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MONTHLY REVIEW O f Credit and Business Conditions FEDERAL V olum e RESERVE BANK 39 OF N E W Y O R K S E P T E M B E R 1957 No. 9 MONEY MARKET IN AUGUST Against a background of continued strong demand for credit from private borrowers and from the Government, and sustained pressure on member bank reserve positions, most short-term interest rates adjusted upward in August, particularly during the first half of the period. The dis count rates of all Federal Reserve Banks were raised by Vi of 1 per cent to 3 V2 per cent between August 8 and August 22. Longer term yields were generally stable, remaining at the high plateau that had emerged following the rapid increases in May and June. Reserve positions tightened early in the month, with member bank borrowings from the Reserve Banks rising during the first half of August to an average of 1.1 billion dollars, about the same level that had prevailed from early June through mid-July. The usual midmonth bulge in float supplied funds to the banking system after the middle of the month, bringing some relaxation of nation wide reserve pressures and permitting the repayment of a portion of the member bank borrowings. Reserve posi tions promptly tightened, however, as required reserves rose after payment was made on August 21 for the Treasury’s cash borrowing of 1.75 billion dollars through a special issue of Treasury bills. In addition, reserve bal ances were also absorbed by a reduction in float during the final statement week of the month. P r in c ip a l I n c r e a s e s in Sh o r t - T erm cisco on August 14, Richmond on August 16, St. Louis on August 20, and Cleveland and New York on August 22, in each case with the higher discount rate to become effective on the following business day. As with the prime rate, these were the first changes in the discount rate since August of last year. In the midst of these rate changes, the average issuing rate for three-month Treasury bills rose to 3.498 per cent and a Treasury offering of 1.75 billion dollars of special 237-day bills went at an average issuing rate of 4.173 per cent. Rates on bankers’ acceptances rose twice more by the middle of the month to a peak of 4 Vs per cent bid on 90-day acceptances, but later in the month acceptance dealers announced a Vs of 1 per cent reduction. Treasury bill yields also declined after midmonth, with longer regu lar bills falling from about 3Vi per cent to 3XA per cent, but bill yields again advanced to the 3 V2 per cent level as the month drew to a close. The effective rate for Federal funds held at 3 per cent through August 9 and at ZV2 per cent after August 22. In the interval, however, while there was a split discount rate in existence, there were in effect two Federal funds markets, with trading among New York banks mainly at 3 per cent and with transactions outside New York taking place at rates ranging generally from 3 to 33/s per cent. M em ber B ank R eserve P o s it io n s Over the four statement weeks ended August 28 mem I R ber bank borrowings from the Reserve Banks, less excess On August 6 and 7 the principal banks in New York reserves, averaged 525 million dollars as compared with City and other money market centers raised their lending rates to prime borrowers to AV2 per cent from 4 per cent, CONTENTS the first change in the prime rate since August 1956. Rates on bankers’ acceptances and commercial paper were raised Money Market in A u g u st.................................... . 117 on August 7, and on August 8 the Reserve Banks of International Monetary D evelop m en ts.......... 121 Chicago, Kansas City, Minneapolis, and Philadelphia an Earnings and Expenses of Second District Member Banks in the First Half of 1957.. ,. 123 nounced that their discount rates would be raised from 3 to 3^/2 per cent, effective on the following day. Similar Selective and Direct Credit Controls Abroad. ,. 126 announcements were made by the Reserve Banks of Selected Economic In d icators............................. 132 Atlanta, Boston, and Dallas on August 12, by San Fran nterest ates 113 MONTHLY REVIEW, SEPTEMBER 1957 a 391 million dollar average during the month of July. Average excess reserves decreased by 48 million dollars, while borrowings expanded by 86 million. Some of the borrowing, however, may only have represented tempo rary overborrowing by particular banks in anticipation of an imminent rise in the discount rate in their Districts. Early in the month the banks lost a large amount of reserves as repurchase agreements extended by this Bank to Government securities dealers late in July (during the Treasury’s recent refunding operation) matured with only partial and temporary replacement; on a daily average basis 276 million dollars of reserve balances were ab sorbed through this channel alone during the first two weeks ended in August. In addition, a decline in float and an increase in currency in circulation also drained reserves from the banking system. As a result, member banks stepped up their average borrowings at the Reserve Banks from about 550 million dollars in the last week in July to about 1.1 billion dollars in the first week in August and to 1.2 billion in the succeeding week. The increased pressure on reserve positions was moderated, however, by a decline of almost 250 million dollars in average required reserves during the two weeks ended August 14. The re serve drain was heavily concentrated in New York, so that over half of the increase in borrowing was accounted for by the New York central reserve city banks, despite the fact that these banks also sold or redeemed over 230 mil lion dollars in Government securities during the two weeks. Table I Changes in Factors Tending to Increase or Decrease Member Bank Reserves, August 1957 (In millions of dollars; ( + ) denotes increase, (— ) decrease in excess reserves) Daily averages—week ended Factor Operating transactions Treasury operations*...................................... Federal Reserve float...................................... Currency in circulation.................................. Gold and foreign account.............................. Other deposits, etc.......................................... Total............................................. Aug. 7 + + - changes Aug. 21 Aug. 28 + 27 - 54 - 86 - 8 r - + 38 - 250 + 57 tT* 2o - + 5 — 18 + 2 ~r 2 — + 172 + 25 - 136 - Ill - 271 + 354 + 7 — + 32 - 82 + 133 + 51 - 13 — - 231 — - 1 — - 244 _b 20 - 28 - 8 1,156 531 S25 523 907 412 i,o m 487i Aug. 14 34 3 70 353 74 14 18 16 154 + 7 87 279 - 114 + 264 G + + - 147 - 34 21 89 31 232 276 Direct Federal Reserve credit transactions Government securities: Direct market purchases or sales............... Held under repurchase agreements............ Loans, discounts, and advances: Member bank borrowings.......................... Other........................................................... Bankers’ acceptances: Bought outright.......................................... Under repurchase agreements.................... Total............................................. - 6 - 238 + 507 — - 1 — + 262 17 Total reserves........................................................... Effect of change in required reservest ................... -f 108 Excess reserves}....................................................... -4- 91 Daily average level of member bank: Borrowings from Reserve Banks................... 1,060 480 Excess reserves!.............................................. 13 38 - t 1 _ Note: Because of rounding, figures do not necessarily add to totals. * Includes changes in Treasury currency and cash, f These figures are estimated. | Average for four weeks ended August 28. Reserve pressures relaxed somewhat during the follow ing week as a result of the midmonth expansion in float. Average member bank borrowings from the Federal Reserve Banks declined to 925 million dollars, as banks outside New York City repaid 220 million dollars of their indebtedness while the borrowings of the City banks re mained virtually unchanged. In the succeeding week reserve positions came under renewed pressure, as float receded from its midmonth peak and required reserves rose. (On August 22 the banks experienced the reserve effect of their payments made on the preceding day by credit to Treasury Tax and Loan Accounts for their pur chases of the 237-day Treasury bills that had been auc tioned on August 14.) Thus, despite System purchases of Treasury bills during that week, average member bank borrowings from the Reserve Banks remained above 900 million dollars and average net borrowed reserves rose to around the 500 million dollar level. System securities holdings declined by 7 million dollars over the four-week period, with securities held under re purchase agreements contracting by 240 million dollars between July 31 and August 28, more than sufficient to offset a net increase in outright holdings of Treasury bills of 233 million. Although 276 million dollars of repur chase agreements were outstanding on July 31, the bal ance in this account was reduced to zero during the fol lowing week and no further agreements were extended until close to the end of August. Outright holdings de clined by 45 million dollars between July 31 and August 21, but rose by 278 million during the week ended August 28 as open market purchases were undertaken during that period to relieve the increased pressure on bank reserve positions caused by the expansion in required reserves on August 22 and the subsequent decline in float. + 181 + 131 _ — + 222 - 54 + 77 + 23 overnm ent Se c u r it ie s M arket The prices of most Treasury notes and bonds remained fairly steady or even moved higher on balance over the month as a whole in generally light trading, despite the upward adjustment in short-term interest rates. During the first half of the period, when short-term money market rates were moving rather sharply upward, prices of longer issues moved in a narrow range, with the trend generally upward early in the month but followed by a slight decline beginning on August 7 after the initial announcement re garding the rise in the prime loan rate. Prices fell only fractionally during the ensuing week despite the subse quent announcements of higher Federal Reserve discount rates; trading activity remained light throughout that period and by August 13 prices had steadied. Apparently the higher prime and discount rates had been anticipated in the capital markets and were largely discounted in advance, so that the reaction to these moves 119 FEDERAL RESERVE BANK OF NEW YORK was moderate. The generally favorable reception of new long-term corporate and municipal offerings, particularly in the latter half of the month, also had a steadying influ ence on the prices of longer term Treasury securities. In addition, some investors were reported to be diverting funds in small amounts from equities into Treasury and other bonds. Thus prices generally resumed their upward trend after August 13, although they then declined slightly late in the month as the prospect for a heavy volume of corporate and municipal issues expected during September and the following months became a more immediate market factor. Over the month as a whole, the prices of most Treasury bonds and notes maturing through 1962 showed mixed changes, ranging from losses of about % 2 of a point to gains of as much as about Vi of a point. Issues due after 1962 and through 1972 generally rose by between V2 of a point and a full point. All three of the new issues marketed by the Treasury late in July remained at par bid or higher throughout the month, with the new four-year notes reach ing a premium bid of % of a point at one time during the month and closing at 100 1% 2 (bid). The attractiveness of that issue to investors was another strengthening factor in market psychology. The 3V4’s of 1978-83 and the 3’s of 1995, however, both lost 1% 2 of a point, with the former closing the month at 923%2 (bid) and the latter at 8724/32 (bid). Table II Changes in Principal A ssets and Liabilities of the W eekly Reporting Member Banks (In millions of dollars) Statement week ended Item .Assess Loans and investments: Loans: Commercial and industrial loans........... Agricultural loans.................................... Security loans.......................................... Real estate loans..................................... All other loans (largely consumer)......... Total loans adjusted*......................... Investments: U. S. Government securities: Treasury bills...................................... Other.................................................... Total................................................. Other securities........................................ Total investments............................... Total loans and investments adjusted*........ Loans to banks................................................ Loans adjusted* and “ other” securities...... Liabilities July 31 + + + + + t + + + Aug. 7 45 — 49 9 62 72 + — — — - 12 8 18 10 4 27 23 5 18 31 49 121 129 103 218 — 202 _ 420 + 37 - 383 - 410 - 139 + 10 Aug. 14 Aug. 21 + 215 + + 8 — 100 + + 20 — 33 — + 109 + 109 — 66 _ 175 - 21 - 196 - 87 + 315 + 88 253 1 203 3 38 414 + 741 — 84 + 657 + 34 + 691 +1,105 - 140 + 448 Change from Dec. 26, 1956 to Aug. 21, 1957 + + + 942 38 529 170 270 287 - 18 -1,333 -1,351 + 112 -1,239 - 952 - 12 + 399 Demand deposits adjusted............................. — 20 — 454 — 413 — 201 -3,732 Time deposits except Government................ — 16 + 50 — 19 — 4 + 1,524 U. S. Government deposits............................ + 34 -1,069 + 110 +1,700 + 747 Interbank demand deposits: 121 334 601 -1,025 Domestic...................................................... + 161 30 t 62 t 25 + 32 + 99 Foreign......................................................... ' Exclusive of loans to banks and after deduction of valuation reserves; figures for the individual loan classifications are shown gross and may not, therefore, add to the totals shown. Treasury bill yields were more immediately affected by the rapid rise in various short-term rates during the month, as well as by the auctioning of 1.75 billion dollars of special 237-day bills by the Treasury on August 14. How ever, over part of the period a scarcity of regular Treasury bills in the market exerted a restraining influence on the extent of the upward yield movement for three-month bills. The average issuing rate established in the regular weekly auction held on Monday, August 5, fell to 3.308 per cent from 3.363 per cent the previous week, but in the succeeding week (on August 12) it rose 19 basispoints to a 24-year high of 3.498 per cent, reflecting the effects of the forthcoming special bill auction on August 14 as well as the immediately preceding increases in other money market rates. Although it fell back to 3.354 per cent in the auction held on August 19, the fulfilment of most of the nonbank demand, tightening conditions in the money market, and the imminence of a second regular auction at the end of the week resulted in an average issu ing rate of 3.497 per cent on August 26. The additional auction during the last week of the month was held on Friday, August 30, for bills dated September 5 because of the Labor Day holiday on September 2; the average issu ing rate rose slightly to 3.571 per cent, breaking through the previous 24-year high established on August 12. As mentioned above, the Treasury auctioned 1.75 bil lion dollars of special 237-day Treasury bills for cash on August 14. The bills were dated August 21 and are to mature on April 15, 1958. Commercial banks were per mitted to pay for their own and their customers’ allotments by credit to Treasury Tax and Loan Accounts. The spe cial bills were awarded at an average issuing rate of 4.173 per cent, 69 basis-points above the 3.485 per cent average issuing rate on the 264-day March tax anticipation bills auctioned by the Treasury on June 26. Bidding for the new bills was cautious, partly because banks expected the resulting Tax and Loan deposits to be of relatively short duration and partly because of their need to husband funds to meet the anticipated seasonal increase in customer loan demands. In addition, the upward movement in short term rates then in progress contributed an added element of uncertainty to the atmosphere. Initial trading on a “when-issued” basis took place at a rate of about 4.30 per cent, but a fair demand was soon attracted by the rela tively high yield, so that after an initial flurry of liquida tion further offerings were available only at sharply de clining rates. By the end of the period the new April bills were bid at 4.16 per cent after having temporarily dipped to 4.09 per cent, and the March issue was 4.02 per cent (bid). O ther Se c u r it ie s M arkets Early in August the markets for new corporate and municipal bonds were characterized by the same weak undertone that had prevailed during the latter part of 120 MONTHLY REVIEW, SEPTEMBER 1957 July, but as the month progressed a firmness developed which continued until near the end of the period. The volume of public offerings of corporate bonds for new capital purposes is estimated to have been about 470 million dollars, compared with an average of 515 million per month during the seven previous months this year. The volume of new public municipal offerings is estimated at about 495 million dollars, compared with an average of 480 million per month through July of this year. Although new issues were well received when reoffered at attractive yields, the prices on outstanding bonds con tinued to decline, so that Moody’s index of yields on sea soned Aaa-rated long-term corporate bonds rose from 4.05 per cent on July 31 to 4.13 per cent by the end of August, and the long-term Aaa-rated municipal bond in dex similarly increased from 3.25 per cent on July 31 to 3.45 per cent. The firmer tone imparted to the corporate and munici pal markets after the beginning of the month reflected the favorable reception generally accorded major new flota tions during the period. Late in the first week of the month, for example, a large sales finance company offer ing of 5 per cent 20-year debentures (noncallable for ten years) quickly sold out at a 5.20 per cent reoffering yield and moved to a premium bid, as did a subsequent 18 million dollar Aa-rated public utility flotation of 5 per cent 30-year first mortgage bonds reoffered at par, even though it is callable on thirty days’ notice. In the lat ter part of the month, a 90 million dollar issue of 23year Aa-rated utility bonds (noncallable for five years) moved equally well when reoffered to yield investors 4.95 per cent. However, two subsequent similarly rated utility issues were offered to investors at lower rates and received a mixed response. As mentioned earlier, commercial paper and bankers’ acceptance dealers raised their rates during the first half of the month. On August 7 dealers in commercial paper raised their rates by Vs of 1 per cent on all maturities, bringing the rate on prime four-to-six months’ paper to 4 per cent. The former rate of 3% per cent had been in effect since June 18. There were no further changes in commercial paper rates during August. Bankers’ accept ance dealers raised their rates by XA of 1 per cent across the board on August 7, by a further Vs of 1 per cent on August 13, and again by Va of 1 per cent on August 14. These changes, the first since June 6, brought quotations on 90-day acceptances to AVs per cent bid and 4 per cent offered, the highest rates since January 1930. The extent of the rise in acceptance rates was primarily attributable to a large increase in the supply of acceptances entering the market, which stemmed partly from the sale of surplus cotton by the Commodity Credit Corporation and partly from new dollar exchange acceptances drawn by banks in Latin American countries. During the weeks ended August 14 and August 21 the market supply reached suc cessive record highs for any week since the early 1930’s, but the higher rates also resulted in a considerable broad ening of the demand. In the following week, however, the market supply diminished sharply, and at the close on August 23 acceptance dealers announced a rate decrease of Vs of 1 per cent on all maturities, effective on the following business day. This brought quotations on 90-day acceptances down to 4 per cent bid and 3 Vs per cent offered. M em ber B a n k C r e d it Total loans and investments at the weekly reporting member banks increased by 729 million dollars during the four weeks ended August 21, as loans expanded by 568 million dollars and investments rose by 161 million. The loan expansion included an increase of 435 million dollars in business loans. The upward trend in business loans began in the week ended August 7 and continued in the two subsequent weeks, thus reversing the net repay ments which up to then had prevailed in every week since shortly after the heavy tax-period borrowing of this past June. Loans to sales finance companies and to commodity dealers were responsible for a large part (about 60 per cent) of the rise in business loans during these weeks. The increase in loans to commodity dealers was attributable in part to the same factor responsible for much of the in crease in the supply of bankers’ acceptances entering the market during the month, namely, the sale of surplus cot ton by the Commodity Credit Corporation. Investment holdings of the reporting banks declined on balance until the week ended August 21, at which time a sharp rise in Treasury bill holdings more than offset previous securities sales and redemptions. However, data on New York and Chicago reporting banks for the week ended August 28 indicate that the decline in securities holdings was subsequently resumed. The increase during the week ended August 21 primarily reflected bank acqui sition of the new 237-day bills that had been auctioned by the Treasury on August 14, although a substantial part of the banks’ awards was not shown in the reports on August 21 because most banks had made sales in the market before the payment date. Thus far this year total loans have increased by 287 million dollars at the weekly reporting banks, with busi ness loans expanding