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FEDERAL RESERVE BANK OF NEW YORK

199

The Business Situation

President N ixon’s announcem ent on A ugust 15 of a set
of new economic policies for the country has apparently
provided a significant and welcome boost to confidence in
the nation’s econom ic prospects. Such a gain in confidence
will, if sustained, help greatly in bringing about the
stronger business expansion the President hopes to achieve.
P rior to the P resident’s announcem ent, business devel­
opm ents had continued to attest to the sluggish character
of the recovery. In July, industrial production declined for
the second consecutive m onth as labor contract deadlines
and strikes precipitated decreases in the o utput of steel
and other raw m aterials. M oreover, there was only a small
increase in personal income after m aking allowance for a
special factor that had caused an unusually large rise in
June. In addition, the advance report on retail sales indi­
cated a contraction in July. F urtherm ore, the unem ploy­
m ent rate in August, according to a survey in the second
week of the m onth, rose from 5.8 percent to 6.1 percent,
alm ost back to the recent 6.2 percent high of M ay. One
area of economic strength was residential construction.
H ousing starts increased sharply in July to a figure that
eclipsed the previous record, and building perm its m oved
appreciably higher, suggesting that further gains in starts
m ight be forthcom ing.
It was against the background of generally slow eco­
nomic expansion, accom panied by persistent inflation and
m ounting international financial pressures, th at a basic
change in the approach to achieving both econom ic growth
and price stability was announced by President N ixon in
mid-August. H e used the pow ers available u nder the E co­
nomic Stabilization A ct of 1970 to order a ninety-day
freeze on wages and prices. A surcharge of 10 percent was
im posed on a wide range of products im ported by the
United States. T he convertibility of dollars into gold and
other reserve assets was tem porarily suspended. A nd sev­
eral changes in taxes to stim ulate a m ore rapid expansion
in production and em ploym ent were recom m ended to the
Congress. T hese recom m endations included the elim ina­
tion of the 7 percent excise tax on autom obiles, retro­




active to m id-A ugust; the establishm ent for one year, also
retroactively, of a 10 percent investm ent tax credit on
new m achinery and equipm ent, provided it is A m erican
m ade, to be followed by a perm anent 5 percent credit;
and the bringing forw ard to January 1972 of reductions
in personal taxes previously scheduled to take effect at the
beginning of 1973 through higher standard deductions
and personal exemptions.
P R O D U C T IO N , S H IP M E N T S , A N D IN V E N T O R IE S

T he Federal R eserve B o ard ’s index of industrial pro ­
duction declined by 0.8 percent in July, the second con­
secutive m onthly drop. R educed output of raw m aterials
— notably steel, copper, and coal— accounted for m ost of
this latest decline, with labor disputes playing an im por­
tant role. In the steel industry, production was depressed
as users w orked down the am ple stocks of steel mill pro d ­
ucts that had been accum ulated earlier in the year in antic­
ipation of a strike. M oreover, a num ber of large producers
began to bank their furnaces as the July 31 contract settle­
m ent deadline approached, thereby cutting further into
steel output. A strike in the copper industry significantly
curtailed the output of nonferrous metals, while the rail­
road labor dispute cut progressively into coal production
because of the reduced availability of freight cars. Even
apart from these special situations, industrial production
was distinctly lackluster. T he output of consum er goods
showed essentially no change, while the output of both
business and defense equipm ent declined.
The July decrease in production underscored the con­
tinued slow pace of the current econom ic recovery. In the
eight m onths following N ovem ber 1970, which has been
tentatively designated by the N ational B ureau of E co­
nomic R esearch as the trough m onth of the 1969-70
recession, total industrial production rose only 3.3 percent
even though output had been abnorm ally depressed in the
trough m onth by the G eneral M otors strike. In sharp con­
trast, the gains in industrial output over the first eight

200

MONTHLY REVIEW, SEPTEMBER 1971

Chart I

INDUSTRIAL PRODUCTION IN
FOUR ECONOMIC CONTRACTIONS AND RECOVERIES
Percent

Percent

Note: The business-cycle troughs, as identified by the National Bureau of
Economic Research, are A ugu st 1954, April 1958, February 1961, and
N ovem ber 1970 (tentative).
Source: Board of Governors of the Federal Reserve System.

m onths after the troughs of the three previous postK orean w ar recoveries ranged from 10 to 13 percent (see
C hart I ) . T he limited d ata available for A ugust do not
indicate there was any step-up in production during the
two weeks im m ediately before the P resident’s new eco­
nom ic program was announced.
The policy changes initiated on A ugust 15, however,
will probably have a stim ulating effect on econom ic ac­
tivity, and perhaps m ost im m ediately on the sale and
production of dom estic autom obiles. T here may be a
quickened pace of dem and for autom obiles in general in
response to the proposed elim ination of the excise tax.
Sales may be additionally spurred by the tem porary price
freeze. Beyond this, the A dm inistration’s new econom ic
policies will tend to reduce the prices of dom estic auto­
m obiles relative to prices of im ported cars. T he latter are
now bearing a tem porary surcharge of 6.5 percent in
addition to the regular 3.5 percent duty. (T he surcharge
is not the full 10 percent inasm uch as total im port duties
on any item may not exceed the ceiling prescribed by the
Tariff A ct of 1930, which for autos is 10 percent.) U p­
w ard movem ents in the exchange rates of foreign curren­
cies will also tend to push up the prices of im ported cars.
It does not seem likely, on the other hand, th at the
proposed 10 percent investm ent tax credit will generate
sizable near-term gains in the output of business equip­
m ent. M ost businessm en presum ably will defer any firm
decisions about undertaking additional new investm ents




