Full text of Economic Policy Review (Federal Reserve Bank of New York) : May 1970, Vol. 52, No. 5

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M ONTHLY REVIEW, M A Y 1970

The Business Situation
The slowdown in economic activity in the first quarter
of 1970 was reflected in both a decline in real GNP and
an increase in unemployment. At the same time, price and
cost pressures continued to be severe. Toward the end of
the quarter, there were some tentative signs of a bottomingout in economic activity and of a slight moderation in price
pressures. Industrial production increased in March for the
first time since last July, and housing starts posted a second
successive monthly gain. At the same time, price increases
at the wholesale level showed some signs of lessening in
March and April.
More broadly, the economic outlook remains quite
strong despite a number of uncertainties, including the re
cent sharp drop in the stock market and developments in
Indochina. In April the pay increase for Federal employees
and the boost in social security payments began to add to
spendable income, and the income tax surcharge is due to
expire at the end of June. Moreover, recent surveys con
tinue to suggest that a sizable growth in capital spending is
likely. The underlying strength of the economy and the
prospect of continued large wage settlements point to the
need for persistence in the fight against inflation.
G R O S S N A T IO N A L P R O D U C T

The nation’s total output of goods and services, accord
ing to preliminary estimates, declined again in the first
quarter of 1970, after allowing for the continued sharp
increase in prices. Real gross national product (GNP) fell
at an annual rate of 1.6 percent, following the previous
quarter’s fractional decline. Despite this further slowing in
real GNP, the implicit price deflator accelerated slightly
from a 4.7 percent rate of growth in the final quarter of last
year to the first quarter’s rate of 5.0 percent. While this in
formation scarcely constitutes evidence that inflation has
worsened, it does cast doubt on the view that prices are
beginning to respond favorably to moderating demand. Ex

pressed in current prices, GNP continued to expand, but
the gain of $8.2 billion (see Chart I) was the smallest since
the first quarter of 1967. As in the fourth quarter of last
year, the expansion in current-dollar GNP was depressed
by a sharp drop in inventory accumulation. Final de
mand, that is, GNP less inventory change, actually rose
by a slightly larger amount in the first quarter than in
the October-December period. The first-quarter increase
in final demand was centered in consumer spending for
nondurable goods, in business fixed investment, and in
state and local government purchases.
The inventory component exerted a $4.8 billion drag
on the expansion of GNP. A slowdown in inventor}?
spending can reflect either deliberate efforts to correct
for excesses in stocks or an unexpected bulge in sales.
In the first quarter, the former appears to be a more
plausible explanation for most of the behavior of inven
tories. The business inventory data for January and Feb
ruary, on which these preliminary inventory estimates are
based, indicate that firms in the durable goods sector at
both the manufacturing and trade levels have attempted to
correct the imbalances that developed near the end of
1969. This behavior has been particularly evident in the
automobile industry, where the stock of unsold cars has
been reduced substantially since late last year. On the
other hand, consumer spending on nondurable goods
showed such strength that some of the slowdown in in
ventory accumulation may have reflected unexpectedly
strong sales.
The reduction of the income tax surcharge from 10
percent to 5 percent at the beginning of 1970 contributed
substantially to the first-quarter gain in disposable per
sonal income. While the first-quarter rise in pretax
income was only $0.2 billion more than that for the pre
ceding quarter, spendable income rose by $3.9 billion
more in the first quarter of 1970 than in the previous
quarter. The first-quarter gain in disposable income was

FEDERAL RESERVE BAN K OF NEW YO RK

accompanied by a fairly large increase in personal con
sumption expenditures, and the saving rate changed very
little. The boost in consumer spending reflected the largest
increase in expenditures on nondurable goods since the
first quarter of 1968. Spending on services continued to
expand at much the same rate as in recent quarters, but
expenditures for durable goods declined slightly. Much
of the weakness in durables can be seen in unit auto sales,
which dropped from a seasonally adjusted annual rate of
8.1 million units in the final three months of 1969 to a
7.4 million unit pace in the first three months of this year.
The poorest sales performance occurred in January, how
ever, when dealer deliveries were at a 6.8 million unit
rate. Auto sales recovered strongly in February to a 7.9
million unit rate, then fell back in March to a 7.4 million
unit pace. In April the sales pace was a little better than
the previous month’s rate.
Investment in plant and equipment continues to ex
pand, in agreement with the surveys of business capital
spending intentions. Most of the first-quarter increment
resulted from a fairly sizable rise in spending on struc
tures. The unusually small increase in expenditures on
equipment probably reflected the General Electric strike.
Recent survey findings and actual spending results have
yet to show the cutbacks that might normally be expected
in light of falling profits, plant operating rates substan
tially below preferred levels, and tight credit conditions;
apparently, efforts to check the steep climb in labor costs
continue to outweigh such inhibiting factors. The
McGraw-Hill spring survey indicated a 9 percent increase
in 1970 expenditures on plant and equipment. Although
this represents a slightly smaller gain than the Department
of Commerce-Securities and Exchange Commission survey
had indicated earlier in the year, the 9 percent boost ex
ceeds, though narrowly, that which had been suggested by
the fall McGraw-Hill survey. Upward revision of spending
plans by nonmanufacturing firms has tended to offset
some cancellations or deferrals by manufacturers.
Spending on residential structures declined in the initial
quarter of 1970 and remained substantially below the high
attained at the outset of 1969. Housing starts were also
down for the quarter, but the rate moved up from the
very low January figure with some vigor in the latter two
months of the period. Despite the February and March
advances in starts, the near-term outlook for home build
ing appears considerably short of buoyant. The rate of
starts is still substantially below the pace recorded in
early 1969 and the rate of permits issued for new homes
fell off in March, though this series has been unusually
wobbly of late. The availability of funds for mortgages
has shown some slight improvement in recent months,

C h art I

RECENT CHANGES IN GROSS N A TIO N A L PRODUCT
A N D ITS COMPONENTS
S eas o n a lly ad ju sted

C h a n g e from th ird q u a rte r to
fourth q u a rte r 1969

C h a n g e from fo u rth q u a r te r 1969

(

to first q u a rte r 1 970

GROSS NATIONAL PRODUCT
In v e n to ry in vestm en t

R e s id e n tia l construction

Business fixed in vestm en t

F e d e ra l G o v e rn m e n t p u rchases
S ta te a n d lo c a l g o v e rn m e n t
p u rch ases
N e t e xp o rts o f g o o d s a n d
services
0

Billions of dollars

Source: United States Department of Commerce.

but land, labor, and financing costs continue to soar,
pushing the price of homes beyond the means of a grow
ing proportion of young families.
The increase in state and local government spending
was larger in the first quarter than in either of the pre
ceding two quarters, although these governments con
tinue to experience financing difficulties. Federal Gov
ernment expenditures dropped by $2.1 billion in the first
quarter, the largest decline since the spring of 1954; a
cutback in defense outlays accounted for most of the
fall. Upward pressures in expenditure programs continue
to accumulate, however, and the Federal employees’ pay
increase, retroactive to December 27, will also contribute
to higher Federal spending.
The remaining GNP component, net exports, added
$1.0 billion to the expansion in total spending. In recent
quarters, the growth in exports of goods and services
has exceeded that for imports; first-quarter net exports
were at the highest level since late in 1967.

M ONTHLY REVIEW, M A Y 1970

IN D U S T R IA L P R O D U C T IO N

Like real GNP, industrial production was lower in the
first quarter of this year than in the final quarter of 1969,
but the monthly data on industrial output showed a slight
rise in March following a small decline in February and a
sizable drop in January. This pattern raises the possibility
that production, after a seven-month downward drift
in the overall index, may be regaining some strength. The
decline in output from last July to this February was
gradual, and never developed into the widespread, sharp
cutbacks in production that have been associated with
post-World War II recessions. The total decline in the
July-February period was 2.7 percent, exceeding nar
rowly the 2.4 percent drop in the index that had occurred
during the mini-recession of early 1967. Subsequent to
similar extended periods of decline, a one-month rise
has usually been followed shortly by an upswing. The
March figures, however, are still preliminary, and past
experience, of course, need not be repeated.
Although the resumption of operations at General Elec
tric plants, following a long strike, contributed positively
to the production index in March as well as in February,
the March rise in the index reflected mainly sizable gains
in the automotive products and steel components, two in
dustries that are highly sensitive to cyclical fluctuations
in demand. Iron and steel production rose 2.4 percent in
March, the largest gain since last June, and the raw steel
output figures suggest another increase in April. As long
as the export demand for steel products remains healthy,
as is expected, the near-term outlook for the industry is
primarily dependent upon the auto situation.
The output of motor vehicles and parts advanced by
5.6 percent in March, the first increase since last July.
The same pattern is evident in the unit figures, as auto
production fell from a seasonally adjusted annual rate of 9.1
million units last July to a 6.5 million unit pace in Febru
ary, then rose to a rate of 7.1 million units in March. As
sales have shown some steadiness, inventories have been
brought down further in recent months. The stock of
unsold cars at 1.4 million units was at the lowest level, on
a seasonally adjusted basis, for any month since the sum
mer of 1968 with the exception of July 1969, when dealer
inventory holdings were at about the same level. With
inventories coming within acceptable limits and the de
mand for new autos at least holding firmly at recent
levels, production schedules for the April-June period
indicate that output might continue rising. Nonetheless,
actual production in April ran below the planned rate,
apparently reflecting plant shutdowns necessitated by
striking teamster locals rather than an unexpectedly poor

sales performance. In the months immediately ahead, the
production figures will no doubt show adjustments in
anticipation of a possible strike by auto workers when the
contract expires in September.
W A G E A N D P R IC E D E V E L O P M E N T S

The slowdown in economic activity has been accom
panied by easing in the demand for labor, but labor costs
continue to rise steeply, and recent labor contract settle
ments indicate that these costs will remain a source of
intense pressure on prices in coming months. Summary
data on major collective bargaining settlements for the
1965-69 period bring into sharp focus the uptrends in
first-year wage increases and in the wage-benefit package
over the life of the contract (see Chart II). Preliminary
first-quarter data for 1970 indicate a further boost in the

C h art II

M A JO R LABOR CONTRACT SETTLEMENTS
M e d ia n a n n u a l increase
Percent

Percent

INCREASE IN W A G E A N D FR IN G E BENEFITS
__OVER THE LIFE O F THE C O N T R A C T

1965

1966

1967

1968

1969

1970
1st q u a rte r

Source: United States Department of Labor.

