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FEDERAL RESERVE BANK OF NEW YORK 167 The B usiness Situation Recent developments would seem to bear out earlier judgments that the underlying strength of the economy has been greater than many business analysts had thought. Indeed, the pronounced improvement in business sentiment that has occurred over the past month as fears of an imminent downturn have receded should in itself act as a stimulant to total spending. At the same time, it is important to recognize that even the more optimistic current business forecasts do not envision a rate of advance in activity during the coming year that will be sufficient to bring about a marked reduction in the unemployment rate. A need for tax revision consequently remains, not because the economy would otherwise slide into a reces sion, but because such action seems to be required to help strengthen the incentives for longer term economic growth. In this context, it is encouraging that growing support for a significant cut in income taxes has in the past few weeks been expressed by a wide range of groups and individuals. The prospect of a tax cut, in turn, makes restraint in Gov ernment spending all the more desirable. The recent improvement in business sentiment is in part explained by the firmer tone of many of the available economic statistics. To be sure, production and employ ment continued at virtually unchanged levels in October, and fragmentary November data suggest no marked im provement in that month. Recent automobile sales, how ever, have been at a very high rate, housing starts re bounded in October following the sharp September decline, and new orders received by durable goods manufacturers in October advanced after remaining virtually unchanged dur ing the previous two months. Moreover, consumer plans to buy new automobiles and household durables have in creased markedly since midyear, according to the Federal Reserve’s October survey. In the capital goods sector, ap propriations have picked up, and business plans for plant and equipment expenditures, while certainly not buoyant, do point to some increase in 1963. PR O D U C TIO N, E M P L O Y M E N T , A N D S A L E S Industrial production was virtually unchanged in Octo ber, remaining on the high-level plateau which it has held since July (see chart). Although automobile production showed strength and production of business equipment continued upward, these gains were offset by declines in the output of other consumer durable goods and of some non durable materials. In November, steel output increased markedly, with the advance accelerating toward the latter part of the month. Steel ordering by auto manufacturers has finally been stepped up, following months of inventory liquidation. Automobile production remained at the high rate of the past several months. The employment situation also has shown little change for several months. Nonfarm employment inched upward in October, according to the Bureau of Labor Statistics payroll survey (see chart), largely reflecting an expansion in state and local government hiring; gains in this sector have accounted for slightly more than half the total in crease in nonagricultural employment thus far this year. In the manufacturing sector, employment was virtually un changed in October, but average weekly hours tallied by production workers declined to a level near the year’s low. In spite of the lack of improvement in employment, un employment in October fell to 5.5 per cent of the civilian labor force from 5.8 per cent in the previous month, largely because of a decline in the number of women look ing for work. Weekly data on unemployment insurance compensation claims filed in the first half of November, however, suggest little change in unemployment for that month. The major element of strength in the over-all picture has been the performance of automobile sales in October and November. The unusually strong reception of the 1963 models pushed sales in October to an annual rate of over 8 million units. This more than offset a decline in nondur ables sales and helped to raise total retail sales by 1 per cent to a new high (see chart). Auto sales continued strong in November, although in seasonally adjusted terms some what below the near-record October pace, and department store volume apparently recovered most of the previous month’s loss. According to the recent Federal Reserve sur vey of consumer spending plans, intentions to buy new automobiles in October were the highest since October 1959 and showed a larger increase from July than in both MONTHLY REVIEW, DECEMBER 1962 168 IN V E S T M E N T A C TIV ITY CURRENT ECONOMIC INDICATORS S e a s o n a lly a d ju s te d m o n th ly d a t a B illio n s of d o lla B illio n s of d o lla rs 120 In d u s tria l p ro d u c tio n 1957-59=100 115 115 no - - / 105 100 .. ! 1 1...1....! I 1 1 1 1..... 1 1 I 1 1 I 1 1...L 100 M illio n s of p e rso n s M illio n s of p e rso n s 56 55 54 53 1961 1962 N o te : The in d e x of in d u s t r ia l p ro d u c tio n from 1919 to the p re se n t h a s b een s h ifte d to a 1 9 5 7 -5 9 b a s e . A t the sa m e tim e, a g e n e ra l r e v is io n in s e a s o n a l fa c to rs a n d in terim a d ju stm e n ts in the le v e ls of e ig h t co m p o n e n t s e rie s h a v e b e e n in tro d u c e d from 1 9 5 7 o n . Fo r fu rth e r in fo rm a t io n , see F e d e r a l R e se rv e B u lle t in . O c to b e r 1962. Sources'. B o a rd of G o v e r n o r s of the F e d e r a l R e s e rv e S y s te m ; U n ite d S t a t e s B u re au of L a b o r S t a t is t ic s ; U n ite d S ta te s D e p a rtm e n ts of C o m m e rce a n d L a b o r. of the two preceding years. Plans to buy household durables were also strong, showing a greater than seasonal rise. New orders received by durable goods manufacturers advanced by 3.5 per cent in October (see chart). While the increase partly reflected the high rate of automobile orders, materials and defense-producing industries also recorded gains. New orders for capital equipment declined in October from their September high, but remained in the narrow range that has prevailed for the past year. Business investment in plant and equipment has advanced at a slow rate in the current expansion, lagging behind even the relatively weak 1958-60 upswing. Indeed, although the latest Commerce Department-Securities and Exchange Commission survey, taken in August, showed small net increases in planned business outlays on plant and equipment in the third and fourth quarters, the failure of manufacturers’ sales in the third quarter to come up to expectations had raised some question whether even these relatively modest investment plans would be sustained. Recent developments have tended to allay some of these doubts. Thus, the October McGraw-Hill survey of busi ness capital spending plans for 1963 indicates that business men expect to increase their outlay rate slightly above current levels. For the last seven years, the McGraw-Hill surveys have correctly indicated the eventual direction of the year-to-year change in total spending for plant and equipment. The likelihood that