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September 29, 1978

HappyN ew Year?
The business community and the forecasting fraternity usually think of Labor
Day as the beginning of their new
year, because that's when most of the
action starts in their activities. But since
they still do their record-keeping on a
calendar-year basis, everyone's attention is now turning to what will happen
after next January 1. This year, the interest will be greater than usual, because of the uncertainty over the
continued viability of a prolonged business expansion which first got underway in the dismal days of early 1975.
The consensus view is that 1979 will
be a rather mediocre year, whatever
euphemistic or pejorative term is
used to describe the situation - soft
landing, rolling readjustment,
profitless prosperity, growth recession,
or whatever. The ugly word
flation" may do as well as any other,
because most observers see the 1979
performance as a combination of inflation and relatively stagnant business
activity, with the plus and minus signs
in the marketplace generally offsetting
one another. Most expect real GNP to
grow at less than the approximate
4-percent trend line generated by a
continually expanding workforce and
technological improvements, but relatively few expect an actual recession,
with real GNP declining for a half-year
or more.

Plusand minus
Consumer spending, which accounts
for roughly two-thirds of total GNP,
represents one of the major question
marks in the outlook. This sector has
dominated most of the expansion to

date, aided by a vast increase in consumer instalment and mortgage credit. (New funds raised by households
have been roughly half again as large
in the 1977-78 period as in 1976, and
roughly double the amount raised in
any earlier year.) But spending in this
sector should now decelerate, at least
in part because of a reduction in credit
use. In addition, spending on new
home construction may actually decline, although from a very high level,
because of the reduced inflow of
funds available to mortgage-lending
institutions.
Business capital spending also is a major question marlc This sector has consistently performed better than the
headlines have suggested - spending
has increased 27 percent (in real
terms) since the recession trough -but
much of the spending has been mandated by energy and environmental
purposes rather than by economicexpansion needs. Again, the business
sector has emphasized purchases of
short-lived equipment rather than
long-lived assets such as new structures - the type required for major expansions of capacity. This attitude of
caution probably reflects an increase in
the projected rate of return needed to
justify new investment, undoubtedly
as a result of the uncertainties created
by prolonged inflation.
In contrast, spending could rise significantly in several other sectors of the
economy. The export sector is likely
to be stimulated by the expected upturn in the economies of our major
trading partners, and primarily by the
(continued on page 2)

CGJ
TI
Opinions expressed in this nevvs!etter do not
necessarily reflect the views of the management orthe
Federa! Reserve Bank of San Francisco, nor of the Board
of Governors of the Federal Reserve System.

bargain-basement price-tags on
American goods resulting from the
past year's 10-percent drop in the
average trade-weighted value of the
dollar. Also, military spending is scheduled to rise as a result of Congress'
commitment to an expanded defense
establishment, following the prolonged post-Vietnam decline.
These mixed trends suggest a record
of modest growth in 1979, following
the path of gradual deceleration evident over the past several years. (Real
GNP increased almost 6 percent in
1976 and 5 percent in 1977, and could
rise perhaps 4 percent this year and
3 percent in 1979.) Over the longer
term, however, a more important
question will be how well the economy copes with some of its structural
problems, beginning with energy.

1
E1lil€li'gy
The nation for several generations
based its growth on ample supplies of
cheap energy, but in this decade, the
can no longer call itself a cheapenergy country. Around 1970 a ""quiet
revolution occurred (in Alan
Greenspan's phrase), as the U.s. Gulf
Coast states were supplanted in the
role of marginal supplier in the world
petroleum market by the Persian (Arabian) Gulf Coast states. The magnitude of the shift can be measured
by the eight-fold increase since 1970 in
the price of Saudi Arabian crude. The
oft-quoted quadrupling of Arab oil
prices in the 1973-74 period obviously
understates this shift.

u.s.

N

OPEC actions have levied a severe tax
on the entire industrial world. (The

2

u.s.

impact on the
economy can be
measured by a sharp rise, from
$5 billion to $45 billion, in net oil imports between 1972 and 1977.) Again,
this shift has disrupted production
functions in the world economy, making obsolete many hitherto-productive
industrial processes. Over time, but
with some difficulty, the price mechanism will enforce conservation practices and will generate the
development of new energy sources.
In the meantime, the nation's present
energy policy is creating bewilderment among economists, apoplexy
among Wall Street Journal editorial
writers, and rising living standards
among the hordes of lawyers, accountants and Energy Department employees dealing with the problem.
Some facets of infiatnon
Our other major structural problem,
of course, is inflation. The U.s. can no
longer call itself a low-inflation country; indeed,-the 1970's now threaten to
be the most inflationary decade in the
nation's peacetime history. Early in the
year, Administration economists argued that the nation was faced with an
""imbedded 6-percent rate of inflation, and following the second quarter's double-digit upsurge, they now
claim to see an imbedded rate in the
7-to-8 percent range. Whatever the
causes demand pull, cost push, or
imported - the acceleration in prices
has been as severe as it has been
unexpected.
N

This year's decline in the value of the
dollar threatens to aggravate 1979's
inflation problem. U.s. consumers will
now pay considerably more for Japanese, German and other countries'
products. U.s. business firms will now
pay considerably more for foreign ma-

Change(%)

12

8

4

o

terials, and will pass these higher
prices on to consumers. Again,
producers will find themselves protected by the price umbrella raised by
foreign firms, and accordingly will be
able to raise their own prices with
greater impunity. The process won't
be reversed without a stronger dollar,
which to a large extent will depend
upon the fate of the overall attack on
inflation.