until the Congress, which reconvened on Septem ber 8,
acts on the President’s recom m endation. M oreover, busi­
ness spending on plant and equipm ent during the
im m ediate future will certainly be tem pered by the rath er
sizable am ounts of excess capacity th at currently exist in
m any industries. In the second quarter, the rate of capacity
utilization in m anufacturing was only 73 percent or well
below the rates that prevailed in 1968, the last full year
of econom ic expansion. T he m ost recent D epartm ent of
Com m erce-Securities and Exchange C om m ission survey
of plant and equipm ent spending intentions underscored
the weakness in the near-term outlook for capital spend­
ing. This survey, which was com pleted too early to be
influenced m aterially by the President’s announcem ent,
showed further cutbacks in plans for 1971, indicating a
rise over 1970 of merely 2.2 percent, com pared with the
4.3 percent increase that had been slated six m onths ago.
However, the fact that the President’s proposal calls for a
10 percent tax credit only until A ugust 1972, and for a
subsequent drop in the rate to 5 percent, provides a spe­
cial incentive for businesses to undertake new capital
spending program s within the period during which the
higher tax credit will be in effect.
T he m ost recent data on business inventories and sales
continue to show im provem ent in the inventory-sales
ratios for m ost sectors. T otal m anufacturing and trade
sales increased in June by $1.4 billion, while inventories
rose by a less than proportionate $0.4 billion.1 Conse­
quently, the inventory-sales ratio for all business fell to
the lowest figure since m id -1966. D ata for both ship­
ments and inventories were som ew hat distorted by the
com pletion of billings in June on a large am ount of aero­
space equipm ent, which reduced reported inventories by
over $500 million while increasing shipm ents by the same
am ount. H ow ever, even after adjusting for this special
factor, there was a decline in the overall inventory-sales
ratio. T o be sure, these adjusted inventory data indicate

1 The Department of Commerce has announced an upward re
vision of $0.8 billion in the gross national product (G N P ) estimat
for the second quarter, reflecting in part the availability of inven
tory spending data for the entire quarter. GNP for the quarter i
now estimated at $1,041.3 billion on a seasonally adjusted annua
rate basis, and the annual rate of real GNP growth is put at 4.
percent rather than 3.7 percent. Net exports, however, are re
ported as having dropped by $6.4 billion (seasonally adjusted ar
nual rate) rather than $4.1 billion, but this downward revisio
was more than offset by upward adjustments in other component
including $0.8 billion in consumption spending, $0.9 billion i
business fixed investment, and $1.0 billion in inventory accumul;
tion. Corporate profits before taxes are shown as rising during tl
quarter by $2.9 billion to $82.0 billion (seasonally adjusted ai
nual rate).

FEDERAL RESERVE BANK OF NEW YORK

a m ore expansionary pace of inventory spending than do
the unadjusted data. A fter the adjustm ent, the book value
of total business inventories shows a rise in June at an
annual rate of $11.3 billion, m ore than double the gain
suggested by the unadjusted figures. This m ore robust
rate of inventory accum ulation exceeded the increases
registered in the three preceding m onths and was well
ahead of the rate of spending in January and February,
when relatively high inventory-sales ratios tended to
dam pen inventory investm ent.
In July, data for the m anufacturing sector alone show
there was a decline in inventories and a relatively greater
decrease in sales. C onsequently, the inventory-sales ratio
rose. H ow ever, after adjusting the previous m onth’s data
for the unusually large aerospace equipm ent billings, the
July decrease in inventories was larger than th at in sales,
and the inventory-sales ratio was virtually unchanged
from the M ay and June levels.
New orders received by m anufacturing industries in
July advanced by $1.0 billion, owing entirely to a 3.3
percent rise in orders for durable goods. H eavier orders for
defense goods, which tend to be especially large in the first
m onth of the fiscal year, accounted for about $500 million
of the overall advance. Sizable gains in new orders were
also recorded in the autom obile, aerospace, and m achinery
industries. Bookings for prim ary metals declined, how ­
ever, largely as a result of the labor contract negotiations
in the copper and rail industries. O n balance, the pattern
of new orders for m anufacturers’ goods has not yet dis­
played the clear and pervasive upw ard thrust that accom ­
panied the other post-K orean w ar recoveries.

201

for which actual construction activity has not yet begun,
indicates th at further gains in housing starts may well be
forthcom ing in the m onths ahead. T he total supply of
living units is being enlarged by continued strength in the
dem and for mobile homes. In June, factory shipments of
mobile hom es were running at a seasonally adjusted
annual rate of 490,000 units, up dram atically from the
369,000 units shipped a year earlier.
T he value of total new construction declined in July
for the first time in twelve m onths. Industrial construc­
tion continued its generally dow nw ard m ovem ent from
the high of O ctober 1969, and com m ercial construction
dropped sharply after a June surge. H ow ever, expendi­
tures on both public construction and private residential
construction showed strong gains. T he near-term outlook
for residential construction has been bolstered, m oreover,
by recent developm ents in the m ortgage m arket that
should have a favorable influence on the supply and cost
of m ortgage credit. Perhaps the m ost im portant of these
developm ents was the sizable decline in interest rates on
corporate bonds in the week following President N ixon’s
announcem ent of the w age-price freeze. If these declines
are at least partially m aintained, existing rates on new

