial Banks A m ount O utstanding 2 /5 /7 5 84,838 66,310 1,350 23,904 19,944 9,879 5,623 12,905 83,061 22,126 496 58,797 7,012 18,393 30,174 16,653 Weekly Averages of Daily Figures W eek ended 2 /5 /7 5 Change from year ago D ollar Percent + + + + Loans (gross, adjusted) and investments* Loans (gross, adjusted)— total Security loans Commercial and industrial Real estate Consumer instalm ent U.S. Treasury securities O ther securities Deposits (less cash items)— to ta l* Demand deposits (adjusted) U.S. G overnm ent deposits Time deposits— total* States and p o litica l subdivisions Savings deposits O ther tim e deposits! Large negotiable CD's Change from 1 /2 9 /7 5 + 5,699 + 6,412 + 89 + 2,925 + 1,409 + 725 - 655 58 + 8,442 + 804 - 421 + 7,569 - 102 + 698 + 6,391 + 5,473 233 103 260 22 — 52 5 + 8 + 122 + 283 — 268 + 86 + 125 149 74 + + 201 + 125 W eek ended 1 /2 9 /7 5 + + + + + + + + — + + + + 7.20 10.70 7.06 13.94 7.60 7.92 10.43 0.45 11.31 3.77 45.91 14.78 1.43 3.94 26.87 48.95 Comparable year-ago period Member Bank Reserve Position Excess Reserves Borrowings Net free ( + ) / Net borrow ed ( - ) - 1 2 1 - 84 3 87 - 112 126 14 Federal Funds— Seven Large Banks Interbank Federal fund transactions Net purchases ( + ) / Net sales ( —) Transactions of U.S. security dealers Net loans ( + ) / Net borrowings ( - ) + 1,525 + 1,532 + 1,539 + + + 558 401 156 ■"Includes items not shown separately. In d iv id u a ls , partnerships and corporations. Information on this and other publications can be obtained by calling or writing the Administrative Services Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, California 94120. Phone (415) 397-1137.