by 942 million dollars. In the cor responding 34-week period last year total loans increased by 2.8 billion dollars, 2.6 billion of which was in the form of business loans. Investments, on the other hand, have declined by 1.2 billion dollars thus far this year, while in the comparable 1956 period they fell by 3.7 billion dollars. Total loans and investments have thus fallen by 952 mil lion dollars during the first thirty-four weeks of 1957 as compared with a decline of 879 million dollars during the similar weeks last year. FEDERAL RESERVE BANK OF NEW YORK 121 INTERNATIONAL MONETARY DEVELOPMENTS M onetary T rends and P o l ic ie s The upward trend of interest rates in Western Europe and Canada continued during August (see chart), under the stimulus of a persistent demand for loan funds. Further increases in the official discount rates were made in two countries, France and the Netherlands. F rance. The Bank of France increased its discount rate to 5 per cent from 4, effective August 12; the last previous increase, also 1 per cent, had been in April. Corresponding increases were made in the penalty rates for discounts in excess of the individual banks’ discount ceilings: the rate applicable to discounts up to 110 per cent of the ceilings is now 7 per cent; for discounts in excess of 110 per cent this rate is to be the minimum, the actual charge being set since April at the discretion of the gover nor. The discount ceilings themselves, which had been lowered by 10 per cent on July 10, were reduced by another 10 per cent on August 10, which made the bank’s penalty rates more effective. Certain medium-term paper, which has accounted for the largest share of the recent ex pansion of central bank credit, is, however, exempt from the discount ceilings and is therefore not affected by the increased penalty rates. Moreover, certain of the bank’s other rates—its lending rate on 30-day advances against short-term government securities and its buying rate for Treasury bills maturing within three months— were left unchanged in April, and again last month, at 3 per cent. The new measures of monetary restraint, coming at the same time as the readjustment in the franc exchange rate, are part of the concerted effort now under way in France to restore internal and external economic stability. The re-emergence of excessive demand has caused a grave for eign exchange drain and put severe pressure on domestic prices and costs. These inflationary developments, which have occurred in the wake of the rapid expansion in eco nomic activity over the past two to three years, have been sustained by a substantial monetary expansion; despite the foreign exchange drain, the money supply rose 10 per cent during 1956 and has been expanding at about the same rate this year. While the growth in the money supply so far has reflected mainly the rapid expansion of bank credit to the private sector, in recent months it has become ap parent that a decisive factor in monetary conditions would be the government’s increasing need to borrow from the banking system to finance the growing budgetary deficit. This year the government has already had to obtain spe cial credit facilities from the Bank of France totaling 350 billion francs. It has thus clearly become necessary to supplement the policy of monetary restraint launched in the spring with a tightening of fiscal policy. Tax increases and expenditure cuts already voted are expected to make it possible to hold the budgetary deficit in 1957 to about 900 billion francs. Furthermore, at the insistence of the finance minister, the government departments have re cently agreed to cut substantially their spending requests for next year in order to prevent a rise in the budgetary deficit in 1958. N etherlan d s. On August 16, the Netherlands Bank raised its discount rate to 5 per cent from this was the second increase in less than a month, the rate having previously been raised by Vi per cent on July 17. The 3A per cent increase was the largest since 1950. The bank also announced corresponding adjustments in its other lending rates, increasing its rates on promissory INTEREST RATES IN SELECTED FO REIG N L o n g - t e r m g o v e r n m e n t b o n d y i e l d (GB) mm mmm. T r e a s u r y b i l l i s s u e r a t e ( j B) Percent COUNTRIES »»« a 0 D a y - t o - d a y m o n e y ( DM) D i sc ou nt rate (DR) UNITED KINGDOM WEST GERM ANY DR -i.i - I M .l. 1.1 I 1 CANADA BELGIUM SWITZERLAND 1 955 19 56 1957 N o t e : A u g u s t 1 9 5 7 f i g u r e s a r e for m i d m o n t h . ^ We st G e r m a n y : M B c ov er s 4 per cent m o r t g a g e b o nd s . ^ B el gi um: G B S c ov er s s h o r t -t e rm g o v e r n m e n t bonds. S o u r c e s : O f f i c i a l s t a t i s t i c a l s o u r c e s of i n d i v i d u a l c o u n t r i e s a n d International M o n e ta r y Fund, int ernational Financial Statistics Pe^ e 122 MONTHLY REVIEW, SEPTEMBER 1957 notes and on advances to banks and other institutions to 5 V2 per cent and its rate for loans to private customers to 6 V2 per cent. While the July discount rate increase was stated to have been prompted mainly by the need to restrain domestic inflationary pressures, last month’s step was reportedly taken in response to recent developments on the foreign exchange market where the weakness of the guilder was accentuated by uncertainties about the maintenance of the existing structure of European exchange rates. During the ten weeks ended August 5 the gold and foreign ex change reserves fell by about 53 million dollars’ equiva lent to 950 million, or to about 30 per cent below last year’s peak level, and the drain was substantially acceler ated in the following two weeks when the reserves declined by another 82 million dollars. Although the large import surplus that has developed since last summer is the principal factor underlying the Netherlands’ balance-ofpayments difficulties, the recent marked worsening of the foreign exchange position was apparently the result of an outflow of funds. Thus the discount rate increase was accompanied by the announcement of new restrictions on capital movements. The foreign exchange loss has fur ther tightened the Dutch money market; the Treasury, having virtually exhausted its balance at the central bank in the past few months, is now heavily dependent on its regular tenders of three months’ Treasury bills. The tender rate has been rising steadily and on August 17 stood at 4% per cent, a postwar high. C anada. The upward trend of interest rates continued into August with Canadian Government bond yields again reaching new highs. Moreover, the average Treasury bill tender rate, which had been moving around 3.80 per cent for the previous two months, rose by more than XA per cent to a new high of 4.08 per cent on August 22; the Bank of Canada increased its Treasury bill holdings by over 50 million dollars, or about 10 per cent, during the month. The chartered banks’ lending rates also moved up mark edly in August; during the second statement week of the month the rate for day-to-day loans rose above 4 per cent for the first time, and toward the end of the month the major banks increased their prime rate to 53A per cent from 5 V2 (the legal maximum interest rate on Canadian bank loans is 6 per cent). On August 26 the Treasury announced that the twelfth series of Canadian Savings bonds, dated November 1, will be priced to yield 4.46 per cent, compared with the 3.76 per cent offered on last year’s series. The slow expansion of the chartered banks’ business loans since the end of June has been offset by the decline in their holdings of government securities, with the result that total bank credit outstanding in Canada is now no higher than a year ago. The money supply (excluding personal savings deposits), which in June rose above the 1956 level for the first time since early this year, has since declined steadily and has been beneath last year’s level since early July. The banks’ cash position, which came under some pressure toward the end of July, improved early last month while their liquid assets ratio remained comfortably above the required 15 per cent. U nited K ingdom . Interest rates rose substantially, as renewed weakness developed on the gilt-edged securities market and the Treasury bill rate moved up at each tender. Prices of long-term government securities, which had re covered somewhat at the end of July, declined steadily after the beginning of the month; the yield of 2 V2 per cent Consols rose above the record July level and reached a new 36-year high of 5.19 per cent on August 22. The average Treasury bill tender rate, which had been quite steady at around 3.85 per cent during June and July, rose sharply after the first tender of the month and on August 30 stood at 4.12 per cent, the highest since early April. While market factors and foreign exchange devel opments apparently played an important role in last month’s events, the rise in British interest rates more deeply reflects the concern in Britain over further in flationary pressure. In its latest move to counter the threat of inflation, the government announced on August 12 the establishment of “an impartial Council on Prices, Produc tivity, and Incomes”; the terms of reference for the threemember council are to “keep under review changes in price, productivity, and the level of incomes (including wages, salaries, and profits) and to report thereon from time to time”. E xchange R ates American-account sterling was generally weak during most of August, partly as a result of seasonal factors but also because of an uneasiness in the market arising from changes in French foreign exchange arrangements, rumors of a revaluation of the German mark, and the continued tension in the Middle East. Thus in the first half of August, American-account sterling slipped from $2.78%e to as low as $2.78%6— the lowest quotation since Sep tember 1952— with official support preventing any fur ther decline. The rate then firmed slightly to $2.78%, reportedly on covering of short positions in the market, but soon weakened again to about $2.78Vk at the month end. The pressure was also evident in the forward market where offerings of sterling, notably by sugar and grain interests, widened the discounts on three and six months’ sterling from iy 1Q and 2Vs cents to 32%2 and 53/s cents shortly after midmonth. Discounts subsequently nar rowed, however, on offerings of forward dollars in Lon don, and on August 30 stood at 2 H ie and 31%6 cents. Good demand from Japan and from sugar interests pushed the rate for transferable sterling up to $2.7750 FEDERAL RESERVE BANK OF NEW YORK on August 2. By August 12, however, the rate had dropped to $2.7650 as rather large offerings from Switzer land came into the market. The general uneasiness of the market subsequently led to a further decline, and at the month end transferable sterling was quoted at $2.7515. Securities-sterling quotations fluctuated rather sharply during the month, rising to $2.72 on August 1 and then drop ping to $2.64 at midmonth as demand softened noticeably. On August 30 securities sterling was quoted at $2.681/4. The Canadian dollar