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M ONTHLY JLV1K J I N B o o c l i m l L I M — FEDERAL RESERVE BANK Of CLEVELAND — e v c IN THIS e u / ISSUE Towards a M o re Stable M on ey Supply . 3 Higher Expense Ratios in Agriculture . . 1 0 S e frte n t& e n 1954 National Business C o n d i t i o n s ..............14 Announcement...................................15 i------- “I Billions o f Dollars I 1 DEMAND DEPOSITS * (U.S.) NOT SEASONALLY ADJUSTED SEASONALLY ADJUSTED ♦Other than inter-bank and U. S. Govern ment, less cash items in process of collection. 1947 1948 1949 1950 Demand deposits, the principal part of the active money supply, rose during the recession period of 195354. That marks a contrast with the _ decline in demand deposits which occurred during 1948-49, as in most previous recession periods. < 1951 1952 1953 1954 Additional copies of the M ONTHLY BU SIN ESS REVIEW m ay be obtained from the Research D e partment, Federal Reserve Bank of Cleveland, Cleveland 1, Ohio. Permission is granted to repro duce any material in this publication. Towards a More Stable Money Supply n u p w a r d trend of the money supply . from mid-1953 to mid-1954, as contrasted with its usual downward movement during recession, suggests that the money supply may have become more “ recession-proof” .1 The increase in the money supply during this period, even though small, has been a stabilizing element in the economy. Part of the explanation of the above de velopment is to be found in a combination of three structural factors: (1) a change in the debt structure of the country, particularly as a result of World War I I ; (2) resultant cyclical shifts in the composition of bank as sets as between public and private debt; and (3) a long-run change in the composition of bank loans. The combined impact of these factors has tended to create a setting which has enhanced the effectiveness of monetary policy in maintaining relative monetary sta bility under the conditions of a mild business recession. Attention is given below to the significance of such structural developments, rather than to monetary policy as such, or to the inter action of policy and structural change. A Meaning of “ Money S u p p l y The most useful definition of the money supply de pends on the type of problem being analyzed.2 When a barometer of private spending po tential is sought, “ adjusted” demand de posits plus currency outside banks seems to be the most significant definition. Unless 1 Mid-1953 to mid-1954 represents a highly tentative dating of the approximate terminal points of the most recent recession. 2 One of the main questions involved in the definition of the money supply is whether or not time deposits should be included. In relating changes in total assets of the banking and monetary system to changes in total liabil ities, all demand and time deposits would be included in liabilities, along with currency. Time deposits are part of the banking mechanism, and their volume is partly a cause and partly an effect of credit creation. otherwise noted, this is the meaning of “ mon ey supply” that will be used below. a “ Adjusted” demand deposits exclude sev eral items from total demand deposits: (1) inter-bank deposits, on the grounds that such funds are not immediately available for spending by the public; (2) deposits of the U. S. Government, on the assumption that the rate of Federal spending is not as de pendent on existing cash balances as is the case with the general public; and (3) cash items in process of collection, in order to avoid double counting of deposits. The re sultant amount—adjusted demand deposits— thus consists of checking accounts of indi viduals, business firms, and state and local governments, plus certified and officers’ checks outstanding. Adjusted demand depos its plus currency outside banks is roughly synonymous with the “ active, privately-held money supply” , although the sum includes a small amount of demand deposits owned by state and local governments. Demand deposits are the principal compo nent of the money supply as here defined; they constitute about four-fifths of the total, with currency outside banks accounting for the balance.3 The annual rate of turnover of demand deposits even at banks outside the major financial centers is as high as twenty times a year; the rate of turnover is much higher at financial centers. Available evi dence indicates that time deposits, on the contrary, turn over about once a year on the average. Thus the behaVior of the two types 3 It is estimated that 85-90% of all money payments are made by checks drawn on demand deposits. These fac tors, together with the others mentioned above, indicate the importance of credit-granting activities of commer cial banks. Demand deposits, as the bulk of the effective money supply, fluctuate largely in keeping with expansion or contraction in the loans and investments of commer cial banks. 