Chart II

PRIVATE HOUSING STARTS AND BUILDING PERMITS
S e a so n a lly a d ju ste d a n n u a l rates
M illio n s of units

R E SID E N T IA L C O N ST R U C T IO N

R esidential construction continued to be an econom ic
bright spot in July, as total private housing starts jum ped
11.2 percent to a seasonally adjusted annual rate of over
2.2 m illion units (see C h art I I ) . A t this rate, starts
exceeded the previous record for a single m onth (in
A ugust 1950) by about 100,000 units. T he strength of
the current housing boom is underscored by the fact th at
the July figure was approxim ately 500,000 units above
the peak level of starts recorded in January 1969 at the
end of two full years of expansion in residential con­
struction. M ost of the July gain reflected an increased
volume of m ultifam ily units. H ow ever, single-family starts
am ounted to 1.2 million units, a relatively high figure by
historical standards. T he seasonally adjusted num ber of
building perm its also soared in July, reaching a record
annual rate of alm ost 2.1 m illion units (see C h art I I ) .
This high level, together w ith a large backlog of perm its




Source: United States Department of Commerce, Bureau of the Census.

M illio n s of units

202

MONTHLY REVIEW, SEPTEMBER 1971

hom e m ortgages will m ake the latter a m ore attractive
investm ent for thrift institutions and other suppliers of
m ortgage credit. F urtherm ore, the A dm inistration indi­
cated in early A ugust th at it would seek to preserve the
7 percent ceiling on G overnm ent-underw ritten mortgages
by allowing the G overnm ent N ational M ortgage A ssocia­
tion (G N M A ) to purchase up to $2 billion in mortgages
at a price not below 95 percent of par. In turn, G N M A
will sell the m ortgages at com petitive rates in the sec­
ondary m arket while absorbing the interest cost differ­
ential by m eans of its special assistance fund. In another
move taken in A ugust to support the flow of funds to the
m ortgage m arket, the F ederal H om e L oan B ank B oard
reduced the liquidity requirem ents of m em ber savings and
loan associations from 7.5 percent to 7.0 percent.
IN C O M E , E M P L O Y M E N T , A N D
CONSUM ER DEM AND

In July, personal incom e declined by $11.0 billion, fall­
ing to a seasonally adjusted annual rate of $859.1 bil­
lion. W hile this decrease reflected prim arily the fact that
personal incom e h ad been tem porarily boosted in June by
an increase in social security paym ents retroactive to the
first of the year, the $2.3 billion rise th at occurred in July
after allowance for this special factor was still relatively
small. T he average m onthly rise betw een D ecem ber 1970
and M ay 1971 had been $5.8 billion. Em phasizing the
underlying weakness of personal incom e in July, total wage
and salary disbursem ents were essentially unchanged, and
in m anufacturing such disbursem ents actually declined by
about $1.1 billion.
In A ugust, the seasonally adjusted unem ploym ent rate
increased to 6.1 percent from the 5.8 percent registered
in July, according to the B ureau of L ab o r Statistics survey
of households, as a rise of 500,000 persons in the civilian
labor force outpaced an advance in em ploym ent of
300,000 persons. This was the second consecutive m onthly
rise in unem ploym ent and brought the rate alm ost back
to the M ay high of 6.2 percent. M ost of the increase
was caused by rising unem ploym ent am ong teen-age and
adult males. T he expansion in unem ploym ent of adult
m en was attributable prim arily to the curtailm ent of p ro ­
duction in the steel industry. N onfarm payroll em ploy­
m ent rem ained essentially unchanged, w ith construction
and m anufacturing showing m inor declines. Em ploym ent
in m anufacturing has been especially w eak during the
current recovery, declining slightly from its N ovem ber
1970 level. In sharp contrast, during the three m ost recent
previous recoveries the num ber of w orkers on m anufac­
turing payrolls over the nine m onths following the




business-cycle trough had risen an average of 4 percent.
R etail sales declined by 0.8 percent in July, according
to the advance report. This drop, which was centered at
nondurables outlets, followed a large increase in retail
activity in June. H owever, the significance of this decline
is questionable in view of the highly tenuous nature of
the prelim inary data. In every m onth of 1971 the advance
report on retail sales has been revised upw ard, frequently
by a significant am ount. W hatever the final reading on
the July data, the near-term course as well as the inter­
pretation of the retail sales figures will in all probability
be substantially affected by the new econom ic policies.
W ith the savings rate at historically high levels, any
bolstering of consum er confidence should have favorable
ram ifications for retail sales. M oreover, tem porary in­
creases m ight develop if purchases of dom estic goods are
accelerated on the expectation th at prices will rise after
the price freeze is term inated. As w ith other m onthly indi­
cators that are stated in dollar term s, however, changes
in m onthly retail sales throughout the price freeze period
will be difficult to interpret relative to recent experience,
during which sizable shares of the increases in dollar vol­
ume reflected simply advances in prices.
PR IC E D E V E L O P M E N T S