U.s.

The inflation problem also involves the
leapfrogging of prices and wages,
which make up the vast bulk of industry's costs. In 1977, labor compensation increased about 9 percent while
labor productivity rose about 3
percent, and the resultant boost in unit
labor costs became translated into increased inflation. In 1978, the increase
in compensation is likely to be larger
and the increase in productivity considerably smaller, with worsening consequences on the pric€ front.
The Administration is now planning to
promulgate some guidelines, in an
attempt to curb the growth of labor
compensation, and hence the rise in
business costs. Over the long run,
however, the more promising avenue
is to boost productivity, which in the
past decade has risen only about half
as fast as in the several preceding decades. Actually, the passageof time may
help bring about a more productive
labor force. The postwar baby-boom
generation, much to their parents'
amazement, is now producing a reasonably mature and productive cadre
of workers. But those workers can't
live up to their potential without new
tools, and those tools won't be available without new investment-stimulating tax measures, such as those
Congress is now considering.
3

Basicinflation prob;em
Basically,however, the inflation problem involves the continued stimulus
generated by a series of large budget
deficits in the midst of a strong business
expansion - which deficits in turn
have pushed monetary policy off
course in an expansionary direction.
Both the M1 and M2 measures of the
money supply have increased more
than 8 percent over the past .year close to or even above the upper limits of their target rariges. The Federal
Reserve is committed to reducing
money growth over time, to a.level
consistent with relative price stability,
but that goa] will be difficult to achieve
as long as Treasury deficit financing
continues at its recent pace. The U.5.
Government and its agencies raised a
total of $96 billion (annual rate) in
the nation's credit markets in the first
half of 1978 - roughly triple the
Treasury's financing demand in any
year prior to 1975.
The nation's energy and inflation
problems, being structural in nature,
seem to require lang-run structural solutions. Meanwhile, in 1979, perhaps
the optimum outcome is the most likely outcome - a year of modest growth
amidst reduced stimulus from monetary and fiscal policy. After all, substantial pressures have built up in .the past
3 V2years, as the economy recorded
its strongest and longest peacetime
expansion of the past generation. In
1979, with reduced pressure in the
boiler of the
economy, this key
"'locomotive'" of the industrial world
may avoid jumping the tracks as it
approaches the long stretch of
the 1980's.
William Burke

u.s.

uOl8u!4SEM 4Eln e uo8<3JO EpEA<3No4EPI
e
e
e
!!EMEH <l E!
UJOJ!IE:) EuozlN <I E>jSEIV

(G)
(;SL ·ON
OI Vd
319\1150«1
·s·n
i1IVW SSVil3 1S(jU:ll

BANKiNGDATA-TWElfTH
(Dollar amounts in millions)

Seiected
Assets liabilities
and
lLargeCommercial Banks

Loans(gross,adjusted)and investments*
Loans(gross,adjusted)- total
Security loans
Commercialand industrialRealestate
Consumerinstalment
U5, Treasurysecurities
Other securities
Deposits
cashitems)- total*
Demand deposits(adjusted)
U5, Government deposits
Time deposits- total*
Statesand political subdivisions
Savingsdeposits
Other time depositst
Largenegotiable CD's
WeeBdyAverages
of Daily figures
Member Bank Reserve Position
Excess
Reserves(+)/Deficiency(-)
Borrowings
Net free(+ )/Net borrowed (-)
federal funds-Seven Large Banks
Interbank Federalfund transactions
Net purchases )/Net sales(
(+
-)
Transactionswith U5. security dealers
Net loans(+)/Net borrowings (-)

Amount
Outstanding
9/13178
1'17,228
94,029
1,735
27,668
32,681
17,487
9,265
13,934
114,655
31,992
476
80,180
6,528
31,580
38,489
19,446
Week ended
9/13178

Change
from
9/6178

-

+

+
+

-

+
+

+

+
+

146
341
423
14
100
12
365
170
1,986
1,383
154
1,035
21
48
897
1,028

+

+ 1,932

+

+

+

697

+ 16,362
+ 16,125
172
+ 3,835
+ 6,926
+ 3,966
835
+
598
+ 15,377
+ 3,265
19
+ 12,162
+ 1,279
67
+ 9,443
+ 8,060

Week ended
9/6178

51
11
40

+

Changefrom
year ago
Dollar
Percent
+
+

-

+
+
+
+

-

+
+

-

+
+

-

16-22
20]0
9.02
16.09
26,89

29.33
9,91
4,12
15.49
11.37
3.84
17.88
24.37
0,21
32,51
70]9

+
+
Comparable
year-ago period

19
50
31

+
+

51
10
41

818

+

686

12

+

358

*Includes items not shown separately.tlndividuals, partnershipsand corporations,
Editorial comments may be addressed to the editor (William Burke) or to the author .•••
free copies of this and otheri'iFederalRe§e!l1le
publications can be obtained by calling 01' writing the Publk
information Section, federal ReserveBank orSan francisco, P.O. Box 7702, Sanfrancisco 94120.Phone
(415) 544-2184.