3 of changes in all other components.5 Adjusted demand deposits plus currency outside banks, as the active money supply, will be singled out here as the resultant of all other assets and liabilities. Changes in Factors Bearing The two charts indicate that the war-time O n Money Supply expansion in the money supply was due al most entirely to an increase in bank holdings The first pair of charts depicts by means of U. S. Government securities. Conversely, of shaded areas the consolidated assets and during the expansion phases of the postwar liabilities of banks and the monetary sys period, the rise in the money supply resulted tem, from 1940 to 1954.4 The data portrayed principally from the fact that loans more bring together all the factors operating to than doubled, although U. S. Government produce changes in the money supply. Since security holdings were declining. total assets obviously must be equal to total Changes in the factors affecting the money liabilities, changes in any one component in supply from mid-1953 to mid-1954 can be a given period can be viewed as the result described as follows: to tal assets rose by $9.9 In the consolidated assets of banks and the monetary system, rising billion, but $8.8 billion loans have eharaeteriied the entire postwar period, Including the ’S3of this was absorbed by '54 recession; the postwar trend toward a decline in holdings of U. S. an increase in liabilities securities was reversed during 'S3-'54. other than the active money supply. The re Billions TOTAL ASSETS sidual increase in liabil o f Dollars of Banking and M onetary System ities, $1.1 billion, repre sents the i n c r e a s e in adjusted demand depos its plus currency out 200 side banks. The net increase in U.S. GOVT. SE C U R IT IE S assets of banks and the H E LD BY F.R. B A N K S monetary system from A N D OTHER mid-1953 to mid-1954 MONETARY 150 A G E N C IE S was compounded of a $4 billion rise in loans, a $4.6 billion rise in holdings of U. S. Gov ernment s e c u r i t i e s , a 100 $1.7 billion rise in other securities, and a decline of deposits is basically different, explaining the exclusion here of time deposits from the “ active money supply” 1940 1942 4 1944 1946 1948 1950 1952 195 4 4 Data from “ Consolidated Con dition Statement of Banks and the Monetary System” , as re ported monthly in the Federal Reserve Bulletin. The statement includes all commercial and savings banks, Federal Reserve Banks, Postal Savings System, and Treasury currency funds. On the chart, amounts are p lotted qu arterly beginning with 1948. Data for 1939 to 1944 are available only at year end, and from 1945 to 1947 only semi-annually. 5 See page 5. of $0.4 billion in gold and Treasury cur rency. The increase in liabilities, other than the active money supply, consisted of a $5 billion rise in time deposits, a $3 billion rise in U. S. Government balances and foreign deposits, and an increase of $0.8 billion in capital and miscellaneous accounts. Thus, from mid-1953 to mid-1954, the growth of the active money supply resulted mainly from nearly equal increases in loans and U. S. Government securities that were re flected only in part by increases in liabilities other than adjusted demand deposits and currency — i.e., mainly by time and U. S. Government deposits. Historical Causes of Unstable Money Supply The traditional view that the money sup ply is “ inherently unstable” was based on the following reasoning: The extension o f loans by commercial banks results in the creation o f demand deposits, while a net reduction o f loans brings about deposit contraction. The demand for loans will vary with the level o f business conditions, and rising activ ity will bring forth new loans, thus expanding deposits. The increase in the money supply will result in larger expenditures, causing an upward spiral in business activity until some sort o f crisis is reached. Then declining production and employment will be aggravated by a contraction o f bank loans and deposits. As the money sup ply declines, expenditures will be reduced still further in a continuing downward spiral. During the postwar period, the principal increases in liabilities have been in demand and time deposits; the latter continued to rise sharply during the '53-54 recession. Such a line of thought has been at the center of the belief that the money supply is inher ently unstable and fluc tuates in a manner which permits and re inforces cyclical swings in economic a c t i v i t y . That view has been sup ported by considerable h i s t o r i c a l experience. As an extreme example, from mid-1929 to mid1933, commercial bank loans declined by $19.4 billion, or 54 percent. Although this decline was partially offset by 5 All the asset items can be viewed as factors, an increase in which produces an increase in adjusted demand deposits plus currency outside banks. Similarly, all liability items ex cept adjusted demand deposits and currency outside banks can be viewed as factors, an increase in which produces a decrease in the active money supply. Thus, between any two dates, adjusted demand de posits plus currency outside banks will vary inversely with changes in other liabilities and will vary directly with changes in assets. All factors produc ing a change in the money supply can thereby be identi fied. 1940 1942 1944 1946 1948 1950 1952 1954 *Other than interbank and U. S. Government, less cash items in process of collection. 