rate appreciated further during most of August, reaching an all-time high of $1.061%4 on August 20 as offerings of United States dollars by Canadian commercial concerns came on to the market and as the Canadian dollar generally continued to meet with brisk investment demand, particularly from Con tinental Europe. The rate then began to ease under the impact of movements of short-term capital to the United States. This decline accelerated following a speech by the premier of the Province of Ontario, suggesting that some action might be necessary to prevent any continued 123 substantial premium on the Canadian dollar, and by August 28 the quotation dropped to $1.04%. At the month end the rate recovered somewhat to $1.05%2The “capital” mark, used by nonresidents for invest ments in West Germany, appreciated during the first half of August, moving to $0.2456— the highest since last October— as investment demand rose notably. Following an official West German statement that revaluation of the German mark was not contemplated, the rate eased some what and on August 30 stood at $0.2430. The French franc declined in the New York market from $0.0028%6 (350 francs=U.S. $1) to $0.0023% (approximately 420 francs=U.S. $1), following the revi sion on August 10 of French foreign exchange arrange ments. The new system provides for a 20 per cent surtax on all foreign exchange purchases except those for import ing fuel and certain essential raw materials, and for a 20 per cent premium on foreign exchange sales except those arising from the export of the surtax-exempt items and of most textiles. EARNINGS AND EXPENSES OF SECOND DISTRICT MEMBER BANKS IN THE FIRST HALF OF 1957 Net profits of Second District member banks showed a notable improvement in the first half of 1957, both in dollar amount and in comparison with the profits of other member banks. For the first time in some years the ratio of profits (after estimated taxes) to capital invested for banks in this District approximated that of other Districts. The rate of return on capital at Second District member banks has tended to lag behind that at other banks be cause of the higher deductions for nonrecurring items made by District banks and their higher capitalization. The New York City banks in particular have experienced relatively larger losses on the sale of securities or loan write-offs or made larger transfers to reserves than other banks, and on an aggregative basis they are somewhat more highly capitalized relative to their assets and deposits. In the first six months of 1957 net profits of Second District member banks were more than 16 per cent above the comparable period of 1956, and they represented an annual return on capital of 7.9 per cent. For all member banks net profits increased somewhat less than 5 per cent, to a level equivalent to an 8.2 per cent return on capital. Net current operating earnings of District banks have for several years shown a better-than-average year-to-year increase. For the first six months of this year they were nearly 13 per cent higher than in the comparable period of 1956, while those of all member banks showed an in crease of only 5 per cent. All classes of operating income at District banks were higher in these six months than in 1956, and income from loans accounted for the major part of the increase. Operating expenses, especially in terest paid on time deposits, also rose, but not so rapidly as in 1956. E a r n in g A s se t s The relative differences in the operating incomes of the central reserve institutions, the reserve city and country banks in the Second District, and banks in the rest of the country reflect in part differences in local eco nomic conditions and therefore in the types of local credit demands and in part the differing impact of credit policy and changes in market conditions on the various bank groups. Late in 1954 Second District banks, like those in other parts of the country, began to expand their loans and reduce their holdings of Government securities1 to obtain the needed funds. These portfolio shifts continued into 1957 (see Chart I). In addition, most banks showed some net increase in the average2 amount of earn ing assets which they held during the first six months of this year relative to the average for the comparable period of 1956. For the central reserve institutions this increase in total loans and investments amounted to less than 1 per cent, but for the other Second District banks it amounted to 4 per cent, and for all member banks to about 2.5 per cent. The principal increase, both in dollar and percentage terms, in earning assets at all member banks in the first half 1 The figures for Government securities holdings include direct and guaranteed issues. 2 Average figures were computed from the data reported in the December, Spring, and June reports of condition. MONTHLY REVIEW, SEPTEMBER 1957 124 of this year was in commercial and industrial loans. The New York City banks, however, showed a substantially larger increase in this type of loans than any other group of banks, and this increase was partly responsible for their more favorable earnings situation in the first half of the year. The increase in the average amount of com mercial loans on the books of these banks relative to the first half of 1956 was 18 per cent, compared with an increase of 12 per cent for all member banks and 9 per cent for other Second District banks. Commercial loans were, in fact, the only major asset item at the central reserve banks to show an increase. Their securities loans were down sharply, and all other types of loans except interbank loans were down by small amounts. The loan increase at the New York City banks probably reflects in some measure credits extended to large national compa nies, some of which have temporarily postponed the issu ance of new securities to finance their expansion programs. At reserve city and country banks, securities, real estate, and consumer loans as well as commercial loans rose. Securities loans rose by the largest amount in percentage terms and consumer loans the largest in dollar terms. In other parts of the country, banks also expanded their loans, but agricultural loans were off about 5 per cent, and the increases in the other types of credits were some what smaller, relatively, than they were at the reserve city and country banks in this District. For all banks, how ever, earnings on loans increased more rapidly than vol ume, indicating higher effective interest rates. The New York City banks reduced their Government securities portfolios by about 7 per cent from the first half of 1956 to the first half of 1957, and they shifted some of their holdings of bonds and notes into shorter-term certificates and bills. The reserve city and country banks followed the same pattern— shifting into shorter maturities —but they reduced their average holdings of Government securities by only 3 per cent and they increased their hold ings of other obligations moderately. For the first half of 1957 securities holdings, on the average, accounted for 33 per cent of the earning assets of the central reserve banks, compared with 37 per cent in 1956; for the other District banks they accounted for 45 per cent, compared with 47 per cent last year. L O A N S A N D UNITED STATES G O V E R N M E N T SECURITIES H O L D IN G S OF S E C O N D D ISTRICT MEMBER B A N K S FIRST HALF YEAR EARNINGS AND EXPENSES AT SECOND DISTRICT BANKS, 1950-57 O p e r a t in g Incom e Total current operating earnings of all Second District member banks rose to a record high— 826 million dollars —in the first half of 1957, nearly 13 per cent above the 731 million earned in the same period last year (see Chart II). The rates of increase at New York City banks and at reserve city and country banks were almost iden tical, 13 per cent and 12 per cent, respectively. All seg ments of gross income rose above year-ago levels; even earnings on securities were up slightly despite a decline in portfolios. As indicated earlier, the major source of increased in come for the District banks was interest and discount on loans. Income from this source was 72 million dollars, or more than 16 per cent larger in the first half of 1957 than in 1956, with the City banks showing an increase of 18 per cent and the other banks 14 per cent. Service charges and fees on loans, although a relatively small income item, increased about 40 per cent at both groups of banks. In relative terms, income from trust depart ments increased by about the same amount as that from loans, 16 per cent, but in dollar terms this increase amounted to only 9 million dollars. Income from service charges on deposit accounts rose 4 million dollars, as C h a rt II B i l l i o n s of d o l l a r s B il li o n s of d o l l a r s 1 ~ ' .........." ..... 1 ! A M ill io n s of d o ll a r s I----------------------- Iooo ------------- 1000 M i l l i o n s of d o l l a r s S"**4 _ 4 Loans i 1% - l - - U nited States G overnm ent securities - - !!!!!!!!!!! 1 95 5 ! M !! 1 ! 1 ! 1 1 (956 TmT 195 7 0 1950 1951 1952 1953 1 9 54 19 55 1956 1957 Source s: B o a r d of G o v e r n o r s , F e d e ra l R e s e r v e S y s t e m , 1 9 5 0 - 5 6 ; 1957 f ig u re s are p r e li m in a ry a n d a re c o m p i l e d b y the F e d e r a l R es e rv e B an k of Mew Yo rk 125 FEDERAL RESERVE BANK OF NEW YORK many banks raised their service charges on deposit ac counts or made such charges for the first time during the past year. It is now common, for example, for banks to make a 50 cent monthly service charge on special check ing accounts (in addition to the customary 10 cents per check) where only a 25 cent charge existed a short time ago. Many banks also increased minimum balance re quirements on demand accounts and compensating bal ances when granting loans; this had the effect of increasing earnings from service charges and raising the real rate of interest charged borrowers. Even though banks sold securities to gain loanable funds and reserves, higher returns on the Government obligations in their portfolios contributed to a rise in gross income. Indeed, interest which the banks earned on United States Government securities rose slightly (less than 1 per cent) at New York City banks and 3.6 per cent at other banks despite declines of 7 per cent and nearly 3 per cent, respectively, in the banks’ average portfolios. Banks thus benefited from both the higher average yields on Governments in 1957 and from the rise in yields on shorter term issues relative to longer issues. The gains, however, were more than offset by losses on securities sold, discussed later. The income on other securities which the City banks received during the first six months of the year was lower than in 1956 while that received by other District banks increased. O p e r a t in g E xpen ses Total current expenses continued to rise— at City banks a little less rapidly and at other banks a little more rapidly than they did in 1956. However, in contrast to previous years when rising wage and salary expenses contributed most to the increasing expenses of commercial banks, interest paid on time deposits in the