such spending will be at least maintained is also supported by the third-quarter survey of capital appropriations taken by the National Industrial Conference Board which shows an 11 per cent increase in net appropriations, recovering two thirds of the second-quarter decline. According to the McGraw-Hill study, business firms in tend to increase their capital outlay rate in 1963 by 3 per cent over the 1962 average. To be sure, this is a very small rise, especially when measured against the current level of spending. On the other hand, the survey does not point to a decrease in capital spending for the year as a whole, as was the case in surveys taken in the fall of 1957 and 1960. Service industries, as distinct from manufacturing, ac count for most of the projected advance in capital spending. Commercial firms and electric and gas utilities, which together are responsible for 40 per cent of total capital spending, plan 6 and 4 per cent increases, respectively. Transportation and communications industries (other than railroads) plan a 2 per cent increase. For the manufacturing sector, the survey points to only a 1 per cent expansion in capital spending in 1963. Most individual manufacturing industries do, however, plan some rise in expenditures. Indeed, the industries planning the largest increases include some in which output is currently particularly far below capacity and which do not expect sizable sales gains. For example, the iron and steel and chemical industries are scheduling substantial increases in capital outlays, although in September of this year— according to the survey— they were operating at only 79 and 78 per cent of capacity, respectively, as against their preferred rate of 91 per cent. Moreover, the iron and steel FEDERAL RESERVE BANK OF NEW YORK industry as a whole expects no change in the physical vol ume of sales in 1963, and the 4 per cent sales increase anticipated by the chemical industry would be much too small to push its capacity utilization to the preferred rate. Furthermore, those manufacturing industry groups which intend to reduce capital spending (electrical machinery; textiles; stone, clay, and glass; and miscellaneous manufac turing) plan to allocate a larger proportion of their spend ing than any other industry groups for the purchase of automated machinery and equipment. Present capital spending plans thus in many cases seem to be related to product improvement and other responses to competitive pressures rather than to gains in demand. This, in turn, suggests that these plans may be relatively firm and would not be much influenced by any minor sales disappointments. Moreover, the current improvement in the tone of business news, coupled with the recent changes in the tax laws and the possibility of reductions in corporate profits tax rates in 1963, may well lead to an expansion of capital spending plans. 169 IN D U S TR IA L. P R O D U C T IO N — 1 9 5 7 -5 9 B A S E The Board of Governors of the Federal Reserve System has just issued a new publication, Industrial Production— 1957-59 Base. The booklet provides detailed statistics— covering the period 1947-61— for all series in the Board’s index of industrial produc tion on the new 1957-59 base, together with a de scription of the new seasonal factors and the changes made in some series and groups. The results of these changes in the index were also summarized in the October 1962 Federal Reserve Bulletin. Copies of the new booklet are available from the Board of Governors of the Federal Reserve System, Washington 25, D. C., at $1 per copy up to ten copies and 85 cents each for ten or more copies in a single shipment. A dvance R efunding: A Technique of D ebt M an agem en t* In September, the United States Treasury completed its sixth advance refunding since the new technique was introduced in June 1960. In an advance refunding, the Treasury offers owners of a given issue that still has some time to run the opportunity to exchange their holdings for new securities of longer maturity. Largely through the use of this new financing method, the Treasury has achieved a more balanced debt structure and extended the average maturity of the marketable debt to five years, the longest it has been since September 1958. The new technique has been particularly helpful in enabling the Treasury to coordinate its debt management responsibilities with fiscal and monetary policies that in recent years have had to take account of the problems of our balance of payments as well as the continuing objec * Ernest Bloch and Joseph Scherer had primary responsibility for the preparation of this article. tive of promoting domestic economic stability and growth. Because advance refunding has recently played such an important role, this article describes how it fits into the broader framework of Treasury debt management, reviews the reasons why the technique was adopted, and sum marizes its accomplishments and limitations. D E B T M A N A G E M E N T IN P E R S P E C T I V E The Treasury is the largest and most active single bor rower in the financial markets. Unlike most private borrow ers who are usually in the market only infrequently, the Federal Government is necessarily engaged in a nearly continuous process of borrowing and refinancing. Some Treasury indebtedness although short term, as in the case of 91- and 182-day Treasury bills, is basically a “perma nent” portion of the total debt and the maturities are so scheduled that the Treasury rolls them over at weekly bill auctions. In recent years, the amounts offered in these 170 MONTHLY REVIEW, DECEMBER 1962 auctions have ranged between $1.4 billion and $2.1 billion. Each quarter the Treasury also rolls over a one-year bill, most recently in the amount of $2.5 billion. In addition, other securities, many of which were originally issued with longer maturities, fall due each year and must be refi nanced, such as the combined refinancing which took place this November of $3.8 billion of publicly held notes due November 15 (originally issued in 1957 and 1961) and of $3.4 billion in publicly held bonds maturing December 15 (originally issued in 1938 and 1945). When there is a deficit, new cash must be borrowed by such methods as increasing the size of the weekly bill offerings, selling a new security, or selling additional amounts of already outstand ing securities (including bills). Even during years when the budget is balanced or when there is a modest surplus, the Treasury must raise substantial amounts of new cash dur ing the July-December half year to tide itself over the seasonal slack in tax receipts. Individual Treasury financings are massive in the short and intermediate markets and relatively large in the long term capital market. While private and municipal borrow ers in the aggregate dominate the long-term capital market, Treasury bond issues are typically substantially larger than individual private or municipal offerings. The largest cor porate or tax-exempt bond issues of the postwar period have with few exceptions amounted to less than $300 mil lion; by contrast, the Treasury’s bond flotations have gen erally ranged well above $400 million (although