1929 NET PUBLIC A N D LO A N S A N D IN VESTM EN T OF PRIVATE DEBT C O M M E R C IA L BANKS 1939 1945 1953 1929 1939 1945 1954 The share of U. S. securities In the total loans and investments of commercial banks I right-hand chart I has closely reflected the changing proportion of Federal debt to total public and private debt I left-hand chart). an increase in bank holdings of U. S. Gov ernment securities, total loans and invest ments were reduced by $19.1 billion, or 39 percent, and adjusted demand deposits con tracted by 36 percent. Despite a sharp rise in currency outside banks, the active money supply declined by $6.9 billion, or 26 per cent. Such a shrinkage of the means of pay ment was both a product and an aggravating force in the major economic collapse of that period. A different type of behavior of the money supply, however, has put in an appearance during recent years. Factors Leading to a More Stable M oney Supply Since the 1930s, several factors have emerged whose combined effect has been to make the volume of bank deposits less de pendent on bank loans and to make bank loans less subject to cyclical shrinkage. The resulting shifts in the nature and composi tion of bank assets have introduced a stabi lizing force into bank assets and deposits. These factors will now be outlined. 6 1. Change in Debt Structure of the Nation. Partly as a result of the deficit financing of the 1930s, but mainly as a result of World War II, the composition of the debt struc ture in this country underwent drastic changes. Such changes are portrayed for se lected dates in an accompanying chart, shown in the left-hand column. The Federal debt represented only 8.5 percent of total public and private debt in 1929, but ten years later it had risen to 22.9 percent of the total. By the end of World War II, the pro portion of Federal to total debt had risen to an unprecedented 68.4 percent, the out come of huge war-time deficits of the govern ment. In the postwar period there was relatively little change in the amount of the Federal debt, but private indebtedness, along with that of state and local governments, expand ed sharply. Consequently, by the end of last year the Federal debt was down to an esti mated 48 percent of total public and private debt. While substantially below the peak war time percentage, the Federal debt still rep resents a large proportion of the total and will probably continue to do so. 2. Changes in Bank Asset Composition. The above changes in the debt structure of the country have had a significant influence on the behavior of the money supply. The growth of the Federal debt has furnished an investment medium to commercial banks that helps to compensate for cyclical movement of loans. Since banks now hold a large amount of U. S. Government securities, the relative fluctuations in total loans and investments (other than during war periods) tend to be less than would be the case if loans consti tuted the bulk of banks’ earning assets. Con sequently, the part of the money supply rep resented by demand deposits tends to exhibit less cyclical fluctuation. The volume of bank loans still varies di rectly with business conditions, particularly during periods of expansion. This is tem pered, however, by the probability that the amount of Federal debt outstanding will move in an opposite direction to the busi ness cycle, and that bank holdings of loans and U. S. Government securities will move in a mutually offsetting manner. The composition of commercial bank assets as between U. S. Government securities on one hand, and loans and other securities on the other hand, has closely reflected changes in the total debt structure. This is illustrated for selected dates in the chart shown in the right-hand column. As a percent of total loans and investments, bank holdings of U.S. Government securities rose from 9.9 percent in 1929 to 39.8 percent in 1939, and to 73.4 percent in 1945. The postwar rise in loans, combined with a net reduction in holdings of U. S. securities, reduced the latter to 43.5 percent of total loans and investments of banks by mid-1954. Government securities are still a major asset of banks, however. 