FEDERAL RESERVE B AN K OF NEW YO RK

first-year wage gain, while the overall wage-benefit in
crease remained about the same as last year’s median.
First-quarter agreements covered fewer than 700,000
workers of the approximately five million covered by con
tracts expiring this year. The relatively small number of
workers receiving large first-year wage increases as well
as declines in overtime work in some high-wage indus
tries have thus far limited the impact of such settlements on
labor compensation per man-hour in the private economy,
but the increase has been rapid. Combining the trend in
labor compensation with the poor performance of produc
tivity, unit labor costs have been accelerating and rose at
an annual rate of 8 percent in the first quarter, the largest
advance for any quarter in fourteen years. Sizable first-year
wage gains will tend to offset the effects of any improve
ment in productivity. In the contract negotiations this year,
workers are seeking to maintain an increase in real wages
and to catch up with other workers who have already
obtained generous settlements. As economic activity slows,
the easing of pressures in the labor market should tend to
reduce the size of union and nonunion wage settlements,
and the easing of demand pressures will make it more diffi
cult for firms to pass along additional labor costs through
higher prices. Nonetheless, we cannot expect slower eco
nomic activity to return the rate of wage increase in the near
future to the noninflationary pace of long-term productivity.
Although industrial wholesale prices continue to rise
at an excessive rate, there are some indications that the
rate of increase may be slowing. According to prelim
inary data, which have been subject to upward revisions

in recent months, industrial commodities prices rose at
a 3.1 percent annual rate in April. The April gain was
equal to that for March, but it was below the rates re
corded in the first two months of the year and the average
monthly increase registered last year. In addition, cyclically
sensitive materials prices have tended to ease downward
in recent months, possibly foreshadowing a further slowing
in the industrial commodities component. Agricultural prod
ucts prices fell in April, causing the overall wholesale
price index to fall. The agricultural component often
moves erratically, however, and the overall index may
thus be of questionable value in discerning the trend in
wholesale prices.
Consumer prices rose at a 6.3 percent annual rate in
March. The March advance in the index exceeded, though
narrowly, the average monthly gain of 6.1 percent recorded
through 1969 and was noticeably higher than the 5.5 per
cent rate of increase registered for the first two months of
this year. Reflecting sharp boosts in mortgage charges and
medical care costs, the gain in services prices was extra
ordinarily large, and the cost of nonfood commodities
climbed at the fastest pace since last November. On the
other hand, a very small rise in food prices softened the
advance in the overall index. After adjustment for seasonal
variation, the consumer price index still shows no solid
evidence of a slowdown in its rate of increase. Even though
the adjusted figures indicate a rise of 4.8 percent for March,
the rate of gain through the first three months of 1970 on
this basis is essentially the same as the average monthly
rate in 1969.

M ONTHLY REVIEW, M A Y 1970

The Money and Bond Markets in April
Prices drifted lower in most sectors of the bond market
during the first part of April and then dropped sharply
after midmonth, in part because indications of economic
strength led market participants to revise their expecta
tions of the interest rate outlook. The confidence in lower
rates that had developed in late March when the banks’
prime lending rate was cut was tested by a record out
pouring of new corporate issues. The previously an
nounced $1.6 billion bond offering by the American Tele
phone and Telegraph Company led to upward rate ad
justments on other new and outstanding securities when
specific terms of the issue were made known on April 13.
Concern also mounted among many market participants
that the economy might resume its expansion before infla
tionary tendencies were contained, especially since fiscal
policy seemed to be tilting again toward the expansionary
side. A somewhat firmer money market suggested that
the monetary authorities were alert to the dangers of
overly rapid monetary expansion. While this augured well
for the long-run health of the bond markets, dealers had
to work off heavy inventories of Treasury bills built up in
anticipation of greater investor demands than materialized.
Accordingly, short-term rates moved rapidly higher in
late April, contributing to the adjustment under way in the
bond market in advance of the Treasury’s May financing.
With prices of Government securities falling sharply
after midmonth, there was growing apprehension concern
ing the terms and the effect of the Treasury’s May refund
ing in that market as the April 29 announcement date
approached. Initial reaction was generally favorable to
the terms on which the Treasury’s new offerings were
made.
The monetary and bank credit aggregates expanded
strongly in April, and the Federal Reserve interposed
some resistance to the acceleration that developed. A
number of unusual developments appear to have con
tributed to unexpected deposit strength. Normal financial
clearings were disrupted early in the period by the effects
of European bank holidays and by the aftermath of
labor disputes and unseasonable snowstorms, which
delayed mail delivery. The early April rise in the aggre

gates was slow to reverse, however, when these special
factors disappeared. In consequence, the System allowed
modestly firmer money market conditions to develop dur
ing the last half of the month. For the three months ended
in April the money supply grew at a seasonally adjusted
annual rate of 5 percent, while the adjusted bank credit
proxy advanced at a rate of 7 percent and time deposits
at 11 percent.
The effective rate on Federal funds averaged 8.1 per
cent in April, compared with 7.7 percent in March. The
rates on three- and six-month Treasury bills closed the
month at 6.93 and 7.18 percent, up 55 and 70 basis points
from a month earlier. The bid rate on ninety-day bankers’
acceptances climbed sharply in several steps to 8Va per
cent by April 30 from IV2 percent at the end of March.
Rates also moved up on the short maturities of directly
placed commercial paper but were unchanged on longer
maturities and on dealer-placed paper over the month.
BAN K R ESERVES A N D THE M O N EY M AR K ET

The behavior of the monetary aggregates in April in
volved a number of uncertainties. Typically, both the
money supply and the bank credit proxy tend at times to
deviate from average seasonal patterns or longer run
growth trends on a week-to-week or even month-to-month
basis. Because of special factors at work in late March,
April turned out to be a month of unusual uncertainty.
The rise in the money supply in the week ended on
April 1 was extraordinary in relation to past seasonal
behavior (see Chart I ).1 A major factor responsible for
this was a very sharp drop during that week in cash items
in the process of collection, which represent a deduction
from gross demand deposits in arriving at the demand
deposit component of the money supply. In part, this

1
Since there is n o growth factor incorporated in the seasonal
line, som e difference between the tw o w ould usually result if the
actual series exhibited a fairly regular growth. The chart shows this
type o f divergence during m ost o f M arch.

FEDERAL RESERVE B AN K OF NEW YO RK

C h art I

THE M O NEY SUPPLY A N D SEASONAL EFFECTS
Billions of d o llars

Billions of dollars

M a rc h

A p ril

^ T h i s lin e is th e a v e r a g e o f the s e a s o n a lly a d ju s te d w e e k ly fig u re s fo r F e b ru a ry
m u ltip lie d by s e a s o n a l fac to rs fo r M a rc h a n d A p ril, b e g in n in g w ilh the w e e k
o f M a rc h 4 . It in d ic a te s w h a t th e u n a d ju s te d m o n ey s u p p ly w o u ld h a v e b ee n
if just the in flu en c e o f th e s e a s o n a l f a c to r s —w h ich a r e d ra w n fro m th e b e h a v io r
o f the m o n ey su p p ly d u rin g c o m p a ra b le w eek s of p re v io u s y e a rs — h a d b ee n
o p e ra tiv e .

drop was attributable to the closing of European money
markets on the Friday and Monday surrounding Easter
Sunday.2 This temporary phenomenon was quickly re
versed after the Easter weekend so that cash items in the
process of collection rose. However, the money supply
did not fall back as promptly as one would have expected
after this and other factors affecting the collection system
faded in importance.
The average effective rate on Federal funds moved to
a higher plateau in the last half of April (see Chart II), as
System open market operations offered some resistance to
the rapid growth in the money supply and bank credit.
Contributing to the firming of the Federal funds rate
were the heavy financing needs of Government securities
dealers, who held unusually large inventories during much
of the period. In addition, the money center banks experi
enced substantial reserve drains when a large rise in re
quired reserves coincided with deposit outflows and siz
able loan demand associated with the mid-April individual
and corporate income tax date. Average borrowings by
member banks at the discount window totaled some $870
million in April (see Table I), down slightly from the $896
million average in March, while net borrowed reserves de
clined by an average of $98 million since excess reserves

2 F or som e further details, see pages 104-5.

also increased by about $70 million over the period.
The average basic reserve position of the forty-six ma
jor money center banks showed virtually no change at
the start of the month but then began to deteriorate, with
the deficits rising to a record $7.5 billion and $8.0 billion,
respectively, in the statement weeks ended on April 15
and April 22. An easing of the deficit occurred during
the final statement week (see Table II) in a pattern which
has recurred in the past several years. Substantial declines
in United States Government balances and private demand
deposits and a sharp rise in lagged reserve requirements
largely accounted for the deepening of the average reserve
deficit of the money center banks during the w7eek of April
15. A sizable inflow of Treasury deposits took place in the
following week as tax collections were made, but this was
more than offset by a continuation of a buildup in loans
and investments which began toward the close of the pre
ceding week.
System open market operations provided $209 million
in reserves during April primarily through repurchase
agreements involving Government securities. Reserves
amounting to $128 million were also supplied by operat
ing transactions, as a large increase in float was only par
tially offset by other transactions which drained reserves.
Required reserves increased by $650 million over the
month.
Preliminary data for the monetary aggregates in April
show a seasonally adjusted annual rate of growth in the
money supply of 13.7 percent following a 13.2 percent
rise during March. Over the three months ended in April
the seasonally adjusted annual rate is estimated at 5.4
percent, compared with an increase of 4.0 percent in the
three months ended in January. The adjusted bank credit
proxy grew at a seasonally adjusted annual rate of 7.0 per
cent in the quarter ended in April, compared with a rate of
3.3 percent in the three months ended in January.
T H 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

Activity in the market for Treasury coupon issues was
rather subdued in April. Based in part on the expectation
that the Treasury’s May refunding would be a rights
offering, some demand developed for shorter dated securi
ties during the first half of the month and prices on issues
due within two years improved over that interval. During
this same period, prices on longer maturities drifted irreg
ularly lower and at midmonth began to fall sharply in
conjunction with the rate adjustments in the corporate
bond market following the announcement of the AT&T
offering terms. Also around midmonth, dealers began to
readjust their positions in preparation for the May re