the Treasury has announced plans to sell a $250 million issue at auction). Hence, Treasury debt management operations, whether short or long term, may exert an important influ ence on the volume of funds available to other borrowers — consumers, corporations, state and local governments— and on the terms at which they can obtain such funds. It is consequently necessary to conduct debt management with a view to its general market impact as well as many other considerations. In seeking to maintain a receptive market to which it may turn at any time, the Treasury provides a selection of maturities ranging from 91 days to many years, with due regard to the needs of the investor groups on which it de pends for funds. By regularly offering securities tailored to the different preferences of various investor groups, the Treasury is enabled to tap funds of all these groups. By refraining from “overselling” any maturity sector, more over, it generally avoids contributing to sharp surges in interest rates. Since they are free of credit risk and readily marketable, the debt instruments of the Treasury have a high degree of liquidity and in many cases are regarded by their holders as a form of “near money”. This is particularly true of Treasury issues maturing within a year, which currently comprise about 45 per cent of the Treasury’s marketable debt. Indeed, these issues account for a tenth of all liquid assets— including money, time and savings accounts, and savings bonds—held by the nonbank public. Moreover, the passage of time increases the liquidity of any given longer term issue, eventually turning even the longest bonds into short debt. Because of the size of the Treasury’s debt operations, debt management tactics necessarily must take account of the impact which particular financing operations or changes in the debt structure may have on the economy. Treasury debt managers are expected to arrange the maturities and other terms of new flotations in a fashion consistent with the current objectives of fiscal and monetary policy. At times, the best that can be accomplished is to minimize inter ference with the execution of such policies. The most de sired course, however, is to shape debt management operations so that they may be of positive assistance in the attainment of broader objectives of national economic policy. Thus, the Treasury has recently been deliberately expanding the volume of short debt in order to help counter the downward pressures on short-term interest rates and thereby to deter the outflow of short-term capital to for eign countries. For example, between the beginning of fiscal year 1962 and its close, the volume of Treasury bills out standing was raised by about $5 Vi billion, constituting the largest part of a $7 Vi billion increase in the short-term Treasury debt. Debt management must thus be conducted with a view to a wide range of objectives, including— in addition to the purely “housekeeping” functions of managing so large a debt— such other aims as the promotion of capital markets favorable for economic growth, the maintenance of a debt structure adequate for the liquidity needs of the economy, and the availability of funds at interest rates which mini mize the cost of carrying the debt without encouraging short-term capital outflows. Moreover, the debt managers must always be aware of the need to accomplish these goals in a manner which contributes to the solution of immediate problems without creating new difficulties for the future. Because the maturity structure of the Federal debt is being continuously shortened by the passage of time, more and more of the Federal debt would turn into near money if the debt managers did not attempt to place some intermediate- and long-term debt. An excessive supply of short-term debt could cause serious problems, particularly in some future inflationary period. At such a time, the need to refund unusually large amounts of debt might well in volve higher interest rates and the disruption of markets or, alternatively, loss of control over the money supply. 171 FEDERAL RESERVE BANK OF NEW YORK SPE C IA L P R O B L E M S OF PLA C IN G LO N G -T E R M D E B T By maintaining an appropriately balanced debt struc ture, potential future bulges in the near-money supply can be avoided. Were the Treasury in fact able to place a sizable volume of long-term debt on the market at any time, coping with the shortening of the debt that comes with the passage of time would be a simple matter: when ever the short-term sector grew larger than desired, some near-term or maturing issues would be funded into long term debt. Unfortunately, an attempt to follow such a policy runs into different kinds of obstacles under different economic conditions, quite apart from the fact that the relatively limited supply of long-term funds makes it neces sary at all times that a major share of the Treasury’s fi nancing requirements be met through issuance of shorter term debt. From the standpoint of over-all economic policy, the most desirable times to curb the total liquidity of the economy are periods of boom, which are usually accom panied by inflationary pressures. But it is precisely in such periods that the Treasury has found it most difficult to sell long-term bonds. In a boom, the financial markets, particu larly in the long-term area, are at full stretch to meet demands of corporate, municipal, and individual bor rowers. In the face of such demands, the new supply of long-term funds has generally failed to keep pace, with the result that markets have become congested and interest rates on long-term issues have tended to rise, sometimes sharply. Because large Treasury borrowing through long term bond issues at such times might overstrain the capital markets and would saddle the Treasury with issues carry ing high rates for extended periods, the Treasury has rarely taken the step of selling long-term bonds during a boom. Moreover, there have been periods in recent years when market rates were at a level which made it difficult, if not impossible, for the Treasury to issue long-term marketables because of the 4V4 per cent interest coupon ceiling set by law. In recession and early recovery, the case is reversed. With new private issues relatively scarce, investors are eager to acquire Treasury bonds, so that the Treasury is generally able to float new issues at advantageous rates. On the other hand, the Treasury has been reluctant to take full advantage of market receptivity at these times. In stead, it has generally permitted the pressure of the excess supply of funds to drive down interest rates in order to stimulate private long-term borrowing, and has avoided absorbing funds that might otherwise find their way into private credit. C h a rt I FLOTATION OF LONG-TERM* BONDS B illions of dollars B illions of dollars N o te ! S h a d e d a re a s a re b u s in e s s -c y c le rece ssio n s, a c c o rd in g to the c h ro n o lo g y of the N a t io n a l B u re au of E con o m ic R e se arch . * W it h m a tu rity o f ten y e a rs or m o re. S o u rc e : U n ite d S ta te s D e p a rtm e n t o f the T re a s u r y . The Treasury thus faces