3. Change in Types of Commercial Bank Loans. Bank loans themselves seem to have become less subject than formerly to fluctu ations in the economy, at least in the down ward direction. As a result of long-term changes in types of loans that began in the 1920s, present loans include a large volume of real estate loans, term loans to business, and consumer instalment loans whose con tractual maturity is much longer than that of the traditional business loans made for working capital purposes. Even though working-capital loans are commonly renewed in prosperous times, technically such loans are short-term and callable at maturity— a fea ture which is often exercised by banks in a recession period. With the relative growth of other types of loans having a longer con tractual maturity, the chance of a major con traction of loans in response to falling busi ness activity is thereby reduced somewhat. The above point is illustrated by the net change in commercial bank loans from mid1953 to mid-1954, a period of recession, in which total loans nevertheless rose by $2.2 billion. Although business and consumer loans declined, this decrease was more than offset by rises in real estate and agricultural loans, loans made for the purchase and carrying of securities, and other loans. C y clica l Trends in A ssets and Deposits Commercial banks hold virtually all the outstanding demand deposits, which consti tute the bulk of the money supply. Demand deposits fluctuate largely, but not entirely, in keeping with changes in commercial bank loans and investments. The tendency for loans and U. S. Government security holdings of banks to move in a partially offsetting fash ion, thus helping to produce a more stable money supply, can best be shown by compar ing several periods of recession and expansion in the economy. An accompanying chart illustrates the compensatory movements of bank loans and holdings of U. S. Government securities in two periods of postwar expansion. From December 1946 to October 1948, commercial bank loans rose by $10.5 billion, and holdings of municipal and corporate securities in creased by $1.1 billion. These movements were almost completely offset, however, by a decline in bank holdings of U. S. Govern7 During the upward phases of the postwar period, the rapid expansion of loans at com mercial banks was partially offset by a reduction in bank holdings of U. 5. securities. As a result, the growth of commercial banks' deposits was more moderate than that of loans. DEC. I9 4 6 - 0 CT. 1948 OCT 19 49- JUNE 1953 Billions o f Dollars -15 A SSE T S I ' I I ■I 1 " 0 Billions o f Dollars ♦ 15 I I 1ri i | r p r - i - T i . , , . , -15 ............ ... O 15 ♦ 30 I ■ I » ■ | ' ■ ■ ■ I ■ » > ' I ■ ■T-rp - r . - r p - ■ h i m . i i LO A N S U.S. GOVT. S E C U R IT IE S T O TAL LO ANS AND IN V E S T M E N T S LIABILITIES A D JU ST E D DEMAND D E P O S IT S T IM E D E P O S IT S 'Only $0.1 billion. ment securities, amounting to $11.5 billion. Even though the increase in total loans and investments was only $0.1 billion, adjusted demand deposits rose by $1.8 billion. Other factors having an effect on the money sup ply, not shown on the chart, were at work in this period, including a rise in cash assets and a decline in interbank deposits. The second phase of rising economic activ ity shown on the chart covers the period from October 1949, to June 1953, which includes the Korean war interval. The expansion of loans, accelerated in part by the war, amount ed to $23.2 billion. At the same time hold ings of municipal and corporate securities rose by $4.2 billion. However, a decline of $9.0 billion in U. S. Government securities held by banks offset one-third of the rise in loans and other investments. The increase of $12.6 billion in adjusted demand deposits was only about one-half the amount of loan ex pansion. Thus, in both periods noted above, a substantial decline in bank holdings of U.S. Government securities helped to moderate the effects on the money supply of the rapid 8 loan expansion typical of rising economic activity. Turning next to trends in the behavior of demand deposits during periods of economic downturn, the final chart shows the percent age change in loans, investments, and de posits of commercial banks during the past three recessions.6 The changes are shown in percentage form, rather than in amounts, in order to focus on the trend in relative changes in demand deposits during the three periods. During the 1937-38 recession, loans de clined by $1.3 billion, or 7.5 percent—a re duction which was reinforced by a $0.6 bil lion decline in bank holdings of U. S. Govern ment securities. Largely as a result of these movements, adjusted demand deposits fell by 6 The periods of economic contraction selected for com parison correspond closely, but not precisely, with the generally-accepted reference dates of peak and trough, which are as follows: Peak— May, 1937, trough— June, 1938; peak— November 1948, trough— October 1949. The dating of the 1953-54 recession is still not definite, but can be taken tentatively as mid-year to mid-year. The_ reason for comparing changes in assets and liabilities during full-year periods, rather than the actual periods between peak and trough, is that substantial seasonal variations in the items might otherwise conceal or exagger ate basic trends, depending upon the time of the year. During the past three recessions, demand deposits at commercial banks have shown less susceptibility to decline; this has been due in considerable measure to increased bank holdings of Government securities during the recession periods. 