100

M ONTHLY REVIEW, M A Y 1970

funding, and thereby exerted further downward pres
sure on the market. This was felt particularly in the
intermediate-term area, where dealers attempted to re
duce their holdings in anticipation of a new supply from
the refunding in this maturity range.
As the month progressed and additional information on
the state of the economy became available, many market
participants became apprehensive that the economy might
begin to expand without the needed check on inflation
and that some tightening of monetary policy might be re
quired. In this atmosphere, rates on all coupon issues rose,
with the sharpest increases occurring on intermediate- and
long-term notes and bonds. As the April 29 announcement
of the Treasury’s refunding terms drew closer, the tone of

the market became increasingly cautious in light of the
pronounced deterioration which the market had under
gone in recent weeks. The terms of the May refunding
were as follows: holders of the $16.6 billion of 5% per
cent and 6% percent notes maturing May 15, 1970 were
offered the right to exchange them for additional amounts
of two outstanding issues. These were the 7% percent note
due May 15, 1973, priced to yield 7.98 percent, and the
8 percent note of February 15, 1977, priced at par. The
public held about $4.9 billion of the notes eligible for
exchange. Subscription books for the exchange were open
from May 4 through May 6. In addition, the Treasury of
fered for cash or exchange $3.5 billion of a 7% percent
eighteen-month note in order to meet the attrition on the

C h a rt II

SELECTED INTEREST RATES
P ercent

M O N E Y M A R K E T RATES

F e b ru a ry

M a rc h

F e b ru a ry -A p n l 1 9 7 0

A p r il

B O N D M A R K E T YIELDS

F e b ru a ry

M a rc h

Percent

A p r il

Note: D ata are shown for business days only.
M O N E Y MARKET RATES QUOTED: Bid rates for three-month Euro-dollars in London; offering
rates for directly placed finance com pany paper; the effective rate on Federal funds (the
rate most representative of the transactions executed); closing bid rates (quoted in terms
of rate of discount) on newest outstanding three-m onth and one-year Treasury bills.
B O N D MARKET YIELDS QUOTED: Yields on new A a a - and A a -ra te d public utility bonds
(arrows point from underw riting syndicate reoffering yield on a given issue to m arket
yield on the same issue im m ediately after it has been released from syndicate restrictions);

d aily averages of yields on seasoned A a a -ra te d corporate bonds; daily averages of
yields on lo n g -term Governm ent securities (bonds due or c a lla b le in ten years or more)
and on G overnm ent securities due in three to five years, computed on the basis of closing
bid prices; Thursday averages of yields on twenty seasoned tw enty-yea r ta x -ex e m p t bonds
(carrying M oody's ratings of A a a , A a , A , and Baa).
Sources: Federal Reserve Bank of N ew York, Board of Governors of the Fed eral Reserve System,
M oody’s Investors Service, and The W e e k ly Bond Buyer.

101

FEDERAL RESERVE B AN K OF NEW YO RK
T a b le I

T a b le I I

F A C T O R S T E N D IN G T O IN C R E A S E O R D E C R E A S E
M E M B E R B A N K R E S E R V E S , A P R I L 1970

R E S E R V E P O S IT IO N S O F M A J O R R E S E R V E C I T Y B A N K S
A P R I L 1970

In millions of dollars; (+ ) denotes increase
(—) decrease in excess reserves

In millions of dollars
Daily averages— week ended on

Changes in daily averages—
week ended on

April
1

April
8

—

April
15

Total “ market” factors . . .

April
22

April
29

—

4-195

51
51
92

4- 295
-j- 671
— 194
—
7
— 306

April
8

April
15

April
29

April
22

E igh t b an k s in N e w Y o r k C ity

— 424
— 426
— 2 11
— 15
4- 295

—

— 128

-|- 132

—

4- 524

— 1,082

4 - 238

— 229

Direct Federal Reserve
credit transactions
Open market operations
(subtotal)
4Outright holdings:
Government securities ........
—
Bankers' acceptances ........
—
Repurchase agreements:
Government securities ........
+
Bankers' acceptances ........ 1 - f
Federal agency obligations.
+
Member bank borrowings ........ ! +
Other Federal Reserve
assetsf ............................................
4i

625

4- 596 — 457
4 - 581 — 584
- f 128 4 - 218
4- 24 4 78
— 1 1 — 231

4 -118
- f 221
—
—
-f

72 —

April
1

Net
viiauyc*

"Market” factors
Member bank required
reserves ..........................................
Operating transactions
(subtotal) ....................................
Federal Reserve float ............
Treasury operations* ............
Gold and foreign account...
Currency outside banks ........
Other Federal Reserve
liabilities and capital ..........

Averages of
five weeks
ended on
April 29

Factors affecting
basic reserve positions

— 650

4 - 128
4 - 463
— 110
+ 29
— 161
—

Reserve excess or
deficiency (— )* ..........................
Less borrowings from
Reserve B a n k s ..............................
Less net interbank Federal
Funds purchases or sales (— ) . .
Gross purchases .......... ...........
Gross sales ..............................
Equals net basic reserve
surplus or deficit (— ) ..............
Net loans to Government
securities dealers ........................
Net carry-over, excess or
deficit (— ) t ...................... ..

96 —

29 —

322

517

227

2,042
2,749
707

2,479
3,073
594

1,358
2,321
963

2,573
809

— 1,463 — 1,545 — 2,417 — 2,966

— 1,445

— 1,967

875

517

833

—

232
1,302

1,640
2,520
880

2,202
899

1,031

915

829

—

1,764

— 522
T h irty -eig h t b an k s ou tsid e N e w Y o r k C ity

— 267

166

—

I ll

225
19
34

14
36

426
4- 156

5 +

— 182 4 . 214
— 13 431
24
— 37 4 — 454 4 - 524

4 - 28 4 -

4 - 216

— 693

+ 243

— 169 —

— 174
-|—

4 - 58

—

— 134
— 26
— 14
— 49

+ 108
4 - 13
46
— 78

4 . 209
— 65
4- 6
4-44—

231
24
13
43

4 - 228

4 - 49

986

— 174

4 - 59

4- 394

— 170

— 128

Reserve excess or
deficiency (— )* ..........................
Less borrowings from
Reserve B a n k s ..............................
Less net interbank Federal
Funds purchases or sales (— ) . .
Gross purchases ................ ..
Gross sales ..............................
Equals net basic reserve
surplus or deficit (— ) ..............
Net loans to Government
securities dealers ........................
Net carry-over, excess or
deficit (— )t .......... .....................

—

19 —

35 —

—

264

269

510

252

362

331

3,023
4,922
1,898

4,222
5,778
1,558

4,575
6,077
1,502

4,704
6,147
1,443

3.481
5,493

2,012

4,001
5,683
1,683

— 4,541 — 5,066 — 4,991

— 3,859

—4,337

— 3,230
683

1,117
54 —

853

9S3

427

813

Note: Because of rounding, figures do not necessarily add to totals.
* Reserves held after all adjustments applicable to the reporting period less required
reserves,
f Not reflected in data above.

Monthly
averages

Daily average levels

T a b le I I I
Member bank:
Total reserves, including
Required reserves ........................
Excess reserves ............................
Borrowings ...... ...........................
Free, or net borrowed (— ),
reserves .........................................
Nonborrowed reserves ................
Net carry-over, excess or
deficit (— )§ ................................

AVERAGE ISSUING RATES*
27,806
27,467
339
949

27,709
27,539
170
496

28,238
28,164
74

— 610
26,857

— 326
27,213

— 946
,27,218

192

119

32
893

28,021|
27,8831:
138$
8661

— 833
27,388

— 925
27,101

— 728$
27,155$

1 10 $

28,359
28,221
138
1,020 :
971

27,994
28,026
—

Total ........................

In percent
Weekly auction dates— April 1970

Net
changes

Changes in Wednesday levels
System Account holdings
of Government securities
maturing in:
Less than one year . . .
More than one year . . .

A T R E G U L A R T R E A S U R Y B IL L A U C T IO N S

Maturities

Three-month.
Six-month___

April
13

April
20

April
27

6.409
6.454

6.310
6.247

6.476
6.494

6.876
7.253

Monthly auction dates— February-April 1970
4 -414

+ 414

-471

-j- 816

+ 464

+ 464
Nine-month.

Note: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t Includes assets denominated in foreign currencies.
$ Average for five weeks ended on April 29.
§ Not reflected in data above.

April
6

One-year___

February
24

March
24

April
23

6.994
6.933

6.100

6.844
6.814

6.132

* Interest rates on bills are quoted in terms of a 360-day year, with the discounts from
par as the return on the face amount of the bills payable at maturity. Bond yield
equivalents, related to the amount actually invested, would be slightly higher.

102

M ONTHLY REVIEW, M A Y 1970

refunded issues and to raise additional funds. Subscription
books were open on May 5 for this part of the offering.
Although market participants were somewhat surprised by
the inclusion of a cash offering, prices on the “whenissued” securities held at a premium during their first
day of trading.
Rates on Treasury bills moved somewhat higher during
the early days of the month, partly as a result of investor
selling following the establishment of positions for quar
terly statement purposes. When the volume of such selling
proved less than had been feared and some investment
demand emerged, rates turned down for about a week.
Dealers carried unusually heavy inventories during much
of the month but exerted little selling pressure during the
first half of the period despite relatively high financing
costs. Substantial demand was expected from state and
local government investing of tax receipts and from the
reinvestment of funds by holders of outstanding tax
anticipation bills (TAB’s) maturing on April 22.
After midmonth, dealers became somewhat concerned
when the demand from state and local governments failed
to materialize to the extent that had been expected, and
some paring of positions began. Nonetheless, the resulting
pressure on bill rates was not too great, since reinvest
ment demand from the TAB’s was still anticipated. The
costs of financing these inventories was increasing, how
ever, and when holders of the maturing TAB’s also did
not purchase bills in the volume expected, rates rose
sharply as dealers marked down prices in an attempt to
reduce their stocks. Over the three-day period from April
22 to April 24, rates on some outstanding issues increased
by as much as 50 basis points. The rise in yields continued
during the remainder of the month but at a more moderate
pace. On balance for April as a whole, rates on bills due
within three months were mostly 30 to 55 basis points
higher while longer term bills generally increased by from
63 to 81 basis points.
Reflecting the increased concern over costly inventories
in the face of disappointing demand, the average issuing
rates on three- and six-month bills jumped by some 57
and 101 basis points, respectively, between the auctions
held on April 13 and April 27. In the monthly auction
held on the day following the TAB’s maturation, rates on
the new nine- and twelve-month bills were set at 6.844
and 6.814 percent, up 74 and 68 basis points from the
month earlier (see Table II I).
Some $1.7 billion of securities was marketed by five
Federally sponsored agencies in April, and initial recep
tions to several of the offerings appeared good. However,
a number of the issues later traded below par as a result
of the overall worsening in the capital markets.