a dilemma with respect to the sale of long-term bonds. If it refrains from substantial flo tations of long bonds in both prosperity and recession periods, it faces the prospect that the maturity structure of the debt will progressively shorten and that an excessive volume of liquidity will be created in the long run. Were the Treasury, in view of this consideration, to sell more bonds during times of boom, it would have to accept higher interest charges and perhaps run the risk of dis turbing the functioning of the capital markets. Increased bond financing in recession and recovery, finally, would lower interest costs to the Treasury but court the risk of interfering with economic revival. Because of the many problems involved in floating long term Government bonds during either boom or recession, the aggregate volume of long-term bonds (i.e., issues with a maturity of ten years or more) has, apart from advance refundings, been only $11 Vi billion in the postwar period.1 1 The first post-World War II marketable issue of more than ten years’ maturity was sold in 1953. MONTHLY REVIEW, DECEMBER 1962 172 About half of this amount was sold during the compara tively brief spans in cyclical upswings when recovery had clearly taken hold but interest rates were still relatively low (see Chart 1). The Treasury, therefore, has actively explored ways to develop alternative methods of maintain ing a Well-balanced debt structure. A D V A N C E R E FU N D IN G S TH E M E C H A N IC S Development of the advance refunding technique has eased the Treasury’s predicament and has afforded a very helpful means of achieving a satisfactory debt structure. When the Treasury sells an intermediate- or long-term issue in traditional fashion, whether for cash or in a refund ing of maturing issues, new investors desiring longer term issues must be found or present longer term investors must be willing to expand their holdings. In an advance refund ing, however, the Treasury takes the initiative to moderate, if not completely avoid, this problem by offering present holders of debt instruments an option to exchange their holdings before maturity for new securities of longer maturity. Thus, there exists in effect a “ready-made” market for the new issues. In contrast to a cash offering, the immediate drain on the available funds in the particular maturity sector is minimized. Moreover, the amount of market “churning” needed to place maturing issues in the hands of longer term holders that usually accompanies large-scale refundings is appreciably reduced. If, for example, current holders are induced, through an advance refunding, to exchange issues that are ten years from maturity for new thirty-year bonds, the twenty-year extension of maturity takes place by and large through an “off the market” bond-for-bond exchange between the holder and the Treasury. In cash offerings and in refund ings of maturing issues, by contrast, the total quantity of long-term bonds is increased. To raise cash, lenders to a considerable extent may sell various other maturities to ac quire the new long-term issues, thereby tending at times to create downward pressure on other securities prices. The effectiveness of advance refundings in keeping churning to a minimum has been demonstrated by the actual market reaction. Despite the large size of the opera tions, fluctuations in Treasury bond yields between the announcement date and the closing of the books of each operation have been mild, yields ended these periods just about where they began, and turnover in “rights” and “when-issued” securities has been relatively moderate. Altogether, six advance refunding operations of market able issues have been completed since 1959, when legisla tion was passed removing certain tax obstacles that had made advance refunding impractical.2 The period has been particularly appropriate for the use of this new technique. In the first instance, the rate of economic growth and of real investment has tended to lag, so that it has been difficult to find occasions when the Treasury could sell a heavy volume of long-term debt in the market (for cash or in exchange for a maturing issue) without taking a chance that it might pre-empt private demands for invest ment funds. Furthermore, the maturity pattern of outstand ing long-term debt has been particularly well suited to the use of the advance refunding technique. Thus, since 1959, some $30 billion of the wartime 2Vi per cent bonds has been moving into the five- to ten-year maturity range. Many long-term investors who hold securities that have moved this close to maturity typically sell such securities in order to lengthen their portfolios. By offering such holders an opportunity to exchange their holdings for longer term issues, the Treasury can hold on to these customers for Government securities without the market impact that a new issue of long-term bonds would entail. On this count, as well as others mentioned below, the owners of the war time IV i per cent bonds have clearly been “ripe” for ad vance refunding offers. The actual maturity of issues chosen for advance re funding has varied greatly. In “senior” advance refund ings, owners of long-term Government bonds which, with the passage of time, had moved into the roughly five- to ten-year maturity range are given an opportunity to ex change their holdings for new issues carrying longer ma turities, roughly twenty to forty years, and higher rates. For example, in the advance refunding offers made to the holders of the wartime 2Vi per cent bonds, the Treasury was able to take into account the fact that a great many holders of the 2 Vi’s were in effect “frozen” into their hold ings with losses which they did not wish to take. The ad vance refundings offered a way out. The Treasury thus attempted to retain its long-term creditors by offering them rates higher than they were receiving currently, but lower than what the Treasury might have had to pay if it tried to sell the same amount of new bonds for cash. In addi tion, these operations opened up spaces for placing debt in 2 Under Title II of Public Law 86-346, passed in September 1959, if the Secretary of the Treasury so stipulates, holders of issues exchanged in an advance refunding are required to postpone recognition of any capital gains or losses for tax purposes. If no payments other than accrued interest are involved, this means that, in the exchange, the value of the existing security on the books of the investor becomes the book value of the new security. In that case, the advance refunding causes no immediate tax consequences to the investor merely because of the exchange. Any gain or loss is deferred until the new security is redeemed or otherwise dis posed of prior to maturity. 