T he behavior of prices in the m onths immediately
ahead will of course be dom inated by the wage and price
freeze. W hile it would be prem ature to speculate to w hat
extent the freeze will affect the rate of inflation in the
longer run, the large drop in long-term interest rates in
the days following the President’s A ugust 15 announce­
m ent suggested that the freeze had the effect at least of
tem porarily reducing inflationary expectations. However,
a lasting reduction in the rate of inflation will depend
heavily upon decisions that are yet to be m ade for Phase
Two, the time after the ninety-day freeze. The C ost of
Living Council, which was appointed last m onth by the
President, is currently considering various proposals for the
achievem ent of price and wage stability over the longer run.
The highly inflationary background against which the
freeze was initiated is illustrated by the recent perform ance
of industrial wholesale prices. In A ugust, the index of
these prices rose at a seasonally adjusted annual rate of
6.4 percent, with alm ost all of the increase having taken
place before the price freeze. This huge rise had been
exceeded in July, w hen the index jum ped at an annual
rate of 8.4 percent, a record increase for the last fifteen
years. Industrial prices during the first half of the year
h ad advanced at an annual rate of 4.0 percent, a some­
w hat m ore rapid pace than for 1970 as a whole. In short,

FEDERAL RESERVE BANK OF NEW YORK

despite alm ost two full years of distinctly sluggish activity
in the industrial sector, prices had continued to advance at
inflationary rates th at were w ithout m odern precedent for
a period characterized by such m arked w eakness in de­
m and.
The overall perform ance of the consum er price index
has been m odestly b etter this year than that experienced
in 1970. D uring the first half of the year, this im prove­
m ent had partially reflected declining hom e m ortgage
interest rates. In July, on the other hand, there was a
small increase in m ortgage interest rates; nonetheless, the
consum er price index rise slowed further to a 2.4 percent




203

annual rate. This followed m uch larger increases in the
two preceding m onths. Smaller advances in food, non­
food commodities, and to a less extent service prices all
contributed to the July easing. This substantial slowing,
however, might well have proved tem porary with no price
freeze, in view of the steep rise in wholesale industrial
prices during the preceding several m onths. Increases in
wholesale prices usually affect consum er prices after some
lapse of time. The m id-A ugust freeze may therefore have
prevented the recent advances in wholesale prices from
having as m uch repercussion on consum er prices as would
otherwise have occurred.

TREASURY AND FEDERAL RESERVE
FO R E IG N E X C H A N G E O P E R A T IO N S

The sem iannual report on T reasury and Federal
Reserve foreign exchange operations will appear
in the O ctober issue of this Review . The report
is w ritten by Charles A. Coom bs, Senior VicePresident in charge of the Foreign function of the
F ederal Reserve B ank of New Y ork and Special
M anager of the System O pen M arket A ccount. It
will cover the period M arch to Septem ber 1971.
Exceptional conditions in the foreign exchange m ar­
kets have forced postponem ent of publication.

204

MONTHLY REVIEW, SEPTEMBER 1971

The Money and Bond Markets in August

The financial m arkets staged a dram atic rally in midA ugust in response to President N ixon’s announcem ent of
a basic shift in the n ation’s econom ic policies. Partici­
pants in the bond m arket were particularly encouraged
by the ninety-day freeze on wages and prices as a step
tow ard reducing domestic inflation.
The rally produced a record decline of 54 basis points
in The W eekly B ond B uyer's index of m unicipal bond
yields during the third week of the m onth. Yields on
newly issued high-quality corporate bonds tum bled by as
m uch as 80 basis points, while yields on T reasury securi­
ties of all m aturities also fell rapidly. T hese precipitous de­
clines in yields suggest th at investors were trim m ing the
inflationary expectations that had becom e em bedded in
yield structures. Stock m arkets also reflected the new­
found optimism. O n A ugust 16 alone, the D ow -Jones
average of industrial stock prices rose a record 32.93
points.
The euphoria sustaining the m id-A ugust rally soon
faded, but confidence rem ained strong th at the new pro­
gram had greatly im proved the prospects for declining or
at least steady interest rates in the m onths ahead. O n Sep­
tem ber 2 the B ond B uyer's index of yields on municipals
stood at 5.39 percent, down 66 basis points from the
July 29 figure. On balance, yields on m ost long-term
T reasury bonds fell during A ugust by 28 to 35 basis
points. A t the end of the m onth, yields on T reasury issues
with interm ediate-term m aturities were betw een 85 to 108
basis points below their levels at the end of July and rates
on m ost T reasury bills were 79 to 112 basis points lower.
W hile yields in the capital and G overnm ent securities
m arkets moved sharply lower over the m onth, develop­
m ents in private m oney m arket rates were mixed. Interest
rates on directly placed com m ercial p aper with m aturities
of less than ninety days declined by about 25 basis points,
b u t the offering rate on dealer-placed four- to six-m onth
prim e com m ercial p aper fluctuated within a narrow range.
The F ederal funds rate rem ained steady in the vicinity of
5Vi percent.
A ccording to prelim inary data, the narrow ly defined
m oney supply (M x), adjusted for seasonal variation, in­




creased in A ugust at about a 3Vi percent annual rate, the
smallest percentage gain in seven m onths. M 2, a broader
m easure of the m oney supply, rose in A ugust at a season­
ally adjusted annual rate of approxim ately 5 percent, while
the adjusted bank credit proxy increased by about 11 percent.
THE G O V E R N M E N T SE C U R IT IE S M A R K ET