O T H E R S E C U R IT IE S M A R K E T S

The highlight of the corporate bond market during
April was the huge AT&T debenture-warrants offer
ing to those owning its shares as of April 10. Until May
18 of this year, holders of thirty-five rights can purchase
for $100 a thirty-year Aaa-rated debenture paying 83A
percent— 10 basis points more than the previous Bell
System offering on March 31— and receive warrants to
purchase two additional shares of stock at $52 each be
tween November 15, 1970 and May 15, 1975. The com
pany plans to raise almost $1.6 billion through its sale
of debentures and an additional $1.6 billion over the 4Vi
years in which the warrants are exercisable. Initial market
reaction to the terms was quite favorable: the when-issued
debentures traded at a premium, and the prices established
on the when-issued rights and warrants also indicated a
good deal of investor interest. Four lower rated utility
syndicates were disbanded on the day after the AT&T
offering, and sizable upward rate adjustments resulted when
the bonds were traded without price restrictions. Appre
ciative of the higher rate levels that were developing,
underwriters marketed a new Aa-rated utility issue on that
same day to yield investors 27 basis points more than
a similar security in the preceding week.
Corporate bond prices drifted somewhat lower over
the remainder of the week of the AT&T announcement
and then dropped sharply at the start of the following
week, prompting underwriters to raise the return on a new
A-rated utility issue to 9.20 percent. Despite the fact that
this was only 20 basis points below the record for a com
parable issue set last December, early sales were dis
appointing; however, the unsold balance was reduced in
the wake of the successful marketing of two more attrac
tive offerings that followed. Under the weight of a record
four months’ supply, additional announcements of forth
coming new offerings, and concern about indications of
an economic upturn, prices continued their decline as the
month progressed, with the AT&T debentures beginning
to trade at a discount.
On balance the tax-exempt bond market deteriorated
during April, though the reception given some particular
new issues was quite good. Reflecting the fairly steady
overall decline, The Weekly Bond Buyer's index tose each
week by from 6 to 23 basis points and reached a high of
6.79 percent on April 30, only 11 basis points below its
peak of 6.90 percent set on December 18. Starting the
month with substantial inventories from the preceding
period (the Blue List of advertised dealer inventories stood
at $557 million on March 31), the market was confronted
with a record thirty-day calendar which had materialized

FEDERAL RESERVE BAN K OF N EW YO R K

as a result of generally rising prices since the start of the
year.
Although prices declined on most tax-exempt issues
during the month, investor interest was for the most part
restrained and dealer inventories remained large through
out the period. At the close of April the Blue List totaled
$521 million, a decline of only $36 million over the month.
Adding to the poorer tone in the municipal market was
an element of uncertainty which arose at midmonth con
cerning the tax status of borrowing costs incurred by

103

commercial banks, which might be associated with the
purchase of tax-exempt securities.
Despite the generally depressed tenor of the tax-exempt
market, two of the month’s largest issues met with favor
able investor receptions. These were a $165 million issue
of New York City bonds, which are attractive to local
residents because they are also exempt from state and
city taxes, and a $100 million issue of Aa-rated Pennsyl
vania bonds which were priced to yield as much as 7
percent on a 28-year maturity.

Banking and Monetary Developments in the First Quarter
The Federal Open Market Committee, at its meeting
of January 15, 1970, concluded that “ in the conduct
of open market operations increased stress should be
placed on the objective of achieving modest growth in
the monetary aggregates, with about equal weight being
given to bank credit and the money stock. It was agreed
that operations should be directed at maintaining firm
conditions in the money market, but that they should be
modified if it appeared that the objective with respect
to the aggregates was not being achieved” .1 In fact, the
growth of the money supply accelerated somewhat in the
first quarter from the rates of expansion recorded in the
final quarter of 1969. Bank credit increased slowly in the
first quarter, but credit growth tended to accelerate as the
quarter progressed. In the case of the money supply,
growth rates within the quarter fluctuated widely, owing
in part to technical factors. Time deposit flows also
strengthened in this period as the higher Regulation Q
interest rate ceilings, made effective by the Board of Gov
ernors of the Federal Reserve System on January 21,
and the lower money market rates in February and March
enhanced the banks’ ability to attract these funds. As a

result of their more favorable deposit position, commercial
banks began to reduce their dependence on nondeposit
sources of funds. Bank credit expansion was characterized
by a shift in the composition of newly acquired earning
assets. The pace of lending slowed, and banks reversed the
liquidation of securities holdings that occurred over most
of 1969 and early 1970. Interest rates, spurred by wide
spread expectations of a more relaxed monetary environ
ment and signs of a slowdown in business activity, were
marked by a broad-based decline. Rates leveled off, how
ever, at the end of the quarter and rose sharply again in
April.2
M O N E Y S U P P L Y A N D TIEVEE D E P O S I T S

The growth of the narrowly defined money supply—
privately held demand deposits plus currency held by the
nonbank public— quickened during the first quarter. The
seasonally adjusted daily average money supply grew at
a 3.8 percent annual rate from December through March,
up from the 1.2 percent rise in the fourth quarter of 1969.
The stronger growth of the money supply in the first

1 “ R ecord o f P olicy Actions o f the Federal Open M arket C om 2 See this Review, pages 98-103 fo r m on ey and bond market demittee” , Federal Reserve Bulletin (A p ril 1 9 7 0), pages 338-39.
velopm ents in A pril.

104

M ONTHLY REVIEW, M A Y 1970

quarter reflected primarily more rapid increases in demand
deposits, though the currency component also rose faster
than in earlier quarters. Within the first quarter, however,
there were very wide month-to-month swings in the rate
of growth of the money supply. It grew at a rapid 9.0 per
cent annual rate in January, dropped sharply by 10.7 per
cent in February, and rose by 13.2 percent in March (see
Chart I), the largest monthly advance since the series be
gan in 1947. Such erratic fluctuations in the narrow
money supply suggest some of the difficulties monetary
authorities may encounter in attempting to control monetary
aggregates in the short run. Erratic short-run swings in the
monetary aggregates may largely reflect measurement prob
lems. Seasonal factors, for example, are used to adjust
monetary data, but the factors may not adjust for newly
emergent seasonal patterns.
One of the major sources of fluctuations in the money
supply is associated with the processing and clearing of
checks that transfer funds between individuals and eco
nomic units throughout the economy. Check-clearing pro

C hart I

GROW TH OF THE N A R R O W MONEY SUPPLY
Seasonallv adiusted a n n u a l r a t e s *

* T h e growth rates are computed in al! cases from monthly averages of daily
money supply figures. The quarterly growth rates are from the last month
of the preceding quarter to the last month of the quarter indicated.
Source: Board of Governors of the Federal Reserve System.

cedures require the physical processing and transportation
of a large and rapidly growing volume of checks, and
introduce an element of double counting in demand de
posits held at commercial banks. When recipients deposit
checks at their banks, the depositors’ accounts are credited
immediately, but usually some time must elapse before the
accounts of the issuers can be reduced. This duplication of
demand deposits is called “ float” , and is estimated by cash
items in the process of collection plus Federal Reserve
float.3 Since estimated float is subtracted from demand de
posits held by the nonbank public in computing the money
supply, distortions in the estimate affect the measure of the
money supply. At any point in time, there may be a differ
ence between the estimate of float and the true duplication
of demand deposits. Part of this difference is attributed to
variations in bank accounting practices. Some banks in
forwarding checks for collection classify them as “ due from
banks” rather than as cash items in the process of collec
tion. The double counting of deposits included in due from
bank balances cannot be ascertained; thus, there is no way
of adjusting the deposit data for this difficulty. Another
part of the difference is that some cash items in the process
of collection represent debits to deposit accounts not in the
money supply. Also, cash items in the process of collection
are typically reduced on the basis of an automatic time
schedule used by the payee bank; scheduled dates may not
correspond to the actual dates on which check issuers’ ac
counts are debited. Estimated float therefore can be sub
ject to wide fluctuations whenever check-clearing processes
are interrupted— for example, as a result of bank holidays
or disruptions in mail or transportation due to labor strikes
or bad weather.
The monthly fluctuations in the money supply within
the first quarter of 1970 were related partly to the inter
ruption of transactions in the Euro-dollar market, when
European banks closed for holidays on December 26 and
again for the Good Friday-Easter Monday weekend
(March 27-30) while New York City banks remained
open. Typically, there is a large volume of Euro-dollar
payments outstanding each day. During European bank
holidays, check-clearing procedures continue at American
banks and such payments are cleared, but no new transfers
arise from European banks. As a result, cash items in the
process of collection at American banks fall, without a
comparable decline in deposits held by the nonbank public,

3
F o r further inform ation about “ bank” float and Federal R e
serve float, as w ell as check-processing problem s and proposed
remedies, see John J. Clarke, “ The Payments System: Problem s,
Fantasies, and Realities” , this Review, pages 109-15.