173 FEDERAL RESERVE BANK OF NEW YORK the five- to ten-year maturity sector, either for cash or through junior advance refundings. “Junior” advance refundings offer intermediate-term investors the opportunity to exchange holdings that are less than five years from maturity for new issues that are generally in the five- to ten-year maturity range. While the junior advance refundings also play an important role in maintaining or improving the debt structure, they are especially helpful in cutting down the size of particularly large blocks of issues as they move closer to their maturity date. To the extent that a part of the eligible holdings is converted, the Treasury refunding task at the scheduled maturity date is made more manageable. Meanwhile the new issue can be placed in a relatively uncrowded area of the Treasury’s future refunding calendar. And, as in the case of senior advance refundings, such operations may open up spaces in which new issues of intermediate debt can be placed. The most recent advance refunding, involving for the first time the exchange of issues maturing in less than one year for five- and ten-year issues, had as its prime purpose the evening-out of the Treasury’s refunding calendar. Through this “prerefunding”, the Treasury reduced sub stantially the heavy scale of the refinancing operations scheduled for the first half of next year. The Treasury’s advance refundings began with a junior refunding in June 1960; the latest advance refunding was the prerefunding offering in September 1962. In between there have been senior refundings, other junior refundings, and a combined operation. In the three senior offerings, the Treasury gave holders of the $28 billion of wartime bonds the opportunity to exchange them for long-term bonds maturing between 1980 and 1998. The public ac cepted nearly $8 billion of these bonds and Government investment accounts took an additional $2 billion. The im portance of these exchanges to the current maturity struc ture of the debt can be gauged from the fact that, of the roughly $15 billion in marketable issues maturing be yond twenty years now outstanding, more than half has been placed by advance refundings. In the junior refundings and the recent prerefunding, holders of about $68 billion of issues with maturities of under five years were given the opportunity to exchange their holdings for three- to eighteen-year issues; about $21 billion was exchanged. Partly as a result of these opera tions, the volume of debt maturing between one and five years was reduced from nearly $75 billion in mid-1960 to about $58 billion in September 1962. Before the Sep tember 1962 prerefunding, the Treasury faced a refunding of $9.4 billion of publicly held debt in mid-February 1963, and another $9.8 billion in mid-May. Following the advance refunding, these maturities were worked down to $5.4 billion in February and about $6 billion in May, thereby thinning out the extremely congested maturity schedule of early 1963. Finally, the two new issues in the refunding assisted in spacing out the Treasury’s maturity schedule further since some of the new securities will mature in 1967 and the remainder in 1972. One measure of the effect of all six advance refundings in restructuring the marketable public debt is the change in the weighted average maturity of this debt as indicated by Chart IL The debt’s average maturity, which had fallen from seven years eleven months at the end of 1946 to a low of four years two months by early 1960, had risen to five years at the end of September 1962. Had it not been for the advance refundings, the average maturity would have been only about 3V2 years. This calculation assumes that the Treasury would not have taken any other steps to prevent the debt from shortening had the advance refund ing technique not been used. Actually, some other debtlengthening procedures would undoubtedly have been tried under such circumstances, but the previously avail able techniques probably would not have extended the average maturity of the debt as much as the advance refundings, and probably would have had a more unsettling effect on credit markets. C h a rt II AVERAGE LENGTH OF THE MARKETABLE PUBLIC DEBT* W ith a n d w ith o u t a d v a n c e r e fu n d in g Y e a rs Y e a rs 8 6 A d v a n c e re fu n d in g s C D © (3) ® (5) © 5 s. 4 W ith o u t a d v a n c e refu n d in g 3 y rs.6m os. M o n th ly liUiil111lliill Lillll 1946 48 50 52 54 56 58 1958 1959 IiL111111111!! t! II!!! I!IIII!III 1960 1961 3 1962 I-----------D e ce m b e r 31 ---------- 1 * A d ju s te d to e x c lu d e 2 l/2 p er cen t b o n d s e x c h a n g e d for n o n m a rk e ta b le 2 3/4 p er cen t b o n d s . P a r t ia ll y t a x - e x e m p t b o n d s to e a rlie s t c a ll d ate,' a l l o th e r c a lla b le b o n d s to m a tu r it y . " f In c lu d e s effe ct o f a d v a n c e re fu n d in g s . S o u rce : U n ite d S ta te s D e p a rtm e n t of the T re a s u r y . MONTHLY REVIEW, DECEMBER 1962 174 Despite the lengthening influence of advance refundings, the average maturity of the debt is still relatively short, compared with that prevailing in the years prior to 1950. This relatively short average maturity of the debt at present is, however, not due solely to the passage of time but also reflects the Treasury’s efforts, in concert with the Federal Reserve, to prevent a decline in short-term rates that would be detrimental to the United States balance of payments at this time. As noted earlier, increases in the Treasury bill issue have raised the volume of such debt by about %5Vi billion in fiscal 1962 alone. Nor have advance refundings provided the sole offset to the shortening of maturities, for other debt management operations un dertaken since mid-1960 also have placed over $10 billion of issues maturing in five years or more. But, as Chart II shows, advance refunding operations have made a signifi cant contribution to holding the line. A D V A N C E R E FU N D IN G S T H E IS S U E S Through the device of advance refunding, the Treasury has marketed more long-term securities than would have been deemed practicable had it relied solely on traditional financing methods. Moreover, in doing this it has probably incurred a lower interest cost than would have been re quired to sell equivalent amounts for cash or in refunding maturing securities. The technique has also allowed the Treasury to reduce the size of outstanding intermediate issues, thereby smoothing out its schedule of refinancing and lessening the risk of market disturbance and interfer ence with monetary policy that may occur when financing operations are too large. Despite this experience, some still contend that the benefits of the advanced refunding technique are not clearcut. One of the main arguments against advance refunding has been that it enables long-term investors to lengthen the maturity of their portfolios, thereby possibly reducing their willingness to allocate as much of their current inflow of funds to the long-term sector. This argument, however, is not really directed against the advance refunding device per se. Rather, it is one version of a frequently asserted position that questions whether any long-term Treasury financings should be undertaken when the economy has some slack or, indeed, whether the Treasury should have any long-term debt. In essence, the problem is one of evaluating the pres sures which alternative methods of lengthening the debt exert on the capital market and of assessing the probable impact on the total economy in each case. In the period since