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’ H k T r i . - M i g -------- SI K ------- St V ' -M M ■ M « ----- StV ------ « U — ■W V — — -%*y - ■ V W Si m FEDERAL RESERVE BANK OF NEW YORK MONTHLY REVIEW A U G U S T 1958 5 Contents 1 The Business Situation ................................ ...106 Money Market in J u l y ................................ ...110 I International Monetary Developments . . 114 Sterling: A Year of R e c o v e ry .................. ...115 Volume 40 No. 8 106 MONTHLY REVIEW, AUGUST 1958 The Business Situation It seems probable that business activity passed a low point in April and has recovered moderately since that time. Production has advanced along a broad front, con struction work has increased, and total sales and orders have continued to improve. Employment has expanded, hours of work have lengthened sharply, and personal in come is probably at an all-time high. Even though the number of students and graduates entering the job market in May and June was close to the record totals of 1956 and 1957, unemployment increased only about seasonally to 5.4 million, when just a few weeks earlier it had been feared the total might reach 6 million. Unem ployment as a proportion of the labor force dropped from 7.2 per cent in May (seasonally adjusted) to 6.8 per cent in June (see Chart I). In July, moreover, although the data are still frag mentary, business apparently improved in many lines. Steel production declined only about seasonally, and new orders reportedly held up better than expected. Petroleum output increased and is scheduled to gain fur ther in August, while demand for both natural and syn thetic textiles is reported to have firmed somewhat. Construction activity appears to have started on a strong summer surge; housing starts increased in June for the fourth consecutive month, and, beginning with May, con tracts for public construction have been awarded at record rates. Personal income was bolstered by the Federal Civil Service pay increases and retroactive payments, and de partment store sales increased sharply; auto sales appar ently showed only the usual seasonal drop. On the other hand, a number of reports of unusually prolonged vacation shutdowns suggest a good many industries must still be trying to reduce excessive inventories. Moreover, while total new orders received by equipment manufacturers re mained steady or rose slightly in the second quarter, prob ably reflecting the sharp increase in military orders, backlogs of orders in the capital goods industries are apparently still on the decline. An added note of uncertainty has been injected into the business picture by the Middle East crisis. It is possi ble that the crisis may lead to higher military spending and to some precautionary inventory buying both here and abroad— even though, as in the case of the Suez crisis, these increases in demand might be transitory. Of course, the fear of war and shortages has strengthened the upward pressures on raw-material prices that already ap peared to be emerging even before the crisis broke out. Increases have just been announced for steel and alumi num prices, and there also have been more frequent reports of price increases, actual or under consideration, on items that are primarily consumer goods, such as autos, apparel, tires, and gasoline. In the few weeks since midJune, the industrial wholesale price index has regained almost all of its earlier small decline (about % of 1 per cent) from the January 1958 record. While there have been further increases in wage rates, the price pressures may be eased to some extent by in creases in productivity, if output continues to rise and thus moves closer to the optimum rates for which plants and equipment have been designed. In addition, competitive restraints resulting from ample capacity and the large inventories still on hand in some lines also may help to keep prices from rising. On the other hand, recovery is often associated with a climate in which resistance to higher prices and to wage demands tends to weaken. If April does turn out to have marked the recession low and business trends continue upward, the 1957-58 business contraction will have been not only the sharp est and most severe of the postwar period but also the shortest. It is prudent to recall, however, that during the earlier postwar recessions of 1948-49 and 1953-54, the initial strengthening in business activity was followed by a mild setback, so that in both these instances the economy may be described as having “bumped along the bottom” for several months before embarking on a sustained upturn. While the recent gains in output and employment have been larger than the initial improve ments in 1954, they are no greater than in 1949. How ever, the advance in output and employment has been broader than in either 1954 or 1949, in terms of the num ber of industries participating. Between April and June, for example, almost every major category of the industrial production index showed a gain of at least 2 points, and employment also increased significantly in such nonmanu facturing industries as construction and retail trade. SOURCES OF THE IM P R O V E M E N T The recent improvement has come somewhat sooner and more vigorously than many observers had perhaps anticipated. Taking into account the more drastic cut backs in business investment, both in plant and equipment and inventories, the abnormally sharp drop in consumer purchases of automobiles, and the more rapid spread of unemployment, the recession appeared to many to have gathered considerably more momentum than the earlier FEDERAL RESERVE BANK OF NEW YORK Chart I IN D ICA TO RS O F TO TA L BUSIN ESS A C TIV ITY S e a s o n a lly a d ju sted B illio n s of d o lla rs B illio n s of d o lla r s 1957 1958 Sou rces: United States D epartm en t of C o m m erce, B oard of G o ve rn o rs of the F e d e r a l R e se rv e System , United States B u reau of La b o r S ta tistics, and U nited States C e n su s Bu reau . postwar recessions. Nevertheless, the contraction—if it is indeed over— has, as already noted, been even briefer than its two postwar predecessors. While it is too early for a definitive analysis of this favorable turn of events, it seems clear that much of the explanation is to be found in the massive support provided by the government sector, which has been of consider ably greater importance than has been generally realized. Indeed, the swing from surplus to deficit appears to have been faster and larger than during the recession periods of either 1948-49 or 1953-54— despite the tax cuts which reduced revenues in each of these periods. Partly as a result of the operation of the “built-in stabilizers”, partly as a result of anti-recession legislation, and partly as a result of other measures not primarily related to the reces sion, total government spending (Federal, State, and local) rose from a seasonally adjusted annual rate of $114Vi billion in the third quarter of 1957 to $123Vi billion in the second quarter of 1958 (see Chart II), and seems likely to increase considerably further. Over the same interval, receipts fell from over $117 billion to an estimated $111 billion. Thus, within three quarters, the government sector turned from a net “saver”, with a sur- 107 plus (at a seasonally adjusted annual rate) of nearly $3 billion, to a net spender with a deficit of $12Vi billion. A significant part of the growth in net government out lays reflects higher spending by State and local gov ernments. Although the recession has tended to pinch municipal revenues, the reductions in receipts have appar ently been offset in most cases by higher tax rates, in creased Federal grants under the highway and other programs, and by the greater volume of funds and more favorable terms available for new borrowing. Between the first and third quarters of 1957, State and local purchases had shown virtually no increase. Since then, however, such spending has been advancing rapidly; through the second quarter of 1958, the gain amounted to about 9 per cent or, in terms of seasonally adjusted annual rates, to over $3 billion. Federal purchases and payrolls, on the other hand, did not turn upward until quite recently. (In 1953-54, it may be recalled, they declined throughout the recession.) But while actual outlays were roughly stable, orders for heavy military equipment were being stepped up sharply, from a curtailed annual rate of $8 Vi billion in the third quarter last year to more than $20 billion (if schedules have been met) in the second quarter of 1958. For the first half of 1958, these orders for military equipment amounted to some 15 per cent of all orders received by all manufac turers of durable goods, and the subcontracts and the TOTAL FED ERA L, STA TE, AN D LO CA L G