A cautious atm osphere persisted in the m arket for
U nited States G overnm ent securities during the first half
of August. M arket participants were apprehensive over the
continued evidence of inflation and the increased pres­
sure on the dollar in foreign exchange m arkets. T here
was concern that a rise in the prim e rate and a firm­
ing in m onetary policy lay ahead. M arket sentim ent
changed dram atically at m idm onth, however, when Presi­
dent Nixon m ade his announcem ent of a m ajor shift
in the nation’s dom estic and international econom ic poli­
cies. Investors responded optim istically to the A dm in­
istration’s program for a wage and price freeze and
were further encouraged by the President’s action to
im prove the international com petitive position of the dol­
lar. Yields on G overnm ent securities of all m aturities
plunged in the wake of the P resident’s announcem ent, as
many concluded th at his program m ight foster a decline in
interest rates during the next several m onths. Prices fluc­
tuated thereafter as m arket participants began to assess the
longer range im plications of the new policies, but bidding
in the A ugust 31 auction of $1.25 billion of a 6V4 percent
five-year tw o-m onth T reasury note was aggressive.
There was little change in yields on coupon securities
during the early p art of A ugust, when a m ood of appre­
hension continued to prevail in the m arket. O n A ugust 5,
the T reasury auctioned $2.5 billion of new 6 V2 percent
eighteen-m onth notes, which covered the attrition from
an A ugust refunding and raised about $1.1 billion of new
cash. Bidding in the auction resulted in an average issuing
price equivalent to a 6.54 percent yield. T he auction
elicited m oderate interest from banks, which were per­
m itted to pay for 50 percent of the awards by credits to
their T reasury T ax and L oan A ccounts. T ow ard the end

FEDERAL RESERVE BANK OF NEW YORK
Table I
AVERAGE ISSUING RATES*
AT REGULAR TREASURY BILL AUCTIONS
In percent

Weekly auction dates— August 1971
Maturities

2

August
9

August
16

August
23.

August
30

5.273
5.618

5.372
5.770

4.921
5.202

4.747
4.860

4.549
4.771

August

Three-month
Six-month ..

Monthly auction dates— June-August 1971

Nine-month
One-year . . .

June
24

July
27

August
24

5.425
5.567

5.944
5.953

5.090
5.126

f 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 m aturity. Bond yield
equivalents, related to the amount actually invested, would be slightly higher.

of the second week of the m onth, yields on coupon securi­
ties drifted lower. This decline was m ainly a result of
professional dem and and System purchases. Light dealer
inventories at the start of the week created an excellent
technical position, b u t investors rem ained very cautious.
W hen the m arket opened on M onday, A ugust 16, in­
vestors responded enthusiastically to the President’s an­
nouncem ent of the evening before. Yields on coupon
securities fell sharply during the m orning hours. Trading
was extrem ely active as participants scram bled to cover
short positions. A lthough investor dem and contracted at
m idday, yields edged upw ard only slightly. A fternoon
trading was less hectic, and yields fluctuated som ewhat
above the low levels prevailing during the m orning. The
following day, however, yields dropped sharply again as
the rally continued despite occasional profit taking. O ver
this dram atic two-day period, yields on long-term T reasury
bonds declined by about 20 basis points while yields on
interm ediate-term coupon issues plunged about 65 basis
points.
D uring the rem ainder of the m onth, yields on coupon
securities fluctuated over a wide range. T he T reasury’s
announcem ent on A ugust 25 that it would auction $1.25
billion of a new 6 lA percent five-year tw o-m onth note on
A ugust 31 prom pted an initial rise in yields. H ow ever,
the weakness was short-lived; m any participants expected
that bidding for the new notes w ould be strong, since the
size of the financing was small and banks would be able




205

to pay for the issue by crediting their T reasury T ax and
L oan A ccounts. The notes were subsequently auctioned
at an average issuing price equivalent to a 5.98 percent
yield. O ver the m onth as a whole, yields on interm ediateterm T reasury securities declined by 85 to 108 basis
points while yields on m ost long-term bonds fell by 28 to
35 basis points.
Investor caution and a strong technical position also
influenced the T reasury bill m arket in early August. R ates
on Treasury bills were little changed during the first wreek
of the m onth and trended m oderately lower over the sec­
ond week. Investor caution over the interest rate outlook
and concern over the growing pressure on the dollar led to
a steady dem and for shorter m aturities, and rates on bills
were also pushed dow nw ard as foreign central banks
invested a large volume of dollars acquired in exchange
operations.
T he President’s A ugust 15 announcem ent elicited a
response in the T reasury bill m arket th at was m uch the
same as the response in the m arket for coupon issues.
R ates on outstanding bills declined sharply during the
early trading hours of M onday, A ugust 16. M any p a r­
ticipants viewed the rate levels reached in the m orning as
unrealistically low, and bidding in the regular weekly bill
auction in the afternoon was hesitant. N onetheless, reflect­
ing the steep rate declines in outstanding issues, the aver­
age issuing rates for the new three- and six-m onth issues
were set at 4.92 percent and 5.20 percent, respectively, 45
and 57 basis points below the levels established for com ­
parable issues in the preceding week’s auction (see Table
I ) . Rates on outstanding bills plunged sharply again on
Tuesday, and fluctuated over a wide range during the re­
m ainder of the m onth. Foreign dem and continued and, in
addition, dealers rebuilt their depleted inventories. By the
end of A ugust, rates on m ost issues were 79 to 112
basis points lower than at the beginning of the m onth.
The large foreign dem and for bills that contributed to
this dram atic decline in A ugust m aterialized as a re­
sult of the massive flow of dollars to foreign institutions
during the period, with some of these dollar balances being
channeled into the bill m arket for short-term investm ent
purposes. M arketable U nited States G overnm ent securi­
ties held in custody by the Federal Reserve Banks for
foreign and international accounts rose to $20.0 billion
on A ugust 25, a gain of alm ost $1.6 billion in three weeks.
O TH ER S E C U R IT IE S M A R K E T S

