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November 29,1974

Not since the days of the Edsel has
so much gloom descended upon
the nation's motor capital— and that
was only a $250-million blunder,
nothing like this still-unfolding
multi-billion dollar slump. Under
pressure from affluent Arabs and
impoverished Americans, the
industry suddenly has found its
showrooms deserted; the new-car
sales pace so far this quarter has
been little better than half the third
quarter's 10.3-million annual rate of
sales. And with several months'
supply of new cars piling up around
the country, the industry has taken
the unprecedented step of closing
down entire plants for indefinite
periods, so that as many as 200,000
workers may be on the jobless rolls
by Christmas Eve.
For decades, automakers have
relied upon the American con­
sumer's steadily rising income to
support a strong expansion of their
market. Thus, with this year's
slowdown in disposable income—
and an actual decline in real income
— they should have anticipated a
weakening of auto sales on the
basis of their statisticians' incomesales regression equations. After
three very strong years back-toback during the 1971-73 model
years, the inevitable slowdown
developed in the 1974 model year
— but evidently, that was not the
end of the matter. Also, automen
historically have relied upon plenti­
ful supplies of cheap fuel to power
their products, but here again their
longstanding expectations have
been dissappointed and the results
have shown up on their sales
charts.
1



Even so, industry planners have
contributed to their own misfor­
tunes. By concentrating on the
production of oversized gasguzzling vehicles, they apparently
have guessed wrong about what the
market of the 1970's requires,
although in their own defense they
can point to the strength of the
large-car market in the middle of
the past model year. Moreover, by
boosting prices sharply and thereby
bringing to an end an era of cheap
transportation, they have not only
pushed many potential '75 sales
into the just-concluded model year,
but have also priced many custom­
ers out of the market completely.
Prices and income
The industry's admirable sales
record over the decades has been
based to a large extent upon its
price performance, since new-car
prices have consistently lagged
behind the growth of disposable
income, permitting consumers to
buy more (and larger) cars with
their increased real income. But
now the price of cars has begun to
soar along with the price of every­
thing else, helped along by the cost
of newly required safety and
pollution-control equipment as
well as the cost of other materials.
The sharp price increases of recent
months have now begun to have an
impact. Over the past six months
alone, new-car prices have risen at
a 20-percent annual rate. (For used
cars, prices have doubled at an
annual rate.) With a price elasticity
of (say) 0.5, the industry could lose
about 10 percent of its market with
that 20-percent rise. This factor
(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.

would help account for the indus­
try's constantly falling sales
forecasts for the '75 model year;
originally, the forecast was for 10.5
million units (including imports),
but now the standard forecast is
closer to 9 million. Besides, much
of that market was pushed into last
summer's '74 model cleanup, after
heavy price increases had already
been announced on the '75 models.
The industry's past strength was
based not simply on low price but,
more than that, on rising disposable
income. Thus, the 1973 model
year's 16.2-percent rise in consumer
auto spending (to a record $44.4
billion) went hand-in-hand with a
12.1-percent rise in disposable
income. When income growth
sagged to 9.5 percent in the '74
model year— and when inflation
brought about a sharp cut in real
income— some problems could
have been predicted, although
nothing comparable to the 12.4percent sales reduction actually
experienced. The extra factor was
the soaring cost of necessities. The
percentage of food spending out of
income, after falling steadily for
decades, jumped from 18.1 percent
in 1973 to 18.9 percent in 1974.
Similarly, the gas-and-oil share of
household income rose in the past
two years from 3.1 to 3.7 percent.
These shifts of course reflect the
rapidly rising price of these neces­
sities— 11.3 percent for food and
38.5 percent for gas and oil over
the past year.

Ages of cars— and people
With the growing squeeze on
family budgets, consumers may
hold on to their present cars longer
than usual, thus reducing the
normal impact of scrappage on
auto sales prospects. The scrappage
factor may be diluted also by the
relative newness of the auto stock,
caused by the phenomenal sales
pace of the 1971 -73 model period.
About 59 percent of all cars on the
road were less than six years old in
1973, compared with a 53-percent
figure a decade earlier, and scrappage only becomes a major factor !
after six or seven years.
Another expected prop of the auto
market— the sharp rise in the
number of young households— may
also be weaker than some market
analysts have projected. Some rosy
sales forecasts had been based
upon a one-third increase in the
number of households in the 25-34
age bracket during the first half of
this decade, but those forecasts had
failed to realize that potential
demand is not the same as effective
demand. In a weakening economy,
younger workers are the first to be
laid off because of their lack of
seniority. Also, with their relatively
low wages and heavy needs for
family-formation expenses (hous­
ing and appliances— and occasion­
ally babies), these young families
generally are not new-car buyers,
although they provide overall
support to the market through their
purchases of used cars.
Another important factor affecting
most carbuyers, but young buyers
in particular, is the state of