O V ER N M EN T RECEIPTS A N D EXPEN D ITU RES S e a so n a lly ad ju sted q u a r t e r ly to ta ls at a n n u a l rates B illio n s of d o lla rs 125 1956 B illio n s of d o lla rs 1957 1958 N o te: D ata a re ta k en from the n a t io n a l in com e accounts a n d d iffer from the f in a n c ia l accoun ts m a in ly in that they a r e on a n a c c r u a l r a th e r than on a cash b a sis. Se co n d -q u a rte r 1958 receip ts a re p a rtly e stim a te d . Sou rce: United States D e p a rtm e n t of Com m erce. 108 MONTHLY REVIEW, AUGUST 1958 purchases of materials and parts by the companies that received military orders may well have accounted for a further significant fraction of the over-all order volume. Activity in the military equipment industries, which had been declining earlier, stabilized soon after the increase in orders began and recently may have started to expand. Above and beyond the increased purchases, payrolls, and orders, government outlays under various benefit pro grams also showed a much sharper increase than in the earlier postwar recessions. Such “transfer” payments jumped by billion (annual rate), or more than 20 per cent, between September and April. About %2Vi billion of the rise occurred in unemployment insurance payments, and about %IV2 billion in public retirement benefits, as many older persons took advantage of the liberalized pro visions enacted in 1956 for women and the self-employed. The rise in these transfer payments offset fully half the contraction in wage and salary earnings between last August and the April low, and largely explains why the decline in total personal income during the recession was so moderate. Other important factors which contributed to the maintenance of personal income were the sharp expansion in farm proprietors’ income and the wellsustained level of dividends; in the first quarter of 1958, dividend payments equaled the year-earlier total although after-tax corporate profits had declined by about one third. At its recession low in February, personal income had declined only IV 2 per cent from its all-time peak, and this loss had been almost completely recovered by June. The steadiness of personal income in turn helps to ex plain why, as in the previous recessions, total consumer spending held up so well. Despite the pronounced weak ness in the demand for consumer durables and the con traction in instalment credit, aggregate consumer buying dropped less than 1 per cent between the third quarter of 1957 and the opening quarter of 1958, and most of this drop was made up in the second quarter. Notwithstanding the growth in unemployment and the shortening of work weeks, which may have affected at one time or another as many as one out of every four families, consumers were apparently determined to maintain prosperity stand ards of living wherever possible. Outlays on food and services increased in line with the prices of such items, and generally speaking there did not seem to be any wide spread shift in consumer demands toward goods of lower quality. This summer, a variety of special developments are bolstering incomes. By the last week in July, over half a million persons had filed for benefits under the new legislation that authorizes the continuation of pay ments to persons who have exhausted their unemployment insurance credits. The Federal civilian and military pay increases have added about $ 1 V2 billion to the annual rate of personal income, and widespread pay increases are occurring in industry under long-term contracts and costof-living escalator clauses, as well as under newly nego tiated contracts. The payment of the retroactive portions of the Federal increases is providing a further very large, although temporary, boost. Meanwhile, the monthly rate of instalment repayments has been drifting lower, as people complete repayment on old obligations and take on fewer new ones. Finally, the rise in food prices was halted in May and June, and these prices may well turn down at least seasonally later in the year. These devel opments suggest that many consumers may soon find their discretionary incomes substantially enlarged, quite apart from the growth in such incomes that would result if eco nomic recovery were to gather strength and many of the unemployed again found jobs. However, the fact that spending on goods and services that people regard as essential remained strong during the recession, when incomes were declining, does not neces sarily imply that spending on less urgent items will rise sharply when incomes expand. The latest survey of con sumer attitudes by the Michigan Survey Research Center does show that people generally feel more optimistic about the business outlook than they did last fall, and that more of them think the present is a good time to buy. But the Survey also notes a slight decline in buying plans for major durable goods, and reports a substantial increase in the number of respondents who expect prices to go down over the coming twelve months. On the whole, therefore, the Survey suggests that, although the public may be in a better frame of mind to make discretionary purchases, it may require vigorous selling to convert this attitude into actual sales. PROGRESS IN IN V E N T O R Y L IQ U ID A T IO N The current pickup in over-all business activity has come at a time when business capital outlays and consumer purchases of durable goods appear to be no more than leveling off after their sharp declines, and are giving little indication of any sizable and immediate recovery. So far, home building and government spending appear to be the only sectors in which final demand in real terms has in creased significantly. But the key fact is that even the stabilization of final demand is of vital importance for the behavior of inventories; so long as final demand holds steady, inventory liquidation sooner or later must slow down and eventually stop. 109 FEDERAL RESERVE BANK OF NEW YORK Indeed, it seems likely that the recent gains in manu facturing employment and hours rest in some measure on a lessening in the rate at which business firms have been liquidating their inventories. The Council of Economic Advisers’ preliminary estimate of inventory change for the second quarter shows the rate of liquidation as unchanged from the record first-quarter rate of $9.5 billion annually. However, monthly data covering the book value of inven tories show some slackening of liquidation from month to month within the second quarter. The tendency toward a slower rate of liquidation was, however, confined to re tail and wholesale trade. Stocks of new automobiles were still being worked down into line with the low rate of sales, but other durable goods dealers and department stores actually increased their inventories somewhat, fol lowing the sizable reductions effected since last fall. At the manufacturers’ level, where most of the over hang of stocks has been concentrated, liquidation con tinued unabated during the second quarter. Sales, how ever, began to improve, and inventory/sales ratios de clined appreciably. A further encouraging feature of the second-quarter inventory liquidation on the part of manu facturers was the shift toward a more rapid drop in finished-goods stocks (see Chart III). Previously, the de cline in factory inventories had been concentrated mainly in stocks of purchased materials and goods-in-process, which manufacturers can reduce relatively quickly by cut ting back production and purchasing. In May and June, by contrast, half of the drop in manufacturers’ stocks occurred in finished goods. Such stocks are more difficult to control and usually do not decline appreciably until the later stages of a business contraction when sales to cus tomers stabilize or turn up. The mere cessation of inventory liquidation, it may be very roughly estimated, would permit an increase of up ward of 5 per cent in the volume of industrial output. This would, of course, be reflected in sizable gains in employ ment and incomes. In some industries, inventories are reported to have been reduced to near-minimum levels, and the improvement in the business situation, the firming of prices, and the aggravation of international tensions thus come at a time when inventory policies are perhaps already ripe for reversal. Of course, manufacturers’ in ventories are still very high relative to sales, but experi ence has shown that inventory/sales ratios can improve very rapidly once sales begin to show significant gains. On the other hand, the Rowing-down in over-all inven tory liquidation could turn out to be rather gradual and drawn out. Temporary factors may have played an impor tant role in keeping the rate of liquidation in recent months C h art III M A N U FA C TU R ER S’ IN VEN TO RIES BY ST A G E O F FA B RICA