President N ixon’s m idm onth announcem ent triggered
a dram atic and in some ways unprecedented rally in the
corporate and tax-exem pt bond m arkets. Indeed, in the

MONTHLY REVIEW, SEPTEMBER 1971

206

days im m ediately following the President’s statem ent the
declines in some interest rates w ere the largest ever re­
corded over such a short interval, with the returns on
som e securities being pushed dow n to the lowest levels in
alm ost four m onths. A fter a few days, however, investor
enthusiasm w aned som ew hat and rates retraced p art of
the declines recorded earlier. L ate in the m onth, rates de­
clined again, leaving yields at the end of A ugust far below
their end-of-July levels.
P rior to the P resident’s announcem ent, yields on cor­
porate bonds had been little changed in quiet trading. The
highlight of this period occurred on A ugust 3, w hen the
$100 million of A aa-rated Indian a Bell Telephone C om ­

pany debentures was m arketed at an 8.20 percent yield.
This yield provided about the same return as th at on a
sm aller telephone issue m arketed a week earlier, b u t 30
basis points more than another telephone issue of com para­
ble size sold on July 13. The debentures received an enthu­
siastic response from institutional investors and sold
quickly. O ther newly issued corporate securities also sold
well during the first half of August, aided by the relatively
light schedule of new financing. O n A ugust 10, a $60
million A aa-rated Consum ers Pow er C om pany issue was
m arketed at an 8 Vs percent yield. T he issue m et a w arm
reception and was alm ost entirely sold at the end of the
day. A $175 million issue of A aa-rated International

Chart I

SELECTED INTEREST RATES
June-August 1971

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

July

A u gu st

B O N D M A RK E T YIELD S

June

July

A u gu st

Note-. D a ta are show n for b u sin e ss d a y s only.
M O N E Y M A R K ET RATES Q U O T E D : Bid rates for three-m onth Euro d o lla rs in Lo ndon; o fferin g
rates for directly p la c e d fin an ce co m p a n y pap er; the effective rate on F e d e ral fun ds (the
rate most re p re sentative of the tra n sa c tio n s executed); clo sing b id rates (quoted in terms
o f rate of discount) on n ew est o u tsta n d in g three-month T reasury b ills .
B O N D M A R K E T YIELDS Q U O T E D : Yie ld s on new A a a -r a t e d p u b lic utility b o n d s (arrows point
from u nd erw riting syn dicate reoffering y ie ld on a give n issue to m arket yie ld on
the sam e issue im m ed iate ly after it h a s been released from syn dica te restrictions);




d a ily a v e r a g e s o f yie lds on s e a s o n e d A a a -ra t e d co rp o rate b o n d s ; d a ily a v e r a g e s o f yie lds
on lo n g -term G o v e rn m e n t securities (bon d s due or c a lla b le in ten y e a rs or more) a n d on
G o ve rnm e nt securities due in three to five y e a r s , com puted on the b a s is of clo sin g bid
prices; T h u rsd a y a v e r a g e s of y ie ld s on twenty s e a so n e d twenty -ye a r tax-exem pt b o n d s
(carrying M o o d y 's ra tin g s of A a a , A a , A, a n d B aa).
Sources: Fede ral R eserve B ank o f N e w York, B o ard of G o v e rn o rs of the F e d e ra l Reserve System ,
M o o d y 's Investors Se rvice, a n d The W e e k ly Bond B uy er.

FEDERAL RESERVE BANK OF NEW YORK

B ank for R econstruction and D evelopm ent bonds was
m arketed the following day at the same yield. R esponse
to this offering was also favorable.
O n M onday, A ugust 16, corporate bond yields plum ­
meted, and they continued to fall the following day, as
investors responded to the President’s new econom ic pro­
gram with enthusiasm . M oody’s index of yields on A aarated seasoned corporate bonds plunged 27 basis points
over this tw o-day period to 7.44 percent (see C hart I ) .
This was the lowest level in over three m onths. The rally
encouraged underw riters to offer on A ugust 17 a Cin­
cinnati Bell Telephone C om pany issue rated A aa and
priced to yield 7.40 percent, 80 basis points below the
similarly rated Ind ian a Bell debentures m arketed on
August 4. D espite the aggressive pricing, 95 percent of
the $50 m illion issue was reported sold on the first day.
It appeared, however, that a substantial portion of the issue
had been purchased by dealers anticipating still further
price increases. As the third week of the m onth drew to a
close, investor resistance started to develop in the corporate
m arket and this issue was still not entirely sold.
Investor enthusiasm dam pened further on M onday,
A ugust 23, w hen the Federal N ational M ortgage A sso­
ciation (F N M A ) announced th at it w ould sell $1 billion
of debentures on Thursday of th at week, the biggest
F N M A offering ever. O n th at same M onday, a $60 m il­
lion A aa-rated B altim ore G as and Electric C om pany issue
was m arketed at a yield of 7.52 percent. Investor response
to this offering was poor, and less than 25 percent of the
issue was sold the first day. This prom pted underw riters
to offer on the next day a $100 million A aa-rated Southern
Bell Telephone C om pany debenture issue at a yield of
7.60 percent, up 20 basis points from the C incinnati Bell
issue m arketed on A ugust 17. D espite the increase in
yield, this issue also m et first-day buyer resistance. Sales
began to pick up tow ard the end of the m onth, however,
after several m ajor banks announced reductions in their
interest charges on instalm ent and m ortgage loans. By the
end of A ugust, the Southern Bell Telephone debentures
were entirely sold, although approxim ately 5 percent of
the Cincinnati Bell T elephone issue and 40 percent of the
Baltim ore Gas and Electric C om pany issue were still in
syndicate hands.
Yields on m unicipal bonds rem ained steady over the
first half of A ugust and then dropped sharply after the
Presidential announcem ent. The W eekly B o n d B uyer's
tw enty-bond index of m unicipal bond yields was illustra­
tive of these yield m ovem ents, fluctuating w ithin 4 basis
points over the first tw o weeks of the m onth and then
plunging a record 54 basis points to 5.49 percent on
A ugust 19 (see C hart I ) . T he decline brought this index