105

FEDERAL RESERVE B AN K OF NEW YO RK

and the measured money supply rises. The mail strike and
the air controller “ sick out” were additional disturbances
that interrupted the check-clearing process and no doubt
increased the discrepancy between the accounting adjustment for float and the true value of float; these disturbances
may have been contributing factors to the rapid growth
of the money supply on a seasonally adjusted basis.
The more rapid money supply growth during the first
quarter was accompanied by increased time deposit flows
as well. Commercial banks experienced strong time de
posit gains late in the period, signaling a noteworthy
reversal of the losses that prevailed throughout 1969 and
early 1970. In the first quarter, seasonally adjusted total
time and savings deposits rose at a 0.4 percent annual
rate in contrast to the 6.7 percent decline in the last half
of 1969. This improvement in deposit flows reflected the
renewed ability of commercial banks to attract funds, as
higher Regulation Q interest ceilings became effective on
January 21 and as yields on alternative market instruments
fell in February and March. Thus, the outflow, which had
continued into January, reversed as the quarter progressed,
and in March time deposits rose sharply at an annual
rate of 14.4 percent.
The first-quarter gain in time deposits was primarily
attributable to sizable inflows of large certificates of deposit
(CD’s), which commenced during February (seeChart II).
For the first time in over a year commercial banks experi
enced a steady increase in such deposits, and this develop
ment gained momentum as market interest rates declined.
During 1969, the level of large CD’s at weekly reporting
banks dropped precipitously from $22.4 billion in the first
week of January and continued to decline moderately
through the fourth quarter. Although banks had increased
the volume of CD’s issued to official foreign institutions at
rates exempt from Regulation Q ceilings in the closing
months of 1969, declines in total CD holdings persisted
into 1970 and a low of $10.3 billion was reached in the
first week of February. Bank sales of CD’s to a broad spec
trum of investors began to resume, as yields on Treasury
securities fell below rate ceilings on CD’s of comparable
maturities in February and the yield advantage of CD’s
widened during most of March. The volume of large CD’s
outstanding at weekly reporting banks rose by $1,522 mil
lion, seasonally unadjusted, between the first week of
February and the end of the quarter. The March gain of
$448 million in holdings of individuals, partnerships, and
corporations was the first monthly increase in this category
since November 1968. State and local governments also
purchased sizable quantities of CD’s during the same
period.
The first-quarter reversal in deposit flows is also appar-

C h art II

LARGE CERTIFICATES OF DEPOSIT
A N D LIABILITIES TO FOREIGN BRANCHES*

Source: Board of Governors of the Federal Reserve System.

ent in the behavior of time and savings deposits other than
large CD’s and reflects the sensitivity of small savers to
yield differentials between bank deposits and alternative
investments, such as Treasury bills. Weekly reporting
banks sustained a heavy $1.3 billion drop in other time
and savings deposits in January, following the interestcrediting period. Noncompetitive tenders on Treasury bills
— usually submitted by small investors— accounted for
more than one third of the new bills awarded in the first
three weekly auctions in January. The increase in Regu
lation Q ceilings later in January tended to curb this dis
intermediation, as did the Treasury decision— effective
with the auction on March 2— to issue new bills in mini
mum denominations of $10,000. Weekly reporting banks
experienced modest inflows of other time and savings
deposits in February and substantial gains in March.
Commercial banks thus became less dependent on non
deposit sources of funds as the quarter progressed. Com
mercial bank liabilities to their own foreign branches

MONTHLY REVIEW, M A Y 1970

106

fell $1.5 billion from the first week of January to a level
of $12.5 billion at the end of March (see Chart II).
The drop in three-month Euro-dollar interest rates from
10.4 percent early in January to 8.7 percent at the end
of March probably reflected in part the slackening de
mand of United States banks for these funds. Although
bank-related sales of commercial paper rose by $2.2 bil
lion to $6.4 billion at the end of the first quarter, most of
this increase occurred in January, before the resurgence
in deposit flows began. Much of the January increase is
a seasonal reversal of the significant moderation that took
place in December sales of commercial paper by bank
affiliates. Furthermore, although the Board of Governors
on February 24 deferred action on its proposal to apply
interest rate ceilings and/or reserve requirements on
funds obtained by banks through such issues, the growth
of bank-related commercial paper in March was by far
the smallest of the quarter.

C hart III

CHANGES IN BANK CREDIT A N D ITS COMPONENTS
AT ALL COM M ERCIAL BANKS
S e a so n ally adjusted a n n u a l rates

Pero

B A N K C R E D IT

There are a number of bank credit measures; two re
viewed here, the “ adjusted bank credit proxy” 4 and “ all
commercial bank credit” ,5 have been found to be particu
larly useful. These two measures of bank credit, however,
are constructed on different statistical bases. The adjusted

4 The adjusted bank credit proxy consists o f m em ber bank de
posits subject to reserve requirements plus liabilities to foreign
branches and, beginning in September 1969, other nondeposit lia
bilities including Euro-dollars borrow ed directly from foreign
banks o r through brokers and dealers, bank liabilities to own
branches in United States territories and possessions, com m ercial
paper issued b y bank holding com panies o r other bank affiliates,
and loans or participation in pools o f loans sold under repurchase
agreement to institutions other than banks and other than banks’
ow n affiliates o r subsidiaries.
5 A ll com m ercial bank credit is estimated from selected asset
data taken from the consolidated statement o f condition supplied
by com m ercial banks in the United States. M a jor sources fo r this
series are the W ednesday statements o f condition for weekly re
porting large com m ercial banks and a less-detailed weekly statement
fo r smaller m em ber banks. The assets o f nonreporting nonm em ber
banks are estimated in calculating the series. Loans sold by banks
to their affiliates are included in the figures fo r all com m ercial bank
credit given above. Loans sold represent part o f the total credit
extended by the banking system during the period, even though
they do n ot remain on the banks’ balance sheets. D uring the. first
quarter, total loans sold rose by $2.8 billion; seasonally adjusted
total bank credit, excluding loan sales, actually fell by $0.3 billion.
O f the $2.8 billion in loans sold, $1.9 billion occu rred in January
and was associated with the reversal in early January o f tax-related
portfolio adjustments made at the end o f 1969. A fter the heavy
volum e in January, loan sales m oderated considerably in Febru
ary and M arch, reflecting in part the im proved deposit flows into
banks and the decline in the pace o f business lending in M arch.

1st h a lf

1969

j J rd q u a rte r 1969
Source:

4th q u a rte r 1969

1st q u a r t e r 1 97 0

B o a rd o f G o v e rn o rs o f the F e d e ra l R es erv e Sy stem .

proxy is based on average daily deposit and nondeposit
liabilities of member banks and provides a quickly avail
able approximation of changes in total bank credit. All
commercial bank credit is available only as of the last
Wednesday of each month. The adjusted bank credit proxy
expanded at a 0.7 percent seasonally adjusted annual rate
in the first quarter, down somewhat from the 1.9 percent
recorded in the last quarter of 1969. All commercial bank
credit, however, rose at a 2.5 percent seasonally adjusted
annual rate, compared with the 2.3 percent rise in the prior
quarter; some quickening in the first quarter was indicated
by a 5.1 percent rise in February and a 4.2 percent gain
in March. The commercial bank credit data also provide
information about the composition of bank credit.
First-quarter changes in the composition of bank credit
were striking by comparison with earlier quarters (see
Chart III). The persistent liquidation of investment hold
ings over 1969, a common phenomenon in periods of
severe monetary restraint, moderated during the first
quarter and, by the end of the period, banks were adding
to their securities portfolios at a rapid rate. This reflects

FEDERAL RESERVE B AN K OF NEW YO RK

large March purchases of short- and long-term issues,
related in part to the growing portfolios of banks which
function as dealers in Treasury and other securities. Firstquarter holdings of securities other than those of the
United States Government rose at a 10.8 percent annual
rate, following a year in which liquidation proceeded at a
1.1 percent annual rate. The growth in these securities
holdings, primarily state and municipal government obli
gations, accelerated in March, as banks added to their
portfolios at a sharp 27.1 percent annual rate. Although
the liquidation of United States Government securities
moderated during the first quarter, bank holdings of Gov
ernment debt dropped at an annual rate of 15.4 percent,
roughly equal to the rate of decline for all of 1969. In
March, however, banks increased their holdings of United
States Governments at a 9.7 percent annual rate, the first
monthly gain since August. Contributing to this strength
were bank purchases of April and September tax anticipa
tion bills (TAB’s), payable in the first and last weeks of
March. A heavy volume of new issues of corporate and taxexempt securities, in addition to the Treasury TAB’s,
tended to inflate dealer inventories in February and
March. Bank loans to securities dealers, which tend to
vary with dealer inventories, registered considerable
strength in the last two months of the quarter and grew
at a 12.9 percent annual rate for the quarter as a whole.
Total bank loans less securities loans, but adjusted to
include loan sales to affiliates, registered a modest 3.5
percent annual rate in the first quarter of 1970. This
growth was down considerably from the 6.6 percent rate
recorded over the last two quarters of 1969. Busi
ness loans comprise the single largest component of the
banks’ loan portfolios— roughly 38 percent— and fluctu
ations in this component explain much of the movement
in total bank lending. While business loans (including
loan sales) grew in each quarter of 1969, the rate of
growth dropped in each successive quarter, reaching a
5.3 percent annual rate in the fourth quarter of 1969.
The first quarter’s 6.0 percent rate was slightly higher,
despite a March decline of 3.3 percent, the first monthly
drop since 1966 and the largest since mid-1958. The
March decline in business loans may have stemmed from
repayments by corporations’ raising funds directly in the
money and capital markets.
Loans to nonbank financial institutions declined very
sharply at a seasonally adjusted annual rate of 30.3 per
cent in the first quarter. This drop followed a sharp rise
during the previous quarter, particularly in December when
finance companies sought temporary credit in the banking
system. The drop represented in large part the shift by non
bank financial institutions back to borrowing through com

107

mercial paper. In March, this loan component declined at
a more rapid pace, as commercial paper rates fell below
the prime rate toward the end of the month, making it less
expensive for nonbank financial institutions to borrow
through issuing new paper rather than by obtaining credit
in the banking system.
Consumer and real estate loans both increased at
modest rates in the first quarter, and bank lending in
these categories slowed as the quarter progressed. Con
sumer loans grew at a 3.3 percent annual rate, less than
half that recorded in the prior quarter, while real estate
loans showed virtually the same advance, 5.7 percent, for
the first quarter as in the preceding three months.
IN T E R E S T R A T E D E V E L O P M E N T S A N D
M E M B E R B A N K R E S E R V E P O S IT IO N S

A reversal in the movement of short-term interest rates
was a striking development during the January-March
quarter. The downturn in rates was particularly sharp in
February but showed signs of moderating toward the end
of March. The lower levels were in any case still high by
historical experience.
In the last quarter of 1969, three-month Treasury bill
rates had climbed to a record high, reaching 8.10 percent
in early January and then falling dramatically 184 basis
points to 6.26 percent in March. The January-March
drop in other short-term rates was also striking. Threemonth Euro-dollar rates declined from 10.4 percent to
8.7 percent. The rate on four- to six-month prime com
mercial paper fell from 9.00 percent to 8.03 percent and
was below the 8.5 percent prime bank-lending rate for the
first time since November. The prime rate was reduced to
8.00 percent by major money market banks on March 25.
Over the January-March quarter, the average weekly yield
on United States securities maturing in three to five years
fell 118 basis points to 7.08 percent, while yields on long
term Government bonds dropped 67 basis points to 6.33
percent. As the quarter drew to a close, rates on inter
mediate- and long-term Governments rose somewhat,
paralleling a rise in bill rates. During the quarter, the
average effective rate on Federal funds remained stable at
8.98 percent in January and February and then dropped
to 7.76 percent in March. In a related development, mem
ber bank reserve positions were somewhat less strained in
the first quarter of 1970, compared with the previous two
quarters. The average level of net borrowed reserves (un
adjusted for seasonal fluctuations) remained high relative
to past experience but was reduced from an average $950
million and $936 million in the third and fourth quarters
of 1969, respectively, to $815 million by March.