0 C T .I9 4 8 * OCT. 1949 Percent Change JUNE 1 9 3 7 -JUNE 1938 Percent Change ASSETS O *3% - 2% 0 ♦8 % JUNE 1953* JUNE 1954 Percent Change ♦9% LOANS U.S. GOVT. S E C U R IT IE S T O TAL LO A N S AND IN V E ST M E N T S LIABILITIES A D JU ST ED DEMAND D E P O S IT S T IM E D E P O S IT S 3.6 percent. In the 1948-49 downturn, how ever, loans increased by 0.5 percent, instead of showing a decline. Bank holdings of U. S. Government securities rose by $4.3 billion, but this gain was more than offset by a reduc tion in cash assets of banks—the latter not shown on the chart. Consequently, adjusted demand deposits registered the usual decline in a recession, but by a slight amount—only 0.9 percent, much less than in 1937-38. In the 1953-54 downturn, loans actually increased by 3.4 percent, and this was rein forced by a gain of 8.5 percent in U. S. se curities held by banks. Much of the increase in assets was reflected in a 7.3 percent rise in time deposits. Nevertheless, adjusted demand deposits rose by 1.4 percent, to mark a poten tial new path in the behavior of the major part of the money supply in recession pe riods. In comparing the three recessions, therefore, there is a small but clearly discern ible trend toward a money supply that is able to resist contraction in a period of eco nomic downturn. (See the cover chart for a contrast in the dollar movement of demand deposits during the recessions of 1948-49 and 1953-54.) Stability of the means of payment during a recession tends to be an aid in maintaining expenditures, though it is far from a com plete remedy. Adequate liquidity in the econ omy is a necessary but not a sufficient condi tion for the achievement and maintenance of high-level employment a n d production. Spending decisions of individuals and busi ness firms are influenced by many other forces than the supply of money and liquid assets, and the cost and availability of credit, even though these factors are important. Whether or not the money supply will re main “ recession-proof” in the future can not be known, but basic forces at work seem to point in that direction. If so, the behav ior of the money supply will have changed from an unstabilizing factor to one that makes a contribution, however modest, toward greater economic stability. Such a conjec ture, based on limited trends observed in the past three recessions, does not apply to the circumstances of a major depression. For the latter, there is insufficient recent experience for making a conjecture. Nevertheless, it can be hoped that the factors just outlined would at least moderate any downturn in the money supply, if such a period of drastic contraction of general business should occur. 9 Higher Expense Ratios in Agriculture net farm income of the nation’s farm ers last year, as a proportion of gross income, was the lowest in nearly twenty years.1 Not since 1934 have farmers retained as net income a smaller percentage of the gross. Or, putting it the other way, produc tion expenses as a proportion of gross income have reached the highest point in about twen ty years. Prices received and prices paid have fluctu ated widely over the years. Attention should be given to the physical change in input and output in combination with these price rela tionships to explain why net farm income rel ative to gross farm income in 1953 was the lowest in nearly two decades. The net farm income as percent of gross in come of farm operators in the nation has declined since 1942, offsetting the net ad vance of the previous ten years. The decline became more pronounced after 1946. (See accompanying chart.) In 1942 more than 50 percent of gross farm income remained as he T Net farm income last year, as a proportion of gross income, w as the lowest in nearly twenty years. net farm income.2 Because of the persistent rise of production expenses during subse quent years, only 35 percent of gross income remained as net in 1953. A second chart brings out the same facts in terms of the rise in production expenses as a percentage of gross income. Thus, the ex pense ratio in the aggregate has risen during the past decade, and is currently about on a par with that of 1934, although it has not quite reached the previous high of 1932. The high of nearly twenty years ago, incidentally, was only slightly above that of 1921. The fact that gross income to the nation’s farm operators this past year was over four times what it was in 1934 tends to obscure the current low ratio of net to gross farm income. The relatively high net income of this past year, as compared with such a year as 1934, can be attributed to marketings which were approximately double and prices which were nearly three times as high as in 1934. A trend similar to that observed nationally in the ratio of expenses to gross farm income is revealed by data assembled from several different types of farms.3 All of the major types of farms in Ohio, for example, have experienced the ten-year long rise in the ra tio of expenses to gross income illustrated in the preceding chart. The differences among the ratios for the three types of farms shown in the chart have been relatively narrow dur ing the past three years. 