TIO N S e a s o n a lly a d ju ste d book va lu e s B illio n s of d o lla rs B illio n s of d o lla rs N ote: L a te st d a t a plotted are for end of Ma y. Source: United States D e p a rtm en t of Com m erce. from becoming even more rapid. Some part— opinions vary as to how much— of the increase in inventory demand for steel and other metals undoubtedly represented hedg ing against the widely anticipated price increases. Further more, the restocking by appliance retailers, which in turn was probably responsible for the reported increase in production by appliance manufacturers, could be quickly reversed if sales fail to improve. Finally, to the extent inventory purchases are increasing because of the inter national situation and the upward pressure on prices, they could rapidly fall back should the international crisis subside. More generally, inventory purchasing is governed not only by current sales, but also by businessmen’s expecta tions with regard to future demand, availability of sup plies, and prices. Sales have increased only modestly so far, but the pickup follows a period of sharp decline, and may therefore give rise to expectations of more sub stantial gains to come, particularly in the area of durable consumer goods. Similarly, supplies of virtually all types of goods have remained ample but, if businessmen antici pate sharply larger demand or fear shortages and price increases because of the international situation, they may choose to step up inventory purchasing nonetheless. Depending on how businessmen evaluate and take action in response to these various contingencies, the reduction in the rate of inventory liquidation may be fast or slow. The vigor of the business recovery may be determined in large measure by the speed with which strength develops in this most volatile sector of demand. 110 MONTHLY REVIEW, AUGUST 1958 Money Market In July July was a month of turbulence in the Government securities market and of difficult decisions in the area of monetary policy. Although reserve balances were in ample supply and the money market generally easy, serious strains developed in the Government securities market. To a considerable extent, the imbalance in the market arose out of the large volume of securities acquired during the June and earlier financings by temporary holders, some outright and some on unduly thin margins, in the hope of speculative gains derived from further credit-easing moves by the Federal Reserve System. In July, however, the continued improvement in business news, the growing rumors that a consequent hardening of Federal Reserve credit policy might be in prospect, fiscal developments, and, finally, the Middle East crisis combined to bring about a sharp reversal of anticipations. Institutional in vestors joined speculative holders in attempting to reduce their portfolios of Governments, and the pressures, which had been concentrated on the recently issued securities, spread throughout the list. The resultant declining trend in Government securities prices became accentuated by forced selling brought about by margin calls by lenders other than commercial banks who had financed specula tive securities holdings on thin margins. The decline in prices of long-term Treasury securities, which had begun in mid-June, accelerated during the first half of July, although a steadying influence was exerted by the Treasury’s announcement on July 9 that it had pur chased almost $600 million of the new 25/s per cent bonds of 1965. The decline in prices halted only briefly, how ever, and the volume of offerings in the market continued to expand while potential purchasers held back to await developments. On July 18, with offerings rapidly mount ing and virtually no buying in the market, it was an nounced that, “In view of conditions in the United States Government securities market, the Federal Open Market Committee has instructed the Manager of the Open Mar ket Account to purchase Government securities in ad dition to short-term Government securities”. The announcement had an immediate effect upon ex pectations, and bond prices recovered somewhat. Al though subsequent modest System purchases in the inter mediate and long-term area tended to stabilize prices, the market atmosphere remained heavy and investor reaction to the Treasury’s $16.3 billion August 1 re funding operation was not favorable. Despite Federal Reserve System purchases of “rights” to the exchange and of more than $1 billion “when-issued” securities during the July 21-23 subscription period, the attrition on the refunding amounted to about $2.8 billion. Simultaneously with the disclosure on July 25 of the results of the ex change operation, the Treasury announced a $3.5 billion cash offering of tax anticipation certificates for July 29. The issue was oversubscribed, although by a considerably smaller margin than usual. The Treasury bond market again was subject to selling pressure late in the month, but prices turned around and were moving upward as the month drew to a close. Federal Reserve purchases of Government securities pro vided sufficient funds to the banking system over the month approximately to offset the drains of reserves brought about by market influences. Thus, a general atmosphere of ease continued to prevail in the money market. Except for some temporary firmness on a few days early in the month, the effective rate for Federal funds was below 1 per cent, occasionally falling to Va- or even Vs per cent. Treasury bill yields edged up intermittently during the first half of the month and moved within a fairly narrow range thereafter; at the end of the month the longest Treasury bill was bid at 0.91 per cent, as against the month’s peak of slightly over 1 per cent and 3A per cent on June 30. M EM BER BANK RESERVE P O S IT IO N S Free reserves of member banks averaged $575 million during the five statement weeks ended July 30, about $90 million above the average for June. Average mem ber bank borrowing from the Reserve Banks, at $110 million, was somewhat lower than in June, while excess reserves edged up on average. A decrease in average required reserves in each of the five July statement weeks added $460 million to mem ber bank excess reserves, as bank credit and deposits fell back following the sharp increases in June. Other operat ing transactions as a whole drained reserves in all but the fourth July statement week, for a net loss of reserves of $557 million over the month. Of this absorption of re serves $142 million was attributable to gold and foreign account transactions, considerably less than the reserve losses stemming from this source in recent months. The reduced outflow of gold reflected in some degree a sea sonal shift in the balance of payments of some countries that had been adding rapidly to their gold and dollar re serves earlier this year. Early in July, System open market purchases more than offset the large drain on reserves stemming from currency outflows, float movements, and other market factors. Later in the month, however, a net decline in System holdings FEDERAL RESERVE BANK OF NEW YORK Table I C hanges in F actors T en ding to Increase or D ecrease M em ber B ank R eserv es, J u ly 1958 (In millions of dollars; ( + ) denotes increase, (—) decrease in excess reserves) Daily averages—week ended Factor July 23 July 30 Net changes 17 32 9 99 8 + 27 + 66 + 158 + 45 + 35 - 80 - 222 + 131 - 35 + 57 - 100 - 201 - Ill - 142 1 68 + 330 - 149 - 557 - 194 - 105 - 122 + 144 46 — - 28 — - 30 — + 23 — + - 1 2 - 1 - 1 - 3 - + July 2 July 9 July 16 Treasury operations*..................... Federal Reserve float.................... Currency in circulation................. Gold and foreign account.............. Other deposits, etc......................... + 4 - 209 - 188 - 13 - 137 - 34 + 132 - 221 - 40 + 36 + + + Total....................................... - 543 - 127 - + 528 + 37 - 108 - 3 - 2 + 1 2 + 419 Operating transactions Direct Federal Reserve credit trans actions Government securities: Direct market purchases or sales Held under repurchase agree ments...................................... Loans, discounts, and advances: Member bank borrowings......... Other.......................................... Bankers' acceptances: Bought outright......................... Under repurchase agreements... Total....................................... + — Total reserves...................................... - 124 Effect of change in required reserves f + 108 Excess reserves f ................................. Daily average level of member bank: Borrowings from Reserve Banks .. Excess reserves f ............................ - 16 97 683 - Ill — — 136 — - 101 9 7 — 77 - 223 - - 50 + 122 - 291 + 98 + 194 + 32 - 250 + 100 + - 521 + 460 36 + 72 - 193 + 226 - 150 - 143 755 115 562 85 788 108 638 61 110J 6851 Note: Because of rounding, figures do not necessarily add to totals. * Includes changes in Treasury currency and cash, t These figures are estimated. t Average for five weeks ended July 30. of Government securities served to neutralize the release of reserves by various market forces, as well as to reduce the forthcoming reserve effects of the System Account’s large-scale purchases of the new 1% per cent Treasury certificates on a “when-issued” basis. These purchases did not affect member bank reserve positions in July since payment was not made until August 1. Total System holdings of Treasury securities declined by $40 million between June 25 and July 30, as increases of $10 million in notes and $165 million in bonds (of which $110 million were bonds maturing within five years) were more than offset by a decline of $215 million in holdings of Treasury bills. G O V E R N M EN T S E C U R IT IE S MARKET During the first half of July prices of Treasury notes and bonds declined with only a few brief rallies. Sales of the new 2% per cent and per cent bonds issued in June, and to a lesser extent other recent issues, many of which were held on thin margins, continued to be pressed on an unreceptive market. The weakness of investor demand stemmed in part from the continuing signs of improvement in the business picture and a 111 revival of fears of inflation, and the consequent press re ports conjecturing a change in credit policy; the crisis in the Middle East also served to cut buying interest further. On July 9, the Treasury announced that in the preceding few weeks it had purchased $589.5 million of the new 2% per cent bonds of 1965, and that $456 million of the $7.4 billion issue would be retired. The excessive market supply following the heavy subscriptions for this issue in the June refunding had been a major factor in depressing the entire Government securities market. The Treasury’s statement regarding its purchases served to strengthen the market basically despite adverse criticism in some quarters. The Treasury’s announcement on July 17 that a oneyear certificate would be the only issue offered in the August 1 refunding was accompanied by an announce ment to the effect that cash borrowing to take place shortly after the refunding would be carried out through a security maturing in one year or less. But these announcements led to only a very brief rally in bond prices, and sell ing pressures resumed by midmorning of July 18. Offer ings from speculative sources were augmented by offerings from institutional investors, and the pressures fanned out from recently issued bonds to the entire range of Govern ment securities. In the midafternoon of July 18, as bond prices were piercing earlier 1958 lows and there was a virtual absence of bids in the market, the Federal Open Market Committee authorized purchases by the System Account of Government securities in addition to short term issues. Prices immediately recovered, and after rising further the next trading day, held more or less steady for several days, in part as a result of Federal Reserve purchases. The subscription books for the Treasury’s refunding offer of a one-year 15A per cent certificate dated August 1 were open on July 21 through July 23. Rights to the exchange included $11.5 billion of 4 per cent certificates maturing August 1 and $3.8 billion of 2 V* per cent bonds plus about $900 million of 23/s per cent bonds called for redemption on September 15. Prior to the refunding, about $9.1 billion of the $16.3 billion maturing and called securities was held outside the Federal Reserve System and Government Investment Accounts. The exchange offering met with an unenthusiastic reception and failed to improve the heavy atmosphere in the market. Despite Federal Reserve purchases of “rights” and of $1,090 million of the new certificates on a “when-issued” basis during the subscription period, exchanges totaled only some $13.5 billion; this left a total of $2,770 million to be redeemed for cash, $890 million of the matured certificates on August 1 and $1,880 million of the called 112 MONTHLY REVIEW, AUGUST 1958 bonds on September 15. The “when-issued” certificate declined below par after the subscription books closed, and was bid at 99.31 at the end of July. Late in the month, prices of Treasury notes and bonds moved downward again, but as the month ended the mar ket strengthened with the return of some investor buying interest. Nevertheless, over the month as a whole, Treasury issues maturing before 1962 lost as much as 25/ 32 points, while those in the 1962-72 range lost up to 2% 2 points. Longer term bonds closed 2 to 4 1% 2 points down for the month. Long-term Treasury yields thus climbed to 3.38 per cent from 3.26 per cent at the end of June and the recent low of 3.07 per cent at the end of April; this compares with the peak of 3.76 per cent reached last October. (See chart.) On July 29 the Treasury offered for cash $3.5 billion of IV 2 per cent tax anticipation certificates, to be dated August 6, 1958 and to mature March 24, 1959. They will be accepted at par plus accrued interest in payment of income and profits taxes due on March 15, 1959. Commercial banks were permitted to pay for the new certificates by credit to Treasury Tax and Loan Accounts. While the interest in this issue was confined mainly to the larger banks in the country, subscriptions to the offering, the books for which were open only on July 29, totaled $5,960 million. Allotments amounted to 59 per cent for subscriptions over $100,000, with subscriptions of $100,000 or less allotted in full. On July 31 the new Y IELD S O N UNITED STATES G O V E R N M E N T SECURITIES 1957 1958 N o te : La test d a ta p lo tted : w eek en d e d J u ly 2 6 (or lo ng-term bonds a n d 3-5 y e a r issu e s; a uction Held on Ju ly 28 for T re a su ry b il k . certificates were quoted at 99.30 in “when-issued” trading. Treasury bill rates during the first half of July resumed the rise begun in June, partly reflecting light private de mand and partly temporary reserve pressures on the central reserve city banks. Rates declined irregularly later in the month, as an easier tone returned to the money market and investor demand revived. The average issuing rate established in the weekly Treasury bill auction advanced from 0.768 per cent on June 30 to 0.934 per cent on July 7, and to 1.137 per cent the following week, a two months’ high. In the last two auctions of the month the average issuing rates receded to 0.988 per cent and to 0.984 per cent. OTHER S E C U R IT IE S M ARKETS The markets for corporate and municipal bonds dis played a somewhat heavy tone during most of July, partly in sympathy with price movements in the Government bond market and partly because of a continued sizable volume of new issues. Price and yield adjustments, how ever, were mainly confined to new and recent issues rather than seasoned securities, and many attractively priced new issues were favorably received. An estimated $680 million of corporate bonds for new capital purposes and $540 million of municipal bonds were publicly marketed in July. The July total of $1,220 million was substantially above the $785 million of June flotations and somewhat larger than the $1 billion offered in July 1957. In the first part of the month, two corporate offerings were postponed and the size of another was reduced, rereportedly due to unsettled market conditions. A number of underwriting syndicates for corporate and municipal issues formed prior to July were terminated with substan tial price cuts. Longer maturities of a $100 million issue of highway revenue bonds offered at the end of May sold as low as 13A points below the original reoffering price after the syndicate was terminated in mid-July. On the other hand, most new issues offered in July, re flecting their more attractive terms, met with a favorable investor response. The corporate calendar in July was dominated by a $300 million Aa-rated industrial flotation offered at midmonth to yield 3.97 per cent. (Similarly rated industrial issues early in April were marketed at reoffering yields ranging from 3.75 to 3.90 per cent.) This issue enjoyed good investor demand, and was about 90 per cent sold out on the day it was offered to the market. One new Aa-rated public utility flotation was marketed at a reoffering yield of 4.10 per cent, a high since March, which compares with a level of almost 5 per cent in early November. Over the month, average yields on seasoned long-term Aaa-rated corporate bonds 113 FEDERAL RESERVE BANK OF NEW YORK (as measured by Moody’s Investor Service) advanced to 3.71 per cent from 3.62 per cent. The large volume of new municipal flotations led to some hesitancy in that sector of the market. Interest in