108

MONTHLY REVIEW, M A Y 1970

T H R IF T IN S T IT U T IO N S

Deposit growth at thrift institutions in the first quarter
was quite weak, continuing the pattern that persisted
throughout 1969. By the end of the period, however,
thrift institutions experienced substantially improved de
posit flows, as did the commercial banks. Combined de
posits at savings and loan associations and mutual savings
banks seasonally adjusted grew at a 1.9 percent annual
rate in the first quarter, up somewhat from the 1.4 percent
growth posted in the preceding quarter. Deposit flows
were particularly adverse in January, and combined de
posits dropped sharply by 5.2 percent, the worst monthly
performance recorded since the series began in 1955.
This weakness followed the quarterly interest-crediting
period, when yields on alternative market instruments
were at, or near, record highs. During the remainder of the
quarter, deposit growth showed substantial improvement
and registered a 7.5 percent annual rate of increase in
March alone. This reversal reflected the declining yields on
market instruments and the late January increase in ceiling
rates paid on deposits at thrift institutions. Moreover, the

Treasury’s announcement that minimum denominations on
newly issued Treasury bills would be $10,000 beginning
in March discouraged late-quarter withdrawals.
The rate of growth of mortgage loan portfolios at thrift
institutions moderated in the January-March period and
fell below that posted in the preceding quarter. In order
to sustain the level of mortgage lending, the Federal
Home Loan Banks (FHLB) have advanced substantial
quantities of credit to savings and loan associations, par
ticularly during the latter half of 1969. Some associations
began to repay part of their outstanding borrowings as
deposit flows improved during the quarter. As a result,
growth in the aggregate level of advances from the FHLB
continued, but at a much slower rate than in the last
quarter of 1969. In an effort to free additional funds for
housing construction, the FHLB Board announced liberal
ized borrowing terms on March 25. The Board authorized
sharp increases in advances to savings and loan associa
tions by raising the ceiling on borrowings from 17.5 per
cent to 25 percent of each association’s withdrawable
savings and also froze at 7% percent the maximum rate
charged on these borrowings.

Subscriptions to the m o n t h l y r e v i e w are available to the public without charge. Additional
copies of any issue may be obtained from the Public Information Department, Federal Reserve Bank
of New York, 33 Liberty Street, New York, N.Y. 10045.

109

FEDERAL RESERVE B AN K OF NEW YORK

The Payments System : Problems, Fantasies, and Realities
By J o h n J. C l a r k e
Vice President and Special Legal Adviser
Federal Reserve Bank of New York

The number of checks in the United States has been
growing rapidly, and is projected to reach about 23
billion this year.1 In another ten years truly staggering
amounts of paper will require processing by the banking
system if present trends continue.
Even with the help of MICR2 encoding and process
ing, banks are experiencing difficulties in handling the
growing number of checks. These difficulties are com
pounded by a noticeable scarcity of qualified bank per
sonnel, and one effect is to accentuate the obstacles that
the ever-expanding volumes of resultant credit extension,
or “float” , put in the way of a smoothly functioning mone
tary system. It seems obvious that these difficulties prom
ise to mount as check volume continues to increase.
This article reviews the problems and current efforts
directed to solving them.

1 Estimates o f check volum e com e from several sources, fo rm
ing a cluster substantiating the figure given above.
The Bank Adm inistration Institute estimates, on the basis o f a
1967 survey, An Electronic Network for Interbafik Payment Com
munications (Park Ridge, Illinois, 1 9 6 9 ), that the annual volum e
in that year was 18.7 billion checks; and in another m ore recent
study, The Check Collection System: A Quantitative Description
(Park Ridge, Illinois, 1970), it assumed an annual growth rate
o f 7 percent to 8 percent.
In early 1969, the Chairman o f The A m erican Bankers A ssoci
ation’s A utom ation Com m ittee, in an unpublished m em orandum
to the A ssociation’s M onetary and Payments System Com m ittee,
forecast ch eck volumes o f 21.75 billion fo r 1969, 23.49 billion
fo r 1970, and 34.50 billion fo r 1975, based u pon average yearly
increases o f 8.6 percent.
In “ Changing M anpow er Requirements in Banking” , Monthly
Labor Review (Septem ber 1 9 6 2 ), page 989, R ose W iener asserted:
“ Checks cleared through Federal Reserve Banks account fo r only
a little m ore than one-fourth the total, but their rate o f increase
seems indicative o f the overall trend.” The num ber o f checks on
com m ercial banks handled by the Reserve Banks rose from 4.6
billion in 1965 to 6.5 billion in 1969, an average yearly increase
o f 8.5 percent.
2 M IC R is an acronym fo r M agnetic Ink Character Recognition.

THE PR O BLEM S

The basic problems arise because, under present laws
and practices, the check, once it is deposited in a bank,
must be handled by people and processed by machines
and must be presented to the payor bank— the drawee—
for payment. Check operations are complex, in large
part because check volume is so high and the average
check is subject to multiple handling. The number of
checks dwarfs that for other methods of funds transfer,
although the dollar value of checks is only about half
the total for all money transfers, according to the 1967
study by the Bank Administration Institute (BAI) (see
chart). The same study found that the average check is
handled in 2.6 banks and sometimes more than once
in a single bank. About 70 percent of all checks drawn in
the year of the study were “transit items” , that is, were
sent for collection through the banking system. Transit
items are sent to the drawee either directly or indirectly
through clearing houses, correspondent and other banks,
Federal Reserve Banks, or some combination thereof.
The study found that Federal Reserve Banks play an espe
cially important role in the check-collection process, as
they received over half the transit items in 1967. The
larger the size of the sending bank (if a Federal Reserve
member), the greater is the reported likelihood that it
would send its transit items (other than local clearing
items) to the Federal Reserve Banks.3

3
The study foun d that the larger banks ($1 billion and over in
deposits) sent 86 percent o f transit items to Federal Reserve Banks
for clearance, while the smaller banks (up to $10 m illion in de
posits) sent only 5 percent. Other factors also influence the p ro
portion o f checks sent to the Federal Reserve Banks. The enact
ment o f par clearance statutes, such as the M innesota 1968 legisla
tion, cou ld increase the proportion by making m ore checks eligible
fo r Federal Reserve Bank handling.

110

M ONTHLY REVIEW, M A Y 1970

1967 ESTIMATED DISTRIBUTION OF M O N E Y TRANSFERS
In percent
VOLUME

Source: The Check Collection System: A Quantitative Description (Park Ridge, IllinoisBank Administration Institute, 1970), page 1.

One of the most acute problems related to the process
ing and physical handling of checks is that of finding
and keeping qualified and efficient personnel. This was
one of the conclusions of the 1969 Automation Survey
conducted by The American Bankers Association (A B A ),
and it is a matter of frequent comment by knowledge
able bankers. It is probable that this problem does not
exist with the same severity in all parts of the country,
but indications are that it is pervasive, in business gen
erally as well as in banking. Whatever may be the longrange prospect, it would appear likely that, for the short
run, the most optimistic view is that the situation will get

worse before it begins to get better. Hence it seems that
personnel shortages in banks, particularly as they affect
check handling, will have a more and more serious ad
verse impact upon the efficiency of the collection process
in the years just ahead. A pessimistic view of the future
would, on the other hand, raise the specter of a banking
system whose channels of payment would be so clogged
with paper that a progressive degeneration would set in
and ultimately require the abandonment of that system in
favor of some jerry-built system of the future.
Increasing use of high-speed data processing machines
has helped to improve the productivity of employees en
gaged in handling checks and has enabled banks to cope
with the growing volume of this paper. A check carries
information identifying the payee, the payor— or drawee—
bank, and the drawer; and, in effect, it tells the payor
bank to pay a stated amount to the payee, or order, for
account of the drawer. Encoded on standardized checks,
in magnetic ink characters that are machine readable, is
information identifying the drawer and the drawee bank
and stating the amount; this information qualifies the
check to pass through automatic sorting machinery that,
with the aid of human hands, combined with the appro
priate form or forms of transportation, will enable a par
ticular check finally to “ come home” to its destination—
the drawer’s account in one of the thirty-odd thousand
banking offices in the country— and to be charged to that
account if it is “ good” , and returned if it is not. Despite
the use of machine techniques, time is required for manual
processing and for the physical transportation of the
paper— at what sometimes seems to be a snail’s pace—
between banks.
One important aspect of our check-collection pro
cedures is the creation of “ float” . Float is essentially the
double counting of the same deposits, and it arises because
banks typically credit a depositor’s account with the
amount of a check before the check issuer’s bank account
is debited.4
Float consists of the so-called “bank” float and Federal
Reserve float. A check in the process of collection between
two commercial banks always contributes to bank float.
Checks presented to a Federal Reserve Bank for collec
tion become part of Federal Reserve float and are re
moved from bank float if the depositing commercial bank

4 Tim ing delays also cause a discrepancy between the records
kept b y deposit holders and the records o f their deposit kept by
banks; this is know n as “ m ail” float. See “ A N ew Measure o f the
M on ey Supply” , Federal Reserve Bulletin (O ctob er 19 6 0), pages
1102-23.