1 Net farm income refers to income from farming after production expenses. It corresponds broadly to the amount available to cover operator’s compensation for labor, man agement and capital invested. Gross income includes all receipts from the sale of farm products, and an adjust ment for net change in inventories. 2 The price situation in 1942 was in some respects un usually favorable for farmers because of the effects of general price controls, coupled with less effective re straints on prices of farm products. 3 Ohio Farm Account Summaries, 1935-1953, Agricultural Economics Department, Ohio State University, Columbus, Ohio. 10 The expense ratio has risen during the past decade, and is currently about on a par with that of 1934. On all three major types of farms in Ohio, the expense ratio has risen during the past ten years. In seeking an explanation as to why the ratio of net to gross farm income turned downward after the early 1940s, a period when output was expanding and average prices received were advancing, it seems ap propriate to note the change in production ex penses in contrast to the change which oc curred in farm output. In the period since 1942, for example, total production expenses in dollars have increased by 128 percent, while the prices paid for items used in farm production rose only 88 percent; the expan sion in farm output in the same period was 14 percent. Thus, on a “ constant dollar” basis, it would appear that expenses rose about 20 percent while physical output was rising by 14 percent. If production expenses in dollars are related to the rise in physical volume of farm output, it is evident that there was a substantial increase in the ex pense per unit of farm output,—in fact, a greater increase than the rise in prices paid (see chart on page 12). Presumably the more rapid rate of increase in expense per unit can be attributed to an increase in phy sical input relative to physical output over the period since 1942. It is common knowledge among those as sociated with agriculture that farm operators during the past decade have purchased much more of the goods and services required in farm production than their predecessors. Un der the impetus of rising prices and income in the early 1940s, farmers generally adopted the findings of research more rapidly—some authorities say at an unprecedented rate— and added materially to their investment in mechanized equipment and other labor-sav ing devices to compensate for the exodus of farm workers attracted into war industries and those called in the armed forces. Each of these developments necessitated purchases of goods formerly produced on the farm, or services formerly performed by farm work ers, and the combination unquestionably had a large influence on the quantity of pur chased goods and services. The decline in gross farm income from the postwar high of 1951 was accompanied by a slight contraction in the dollar total of pro duction expenses in 1953. The contraction, however, was negligible in relation to the shrinkage in gross income. Unless production expenses can be adjusted to coincide more closely in time and amount with the present downward trend of gross income (which ap pears questionable in view of the greater quantity of purchased goods and services needed in agriculture) it is probable that the expense ratio will move even closer to the high of 1932. What then are the impacts on agriculture of an expense ratio comparable to that experienced in the early 1930s? In considering some of the impacts of a 11 Per unit expense of farm operators has rhea more rapidly than average prices paid, suggesting a relative rise in physical input. (1) Per unit expense means production expenses divided by farm output. (2) Prices paid exclude items used in family living. high expense ratio on agriculture it seems appropriate to think in terms of land, labor, capital and management—the four principal factors of the agricultural enterprise. The impact on one of these factors may well be reflected further to one or more of the other factors. The addition of power and equip ment to save labor, for example, has often led subsequently to an enlargement of the farm business so as to permit distribution of the investment cost over a greater volume of output. Impact on Capital. A marked substitution of capital in the form of power, machinery and equipment, for labor in recent years (and possibly to a lesser degree the substitution of capital in the form of soil amendments for land) was associated with the rise