these issues was mixed, with most smaller issues moving slowly. The month’s largest municipal issue, a $100 million State offering on July 23, was very well received at reoffering yields 25 to 35 basis points higher than on a similar issue floated three months earlier. Toward the end of the month the municipal market improved some what, partly because of a decline in the volume of new offerings scheduled for the coming weeks. Moody’s index of yields on outstanding Aaa-rated municipal issues stood at 2.84 per cent on July 30, compared with 2.78 per cent at the end of June. In the market for private short-term debt instruments, major finance companies announced a X A of 1 percentage point reduction, effective on July 24 and 25, in the rates they pay on directly placed paper, bringing the rate on 30 to 89-day finance paper to 1 per cent. This rate cut, the first by a finance company since April 22, reportedly reflected the general lowering of short-term money rates as well as debt repayments by automobile dealers made possible by the recent cutbacks in automobile inventories. M EMBER BANK C R E D IT Total loans and investments of the weekly reporting member banks declined sharply during the five weeks ended July 23. This was due in part to an “unwinding” of the rapid expansion that occurred in the first three weeks of June, when tax borrowing and large-scale Treasury debt operations caused a temporary bulge in bank credit. The five-week $2,163 million drop in member bank credit was mainly the result of a $760 million fall in business loans and a $1,244 million reduction in securities loans; the cutback in securities loans, which reversed most of the steep rise of the first part of June, was largely con centrated on loans against Government securities. Invest ments contracted by $289 million. The drop in business loans included reductions of $288 million in loans to metals and metal products firms, $127 million in loans to public utilities and transportation com panies, and $123 million in loans to food, liquor, and tobacco concerns. In the corresponding five-week period last year, business loans had declined by $684 million, in large part owing to repayment of borrowing by sales finance companies after the tax date. Thus far this year, business loans of the weekly reporting banks have fallen by $2.7 billion and total loans by $2.3 billion; in the same interval last year, business loans had risen by $674 Table II C hanges in Principal A s s e ts and L iab ilities of th e W eek ly R eporting M em ber B anks (In millions of dollars) July 16 July 23 Change from Dec. 31, 1957 to July 23, 1958 - 186 + 6 - 115 + 41 - 306 + 12 7 + 8 -2,682 + 96 + 471 + 189 + - - Statement week ended Item June 25 July 2 July 9 Assets Loans and investments: Loans: Commercial and industrial Agricultural loans.................. + Securities loans....................... — Real estate loans.................... + All other loans (largely con+ 23 + 6 + 508 — 21 — 55 + 5 250 10 + 4 299 — 315 11 1 + 12 23 7 24 306 Total loans adjusted*......... - 451 - 288 - 572 - 245 - 318 -2,280 Investments: U. S. Government securities: Treasury bills..................... + + 94 122 + 127 201 87 — 37 - 170 - 13 - 35 53 +5,643 Total............................... + Other securities...................... + 216 _ 80 - 40 _ 243 + 238 70 - 183 + 59 + 88 78 +5,643 +1,475 Total investments.............. + 296 - 283 - 168 - - 10 +7,118 Total loans and investments ad justed*........................................ - 155 - 571 - 740 - 369 - 328 +4,838 Loans to banks.............................. _ 181 + Loans adjusted* and “ other” secu rities........................................... - 371 71 + 125 - 225 + 100 + 788 531 502 - 186 - 240 - 805 Demand deposits adjusted............ -2,168 706 Time deposits except Government + 192 + 74 U. S. Government deposits........... +2,268 925 Interbank demand deposits: Domestic.................................... _ 541 +1,191 48 + 19 + 284 54 + —1,736 + 810 - 53 - 610 + 786 + 31 - 844 - 447 +4,023 + 728 62 44 - 224 + 169 - 510 8 - 124 Liabilities + 916 46 * Exclusive of loans to banks and after deduction of valuation reserves; figures for the individual loan classifications are shown gross and may not, therefore, add to the totals shown. million while total loans had dropped by $121 million. The cutback in investments of the reporting banks during the five weeks ended July 23 was the result of a $439 million decrease in Treasury bill holdings partly offset by a $106 million rise in holdings of other Government securities. For the year to date, however, investments show an increase of $7.1 billion, in contrast to a reduction of $1.5 billion in the comparable period last year. The rise in investments thus far this year reflects increases of about 20 per cent in holdings of both Government and other securities; the reporting banks’ portfolios of Gov ernment securities were up by $5.6 billion (or 21.4 per cent), as holdings of notes expanded by $2,177 million (or 45.6 per cent) and holdings of bonds by $3,546 million (or 19.7 per cent). Holdings of certificates de clined by $80 million and bill holdings were unchanged. The expansion of investment holdings in the first twentynine weeks of 1958 has been substantially larger than the fall in reporting banks’ loans, with the result that total loans and investments were up by $4.8 billion, as against a decline of $1.4 billion in the comparable 1957 period. 114 MONTHLY REVIEW, AUGUST 1958 International Monetary Developments MONETARY TRENDS AND P O L IC IE S u n i t e d k i n g d o m . The Chancellor of the Exchequer on July 3 announced two changes in the field of British monetary policy. One constitutes a major relaxation of existing restraints on bank lending and on new capital flotations, as discussed on page 119 of this Review. The other introduces a new monetary control device in the form of special deposits with the Bank of England that would be required of the banks if a reduction in their liquidity should once more be deemed desirable. Such deposits would carry an interest rate based on the current Treasury bill rate and would not qualify for inclusion in the banks’ liquid assets. According to the Governor of the Bank of England, arrangements for such deposits would initially be made with two groups of banks— the London clearing banks and the Scottish banks— but later might be applied more widely. The amount of the calls would be related to the total gross deposits of each group on a specified date, with monthly adjustments to take account of variations in deposits; the ratio of a call to total deposits would not necessarily be the same for each group. The new arrangements, the Governor declared, “would serve to reinforce the existing monetary instruments and would be employed as a general control of credit in the same way . . . as bank rate”. Following announcement of the easing of credit restric tions, the average Treasury bill tender rate, which had stood at 4.29 per cent at the final June tender, fell to 4.17 per cent and at the second July tender dropped further to 4.02 per cent, the lowest since mid-August of last year. Under the impact of the Middle East crisis the rate stiffened again to 4.25, closing at 4.16 on July 25. The yield on 2Vi per cent Consols, which had reached a low for the year of 4.85 per cent on July 11, closed at 4.94 per cent on July 31. canada. The Canadian Government on July 14 an nounced an offer to exchange all outstanding Victory Loan bonds issued during World War II for new, noncallable bonds of longer maturity. The five outstanding series of Victory Loan bonds amount to $6,416 million, equal to 43 per cent of Canada’s national debt and to 61 per cent of outstanding marketable government securities. The maturities of these 3 per cent bonds extend from January 1959 to September 1966; for three of the five issues, aggregating $4,304 million, the conversion offer antici pates their earliest call dates, which range from February 1959 to September 1961. The new securities offered in exchange are four issues of 3V4, 7, 14, and 25 years, carrying coupons, respectively, of 3, 3% , 4V4, and AV2 per cent. When transfers begin on September 1, holders of Victory Loans may exchange them for any of the four new issues offered, provided the maturity of the new issue exceeds that of the converted one by a specified margin; those accepting the conversion offer will receive a cash premium of between $12.50 and $25 per $1,000, depend ing on the new series selected. The government’s imme diate cash needs have been covered by a $400 million 2 V2 per cent five-month bond issue placed in mid-July with the Bank of Canada and the chartered banks. The short maturity of these obligations was stated to be dic tated by the customarily heavy net sales of