FEDERAL RESERVE B AN K OF N EW YO RK

receives credit in its reserve account with its Reserve
Bank (which is effected automatically on the basis of a
prescribed time schedule) before the Federal Reserve
Bank receives payment or remittance therefor. Thus, a
given check may initially be part of bank float and subse
quently become a portion of Federal Reserve float.
Both bank float and Federal Reserve float are quite
volatile, and have tended to mount with the increase in
check volume.5 Bank float can be measured only imper
fectly and distorts the data on monetary aggregates, such
as the money supply. Wide swings in Federal Reserve
float distort the reserve positions of banks and make the
open market operations of the Federal Reserve System
more difficult.6
Float, however, provides a distinct benefit to banks
and depositors. Bank float adds to the cash and “ due
from” bank balances that are important in measuring
banks’ liquidity positions. Of course, any increase in
these balances adds to the banks’ willingness and urge to
lend or invest. Even more significant is an increase in
Federal Reserve float, which adds to the high-powered
reserves of the banking system, provided there are no
offsetting open market operations by the Federal Reserve
System. In any event, it is apparent that the benefits of
Federal Reserve float are distributed disproportionately
among banks. Those that are some distance away from
a Federal Reserve office appear to be the primary bene
ficiaries and, in addition, are only remotely affected by
any offsetting Federal Reserve open market operations.
Depositors are also beneficiaries of float because there
are delays before the checks they issue are charged to
their accounts, while deposited checks are credited imme
diately (though the balances are not necessarily avail
able for immediate use). On the whole, this state of
affairs tends to give them the use of their funds for
longer periods of time. These various benefits have led
to some resistance to change, even though the costs of
check processing and of slow payments are high.
Despite these obstacles, the desirability of shortening
or eliminating payment delays has long been recognized;

5 Elim ination o f float, as might be envisaged by som e o f the
proposals outlined below , cou ld bring revolutionary changes to the
theory and management o f m oney. See G . G arvy and M . R. Blyn,
The Velocity of M oney (N ew Y o rk : Federal Reserve Bank o f
N ew Y ork , 1969), pages 92-94.
6 Federal Reserve average daily balance-sheet float, on a weekly
basis, fo r the year 1969 ranged between a low o f about $2.0 billion
and a high o f $3.6 billion.

111

some thought has been given to ways it might be done;
and some action— though perhaps not enough— has been
taken.
P R O P O S A L S F O R IM P R O V IN G
T H E PAYMENTS S Y S T E M

The proposals thus far advanced have been of three
general kinds, all designed to bring about the speedier
transfer of funds: (1) those which, contemplating the
continued use of the check as a written order on paper for
the payment of money, would attempt to shorten the time
now required to move the information on the paper from
place to place, either by routing the checks to the payor
banks more efficiently or by substituting electronic mes
sages for paper messages to move the information on the
check some part of the way to its destination; (2) those
which would register that information on magnetic tape
before it entered the banking system, and would pass the
information through the banking system on tapes or by
means of wire bridges between banks, the accounting
being handled as at present, though on the basis of mag
netic tape items rather than paper items; and (3) those
which envision the gradual development of a nationwide
computer-communications network through which instan
taneous money transfers could be ordered and made,
utilizing depositor-operated terminals remote from the
computers on which the depositor’s account records were
stored.7 The first class of proposals would hasten check
collection; the second and third would tend to eliminate
checks as a method of payment.
The proposal— that checks be routed more efficiently
so that they can be presented and paid (or returned un
paid) sooner— certainly has its supporters, but a far
greater amount of attention is being directed toward the
utilization of the technological advantages that the com
puter and high-speed communications lines are thought to
afford. Certainly the use of paper from the beginning to
the end of the collection process is, at best, conceived of
as a phenomenon which will inevitably taper off (if not

7
The mass o f published material on the automated aspects o f
check collection and the other proposals described cou ld not be
listed here conveniently and econ om ically. The author has been
guilty o f contributing to this situation; som e o f his published articles
in this general field, having a legal tinge, are listed below : “ M ech
anized Check C ollection ” , The Business Lawyer (July 1959), pages
989-1007: “ E lectronic Brains fo r Banks” , ibid. (A p ril 1 9 6 2), pages
532-47; “ C heck-out T im e fo r Checks” , ibid. (July 1 9 6 6), pages
931-45; “ A n Item is an Item is an Item : A rticle 4 o f the U C C and
the Electronic A g e ” , ibid. (N ovem b er 1 9 6 9 ), pages 109-19.

112

M ONTHLY REVIEW, M A Y 1970

disappear) because of the higher speed with which elec
trons can, under ideal conditions, move from place to
place information on which payment is to be based.
While paper continues to be used, various schemes are
being proposed for the purpose of speeding up the time of
payment, in the hope that they will, if they work, partially
compensate for the slow movement of paper, and thus
blunt the undesirable effects noted above. But since these
proposals appear to depend for success upon the consent
of the payor banks to make early payment, and since those
banks would, if the schemes were put into effect, be losing
funds earlier than they now do, it is difficult to suppose
that, without some compensating advantages, banks would
generally be willing to make payment before the law re
quired them to. If compensating advantages have been
thought of, they have not thus far been put forward pub
licly.
The proposal to use electronics for moving the infor
mation on checks part of the way to its destination (the
so-called “ truncation” method) does not seem to have
taken hold, though publicly proposed at least four years
ago.8 Both operational and legal objections to the pro
posal have been raised; these seem to have tempered
the initial enthusiasm with which it was received. Al
though a somewhat similar plan is in operation on a pilot
basis in Sweden today, the impediments to successful
transplants, in business systems as in heart surgery, are
too well known to call for more than mention.
U SE O F M A G N E T IC T A P E S T O E F F E C T P A Y M E N T S

Magnetic tapes are now being used by the American
banking system for such things as the payment of pay
rolls; they are also being used by the London clearing
banks for interbank debit transfers (functionally analogous
to the paper check) as well. The SCOPE9 project in Cali
fornia (a joint venture of the San Francisco and Los
Angeles clearing houses), initiated in April 1968, seems

8 Hearings, Subcomm ittee on Legal and M onetary Affairs, House
Com m ittee on G overnm ent Operations (February 9, 1966). The
specific suggestion made was that it might one day be possible for
the Federal Reserve Banks to present all checks received by them
on their ow n premises, and transmit facsimiles to the drawees b y
electronic means. The paid checks w ould be retained by the Reserve
Banks subject to requests fo r retrieval m ade by the drawers. The
sending banks w ould be given immediate credit for the checks and
the drawee banks w ould be im mediately charged, subject in each
case to reversal if an item were not finally paid.
9 SCO PE is an acronym fo r Special Com m ittee on Paperless
Entries.

to be pointed in this same direction. The New York Clear
ing House, too, has a group actively pursuing this matter
on the East Coast.10 Questions of message format (among
many others) are very important, for a decision must be
made in each of these projects, quite early on, whether
compatibility is to be sought on a local level only, or
whether it must relate to some national standard of com
patibility as yet unformulated. Waiting for a national
standard to evolve may well frustrate early completion of
such projects; what may ultimately be needed is the
exertion of some wise and strong leadership on a national
scale to create such a standard and bring it into use.
To the extent that customer-generated magnetic tapes
enter the banking system for the purpose of bringing about
money transfers, paper is eliminated, the amount of han
dling by both machines and human beings is reduced, and
delays in payment, and thus float, tend to drift toward more
tolerable levels. However, undertakings of this sort now
on the march are so puny, in relation to the total prob
lem, that some time will elapse, assuming that these
efforts are continued and expanded, before they begin to
chip away at the amount of credit extension that flows
from the operation of the present paper-burdened pay
ments system.
P R E A U T H O R IZ E D P A Y M E N T S

“ Preauthorized payments” , a term often used in con
nection with both “ credit transfer” and “ debit transfer”
systems, is a means of assuring that the debtor’s bank
of deposit will pay his recurring bills, whether level or
variable in amount, without recurring action by him.11
Preauthorized payment plans are not the exclusive pre
rogative of nonpaper payments systems; in some coun
tries they have been operating successfully on a paper
basis for decades. The American psychology is not, it
appears, hospitable to such schemes unless the depositordebtor is offered some economic inducement for prompt
payment (such as a discount or the nonaccrual of extra
charges) in order to secure his participation. The success

10 Banks in Seattle, Indianapolis, and perhaps other places are
investigating the possibility o f SCO PE-like projects.
11 A “ debit transfer” system is one in w hich an item containing
a request or order fo r the payment o f m oney is received by the
banking system from a depositor w ho is to receive payment if the
item is h onored by the drawee after receipt; and a “ credit transfer”
system is one in w hich the first im pact on the banking system is
the receipt by the paying bank from its depositor o f an order to pay
m oney, to the debit o f his account, to credit an identified account
in the same or another bank, w hich is also identified.

FEDERAL RESERVE BANK OF NEW YO RK

of the insurance premium draft plan (under which appre
ciable economic benefits are reaped by a participating
depositor-debtor)12 and the failure of other preauthorized
payment plans to take hold when no such benefits can
be realized seem to offer ample verification of this thesis.
There are some straws in the wind which suggest that
preauthorization plans will receive increasingly active
attention in the very near future. If this occurs, it should
prove an interesting and helpful development.

113

communications.14

i d e n t i f i c a t i o n . It is apparent that the matter of identi
fying and legitimating each order to pay out of an account
under such a system is of high importance. If a malefactor
could readily penetrate the system to order unauthorized
payments, there would be little confidence in it, nor use
of it. To counter the threat of penetration, various pro
posals have been put forward for identifying an account
holder before a payment can be made from his account.
None of these has as yet been proved to be wholly
acceptable, if the goal is to exclude the possibility of
E L E C T R O N IC P A Y M E N T S
successful deception, or if the expense of detecting a
The most ambitious of the proposals thus far made for would-be malefactor is so high, when weighed against
improving the payments system contemplates the gradual the losses his success could cause, as to be economically
development of a nationwide computer-communications unjustifiable.
The prerequisites of a successful identification system,
network through which money transfers could be effected,
utilizing depositor-operated terminals remote from the for this purpose, include: (1) an identification device
computers on which the depositors’ account records were that is difficult to counterfeit to the point of being virtu
stored. Proposals of this sort usually include such fea ally self-authenticating and (2) a technique for establish
tures as: (1) a machine-readable identification card13 ing, without subjective human intervention, that the user
with a built-in verification factor of sufficient reliability, of the device is the person to whom the device pertains.
(2 ) a credit rating with overdraft privileges (for depos It seems to be accepted that absolute identification is an
itors with steady income or assured assets), (3) a system unattainable goal at present; the best that can be expected
of preauthorizing repetitive payments, and (4) an on now is a very high degree of probability.
While claims have been made that some identification
line terminal at each place where payments might be
devices are virtually self-authenticating (in the sense that
originated by a depositor.
Apart from the rather obvious questions of sponsor they are almost impossible to counterfeit), the validity
ship, customer acceptance, the possible need for changes of those claims does not seem to have been publicly
in the legal environment, and the effect of such a system demonstrated, or tested on a sufficiently wide scale to
upon the structure and functioning of the banking system, induce confidence in them.
At one time great hopes were entertained for the voicethere are two aspects of the proposal for a nationwide
spectrogram
technique, involving what are commonly
computer-communications network, which, for the pres
called
“
voice
prints” as a means of identification. It
ent at least, induce caution in embracing it. They merit
seems
to
have
lost
much of its former glamour, in the view
comment. The first of these is identification; the second,
of some technicians.15 Another proposed technique is the

12 In these plans, which generally relate to life insurance policies,
the insurance policyholder authorizes his insurance com pany to
initiate at regular intervals— usually m onthly— drafts on his bank,
chargeable to his checking account, to pay the premiums. The
policyh older also authorizes his bank to h on or these drafts upon
presentment. The policyholder enjoys an econ om ic advantage, as
well as a convenience, in these preauthorized payment plans. Insur
ance com panies usually charge a higher premium fo r m onthly
rather than yearly payment plans, but in the case o f preauthorized
m onthly paym ent plans the premium is low er than that in co n
ventional m onthly plans.
13 In som e circumstances, the present check system places re
liance on identification cards; their experimental use in connection
with the cashing o f N ew Y ork City welfare checks is said to have
reduced losses markedly. These cards will also be used as an
identification medium in connection with the expanded food stamp
program in N ew Y o rk City this year. “ W elfare Recipients to G et
I.D .” , The New York Times (A p ril 8, 1 9 7 0), page 30.