207

to its lowest point in alm ost four m onths. Yields on some
individual newly issued securities showed even m ore spec­
tacular declines. O n A ugust 18, for instance, Tulsa, O kla­
hom a, aw arded $16 m illion of A -rated bonds at a net
interest cost of 4.78 percent. U nderw riters offered the
securities to the public the same day to yield from 3.10
percent on those m aturing in 1973 up to 5.40 percent on
those com ing due in 1996. By com parison, another
A -rated m unicipal bond issue had been m arketed on
August 10 with yields of 3.70 percent to 6.40 percent for
similar m aturities. D espite the lower yields of 60 to 100
basis points on the later securities, investors responded
favorably. D uring the rem ainder of the m onth, yields on
m unicipal bonds fluctuated widely. O n Septem ber 2 the
B ond B uyer's tw enty-bond index stood at 5.39 percent,
down 66 basis points from July 29.
A series of m easures taken in A ugust to keep down
rates on m ortgages, particularly those on hom e mortgages,
should help support prices of corporate and m unicipal
securities. E arly in the m onth, the Federal G overnm ent, in
a move designed to hold the ceiling rate on subsidized
mortgages at its current level of 7 percent, announced that
it would allow the G overnm ent N ational M ortgage A sso­
ciation (G N M A ) to purchase up to $2 billion in m ort­
gages at a discount. In turn, G N M A would sell the
mortgages in the secondary m arket at com petitive rates
while absorbing the interest cost differential by means of
its special assistance fund. L ater in the m onth, the F ed ­
eral H om e L oan B ank B oard reduced the required liquid­
ity ratio at m em ber institutions to free additional funds
for mortgages. Since m ortgages com pete with corporate
and m unicipal bonds for funds, these steps to hold down
mortgage rates will also tend to reduce upw ard pressure
on bond rates.
A n interesting developm ent in the tax-exem pt m arket
during A ugust was the reduction in the size of a New
Y ork housing agency issue as a result of the A dm inistra­
tion’s freeze on prices. T he New Y ork agency had
originally planned to offer $166 m illion w orth of bonds
on M onday, A ugust 16, b u t delayed the offering to
assess the im pact of the President’s program on the credit
m arkets. The issue was finally m arketed later in the week,
but the am ount of the financing was reduced by about
$39 million. R eportedly, the reduction was m ade because
eight of the agency’s housing projects w ould have required
increased rentals and, therefore, had to be postponed.
THE M O NEY M ARKET

R ate trends were mixed in the m oney m arket in A ugust,
with some rates rising, some fluctuating narrow ly, and

208

MONTHLY REVIEW, SEPTEMBER 1971

others declining. T he average effective Federal funds rate
advanced to 5.56 percent (see C hart I ) , up 25 basis points
from July’s average. Reflecting the disturbance in the inter­
national currency m arkets, three-m onth E uro-dollar rates
soared to 10 percent on A ugust 17 as participants scram ­
bled to liquidate dollar claims and to borrow dollars
for conversion into other currencies. A t the close of the
m onth, this rate stood at 9 percent, up 2%6 percentage
points from the end of July. O n A ugust 3, a m edium ­
sized D etroit bank raised its prim e rate by V2 percentage
point to 6 V2 percent, and late in the m onth a small St.
Louis b ank cut its prim e rate to 53A percent. H owever,
m ajor m oney m arket banks held their prim e lending rates
at 6 percent. T he offering rate on dealer-placed four- to
six-m onth prim e com m ercial pap er and bid rates on
ban k ers’ acceptances fluctuated in a narrow range. O n
the other hand, interest rates on directly placed com m er­
cial p ap er with m aturities of less than ninety days declined
by about 25 basis points over the m onth.
T he firm pressure on m em ber b an k reserve positions
th at had em erged in July was m aintained in A ugust as
net borrow ed reserves averaged $612 m illion (see Table
I I ) , little changed from the net reserve position that pre­
vailed in July. M em ber bank borrow ings dropped some­
what below their July average during the first two weeks
of A ugust, but then rose sharply during the third state­
ment week. F o r the m onth of A ugust as a whole, b o r­
rowings averaged $827 million, down $3 m illion from
the average in July. As a result of this decline in bor­
rowings and a $22 million fall in nonborrow ed reserves,
total m em ber b ank reserves decreased by $25 million, be­
fore seasonal adjustm ent. H ow ever, because bank reserves
are typically characterized by a fairly large seasonal decline
in A ugust, m em ber bank nonborrow ed and total reserves,
adjusted for seasonal variation, rose rapidly after declin­
ing substantially the previous m onth.
As for the m onetary aggregates, prelim inary data in­
dicate th at the grow th in M x slowed to a seasonally ad­
justed annual rate of approxim ately 3Vi percent in August
(see C hart I I ) . T he gain for the m ost recent three m onths
thus was only about IV 2 percent, down from an increase of
11.6 percent for the three m onths ended in July. T he growth
in M-, continued to slacken, with the A ugust increase esti­
m ated at a 5 percent seasonally adjusted annual rate.
H ow ever, there w ere very large increases in A ugust in
two categories of deposits th at are not included in either
M x or M 2. G overnm ent deposits at m em ber banks rose
rapidly, largely reflecting extensive purchases of Treasury
nonm arketable certificates of indebtedness by foreign
central banks, and large negotiable certificates of deposit
at m em ber banks also grew at a rapid pace. As a result,




the adjusted ban k credit proxy, which includes these de­
posits, increased at a seasonally adjusted annual rate of
approxim ately 11 percent in A ugust, the largest percentage
gain since F ebruary and a rate well in excess of the ex-