Canada Savings Bonds to the public in the final quarter of the year. The Finance Minister had already hinted in mid-June at “new long-term issues whenever . . . opportunities occur”, since “to refund maturing issues in the short-term market would only build up greater difficulties for ourselves two or three years hence”. At the time of the conversion offer, the Minister declared that the massive refunding operation was aimed chiefly at lengthening the national debt and at reducing the amount of funding that otherwise would be required over the next few years. Success of the con- YIELD S O N C A N A D IA N G O V E R N M EN T SECURITIES P«r cent p*? cent Noto: G o ve rn m e n t bon d s: W e d n e sd a y c lo sin g y ie ld s. T rea su ry b ills: a v e r a g e te n d e r ra te on T hursd ay. Latest d a ta sh o w n a re for Ju ly 23 a n d 24. Source: B ank of C a n a d a . FEDERAL RESERVE BANK OF NEW YORK version is expected to encourage investors to take renewed interest in all bond markets, including those for provincial and municipal issues. The initial market reaction to the conversion offer was generally favorable. While prices and yields on longer dated government securities showed but moderate move ment, the 3 per cent 1961-66 Victory Loan gained 6 points between July 9 and 16, with the yield declining from 3.83 to 2.91 per cent and falling further to 2.86 on July 23 (see chart). At the short end of the market, the average Treas ury bill tender rate fell from 1.66 per cent in early July to 0.97 on July 24, the lowest level since January 1955. Be l g i u m . The National Bank of Belgium lowered its discount rate to 33A per cent from 4, effective July 3; the rate had previously been reduced by Va per cent each on June 5 and March 27. The latest reduction reflects mainly the continuing improvement in Belgium’s international position (associated with tourist receipts and short-term capital inflows) and the further easing of the money mar ket. Like the earlier discount rate decreases, last month’s move therefore appears primarily as an adjustment to pre vailing money market conditions at home and abroad, and seems to have been little influenced by the domestic economic situation. Although industrial output had been declining early this year, and during January-April was running about 6 per cent below the same months of 1957, production edged upward in May and there are indications of a further advance in June. EXCHANGE RATES Despite international tension and seasonal demand for dollars, American-aceount sterling acted remarkably well during July. Early in the month, good commercial demand for sterling strengthened the rate to $2.802% 2* As sea sonal demand for dollars in London developed, particu larly from tobacco interests, the rate eased to $2.80Vi and 115 then dipped quickly to $2.80 following the news of the Iraqi coup at midmonth. The rate, however, recovered to the $2.80% 6 level by the month end. There was very little evidence that the British authorities found it necessary to lend more than token support to the rate. The forward discounts for three and six months’ sterling moved rather widely between 11Vl6 and 2% 6 cents and 3% and 4% 2 cents, respectively, during the month. The wider discounts followed the revolution in Iraq, while dis counts tended to narrow whenever offerings of forward dollars appeared in London or moderate commercial demand for forward sterling developed in New York. Transferable sterling reacted more sharply than American-account sterling to the events in the Middle East, declining to $2.762% 2 from an early July quotation of $2.78%, with the rate in New York reflecting princi pally the movements of the rate in Switzerland. This greater pressure on the transferable sterling-dollar rate paralleled the weakness of sterling in relation to Con tinental currencies, the latter rates reaching support levels for sterling during the month. By the month end, trans ferable sterling had recovered to about the $2.78 level. Securities sterling ranged between $2.77 and $2.78% dur ing the month and, from time to time, was quoted higher than transferable sterling. The market for securities ster ling was relatively active during July with investor demand reflecting some interest in British oil stocks. The Canadian dollar moved erratically between $1.04 and $1.04% in a comparatively small market. Although the Canadian dollar was more offered than bid in the mar ket, the demand on the part of commercial interests and from the Continent occasionally strengthened the rate. Some demand also resulted from the conversion of United States dollar proceeds of securities sales in the New York market, although such demand was on a considerably re duced scale as compared with past months. As the month ended, the Canadian dollar was quoted at $1.04%4. Sterling: A Year of Recovery Sterling has recovered from the difficulties of 1957 and has weathered the American recession in a manner that few would have dared predict a year ago. The vigorous measures to safeguard the currency, announced by the British Government in mid-September 1957, brought a marked strengthening in sterling rates and reversed the drain in Britain’s gold and dollar reserves which had dropped sharply during July-September to a five-year low of $1,850 million. Even after allowing for Britain’s draw ing on the Export-Import Bank line of credit and its postponement of payments on the United States and Canadian postwar loans, the rise in these reserves from October onward was one of the most rapid in Britain’s history. Indeed, it not only offset the third-quarter losses but pushed the reserves up to $3,084 million at the end of July 1958, the highest since September 1951. 116 MONTHLY REVIEW, AUGUST 1958 ADVERSE PRESSURES IN 1957 to Britain and the rebuilding by dollar-area residents of This recovery was very largely attributable to the elimi , their sterling balances, which had been sharply reduced nation of factors that had weakened sterling during during 1956. Britain’s reserves (which comprise the cen January-September 1957. Early in 1957 sterling was still tral reserve for the entire sterling area) also benefited from convalescing from the Suez difficulties of the previous special dollar receipts, notably the reimbursement, under autumn, which had involved a sharp setback from the a revision of the United States and Canadian postwar loan recovery achieved under the British Government’s finan agreements, of $104 million in interest that had been paid cial restraint policy of 1955 and 1956.1 Largely because into suspense accounts in December 1956, as well as the of this policy, it is true, Britain’s over-all balance of pay $200 million transfer to Britain in connection with India’s ments on current account was still in surplus during drawings on the International Monetary Fund. Despite the January-June 1957, but its balance with the dollar area pressure on sterling, therefore, Britain’s dollar reserves had swung into deficit because of the rise in its imports of rose by $248 million in January-June 1957. The adverse pressures on sterling were greatly intensi petroleum and petroleum products from the dollar area and the reduction of dollar earnings of British oil com fied during the third quarter of 1957. The overseas sterling panies from their overseas operations. Of more basic im area’s (OSA) trade deficit with nonsterling countries, al portance in early 1957, however, were factors that created ready enlarged in January-June 1957 by the rise in im uncertainty about the stability of sterling. This uncertainty ports, was further increased by the seasonal decline in stemmed in part from persisting troubles in the Middle third-quarter exports. At the same time, an intense wave East, where Britain has large investments, but mainly from of currency speculation was set off in Europe in August 1957 by what was in effect a partial devaluing of the difficulties in Britain itself. Upward pressure on wages continued unabated during French franc, as well as by a growing belief that the the winter of 1956-57 despite the fact that, for the first Deutsche mark was about to be revalued and that, in a time since early 1954, unemployment in Britain exceeded general realignment of parities, sterling might be depre the number of job vacancies. Faced with this continuing ciated. Hence, funds were withdrawn from London on a wage pressure, the government took the view that an very large scale, swamping the favorable effects of the sub expansion of production was necessary to meet the ex stantial third-quarter build-up, for debt repayment pur pected growth of consumer expenditures. Actually pro poses, in Germany’s special sterling balances. Britain duction did recover to its earlier highs, the labor market consequently lost $531 million