14 This is not to say that a com parison o f the costs o f the present
system with those o f the proposed system will inevitably be decided
in favor o f the proposed system. Enough is known, however, to
suggest that m ore detailed cost studies than have yet been made
will tend to favor the new system, if certain assumptions as to
minimum traffic volum es are made.
15 A recent article, “ Identification o f a Speaker by Speech Spec
trograms” , appearing in Science (O ctob er 17, 1 969), concludes that
“ the available results are inadequate to establish the reliability o f
voice identifications by spectrogram s” . T he authors (R ichard H.
Bolt, Franklin S. C ooper, Edward E. D avid, Jr., Peter B. Denes,
James M . Pickett, and Kenneth N . Stevens) state:
. . the experi
ments reported thus far d o not provide a direct test o f the practical
task o f determining whether tw o spoken passages were uttered by
the same speaker, or by tw o different speakers . . .” and “ Reliable
machine methods fo r voice identification have not yet been estab
lished” .

114

MONTHLY REVIEW, M A Y 1970

reduction of fingerprint patterns to a digital base, and communications between computers, it will be appreci
yet another is that of “hand geography” , under which ated that, because the “ artificial intelligence” of the most
relatively constant characteristics of the hand— length of advanced computer is far from being a match for the
the fingers, width of the knuckles, distance between human mind, the occurrence of these phenomena will
joints, etc.— are reduced to formulae which are regis impair effective communication between computers on
tered digitally in a card that can be read by a machine a much grander scale than is the case with human beings.
Apart from defects in communication, once a proper
and compared with the characteristics of the hand,
proffered as that of the account holder, which is being connection has been made, are those incident to establish
viewed by the machine. Other more exotic identification ing connection, e.g., inordinate waiting for dial tones,
systems, such as a “body-odor sniffer” , linked to a regis busy signals, wrong numbers, erroneous “ intercepts” , and
ter of the body-odor characteristics of the account holder others of that stripe.18 These defects affect human users
contained in the identification device itself or in the emotionally; while computers through the third genera
memory of a remote computer, have also been spoken tion do not experience emotions, the occurrence of these
of, but their projected cost might well be too high to defects would, if computers were to try to establish con
justify their use to protect only moderate bank balances nections automatically, delay effective computer-tocomputer communication and could also compromise the
from depredation.
A “nonphysical” technique is that of the secret num security of the communications system itself.
However, the outlook is not completely bleak. The
ber, a number known only to the legitimate device
holder and embedded magnetically but invisibly in the communications companies are expending appreciable
device. The user must key-in this number when using the effort and money to improve their facilities. In addition,
device in order to make it work.16 Such a technique has during the past year or so, a great number of parties have
been enjoying limited use and may be adequate when applied to the Federal Communications Commission
the amounts at stake are not very large but, if they were (FCC) for authority to operate microwave systems that
would lease communications channels to banks and other
large, its use would no doubt be thought imprudent.17
c o m m u n ic a t io n s .
The notion that the high-speed organizations. For instance, several applications by affiliates
communications channels, necessary for the routing of of Microwave Communications, Inc., have been made to
payments instructions from point of origin to point of the FCC for permission to provide special service com
destination, are obtainable simply by asking for them mon carrier microwave systems. Among the routes pro
is, at present, a sheer myth. The channels must be of posed so far are: (a) Chicago and St. Louis (approved
“ voice grade” , i.e., capable of carrying telephone conver by the FCC, but now in litigation), (b) Chicago and
sations. It is a matter of common experience even in an New York, (c) San Diego, California, and Everett, Wash
ordinary telephone conversation that such lines do not ington, (d) Chicago, Minneapolis, and St. Paul, and .(e)
function without occasional imperfections of service, such New York and Boston. Other companies, too, have applied
as fadings, echoes, distortions, and even unexplained for these routes, among others.
breaks in the transmission. These phenomena do not
Several months ago, in what was described as the larg
seriously impair communications in all cases (for the est single filing for new communications facilities in his
human mind will sometimes supply imperfectly heard, or tory, the University Computing Company submitted to
unheard, parts of conventional speech patterns) but in the FCC a proposal for a $375 million microwave radio
some they do. However, when it is recalled that in this system to serve thirty-five major metropolitan centers
new payments system humans are not to intervene in across the country. The company sees a broad potential
market for its services in banking, insurance, manufactur
ing, petro-chemical, food retailing, securities, and trans
portation fields. A press statement in connection with the
application notes that the system not only would interface
16 A prominent bank has experimented with this m ethod.
with computers and teletype machines, but would also
17 Stanford Research Institute, “ A T ech n o-econ om ic Study o f
M ethods o f Im proving the Payments M echanism ” , a 1966 study
prepared fo r the Federal Reserve System Subcomm ittee on Im prov
ing the Payments Mechanism , page 78; AFIPS Spring Joint Com
puter Conference (1 9 6 7 ), V ol. 30, page 288; F.C.C. Docket 16979
— In the Matter of Regulatory and Policy Problems Presented by
the Interdependence of Computer and Communications Services
and Facilities, Response of International Business Machines Cor
poration (M arch 1 9 6 8), pages 1-66-67.

18
“ Phone Users Cite Service D eclin e” , The New York Timeg
(N ovem b er 22, 1 9 6 9), page 1; “ Forecasting Telephone Needs at
R oot o f Service Problem s” , ibid. (N ovem b er 23, 1969), page 32.

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provide ready access to and from digital xerographic-type
machines, thereby permitting transmission of facsimile
and other types of graphic information six or more times
faster than today’s voice circuits.19 The Bell System and
Western Union have petitioned the FCC to deny this
application.
Many organizations, within and without banking, have
the payments system under study. A partial list of these
is contained in the BA1 report on check collection. Most
prominent within banking (apart from those mentioned
above) are the ABA’s Monetary and Payments System
(MAPS) Committee, with four task forces— marketing,
economics, legal/legislative, operations/technology— and
the Federal Reserve’s Steering Committee on Improving
the Payments Mechanism (SCIPM). Some of the Federal
Reserve Banks have also launched investigative efforts of
rather wide compass to include inquiry into matters in
this field.
The work of these groups, much of it directed to the
solution of rather narrow problems, could no doubt be co
ordinated better than it is, if the environment were ideal;

19
Other significant developm ents bearing upon the possibilities
just discussed include the follow in g: (a ) A com puter-based credit
authorization system— called Omniswitch-—fo r Master Charge and
all other charge and credit cards. Form ed by First National City
Bank and the members o f Eastern States Bankcard Association, the
system will provide all participating merchants with a single local
telephone number to obtain sales authorization fo r card purchasers.
Bank o f A m erica and Am erican Express C om pany have recently
announced their plan to establish a similar nationwide credit card
authorization service corporation that would be open to all chargecard issuers, ( b ) The United States Post Office announcement o f
the awarding o f a contract to General D ynam ics (E lectronics D ivi
sion ) to make a state-of-the-art study to examine all methods o f
applying electronic technology to the mails, including m icrow ave
and laser-beam methods o f transmission. A m on g the many possi
bilities the study will explore is visual delivery o f mail on a hom e
facsim ile printing device, ( c ) The appearance on the market o f
terminals designed to transmit inform ation regarding a retail sales
transaction from the situs o f the sale to a com puter.

115

but it is not. For one thing, it is not clear on the basis of
the track record up to this point who would be able and
willing to do the coordinating; moreover, the pace of the
whole effort would surely be determined by the co
ordinator, if one existed. The efforts toward coordination,
so far, have failed flatly, involved too limited a group, or
moved too slowly (or too fast) for some of the par
ticipants.
Governor George Mitchell, the Chairman of SCIPM,
recently concluded a talk20 by saying:
The banking industry and the Federal Reserve have
the major responsibility for achieving steady progress
toward an electronic payments mechanism. I suspect
an outsider would judge that neither of us is work
ing at full capacity to do so.
The author, who is not altogether an outsider, would
tend to agree. Strong leadership, and wise, will indeed be
needed to bring current proposals (or others of equal
promise) to flower in good season.

20
“ The N eedle in the Paper Stack” , an address before the Senior
Banking Forum o f the A jnerican Institute o f Banking, Kansas
City, M issouri, M arch 19, 1970, in which G overn or M itchell ex
plored the progress being made tow ard an electronic payments
system. One o f the few encouraging signs he noted in his scan is
the newly designed Federal Reserve com m unications system that
initially will handle a tw elvefold increase in transactions and can
be expanded to accom m odate perhaps one hundred times the
present volum e o f wire transfer transactions. W hen the system is in
full operation, messages w ill be switched automatically between
Federal Reserve offices, and with this capability it is possible to
envisage that the system w ill som e day allow the automatic routing
o f funds-transfer messages originating at a m em ber bank or clear
ing center through the Federal Reserve com m unications system
to the appropriate receiving banks. The system is not quite ready to
function; the switch has been installed in Culpeper, Virginia, and
at present is being readied fo r testing.

Full text of Economic Policy Review (Federal Reserve Bank of New York) : May 1970, Vol. 52, No. 5

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