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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. Subscriptions to the m o n t h l y r e v i e w are available to the public w ithout charge. A dditional copies of recent issues m ay be obtained from the Public Inform ation D epartm ent, Federal Reserve B ank of N ew Y ork, 33 L iberty Street, N ew Y ork, N .Y . 10045. Persons in foreign countries m ay request th a t copies of the m o n t h l y r e v i e w be sent to them by “air m ail-other articles” . T h e postage charge am ounts to approxim ately half the price of regular air m ail and is payable in advance. R equests for this service and inquiries about rates should be directed to the Public In form ation D epartm ent, Federal R eserve B ank of N ew Y ork, 33 Liberty Street, New Y ork, N .Y . 10045. 209 MONTHLY REVIEW, SEPTEMBER 1971 Publications of the Federal Reserve Bank of New York The following is a selected list of this Bank’s publications, available from our Public Information De partment. Except for periodicals, mailing lists are not maintained for these publications. Delivery takes two to four weeks. Orders must be prepaid if charges apply. The first 100 copies of our “general” publications are free. Additional copies for classroom use or train ing are free to schools, including their bookstores, and commercial banks in the United States. (Classroom and training copies will be sent only to school and commercial bank addresses.) Others are charged for copies in excess of 100. Single copies of our “special” publications are free to teachers, commercial bankers, and libraries (pub lic, school, and other nonprofit institutions) in the United States and to domestic and foreign government offi cials, central bankers, and newsmen. Additional copies for classroom use or training are available to these groups (including school bookstores) at our educational price. (Free and educational-price copies will be sent only to school, business, or government addresses.) Others are charged the full price for each copy. G ENERAL PU B L IC A T IO N S (1970) by Thomas O. Waage. 48 pages. A comprehensive discussion of the roles of money, commercial banks, and the Federal Reserve in our economy. Explains what money is and how it works in a dynamic economy. (15 cents each in excess of 100 copies) m o n e y : m aster or se r v a n t ? o p e n m a r k e t o p e r a t i o n s (1969) by Paul Meek. 48 pages. A basic explanation of how the Federal Reserve uses purchases and sales of Government securities to influence the cost and availability of money and credit. Recent monetary actions are discussed. (11 cents each in excess of 100 copies) p e r s p e c t i v e . Published each January. 9 pages. A brief, nontechnical review of the economy’s per formance and the economic outlook. Sent to all Monthly Review subscribers. (6 cents each in excess of 100 copies) SPE C IA L PU B L IC A T IO N S e s s a y s i n d o m e s t i c a n d i n t e r n a t i o n a l f i n a n c e (1969) 86 pages. A collection of nine articles dealing with a few important past episodes in United States central banking, several facets of the relationship between financial variables and business activity, and various aspects of domestic and international finan cial markets. (70 cents per copy; educational price: 35 cents) e s s a y s i n m o n e y a n d c r e d i t (1964) 76 pages. A collection of eleven articles on selected subjects in banking, the money market, and technical problems affecting monetary policy. (40 cents per copy; educational price: 20 cents) t h e v e l o c i t y o f m o n e y (1969) by George Garvy and Martin R. Blyn. 116 pages. A thorough dis cussion of the demand for money and the measurement of, influences on, and the implications of changes in the velocity of money. ($1.50 per copy; educational price: 75 cents) c e n t r a l b a n k c o o p e r a t i o n : 1924-31 (1967) by Stephen V. O. Clarke. 234 pages. A documented discussion of the efforts of American, British, French, and German central bankers to reestablish and main tain international financial stability between 1924 and 1931. (First copy free; educational price: $1) (1966) by George Garvy. 167 pages. A re view of the characteristics, operations, and recent changes in the monetary systems of seven communist countries of Eastern Europe and the steps taken toward greater reliance on financial incentives. (First copy free; educational price: 65 cents) m o n ey , b a n k in g , and c r e d it in ea ster n eu r o pe