the advance refunding technique has been adopted, there is little evidence of any shortage of long-term funds, and this is reflected in the behavior of long-term interest rates. If anything, the various advance refundings may have merely satisfied the desire of bondholders for a lengthening of existing portfolios rather than reduced their allocation of new long-term funds to the private sector. Questions have also been raised with regard to the cost of the technique. Advance refunding offers, the critics say, have involved a self-imposed increase in the interest cost of the Federal debt since higher coupons have had to be offered on the new issues while the lower rates on the old bonds could have been kept on the books for as much as ten years. Furthermore, they argue that the higher in terest cost will remain embedded in the interest structure for a long time because most of the new bonds are long term and without call features. The issue here revolves around whether the cost should be compared with alternatives available at maturity or currently for floating bonds of an equivalent maturity. Only the future can tell whether the Treasury could have refunded these securities more cheaply by waiting to their ultimate maturity. Moreover, even then, the judgment will necessarily be highly problematical, since all debt manage ment steps— including advance refundings— taken in the interim will have had some influence on the then-existing interest rate levels. As for the present, the dollar interest cost for extending debt through advance refundings offer ing long-term bonds has been less than that for long-term issues sold for cash. Even on a present-value basis, interest cost in an advance refunding is likely to be less. Moreover, the impact on market rates and on the availability of funds for private needs would be far greater via the cash route than via the advance refunding route. Furthermore, the only practicable alternative to advance refunding might well have been to refund all maturing issues into short- and intermediate-term issues and, in addition, to raise most of the required new cash in these sectors. Under these circumstances, interest rates in the short and intermediate credit markets would undoubtedly have risen to higher levels. A case in point is the experience of 195960 when the heavy placement of relatively short maturities contributed to pushing yields on securities under five years to maturity to at least half a percentage point above yields on outstanding long-term issues of more than twenty years to maturity. Not only would an excessive concentration of Government issues in the short and intermediate area be likely to raise average interest costs on the debt, but it would also tend to put financial markets under increasing strain, especially since the failure to place any large seg ments of debt in the long area would lead to progressively more crowded refunding schedules. FEDERAL RESERVE BANK OF NEW YORK C O N C LU D IN G C O M M E N T S To the extent that the option for advance refunding has already been offered on most of the low-interest World War II issues, the opportunities for additional senior re fundings of this kind in the near future are more limited, even though considerable scope remains for other types of advance refundings. It is by no means a foregone con clusion that an advance refunding can be accomplished only when the outstanding issue to be refunded carries a lower interest coupon than the new security being offered in exchange. Among the alternatives offered in the refund ing completed last September, a 4 per cent note maturing May 1963 could be exchanged for a 33A per cent note maturing in 1967 or a 4 per cent bond maturing in 1972. Almost $174 million of the 3 % per cent notes was opted for by holders of the maturing 4 per cent bonds. While an offer of a higher coupon no doubt enhances the attractiveness of any proposed exchange, it is clearly not essential. More broadly, the advance refunding technique has 175 greatly expanded the Treasury’s freedom of maneuver. To a considerable extent, the Treasury can choose when it wishes to refund a particular issue and whether to use the operation as a means for rearranging the maturity structure of the debt. Now the Treasury is no longer confined to such a restricted timetable as that determined by the maturity pattern of outstanding debt, and has greater flexibility to dovetail its refunding operations more effec tively with the requirements of other objectives. An expanded time horizon for scheduling Treasury refunding operations can also be used to coordinate more effectively the needs of debt management with the implementation of monetary policy. The greater flexibility for scheduling debt refinancing may allow the Treasury to smooth out the flow of its financing operations so as to reduce the constraint on monetary policy arising when important Treasury financings are under way. Further more, advance refunding may give the Treasury greater scope than heretofore to support the efforts of monetary policy to expand or curtail the public’s liquidity as cyclical or other considerations may dictate. The M oney M ark et in N ovem ber The money market was moderately firm in November despite an expansion in nation-wide reserve availability. Re serve positions of banks in the leading money centers came under some moderate pressure, as reserve distribution tend ed to favor country banks for which the reduction from 5 per cent to 4 per cent in reserves required against time and savings deposits became effective on November 1. The ef fective rate on Federal funds ranged from 2% per cent to 3 per cent but was at the upper end of the range during most of the month. Rates posted by the major New York City banks on new and renewal call loans to Government securities dealers were quoted mainly within a 3 to per cent range. After the close of business on November 1, the Treasury announced that it would auction on November 7 a $1 billion “strip” of Treasury bills, representing additions of $100 million to each of ten outstanding bill issues with maturity dates ranging from January 17, 1963 to March 21, 1963. Commercial banks were not permitted to pay for the bills through credits to Treasury Tax and Loan Accounts. On November 19 the Treasury announced the final results of its successful November refunding operation. Of the $11 billion of eligible issues maturing or called for redemption, a total of approximately $10.5 billion (or 95.5 per cent) was exchanged for the new issues. Of this total, $4.9 billion (including about $3.8 billion held by official accounts) was converted into the new3V& per cent certificates of 1963, $3.3 billion was exchanged for the new 3 ^ per cent notes of 1965, and $2.3 billion was converted into the new 4 per cent bonds of February 1972. These results, including the small public turn-in for the new certificates, were about in line with market expectations. On November 15, the Treasury announced that it would offer holders of approximately $458 million of Series F and G savings bonds maturing from January 1, 1963 through April 1, 1964 the opportunity to exchange them at