in gold and dollars during tightened once more, and, with retail and export prices the third quarter, and $129 million more during October still rising, a continuance of the wage-price spiral seemed (when, in accordance with the normal arrangements, the previous month’s European Payments Union deficit was in prospect. It thus became a question whether Britain could expect settled), for a total loss equivalent to more than one even to maintain the surplus in its balance of payments, quarter of Britain’s gold and dollar reserves at the end to say nothing of expanding it to a level commensurate of June. with Britain’s heavy obligations to other countries, and this uncertainty led to a weakening of confidence in ster R E N E W E D S T R E N G T H S IN C E S E P T E M B E R 1 9 5 7 ling. As a result, there was a marked rise early in 1957 in the flow of sterling capital into nonsterling countries. Drastic measures announced by the British Government Indicative of the flow to the dollar area was the $141 mil on September 19, 1957 put an end to this reserve drain. lion rise in net British purchases of United States long The government unequivocably reaffirmed that it intended term securities in January-June 1957 above a year earlier to maintain the existing exchange parity of $2.80 to the and the $48 million rise in securities purchased in Canada. pound and that it did not intend to allow the margins to The outflow of sterling capital to nonsterling-nondollar widen. To implement this policy the government declared countries also rose, with the result that Britain’s net dollar that it would, if necessary, draw on credits previously payments to these countries were sharply increased. granted on a stand-by basis by the International Monetary Dollar losses on these accounts, however, were more Fund and by the United States Export-Import Bank. It than offset by a variety of other factors, especially the also tightened severely its domestic anti-inflationary poli increased flow of private United States long-term capital cies. The Bank of England’s discount rate was increased from 5 per cent to 7, and instructions were issued to 1 See Sterling After Suez, published in the May 1957 issue of this the London clearing banks to hold the average level of Review. FEDERAL RESERVE BANK OF NEW YORK 117 advances during the next twelve months to the average balance, it was overshadowed in importance by the return of the previous twelve, and to the Capital Issues Com flow of speculative funds into sterling, owing in part to a mittee to take a more restrictive and critical attitude favorable change in the “leads-and-lags” mechanism. toward applications to borrow. Finally, the government Earlier, and especially during the summer of 1957, pur curbed the investment programs of the public authorities chases of sterling had been delayed as long as possible, and nationalized industries. sterling receipts had been sold forthwith, and dollar re The tightening of the government’s financial policies quirements had been covered promptly. Such bearish tend was followed by a distinct reduction of domestic inflation encies were reversed after the September 19 measures ary pressures and by a large-scale reversal of the specula convinced the foreign exchange market of the British Gov tive pressures that had depressed sterling. In these ernment’s determination to maintain the value of the changes, a major role was played by the improvement in pound. It is indicative of this change that the sterling bal Britain’s terms of trade which resulted from the decline ances of nonsterling-area residents (excluding those held in the country’s import prices. This improvement enabled for special purposes by West Germany), which had de Britain to maintain unchanged the physical volume of its clined about $200 million in the six months ended Sep imports while in effect paying for them with a somewhat tember 1957, rose by $73 million in the following six smaller volume of exports. In the six months ended months, almost half of the rise being in the London bal March 1958 there was consequently an increase from a ances of dollar-area residents. Changes in the “errors and year earlier in the goods and services (measured in constant omissions” items of both the British and the United States prices) made available to the domestic economy through balances of payments also point to a major shift, favorable Britain’s international transactions, and these supplies to sterling, in speculative movements. Finally, Britain’s reserves benefited from additional spe were further augmented by a modest expansion in the country’s gross domestic product. On the other hand, cial dollar receipts. As one of its measures to support domestic demand (also measured in constant prices) rose sterling, the British Government in October 1957 drew only moderately, with continued increases in personal con $250 million of its $500 million line of credit at the sumption and fixed investment being partly offset by re Export-Import Bank. The government also availed itself ductions in the goods and services absorbed by the public of its right, granted under the revision of the United States authorities as well as in inventories. At the same time, and Canadian postwar loan agreements, to defer $176 mil unemployment increased and in June 1958 was about lion in payments due at the end of December 1957. How double the reported job vacancies. The upward pressure ever, even after allowing for these special factors, the on wages continued but was considerably moderated, the $1,234 million rise in Britain’s reserves in the ten months index of weekly wage rates rising only 1 per cent in the ended July 1958 was striking testimony to the efficacy nine months ended June 1958 compared with a 5 per cent of the government’s measures to eliminate inflationary pressures in the domestic economy and restore confidence increase in the nine months a year earlier. The decline in Britain’s import prices played a major in sterling. role not only in the achievement of better balance in the S T R A I N S IN T H E O V E R S E A S S T E R L I N G A R E A domestic economy, but also in the strengthening of the country’s international economic position. Although the The improvement in Britain’s position appears the more physical volume of Britain’s imports remained virtually remarkable when account is taken of the OSA countries’ unchanged, their value in the nine months ended June continuing difficulties, which have been reflected in sharp 1958 declined 8 per cent below a year earlier. Since the declines in their sterling exchange reserves. These dropped fall in the value of Britain’s exports was considerably by $188 million equivalent in the nine months ended smaller, the country’s merchandise trade deficit was cut September 1957, and by no less than $451 million equiva by more than one third. Although much of this improve lent in the following six months. Significant reserve ment was with the overseas sterling countries, Britain’s losses were recorded by New Zealand, South Africa, trade position with the United States also strengthened and Pakistan, but the bulk of the loss was attributable to markedly as the exceptionally large petroleum imports of India. The OSA’s sterling balances had thus been reduced early 1957 tapered off and as Britain’s commercial exports by March 1958 to the lowest level in six years, while —paced by enlarged automobiles sales— rose 5 per cent those of India in particular are at the lowest since that in the nine months ended June 1958 over a year earlier. country became independent. Significant as was the strengthening of Britain’s trade In these difficulties, the role of the American recession 118 MONTHLY REVIEW, AUGUST 1958 has frequently been exaggerated. There is no denying, of course, that the prices of many important commodities exported by the OSA have declined considerably. In mid-March 1958 the London prices of lead, tin, copper, sisal, rubber, and wool were all lower than they had been two years earlier, before the outbreak of the Suez difficul ties; only tea, cocoa, and jute among the major sterling commodities were higher. However, the most important of the factors making for these price declines considerably antedated the American recession. Some go as far back as the early postwar and Korean periods when many of the major commodities exported by the OSA were in short supply. To overcome these shortages, vigorous efforts were then made to expand production, especially of min erals, but additional supplies began to come on to the mar kets only in early 1956, after a marked expansion in consumption and various short-term factors (including strikes in producing countries) had pushed prices up to vulnerable levels. With the elimination of these short term factors and