2



the credit market. (Families
aged 25-34 account for
roughly two-thirds of all consumer
debt.) The retail auto market
runs on credit, and when
credit is expensive or unavailable,
the market suffers. This was notably
true in the 1974 model year, when
auto credit extensions dropped 6.2
percent after two straight years of
unparalleled 20-percent increases.
More importantly, Detroit by its
credit record has shown that it is
cutting into future markets, just as
it has shown by its sales record that
it could cut into its '75 sales by
boosting '74s. One manufacturer
now writes 17 percent of its sales
contracts with maturities of more
than 36 months— it had none in this
category two years ago— and
contracts of as much as 48-months
maturity are becoming increasingly
common. In this way, many bor­
rowers can be effectively pushed
out of the market for years.
Getting the message
Standing amidst the shambles of
the 1974-75 models, automakers
are beginning to get the message
that consumers require more
economical transportation. Indeed,
all of the 22-percent increase in
sales since 1965 has occurred in
the small-car end of the market
(including imports). Despite this
indicator, the industry until recently
was reluctant to build small cars
because they offer a much smaller
profit margin than large cars.
Besides, with profits today only
about one-fourth the level of a year
ago, automakers are not anxious
to concentrate on low-margin
products.
3




The preferred answer is to pile
expensive options onto the small
cars. In many cases, this approach
has worked quite well. For example,
about 50 percent of all small-car
owners (domestic models) have
been ordering automatic transmis­
sions and about 40 percent air­
conditioning. (Optional items can
mean as much as a 40-percent
profit.) Detroit's past tendency to
make small cars larger and heavier
over time is no longer a viable
solution. Instead, the industry's
apparent strategy is to load on the
extras, climaxed by the production
of a mini-Cadillac.
The long-term result is the develop­
ment of a different kind of auto
market, with small cars accounting
for at least two-thirds of total sales
in 1980, as against one-half today
and only one-fourth in 1968. This
type of development in the nation's
bellwether industry has important
implications, since it could mean
significant reductions in manpower
and material requirements over
time. The industry employs 800,000
workers in its auto and parts plants,
and it uses up one-fifth of the
nation's steel, two-thirds of its
rubber, and one-twelfth of its
aluminum and copper. For these
and other segments of our auto­
based society, some painful
adjustments could be required in
coming years, although many of the
resources freed up here can
become available to meet the
nation's other needs.
William Burke

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BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)

Selected Assets and Liabilities
Large Commercial Banks

Amount
Outstanding
11/13/74

Change
from
11/06/74

Loans (gross) adjusted and investments*
Loans gross adjusted—
Securities loans
Commercial and industrial
Real estate
Consumer instalment
U.S. Treasury securities
Other Securities
Deposits (less cash items)— total*
Demand deposits adjusted
U.S. Government deposits
Time deposits— total*
Savings
Other time I.P.C.
State and political subdivisions
(Large negotiable CD's)

84,555
67,113
2,025
24,057
19,933
9,762
4,627
12,815
80,814
23,250
346
55,664
17,964
28,579
5,638
15,247

Weekly Averages
of Daily Figures

Week ended
11/13/74

+
+
+

763
484
776
—
185
+
10
+
6
28
+ 307
+ 328
+ 496
— 105
81
+
13
—
5
— 93
+
97

Change from
year ago
Dollar
Percent
+ 8,202
+ 8,893
+ 700
+ 3,772
+ 1,912
+ 784
-1,135
+ 444
+ 7,633
+ 918
19
+ 6,366
+ 300
+ 5,969
- 252
+ 4,369

Week ended
11/06/74

+
+
+
+
+
+
—

+
+
+
—
+
+
+
—
+

10.74
15.27
52.83
18.60
10.61
8.73
19.70
3.59
10.43
4.11
5.21
12.91
1.70
26.40
4.28
40.16

Comparable
year-ago period

Member Bank Reserve Position
Excess Reserves
Borrowings
Net free (+) / Net borrowed ( —)

94
172
- 78

109
105
+ 4

4
140
-1 3 6

+ 646

+ 656

+ 66

+ 665

+ 610

+ 76

Federal Funds— Seven Large Banks
Interbank Federal fund transactions
Net purchases (+ ) / Net sales (—)
Transactions: U.S. securities dealers
Net loans ( + ) / Net borrowings ( —)
‘ Includes items not shown separately.

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.