first half of 1957 rose more in dollar amount and in percentage terms than any other expense item. At the New York City banks interest paid on time deposits amounted to 38.6 million dollars, an increase of nearly 40 per cent above the first half of 1956. Banks outside the City paid 52 million dollars of interest on time deposits— nearly 37 per cent more. The continuing large demand for bank credit together with a scarcity of reserves encouraged banks to seek time de posits in an attempt to acquire loanable funds. As the general level of interest rates moved upward, rates on time deposits also rose. At the beginning of the year the Board of Governors revised Regulation Q to permit commercial banks to pay as much as 3 per cent interest on savings deposits. Many banks subsequently raised their rates, either to gain time deposits or to discourage transfer of their deposits to other institutions with higher rates. Com pared with the first half of 1956, average time deposits were up nearly 12 per cent at City banks and almost 5 per cent at other District banks. Earnings and Expenses of Member Banks in the Second Federal Reserve D istrict During the First Six Months of 1955-57 (Dollar amounts in millions) Item Number of banks......................................................................................................... Earnings: On United States Government securities.......................................................... On other securities................................................................................................... Oil loans (including service charges and fees on loans)................................. Service charges on deposit accounts.................................................................... Trust department earnings................................................................................... Other current earnings........................................................................................... Total current operating earnings........................................................ Expenses: Salaries and wages—officers and employees..................................................... Interest on time deposits (including savings deposits).................................. Interest and discount on borrowed money....................................................... Taxes other than on net income.......................................................................... Recurring depreciation on banking house, furniture, and fixtures............. Other current operating expenses....................................................................... Total current expenses.......................................................................... Net current operating earnings before income taxes.......................................... Recoveries, charge-offs, transfers to and from valuation reserves, and securities profits—net*........................................................................................... Net profits before income taxes................................................................................ Taxes on net income................................................................................................... Net profits after income taxes............................................................. Cash dividends paid or declared.............................................................................. Retained earnings........................................................................................................ New York central reserve city banks Reserve city and country banks 1955 1956 1957 1955 1956 1957 18 18 18 630 590 558 82.4 25.6 221.0 10.2 43.2 32.1 414.5 67.7 24.1 297.3 12.0 49.9 34.9 485.9 68.2 22.6 351.0 12.8 57.6 38.9 551.1 43.3 12.7 128.7 15.7 5.3 10.8 216.5 43.9 14.2 152.6 17.8 5.5 11.5 245.5 45.5 16.0 174.0 20.8 6.5 11.9 274.7 116.9 19.7 2.2 7.1 3.1 76.3 225.3 189.2 132.9 27.6 5.1 7.5 4.7 80.9 258.7 227.2 141.7 38.6 7.0 8.1 5.5 88.1 289.0 262.1 65.2 31.6 0.5 5.7 4.5 42.2 149.7 66.8 71.9 38.1 1.1 6.2 4.9 46.8 169.0 76.5 78.3 52.1 0.9 6.9 6.1 50.0 194.3 80.4 — 15.5 173.7 80.4 93.3 58.2 35.1 - 26.6 200.6 103.1 97.5 62.7 34.8 - 30.6 231.5 113.6 117.9 70.1 47.8 — 6.5 60.3 25.6 34.7 14.2 20.5 - 15.4 61.1 26.3 34.8 15.9 18.9 - 18.0 62.4 26.3 36.1 18.6 17.5 * No breakdown of nonrecurring items is shown because these figures are usually highly tentative at the midyear. Sources: Board of Governors of the Federal Reserve System, 1955-56; 1957 figures are preliminary and are compiled by the Federal Reserve Bank of New York. 126 MONTHLY REVIEW, SEPTEMBER 1957 The upward movement of wage and salary payments at District banks continued at a notably reduced rate, especially in the case of the New York City banks. Even though wage and salary costs at the City banks were 6.7 per cent higher in the first half of 1957 than during the same period in 1956, they were a smaller proportion (49 per cent) of total expenses this year. At banks outside the City the slowing-down of the rise in wage and salary costs was less marked, as these expenses increased 8.9 per cent. However, total wage and salary costs at banks outside New York City declined to about 40 per cent of total expenses. The gap between wage and salary rates at City and coun try banks is apparently continuing to narrow. At both large and small banks increases in officers’ average salaries (less than 2 per cent) lagged behind the rises in em ployees’ average wages (3 per cent), and both lagged behind the rising cost of living (nearly 4 per cent). Two other expense items, although small, deserve notice because they changed substantially. At New York City banks “interest and discount on borrowed money” was more than 37 per cent higher than it was in the first half of 1956. Both interbank borrowing and borrowing from the Federal Reserve Bank expanded, as the banks more frequently found themselves short of reserves and forced to borrow temporarily. Secondly, both central reserve city banks and other Second District banks showed a sharp rise in “recurring depreciation on banking house, furniture, and fixtures”— 17 per cent at New York City banks and over 24 per cent at other banks. Last year some City banks began to charge more of their rapidly rising moderniza tion and equipment costs to “recurring depreciation” rather than “other current operating costs”. Probably many banks outside the City have adopted similar ac counting practices. A substantial number of institutions throughout the District have acquired more mechanized and electronic equipment as well as more modern quarters in the past year. N o n r e c u r r in g I t e m s , T a x e s , and D iv id e n d s The figures reported at midyear by the banks for such nonrecurring items as transfers to and from reserve ac counts and loan charge-offs or recoveries, as well as for income taxes, are preliminary and frequently differ from those finally reported for the first half of the year. However, the data currently available indicate that loan losses, particularly at the City banks, were down sharply this year, and that securities losses increased as the banks sold securities to meet loan demands and to shift into shorter maturity obligations. The City banks reported net securities losses of 25.6 million dollars, up 55 per cent, and other Second District banks reported a 6.6 million dollar net loss, an increase of 27 per cent. Income taxes as reported for the first half of the year did not keep pace with the growth in profits. Cash dividend payments increased, continuing a post war trend. For the first time in some years the rise in divi dends at City banks could be justified by an even greater gain in net profits; the same cannot be said, however, of banks outside New York City. Retained earnings at the City banks jumped 37 per cent to nearly 48 million dollars, but at other banks the amount of retained earnings added to their undivided profits accounts declined moderately as dividend payments increased more than net profits. SELECTIVE AND DIRECT CREDIT CONTROLS ABROAD Apart from the more traditional instruments of mone tary policy, such as the discount rate, open market opera tions, and commercial bank reserve requirements, which have been discussed in earlier issues of this Review,l many foreign countries are employing a wide range of monetary tools that have been devised relatively recently. Among such tools are qualitative or selective credit controls, cen tral bank “directives” to commercial banks, and the direct regulation of commercial bank loans and investments. Selective controls abroad generally differ in purpose and scope from the types of instruments that go under the same name in the United States. In this country, such controls are understood to include consumer credit regula 1 See "Commercial Bank Reserve Requirements Abroad”, October 1955; "Discount Policies and Techniques Abroad”, June 1956; and "Open Market Operations Abroad”, March 1957. tion, which was in force during World War II and twice during the earlier postwar period; real estate credit regula tion, applied during 1950-52; and margin requirements on stock market credit, instituted in 1934, with a number of variations made since then in the actual margins. These three types of controls in the United States have had as their common purpose the regulation of certain compo nents of the credit structure that are regarded, under par ticular circumstances, as especially volatile. To be sure, certain selective controls in foreign countries also aim at curbing credit extension in directions deemed undesirable; consumer credit controls, discussed in an earlier article,2 have thus been applied in a number of countries, especially during the last two or three years. Other controls, how---------------2 See "Consumer Instalment Credit Abroad”, January 1956. Monthly Review , FEDERAL RESERVE BANK OF NEW YORK ever, have been designed and implemented with a view to stimulating bank lending to particular sectors of the economy regarded by the authorities as essential. Another difference is that selective credit controls have assumed a great variety of forms and often are much more elabo rate than the three selective instruments used at one time or another in this country. Central banks in many foreign countries also impose direct limitations, whether informal or statutory, upon the lending of individual commercial banks and of the entire banking system. Broadly speaking, foreign central banks do not appear to have obtained satisfactory results with selective credit policies unless the controls over the distribution of credit have been buttressed by effective general or quantitative controls over the aggregate volume, availability, and cost of credit. Thus, several countries of Western Europe as well as Australia and New Zealand endeavored during the early postwar years to limit the use of credit by elaborate systems of selective control, in combination with direct controls over the allocation of resources, but the results proved disappointing and, as time passed, country after country either abandoned selective controls altogether or readapted them as an adjunct to general quantitative controls. In many of the less developed countries, on the other hand, selective controls occupy an important posi tion among the instruments of monetary policy. The great emphasis laid in these countries upon such controls is, as a rule, explained by the wish to influence the direction of credit in order to channel economic resources into de sired uses. The selective controls have undoubtedly helped to influence the allocation of credit, but it appears from the available evidence that their usefulness has been quite limited, with perverse consequences at times. The inherent difficulties of deciding upon the precise objectives of such controls, and then finding practical techniques for achiev ing them, are very real, as will be pointed out later. More over, the strong inflationary pressures that have prevailed in many of the less developed countries throughout the postwar years have continued to cause serious distortions in the use of economic resources more or less regardless of the selective controls, so long as firm over-all restraints upon the expansion of bank credit were not maintained. Altogether, therefore, the experience of both the more developed and the less developed countries points to the conclusion that selective credit controls may contribute to economic development and well-being if they are under stood and used as supplements to general controls over the availability and cost of credit, rather than as substi tutes for such general controls. 