their 176 MONTHLY REVIEW, DECEMBER 1962 face amount for two marketable Treasury bond issues: the 3% per cent bonds of 1971 and the 4 per cent bonds of 1980, both priced at 99.50 per cent of their face value and accrued interest. Subscriptions from all classes of sub scribers were received November 19 through 26, while individuals could subscribe through November 30, 1962. In the market for Treasury bills, rates rose sharply early in the month following the November 1 Treasury announce ment of its November 7 strip offering. The advance was partly reversed by midmonth, as the higher rates tem porarily attracted increased demand. In the latter part of the month, however, the Treasury stepped up its additions to the weekly bill offerings from $100 million to $200 mil lion and, with demand tapering off seasonally, rates again moved up. Prices of near-dated Treasury notes and bonds weakened somewhat during the first part of the month in sympathy with the rise in bill rates, while intermediateand long-term issues strengthened under the impact of a moderate investor demand. Toward the middle of the month, however, some profit-taking appeared, and prices worked irregularly lower as market psychology reacted to discussion of an improved outlook for the domestic econ omy, to the rise in stock prices, and to the prospects of a larger Federal deficit. In the latter part of the month, prices steadied again and closed the period near endof-October levels. The market for corporate securities was generally quiet in November, and although a slightly easier tone developed during the latter half of the month, prices moved within narrow limits. In the tax-exempt sec tor, prices moved lower in the latter part of the month and dealer inventories rose. Earlier in the period, prices had reached their highest levels in four years. BANK RESERVES Market factors drained reserves in November on balance, as the effects of a substantial seasonal expansion in cur rency in circulation and changes in miscellaneous items— stemming mainly from a large midmonth receipt by the System Account of interest on System securities holdings — more than offset reserves provided by the usual No vember increase in float, by an expansion in vault cash, and by a net contraction in required reserves. This latter decline primarily reflected the reduction in reserve require ments against time and savings deposits which became effective at country member banks on November 1. Re serves absorbed by market factors, however, were more than counterbalanced by the effects of System Account operations. From the last statement week in October through the last statement week in November, average outright holdings of Government securities rose by $141 CHANGES IN FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, NOVEMBER 1962 In millions of dollars; (4-) denotes increase, (—) decrease in excess reserves Daily averages— week ended Net changes Factor Nov. 7 Operating transactions Treasury operations* ......................... Federal Reserve float.................................. Currency in circulation.............................. Gold and foreign account.......................... Other deposits, etc..................................... Total .......................................... Direct Federal Reserve credit transactions Government securities: Direct market purchases or sales........ Held under repurchase agreements... Loans, discounts, and advances: Member bank borrowings...................... Other ...... ................................................ Bankers’ acceptances: Bought outright ...................................... Under repurchase agreements.............. 4— — — — Nov. 14 Nov. 21 Nov. 28 ± 3 — 31 + 17 44— 4— — 417 — 418 4- 519 — 93 — 409 4- 195 + 152 4- 90 4- 53 — 94 — 180 — 50 — 42 4- 141 — 17 + 79 _ — 51 + — 24 — 1 + 2 14 — 66 756 124 23 202 44— — — 151 228 192 6 141 1 — 4— — 4- 29 53 119 21 24 + — 61 634 764 35 302 164 4- 129 — 325 — 93 4- 134 + — 254 — 289 4- 147 4- 194 + 75 — 186 4 - 123 — 275 4- 91 Total reservest ................................................ Effect of change iri required reservest........ — 248 -j- 343 _ 142 4~ 164 4- 269 — 231 — 63 + 15 — 184 4- 291 Excess reservest ........................................ 4- 95 4- 22 4- 38 — 48 -j- 107 15b 549 391 144 571 427 93 609 516 95 561 466 Total .......................................... - f 423 Member bank reserves With Federal Reserve Banks............ Cash allowed as reserves! ........................ Daily average level of member bank: Borrowings from Reserve Banks............ Excess reservest ............................- ......... Free reservest .............................................. 6 123t 5731 450t 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 four weeks ended November 28, 1962. million, while holdings under repurchase agreements de clined by $17 million. From Wednesday, October 31, through Wednesday, November 28, System holdings of securities maturing in less than one year declined by $222 million while holdings maturing in more than one year rose by $80 million. Over the four statement weeks ended November 28, free reserves averaged $450 million, compared with $411 mil lion (revised) in the five weeks ended October 31. Average excess reserves rose by $99 million to $573 million, while average borrowings from the Federal Reserve Banks in creased by $60 million to $123 million. TH E G O V E R N M E N T S E C U R IT IE S M A R K E T Following the Treasury’s November 1 announcement of its offering of a strip of bills, rates on these instruments rose substantially, with advances amounting to as much as 15 basis points in some key issues. The sharpness of the mar ket’s response stemmed, in part, from earlier experiences in FEDERAL RESERVE BANK OF NEW YORK which auctions of this type had been accompanied by rate advances as well as from the scheduling of the auction in a calendar week which, due to the Veterans Day holiday, al ready included two regular auctions. Equally important, the announcement was generally interpreted by the market as demonstrating continued official concern over the level of short-term interest rates in view of the balance-ofpayments situation. As the regular November 5 auction approached, how ever, a broad demand— particularly from nonbank sources — developed at the higher rate levels and a more confident tone reappeared in the market. Thus, while the average issuing rates for the new three- and six-month bills of 2.841 per cent and 2.927 per cent were both about 15 basis points above those of the previous week, they were somewhat be low pre-auction expectations. A good interest also devel oped at the November 7 strip auction at which the average issuing rate was set at 2.866 per cent, also a bit lower than had been anticipated. While rates adjusted downward on November 7 and 8, they tended to move higher over the latter part of the month, reflecting in part the further addi tions by the Treasury of $100 million of six-month bills in each of the final two auctions of the month, thus add ing a total of $200 million to the bill supply in each of those auctions. A seasonal abatement of demand