Table U
FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, AUGUST 1971
In m illions of dollars; (+ ) denotes increase
(— ) decrease in excess reserves

Changes in daily averages —
week ended

Net
changes

Factors
August
4

August
11

August

IS

August
25

“ M arket” factors

Member bank required reserves ...................
Operating transactions (subtotal) ..............
Federal Reserve f l o a t ...................................
Treasury operations* ...................................
Gold and foreign a c c o u n t...........................
Currency outside banks .............................
Other Federal Reserve liabilities

+
—
—
+
—
—

— 126
Total “ market” factors .........................

—

3

96
99
152
266
37
51

+
—
—
—
—
—

157
392

— 77
+ 68
226
4- 125
— 121
— 372

+
—
+
—
—

— 66

4 - 212

— 14

+

6

— 235

—

9

4 - 254

+

7

-)- 116

— 33

— 103

4 - 292

4 - 272

- f 101
— 3

-}- 50
— 5

+ 84
— 2

+ 397

40
— 8
— 14
+ 219
4 35

— 49
— 4
— 25
— 171
4 - 32

— 157
— 10
— 18
4 - 587
— 213

— 101
—
— 10
— 409
- 318

— 22
— 67
4 - 226

+ 370

— 172

- f 271

— 434

4 - 35

- f 367

— 407

+ 262

— 180

4- 42

66

17
81
161

+

360
106
26
113
8
3

+ 536
— 529
+ 34
+ 261
— 247
— 581

Direct Federal Reserve credit
transactions

Open market operations (s u b to ta l)..............
Outright holdings:
Treasury securities ............ ......................
Bankers’ accep tan ces...............................
Repurchase agreements:
Treasury securities ...................................
Bankers’ acceptances .............................
Federal agencv obligations ...................
Member bank borrowings ...............................
Other Federal Reserve assetst.......................
Total

............................................................

Excess reserves

.......................................

+

+

6

—

632
4

— 267

— 464

Monthly
averages

Daily average levels

Member bank:

Total reserves, including vault cash............
Required reserves .............................................
Excess reserves .................................................
Free, or net borrowed ( —), reserves..........
Nonborrowed reserves .....................................
Net carry-over, excess or deficit ( — ) § ___

30,894
30,460
434
764
— 330
30,130
18

30,330
30,303
27
593
— 566
29,737
230

30,669
30,380
289
1,180
— 891
29,489
79

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,
i Average for four weeks ended August 25.
§ Not reflected in data above.

30,129
30,020
109
771
— 662
29,358
135

30,506$
30,291$
215J
827$
— 612$
29,679i
116$

FEDERAL RESERVE BANK OF NEW YORK

Chart II

CHANGES IN MONETARY AND CREDIT AGGREGATES
S e aso nally adjusted annual rates
Percent

Percent

I A ugust 1971
Note: D ata for August 1971 are preliminary.
M l = Currency plus adjusted dem and deposits held by the public.
M 2 = M l plus commercial bank savings and time deposits held by the public, less
negotiable certificates of deposit issued in denominations of $100,000 or more.
Adjusted bank credit proxy = Total member bank deposits subject to reserve
requirements plus nondeposit sources of funds, such as Euro-dollar borrowings
and the proceeds of commercial paper issued by bank holding companies or
other affiliates.
Source: Board of Governors of the Federal Reserve System.

pansion of both M x and M 2. In each of the four preceding
m onths, the expansion of the proxy had been quite m odest
relative to the m oney supply m easures.
Com m ercial bank loans rose substantially in August,
with the increase at least partly related to the interna­
tional currency crisis. M ost of the rise occurred during
the third statem ent week of the m onth, im m ediately fol­
lowing President N ixon’s statem ent concerning the tem ­
porary suspension of the convertibility of the dollar into
gold. D uring th at week, business loans at weekly reporting
banks, including loans sold to affiliates, clim bed by
$799 million, contrasting w ith the $277 m illion decline
registered over the com parable period in 1970. A lm ost half
of the increase was in bankers’ acceptances, m any of
which were apparently related to foreign transactions,
while loans to foreign industrial and com m ercial busi­
nesses accounted for alm ost one quarter of the gain.
Borrowings at weekly reporting banks by foreign com ­
mercial banks also jum ped th at week by $700 million.
Presum ably, foreign corporations and banks borrow ed
dollars to exchange them for other currencies in anticipa­
tion of a depreciation of the dollar in foreign exchange
m arkets. A similar surge in com m ercial bank loans to for­
eigners occurred during the last m ajor currency crisis in
May.

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209

MONTHLY REVIEW, SEPTEMBER 1971

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(1970) by Thomas O. Waage. 48 pages. A comprehensive discussion
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