with new low-cost facilities coming into operation, commodity prices had already come under con siderable strain when the downward pressure was aggra vated by the leveling-off of world economic activity and by the United States recession. Moreover, the ensuing decline in commodity prices resulted more in a slowing-down in the growth of OSA exports than in any decline in their value. The latter was actually 5 per cent higher in 1957 than a year earlier be cause of an increase in physical volume. Only in the final quarter of 1957 did their value dip slightly below a year earlier, mainly because of declines in OSA exports to Britain and to the OEEC countries. In contrast, OSA exports to other nonsterling countries, including signifi cantly enough the dollar area, were higher in OctoberDecember 1957 than they had been a year earlier. These divergent trends continued in the early months of 1958, when OSA exports to Britain were lower than a year earlier and those to the United States were higher, the latter increase being apparently attributable to the shifting of United States purchases away from marginal domestic producers to the aforementioned low-cost sources of sup ply that have been opened up overseas in recent years. A rapid rise in imports, rather than any decline in ex ports, thus seems to have been the major factor in the OSA’s difficulties. The implementation of ambitious development plans pushed New Zealand’s and South Africa’s 1957 imports up by about one tenth over 1956 and those of India and Pakistan up by one quarter. With imports rising more rapidly than exports, the OSA’s trade deficit rose to £ 2 3 0 million in 1957, about one-third larger than in 1956, as a result of roughly equal increases in the area’s deficit with Britain and with nonsterling countries. With the United States, the trade deficit was four times higher than in 1956, but much of this increase reflected enlarged OSA imports of surplus agricultural commodities sold under United States aid programs and involving payment by the recipient countries in local cur rencies only. Faced with widening trade deficits and sharp declines in their sterling reserves, various OSA countries have raised additional funds not only from international insti tutions but also in the London and New York markets. At the same time these countries have sought to strengthen their trade balances through the adoption of domestic restraints, the stimulation of exports, and the tightening of direct controls over imports, and by the spring of 1958 the rise in their imports seemed to be ending. Thus, by April-May 1958 the earlier expansion in Britain’s exports to the OSA had stopped, at least temporarily. In the case of United States exports to the OSA, the earlier rise has actually been reversed, March-May 1958 showing a drop of 11 per cent from a year earlier. These developments, together with the upturn in the prices of many OSA com modities during the spring and early summer of 1958, augur well for a strengthening in the OSA’s international economic position. P O L IC IE S FOR RENEW ED GROW TH The measures adopted in the sterling countries had by the spring of 1958 transformed the problem with which the British Government was faced. Adverse speculative pressure on sterling had ended and the gold and dollar reserves were rising rapidly. However, since sales to the OSA were no longer increasing and those to the OEEC countries were actually declining, the continued, though moderate, rise in sales to the dollar area was not sufficient to prevent a decline in total British exports. At the same time, aggregate domestic expenditure was increasing little, if at all. The conditions that had made necessary the drastic measures of September 1957 had thus disappeared, and the government accordingly began gradually to ease its financial policies. The process began with a reduction in the Bank of England’s discount rate in March 1958 to 6 per cent from the 7 per cent crisis rate that had been maintained since the previous September. It was continued in the government’s budget for the fiscal year beginning April 1958, under which tax incentives for business investments were moderately increased, while in May and in June the Bank of England’s discount rate was further reduced, on FEDERAL RESERVE BANK OF NEW YORK each occasion by V2 per cent, to 5 per cent. Simultane ously, market yields on government securities adjusted downward and rates charged by such government lending agencies as the Public Works Loan Board were also cut in accordance with the official policy of keeping them in line with the market. Then, in a major move toward an easier financial policy, the government announced on July 3 that the control exercised by the Capital Issues Committee would be loosened. A letter from the Chancellor, which served both as a directive to the committee and as a guide for the com mercial banks’ policy on advances, gave priority to invest ments that would strengthen the balance of payments of both Britain and the OSA, and indicated that investments in areas of persistent unemployment in the United King dom should also be favored. In addition, the committee, which had theretofore been required to approve only new issues that were of “immediate urgency”, was authorized to approve also those that “anticipated future needs”. The £10,000 minimum, below which new issues did not require the committee’s approval, was raised to £50,000 and restrictions were lifted on the utilization of bank finan cing in the raising of new capital. Moreover, the ceiling that had been placed on commercial bank advances in September was withdrawn, and new arrangements were provisionally adopted under which the authorities, if it should again become necessary, could restrict both the liquidity of the commercial banks and their ability to extend credit, by requiring banks to hold special deposits at the Bank of England.2 In relaxing its financial policies, the British Govern ment is preparing the way for renewed economic growth, especially in the field of industrial investment. At the same time, it has emphasized that Britain’s basic eco nomic objectives remain unchanged. “We are deter mined”, the Chancellor said when he announced the July 3 measures, “not to return to inflationary conditions.” The government, he said, puts the strength of sterling, the soundness of Britain’s international position, and price stability first. Being acutely aware that its freedom of 2 For details of these arrangements, see this Review, p. 114. 119 action is limited, the government accordingly has stressed the importance of renewed economic growth not only in Britain but also in other major industrial countries, and has called for new measures of international cooperation, including steps to increase the flow of long-term capital to less-developed areas. While there is much to be said in favor of such measures, it is important not to underestimate the factors, already operating, that have brought about the very notable recovery of sterling in the past year. Foremost among these have been the policies, followed by the British Gov ernment since last September, to restore confidence in sterling. Beyond this, movements in the United States balance of payments have thus far been exceedingly favorable to sterling. In January-September 1957, when the outflow of sterling funds from Britain and the OSA was adversely affecting Britain’s gold and dollar reserves, the unfavorable consequences were partly offset by sub stantial inflows of capital from the United States. It is true that the downturn in economic activity in the United States—the world’s largest consumer of most primary commodities— aggravated the difficulties of the OSA but, as already noted, most of these difficulties antedated the recession by many months. Moreover, in the six months ended March 1958, United States imports from the sterling area were higher than a year earlier, United States exports were lower, and the rate of United States capital outflow exceeded the high rate attained in January-September 1957, not only because of Britain’s drawing on its ExportImport Bank line of credit but also because of an increase in the rate of outflow to the OSA. These factors were so strong that they not only offset the impact of heavy draw ings by the OSA countries on their London balances and presumably also on the central dollar reserves, but also pushed those reserves up by $1,234 million in the ten months ended July 1958. With gold and dollar reserves now standing at $3,084 million and with another billion dollars available on a stand-by basis from the Interna tional Monetary Fund and the Export-Import Bank, Britain is now in a much improved position to meet the uncertainties of the future.
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