also con tributed to the upward movement of rates during the latter part of the month. In the final auction of the month, on November 26, average issuing rates were set at 2.853 per cent and 2.936 per cent, respectively, for the threeand six-month bills, up 17 and 16 basis points from the last auction in October. In the market for Treasury notes and bonds, prices of short-term issues adjusted slightly lower early in the month following the sharp rise in bill rates. The market for intermediate- and long-term Treasury issues, however, dis played a generally firm tone during the first part of the period, with the prices of several outstanding issues reach ing new 1962 highs. Investment demand for the new issues involved in the refunding and for other obligations on maturity-lengthening “swaps” was augmented by some pro fessional short covering and easily absorbed a limited vol ume of offers. With the approach of the midmonth payment date for the new issues included in the Treasury’s exchange offering, however, some profit-taking appeared and offer 177 ings from both investment and professional sources in creased. Market sentiment was also influenced by more optimistic appraisals of the economic outlook (highlighted by a rebounding stock market), by widespread discussions of possible tax cuts in 1963, and by new official estimates of the Federal deficit for fiscal 1963. Against this background, prices moved lower around the midmonth period but steadied again in the latter part of the month. Over the month as a whole, prices of Treasury notes and bonds gen erally ranged from % 2 lower to u/^2 higher. O TH ER SE C U R IT IE S M A R K E T S Prices of seasoned corporate and tax-exempt bonds showed little change over the first half of November, re maining near their four-year highs. During the second part of the month, however, prices moved lower in the taxexempt sector, reflecting discussion of an improved outlook for the domestic economy as well as some investor resist ance to the price and yield levels that had been reached. At the same time, prices of corporate bonds were little changed to slightly easier. Over the month as a whole, the average yield on Moody’s seasoned Aaa-rated corporate bonds declined by 1 basis point to 4.25 per cent, while the aver age yield on similarly rated tax-exempt bonds rose by 1 basis point to 2.89 per cent. The total volume of new corporate securities reaching the market in November amounted to $295 million, compared with $540 million in the preceding month and $400 million in November 1961. The largest corporate issue marketed during the month was a $65 million (Aa-rated) utility issue maturing in 1995. Reoffered at par to yield 4.25 per cent, the offering was accorded a fair reception. New tax-exempt flotations during the month totaled $470 million, as against $600 million in October 1962 and $725 million in November 1961. The Blue List of advertised dealer offerings of taxexempt securities rose by $156 million during the month to $559 million on the final day in November. The largest tax-exempt offering was a $48 million (Aaa-rated) state highway bond issue. Reoffered to yield from 1.90 per cent in 1967 to 2.90 per cent in 1983, the bonds met with a fairly good reception. Other new corporate and taxexempt flotations during the period were generally ac corded mixed receptions. 178 MONTHLY REVIEW, DECEMBER 1962 Publications of the Federal R eserve Bank of N ew Y ork The following publications are available free (except where a charge is indicated) from the Public Information Department, Federal Reserve Bank of New York, New York 45, N. Y. Copies of charge publications are available at half price to educational institutions. D O M E S T IC M O N E T A R Y E C O N O M IC S 1. m o n e y : m a s t e r o r s e r v a n t ? (1954) by Thomas O. Waage. A 48-page booklet explaining in nontechnical language the role of money and banking in our economy. Includes a description of the structure of our money economy, tells how money is created, and how the Federal Reserve System in fluences the cost, supply, and availability of credit, as it seeks to encourage balanced economic growth at high levels of employment. 2. t h e m o n e y s i d e o f “ t h e s t r e e t ” (1959) by Carl H. Madden. A 104-page booklet giving a layman’s account of the workings of the New York money market and seeking to convey an under standing of the functions and usefulness of the short-term wholesale money market and of its role in the operations of the Federal Reserve. 70 cents per copy. 3. FED ER A L RESERVE OPERATIO NS IN T H E M O N EY A N D G O V E R N M E N T SECURITIES M ARKETS (1956) by Robert V. Roosa. A 105-page booklet describing how Federal Reserve operations are con ducted through the Trading Desk in execution of the directions of the Federal Open Market Committee. Discusses the interrelation of short-term technical and long-range policy factors in day-to-day operations. Has sections on the role of the national money market, its instruments and institutions, trading procedures in the Government securities market, what the Trading Desk does, the use of projections and the “feel” of the market, and operating liaison with the Federal Open Market Committee. 4. d e p o s i t v e l o c i t y a n d i t s s i g n i f i c a n c e (1959) by George Garvy. An 88-page booklet dis cussing the behavior of deposit velocity, over the business cycle and over long periods, with emphasis on the institutional and structural forces determining its behavior. 60 cents per copy. IN T E R N A T IO N A L E C O N O M IC S 5. TH E QUEST FOR BA LA N C E IN T H E IN T E R N A T IO N A L P A Y M E N T S SYSTEM (Reprinted from Annual Report 1961, Federal Reserve Bank of New York.) A 17-page article reviewing steps taken to strengthen the international financial system, the matter of dealing with basic payments difficulties, and the continuing task of achieving financial stability and economic balance. 6. t h e n e w y o r k f o r e i g n e x c h a n g e m a r k e t (1959) by Alan R. Holmes. A 56-page booklet primarily concerned with a description of the New York foreign exchange market as it exists today. In cludes material on forward exchange and interest arbitrage. 50 cents per copy. 7. FOREIGN C E N T R A L B A N K IN G : T H E IN ST R U M E N T S OF M O N ETARY POLICY (1957) by Peter G. Fousek. A 116-page booklet describing the development of central banking techniques abroad dur ing the postwar period. Includes discussions on discount policy, open market operations, reserve re quirements, liquidity ratios, and selective and direct credit controls. The final chapter describes foreign money markets, and outlines many of the measures taken in various foreign countries since the end of World War II to broaden these markets. 8. M O N ETARY POLICY U N D ER T H E IN T E R N A T IO N A L GOLD STA N D A R D , 1 8 8 0 -1 9 1 4 (1959) by Arthur I. Bloomfield. A 62-page booklet analyzing in the light of current monetary and banking theory, the performance and policies of central banks within the framework of the pre-1914 gold standard. 50 cents per copy.
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