127 tries is the use of differential discount rates, under which a structure of rates is established on the basis of the dif ferent kinds of paper eligible for rediscount or acceptable as collateral against borrowing. As a rule, this device provides for a “general” or “basic” discount rate and various other rates applicable to different categories of paper, such as agricultural or export bills; the “basic” rate may often remain fixed while changes are made in the others. A further degree of selectivity is, in most cases, also sought by different eligibility requirements for the various types of paper. In broad outline, approaches of this kind are indeed similar to the practices which were followed in this country by the Federal Reserve System over the first two decades of its operations. Differential discount rates are employed mainly in Latin American and Asian countries. Thus, in Colombia a pref erential rate has been set for paper representing mediumterm loans for industry, cattle raising, irrigation, and lowcost housing, while in Peru such a rate is in effect for agricultural, industrial, and mining paper. In Japan, paper that can be rediscounted at a lower rate includes in par ticular export bills. Differential discount rate structures have been used in a number of European countries as well. The National Bank of Belgium for a number of years maintained preferential rates for certified export and im port paper— rates that were tightened or eased, relative to the official discount rate, as balance-of-payments condi tions warranted. In Switzerland, the two rates on paper representing compulsory stockpiling of defense materials were maintained below the central bank discount rate when the latter was raised in May 1957; subsequently, in July 1957, one of them was brought up to the level of the discount rate. Similarly, when the Bank of France in creased its discount rate in April 1957, and again in August, the rate for paper arising from exports was left at its former level; moreover, such paper as well as medium-term bills for equipment and construction financ ing are exempt from the rediscount ceilings in effect for commercial banks. In West Germany, export bills like wise had been excluded, until May 1956, from the redis count ceilings established for commercial banks; further more, until then they could be rediscounted at the German central bank at the official discount rates of the countries on which they had been drawn. In August 1957 the authorities announced that, effective December 1, export bills would be altogether excluded from rediscounting facilities as one of the steps to counter continuing heavy trade and payments surpluses. Still another example is the granting of privileged re discount facilities to special credit institutions established T y p e s o f S e l e c t iv e C r e d it C o n t r o l s with the assistance of government funds and guarantees in D ifferen tial D iscou nt R ates and E ligib ility R equirem ents. order to promote economic development. Such institutions One of the typical selective credit controls in foreign coun exist in the Philippines and a number of other countries. 128 MONTHLY REVIEW, SEPTEMBER 1957 D esign ation o f “ F avored ” A ssets as R eserve E ligib le. Selec tive use of another quantitative credit-control instrument can be found in the arrangements in countries like Mexico and the Philippines, under which certain earning assets in the form of loans and investments are “favored”, in that they can be counted as part of the commercial banks’ legal reserves. In Mexico, for instance, specified types of bank loans are to be included in the required reserves, in addition to cash and certain government securities; and, since such loans must constitute a prescribed part of the reserves, the requirements have, in effect, become largely a tool of selective credit control designed to encourage the extension of bank credit for purposes regarded as being in the national interest. Im port-P redeposit R equirem ents. Another form of Selec tive credit control used in many foreign countries re quires importers to deposit with the central bank, when applying for an import license or for foreign exchange, a certain portion of the funds needed to liquidate the import transaction; such predeposit requirements are sometimes varied with the category of imports. Alternatively, the commercial banks may be required to meet supplementary cash reserve requirements with respect to letters of credit opened in favor of importers. An overexpansion of im port credit constitutes, of course, a serious problem for countries with balance-of-p ayments difficulties. Importpredeposit requirements have thus been adopted in many Latin American and Asian countries, e.g., Argentina, Chile, Colombia, Uruguay, Indonesia, Japan, Pakistan, and the Philippines. At various times they also were in force in certain European countries, e.g., in Finland and Greece; France established them in March 1957. It is to be noted that import-predeposit requirements have both quantitative and selective effects on the cost and availability of credit. The quantitative effect arises from the accumulation of funds in the special central bank account that is usually set up for this purpose. The de cline in the money supply that is thus brought about cor responds to a portion of the eventual exchange sales, indicating that import-predeposit requirements serve to anticipate the liquidity-reducing effects of imports. The selective effects of import predeposits, on the other hand, arise from the fact that importers are forced to tie up their own funds (or their credit lines with commercial banks) for longer periods than would be the case if funds (or credit lines) were used for nonimport transactions.3 Thus, the average interest cost of using credit for import transactions will rise relatively to other uses of credit. This selective effect can be reinforced by differentiating the pre deposit requirements by import classes, as is almost in variably done. The quantitative impact of the requirements is, of course, greatest immediately following their imposition. Other things remaining equal, after a certain period the inpayments and outpayments of the predeposit account will tend to come into balance unless the average of the predeposit requirements is constantly raised. Thus, the element of timing is crucial in obtaining the maximum use from this instrument. Evidently, import predeposits are not a substitute for higher cash reserve requirements and other quantitative credit restrictions in countries suffering from serious inflation; however, they may well be suited to the task of bridling speculative tendencies toward over importing. P riority C ategories A m ong Bank L oans. In Some Countries where commercial banks provide longer term credits for investments, it has been deemed necessary to apply to bank loans the criteria governing the order of priorities for capital market issues. Such controls originally grew out of wartime policies for mobilizing and allocating economic resources, and were retained after the war, often in a modified form, in countries like the United Kingdom and Australia. The most comprehensive credit control of this sort exists in the United Kingdom, where com mercial banks, when extending loans of any amount for capital purposes, are required to apply the principles that guide the Capital Issues Committee (in which the Bank of England participates) in passing on all capital issues above certain exempt amounts. In particular, the banks must sub mit for committee scrutiny all loans above a minimum amount that represent a new use of bank funds. Thus, a business firm finds it equally difficult to obtain permission to secure funds either from the banks or from the capital market. The minimum limit for capital issues exempt from control was lowered as recently as 1956 from £50,000 to £10,000, and in 1957 the committee’s jurisdiction was extended to certain credit sectors that had been exempted from its supervision in 1953. Other countries have restricted or prohibited commer cial bank lending for capital purposes or participation in new capital issues in order to force potential borrowers to raise capital from nonbank sources. Such restrictions have been imposed, at one time or another, in Canada, the Netherlands, New Zealand, and Sweden. In Canada, in 1948, in 1951, and again in 1955, the central bank suggested to the chartered banks, and the latter agreed to, a cessation of most forms of “term loans”. These were defined as loans to business corporations not of 3 In Argentina, it should be noted, the banks have been instructed a working-capital character but rather to provide fixed not to grant loans for the purpose of meeting the predeposit require capital, repayable over a period of years. ments. FEDERAL RESERVE BANK OF NEW YORK Controls O ver S tock M arket and R eal E state C redit. Con trols over stock market and real estate credit are relatively unimportant in foreign countries, where these particular types of credit play a considerably smaller role in com mercial banking than in the United States. The specific power to impose (and vary) margin requirements for stock market transactions does not appear to be held by the monetary authorities in any foreign country. In Canada, however, where such requirements have been set by the stock exchanges themselves, the exchanges, after discus sions with the Bank of Canada, informed their members last year that “it would be undesirable for the volume of credit used in stock market trading to increase further under present conditions”.4 In France, the brokers’ asso ciations set margin requirements for future operations that have been varied from time to time. Controls over real estate credit are exercised abroad mainly on an informal basis, often through governmentowned or government-controlled mortgage institutions. An interesting example of an informal control mechanism in this area is the voluntary agreement on restricting mort gage credits, concluded in Switzerland in the summer of 1951 and kept in force until considerably tighter market conditions made possible its abandonment six years later. Under this agreement, the major banks, insurance compa nies, real estate and investment trusts, and other lenders bound themselves to restrict loans to a maximum of 70 per cent of the final cost of residential construction, and of 50 per cent in the case of commercial and industrial buildings. E f f e c t iv e n e s s o f A d m in is t e r e d S e l e c t iv e C ontrols The great variety of attempts at selective controls, under varying conditions in different countries, prevents any detailed historical appraisal in this article. Some more or less consistent results do, however, stand out. Perhaps the most significant is the fact that the selective controls designed to supplement quantitative credit restraints gen erally appear to have been more effective than the meas ures attempting singlehandedly to redirect credit in accord ance with a schedule of priorities. But even the selective controls buttressed by general credit restraints encounter many serious limitations. In the first place, the selective screening of loan applications and discount operations has often proved disappointing, particularly owing to leakages and the increasing importance of self-financing. An even more important limitation to selective controls is the ability of individuals and businesses to use their own funds for nonessential expenditures while requesting credit for essential outlays. Moreover, selective screening has often proved ineffective in the face of the seemingly irre 4 Bank of Canada, Annual Report, 1956, p. 34. 129 futable justification that can be discovered for each indi vidual loan, even though the aggregate may well be clearly in excess of the country’s physical capabilities. Aside from these and other weaknesses, selective con trols are likely to give rise to difficult administrative prob lems. For instance, it is usually necessary for both the central bank and the commercial banks to distinguish arbitrarily, in precise operational terms that can be fol lowed consistently over some considerable period, be tween essential and nonessential sectors of the economy, between productive and nonproductive investment, and between speculative and nonspeculative borrowing. Fur thermore, the authorities must continually accompany their judgments of economic usefulness with concern over frequent and at times serious inequities, over possible dis crimination as between banks, and over the locus of re sponsibility as between the central bank and the commer cial banks concerning various aspects of judgments that must be made on the loans actually extended by commer cial banks. On the other hand, selective controls have, on occasion, served useful purposes. Thus, in situations where fluctuations in demand have been concentrated in certain well-delineated sectors that are fairly susceptible to changes in the supply of credit, it has appeared that selective controls over these strategic areas have exerted an effective limiting influence on the total level of demand and have thus contributed toward effective monetary restraint. C e n t r a l B a n k “D ir e c t iv e s ” In many countries selective restraints have been put into effect in recent years through “directives” to com mercial banks, as well as through certain informal and vol untary agreements between a country’s monetary authori ties and its credit institutions. These devices often are not easily distinguishable from one another, and their effec tiveness depends to a large extent on the degree of con fidence that central banks enjoy with the financial community and the public at large. “Directives” have taken the form of oral or written statements, appeals, or warnings. Actually, the circum stances have varied in each individual case, as have the tenor and the explicitness of the instructions themselves. Thus, the action on the part of central banks has ranged all the way from expressions of concern over credit develop ments, and mild admonitions that credit trends be watched, to full-fledged agreements with, or outright requests to, the banks either to avoid an increase in, or to reduce, the exist ing level of loans. These “directives” have therefore cov ered a wide range of instructions, and have differed equally widely in the degree of “moral suasion” that they have contained. Aside from being used selectively in order to influence individual credit sectors, this method of control 130 MONTHLY REVIEW, SEPTEMBER 1957 in a few notable cases has also been applied comprehen sively, i.e., to the aggregate of bank loans as such. With reference to specific economic sectors, “directives” have been used in Australia, India, the Netherlands, and South Africa, and in the early postwar period in the United Kingdom. With regard to the total volume of bank credit, such instructions have either been couched in more or less general language or, at the other extreme, have contained clear-cut, well-defined lines of action to be followed. Thus, the broad anti-inflationary measures taken in the United Kingdom in July 1955 included a letter by the Chancellor of the Exchequer to the governor of the Bank of England requesting him to call upon the banks to effect “a positive and significant reduction in their advances”. A similar policy of credit contraction was again urged on the banking community on subsequent occasions. Specific reductions in the aggregate of commercial bank loans outstanding, usually below a key-date level, or the limitation of such loans in terms of a percentage of new deposits, were re quested or agreed upon in Austria, Japan, and Sweden, while in Norway the ceiling for commercial bank credit during 1956-57 was set on the basis of the 1955 amount outstanding. Even where such specific over-all reductions or maxima were recommended, however, an element of selectivity has often been present, certain privileged sec tors being exempted from the ceilings, as in the cases of building loans in Sweden and reconstruction, export, and harvest credits in Austria. As already indicated, the effectiveness of this type of credit control depends perhaps less on the existing economic, financial, and institutional setting than on the prestige and stature enjoyed by the central bank and the degree of cooperation the latter can obtain from the finan cial community. The actual results of the use of directives and informal agreements with the commercial banking system are difficult to appraise in any over-all way. Where the system operates under highly competitive conditions, informal requests by the central bank to restrict credit on a voluntary basis are not likely to be observed generally or very long. As a rule, even where initial response is satisfactory, compliance tends to diminish with the pas sage of time. Moreover, in a period of sharply rising de mand for credit, such controls may be equally difficult to maintain unless reinforced by other measures. With few exceptions, therefore, these instruments have been used only in conjunction with increases in the discount rate and other measures of a quantitative nature, and in many cases are currently serving to supplement and reinforce the more traditional tools. D ir e c t C o n t r o l s O v e r L o a n s and In v estm en ts Apart from the “directives” to commercial banks, there are a few instances of other techniques for regulating commercial bank loans and investments directly. In some Latin American and Asian countries, the central bank can prescribe minimum ratios that the capital and surplus of a commercial bank, and of all commercial banks, must bear to the volume of bank assets or to specific categories of such assets. Such capital requirements against assets are designed to reinforce reserve requirements against deposits. An interesting case of over-all commercial bank credit ceilings is that of West Germany in the early months of 1951. At that time Germany’s position in the European Payments Union was deteriorating rapidly, and the au thorities accordingly took a number of drastic creditcontrol measures, in addition to imposing severe import controls and increased taxation. In particular, they estab lished a new set of “guiding principles” designed to re duce the over-all volume of commercial bank credits. Commercial banks were required to adjust their balances by applying a series of ratios of capital, cash, and other liquid assets to the amounts of credit outstanding.5 While these limits appeared as useful safeguards, they presum ably proved inadequate to reverse the inflationary trends prevailing at the time, and the German authorities re sorted to a direct reduction in the outstanding volume of commercial bank credit to business. Over a period of twro or three months, the banks were required to reduce such credit in accordance with quotas fixed for the various regions of West Germany. The Land central bank for each area apportioned the reduction among the commer cial banks subject to its jurisdiction. This particular Ger man experience is interesting in that it illustrates the use of direct credit controls under conditions of great eco nomic stress, when the usual methods of curbing bank credit expansion, adequate under other circumstances, proved inapplicable. In some Latin American countries and in the Philip pines and South Korea the central bank has authority to fix ceilings on the aggregate outstanding volume of loans, advances, and investments of commerical banks, or to place limits on the increase in the aggregate of such assets in specified future periods of time. Such ceilings or limits may also be applied to individual categories of loans, advances, and investment; and, to the extent that this is done, the controls are selective rather than general. 5 More particularly, the total of short-term credits to business was not to exceed 20 times the commercial bank’s capital and reserves; the total of the current credits and acceptance credits was not to exceed 70 per cent of the deposits, capital, and reserves; the total volume of acceptance credits was not to exceed the bank’s capital and reserves by more than the following ratios: in the case of foreign trade and harvest financing, 7 times; and in the other cases, 3 times. The ratio of ’liquid assets” to deposits was not to be less than 1 to 5, this last pro vision aiming at an improvement in the banks’ liquidity; for this pur pose, “liquid assets” meant cash, balances with the central bank, postal-check balances, bills, and Treasury bills. FEDERAL RESERVE BANK OF NEW YORK 131 objectives of monetary policies. These attempts also seem to suggest the extent to which such countries are search ing for means of adapting credit controls to particular situa tions or economic and institutional settings. In fact, in the countries with less developed monetary and banking sys tems, some of these instruments perform a useful function in view of the lack or inadequacy of general or quantitative credit-control instruments, provided, of course, that the expansion of credit and of the money supply is kept within bounds compatible with a balanced growth of the economy and a sustainable international position. By and large, however, credit controls abroad during recent years have been characterized by the use of a num ber of measures in combination, rather than by reliance upon single techniques. “Directives” to commercial banks and other informal arrangements between a country’s monetary authorities and its credit institutions have some times been used in conjunction with increases in discount rates and other measures of a quantitative nature, thus supplementing or reinforcing the more traditional con trols. Consumer credit control in a number of instances has been established or tightened in conjunction with new measures of general credit control; and other selective credit-control measures have been devised or readapted along with discount rate rises, open market sales, increases in commercial bank cash reserve requirements, and other measures to reduce bank liquidity, thereby helping to pro vide a base for a more effective use of monetary controls in general. This synchronization of monetary credit con trols, in ways that depend on the individual country and particular circumstances, can be illustrated by many ex amples from Western Europe, Latin America, and Asia. Thus, not only has the curbing of excessive credit ex pansion been sought through a combination of measures rather than by the use of a single monetary tool, but actual experience has shown that the various types of monetary controls are by no means mutually exclusive. C o n c l u d in g R e m a r k s Credit restraint be fully effective unless there is The wide range of selective controls, “directives”, and principal reliancecannot upon sufficiently quantitative con direct credit controls abroad may well be regarded as an trols of a traditional type; however,strong in particular circum indication of a need on the part of various foreign coun stances such traditional controls may well be usefully tries to devise new tools in order to help achieve the supplemented by selective and direct credit controls. The 6 See "Monetary Control in a Rapidly Developing Economy: The New Zealand Royal Commission Report”, M onthly Review, October exact mixture will necessarily vary from country to country. 1956. Reference may also be made here to monetary legisla tion passed in certain countries during the early postwar years under which the central bank was given statutory power to regulate directly the loans and investments of individual commercial banks. This power was the out growth partly of wartime regulations and partly of at tempts to coordinate credit restriction with the allocation of industrial materials made necessary by the scarcity of resources. In some cases, the legislation also reflected the trends toward economic planning and government in tervention in business that characterized the immediate postwar years in these countries. Thus, in Australia, under the Banking Act of 1945, the Commonwealth Bank was empowered to “determine the policy in relation to ad vances to be followed by banks” and to “give directions as to the classes of purposes for which advances may or may not be made by banks”. The New Zealand Reserve Bank was given similar power under a wartime regula tion that was continued after the end of the war. In India, the nationalized Reserve Bank was empowered to set the commercial banks’ over-all lending policy as well as the purposes for which loans may be granted. The Bank of England Nationalization Act of 1946, on the other hand, authorized the Bank of England to “request information from and make recommendations to banks”; furthermore, it authorized the Treasury to “issue directions to any bank for the purpose of securing that effect is given to any such request or recommendation”. In England, these statutory powers appear never to have been used; and in countries like Australia and New Zealand, the direct regulation of credit has been largely supplanted by use of the traditional monetary instruments, including discount rate changes, open market operations, and variations in commercial bank reserve requirements.6 In India, on the other hand, the more traditional credit-control instruments as well as direct regulation of credit have been employed. 132 MONTHLY REVIEW, SEPTEMBER 1957 SELECTED ECONOMIC INDICATORS United States and Second Federal Reserve District Item UNITED STATES Production and trade Industrial production*...................................................................... Electric power output* .................................................................. Ton-miles of railway freight*.......................................................... Manufacturers’ sales*1f..................................................................... Manufacturers’ inventories*^......................................................... Manufacturers’ new orders, total*1[............................................ Manufacturers’ new orders, durable goods *^j............................. Retail sales*......................................................................................... Residential construction contracts*............................................... Nonresidential construction contracts*........................................ Prices, wages, and employment Basic commodity prices f .................................................................. Wholesale prices f ............................................................................... Consumer prices f ............................................................................... Personal income (annual rate)*^f................................................... Composite index of wages and salaries*....................................... Nonagricultural employment * ff................................................... Manufacturing employment*f t ................................................ Average hours worked per week, manufacturing f ..................... Unemployment................................................................................... Unemployment J................................................................................. Banking and finance Total investments of all commercial banks................................. Total loans of all commercial banks.............................................. Total demand deposits adjusted................................................... Currency outside the Treasury and Federal Reserve Banks*. Bank debits (337 centers)*.............................................................. Velocity of demand deposits (337 centers)*................................ Consumer instalment credit outstanding f ................................... United States Government finance (other than borrowing) Cash income......................................................................................... Cash outgo........................................................................................... National defense expenditures........................................................ SECOND FEDERAL RESERVE DISTRICT Electric power output (New York and New Jersey)*................... Residential construction contracts*................................................... Nonresidential construction contracts*............................................ Consumer prices (New York C ity)f.................................................. Nonagricultural employment*............................................................. Manufacturing employment*.............................................................. Bank debits (New York City)*.......................................................... Bank debits (Second District excluding New York City)*......... Velocity of demand deposits (New York City)*............................ Department store sales*....................................................................... Department store stocks*.................................................................... 1957 Unit 1956 Percentage change Latest month Latest month from previous from year earlier month July June May July 1947-49 = 100 1947—49= 100 1947-49 = 100 billions of $ billions of $ billions of $ billions of $ billions of $ 1947-49 = 100 1947-49 = 100 1947-49 = 100 1947-49 = 100 1947-49 = 100 billions of $ 1947-49 = 100 thousands thousands hours thousands thousands millions of $ millions of $ millions of $ millions of $ millions of $ 1947-49 = 100 millions of $ millions of $ millions of $ millions of $ 144p — — — — — 16.9p — — 90.2 118.Ip 120.8 345.5p — 52,786?? 16,844p 39.9p 2,687 3,007 72,740p 92,360p 106,570p 31,147p 86,048 150.Op — 3,615 7,092 4,194 144 234 107p 28.4p 54 .Op 27. Ip 13. Ip 16.8p n.a. 267 89.7 117.4 120.2 344.8 n.a. 52,762p 16,915p 40. Op 3,030 3,337 72,010p 93,280p 105,540p 31,089 77,684 145.0 32,344 12,214 7,297 3,474 143 228 102 28.6 53.9 28.4 14.1 16.6 n.a. 260 88.2 117.1 119.6 342.9 155p 52,672 16,946 39.7 2,489 2,715 73,680p 91,180p 104,770p 30,955 85,408 148.1 31,901 7,487 7,017 3,166 136 215 96 26.8 50.0 27.7 14.1 15.9 265 249 88.6 114.0 117.0 325.6 149 51,456 16,468 40.1 2,833 n.a. 72,440 87,140 105,200 30,782 78,323 141.9 30,297 3,701 5,603 3,822 # + 3 + 5 - 1 # - 5 —7 + 1 n.a. + 3 + 1 + 1 # # # # -1 1 -1 0 +- 11 + 1 # -f 11 + 3 + 1 -7 0 - 3 + 21 + 6 + 7 + 1 + 4 +_ 92 - 7 + 6 n.a. -1 1 + 2 + 4 + 3 + 6 + 5 +4- 32 - 1 —5 n.a. # + 6 +j- i1 + 10 + 6 + 8 - 2 + 27 + 10 1947-49 = 100 1947-49 = 100 1947-49 = 100 1947-49 = 100 thousands thousands millions of $ millions of $ 1947-49 = 100 1947-49 = 100 1947-49 -100 — — — 118.4 7,819.8p 2,656.6p 77,614 5,507 193.9 121 136 168 n.a. n.a. 117.9 7,827.6 2,661.6 69,637 4,946 181.7 117 134 156 n.a. n.a. 117.2 7,829.0 2,665.0 73,245 5,393 184.4 115 131 149 207 280 114.6 7,813.0 2,669.2 68,618 5,099 179.8 116 127 + 8 n.a. n.a. + 8 n.a. n.a. + 3 + 11 + 11 + 13 + 8 + 8 + 4 + 7 # # # + 7 + 3 + 1 # # Note: Latest data available as of noon, August 30, 1957. J New basis. Under a new Census Bureau definition, persons laid off temporarily and those p Preliminary. waiting to begin new jobs within thirty days are classified as unemployed; formerly these r Revised. persons were considered as employed. Both series will be published during 1957. n.a. Not available. # Change of less than 0.5 per cent. * Adjusted for seasonal variation. ^ % Revised series. Back data available from the United States Department of Commerce, t Seasonal variations believed to be minor; no adjustment made. ft Revised series. Back data available from the United States Bureau of Labor Statistics. Source: A description of these series and their sources is available from the Domestic Research Division, Federal Reserve Bank of New York, on request.
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