in the expense ratio previously described. The fact that the expense ratio in agriculture gener ally has risen over the past decade suggests that the increase in aggregate income was not in proportion to the greater dollar vol ume of capital goods being used. Many farm operators found savings to be inadequate to meet operating capital require ments as it took more cash to meet production 12 expenses. They, therefore, resorted to the use of borrowed funds. Non-real-estate loans, as a consequence, rose steadily after the war and reached an all-time high in mid-summer of 1952.' Farm mortgage debt has also risen steadily from the postwar low of 1946, and at $7.7 billion on January 1, 1954, it was 7 percent above a year earlier and the high est in twenty years. Some further expansion through the first quarter of this year was indicated in recent reports of the principal lenders. During the past two years the expansion in farm mortgage debt has been partially offset by a contraction in non-real-estate outstand ings (exclusive of price support loans) but more recent data indicate that the rate of decline in short-term loans has become less pronounced than a year ago. The agricul tural debt in the aggregate may, therefore, be approaching the relatively high dollar amounts of the early thirties. In relation to net income the present debt is admittedly less burdensome than it was in the 1930s. Nevertheless, with a high ratio of expenses to gross income, the reserve to meet unexpected expenditures frequently proves inadequate. Earnings from the va rious phases of the farm business must prove to be almost precisely as planned, or the abil ity to meet loan repayment schedules is im paired. When repayment schedules prove difficult to meet, then defaults, refinancing or conversions of short-term credit to longerterm farm real-estate loans become more com mon. Refinancing and conversions have in creased in recent months, but the number of cases generally is indicated by lenders to be of moderate proportions except in areas where prolonged drought or other local ad versities have prevailed. Defaults so far have remained at unusually low levels. On balance it can be said that a high ex pense ratio, while partly a consequence of greater capital use, is also a causal factor in increasing the operating capital requirements of agriculture. This in turn has led to a marked expansion in the use of borrowed funds. If the expense ratio continues to rise, bringing continued contraction in net income, a further impairment of ability to service debts is probable. On the other hand, if net incomes can be maintained by improving gross income or by lowering production costs, the present relatively moderate debt burden may be resolved with less unfavorable influ ences on agriculture than occurred in some previous periods when the ratio of net to gross farm income was comparable to that of the present. Impact on Land. In an effort to maintain income when the expense ratio is rising, farm operators tend to expand output by culti vating more land or cultivating the same area more intensively. The acreage of the 52 prin cipal crops grown, for example, was the largest of record in 1932, a year preceded by a three-year rise in the expense ratio. The re cent rise in the expense ratio, however, has not been accompanied by an appreciable change nationality in crop average. (The acreage of principal crops this year is about, on a par with last year, despite a reduction of 20 million acres in crops under allot ments.) While there has been no significant change in the total acreage of crops on a national basis in the recent period, the ag gregate amount of fertilizer represent more intensive cultivation of the area used. The impact of an upward trend in the expense ratio on the use of land and capital is illustrated by the experience of 35 North eastern Ohio dairy-poultry farm operators in the period 1946 to 1953. The operators of those farms enhanced their gross income by 29 percent by milking a third more cows and cultivating a fourth more cropland dur ing the past two years than in the first two years of that period. The net farm income, or the amount accruing to cover labor, man agement, and capital invested, rose less than 8 percent. The total capital invested increased slightly more than 50 percent. In brief, despite a high gross income, the operators of those farms actually received less compen sation for labor and management on the av erage over the last two years than the first two years of the postwar period, even though they milked a third more cows and cultivated a fourth more cropland with the same man power. Such an outcome suggests that the “ break-even points” for most farm enter prises were rising rapidly4, although the available data do not lend themselves directly to the “ break-even point” type of formu lation. Impact on Labor. Farm wage rates rose during and following the war at a much greater rate than the prices of other goods and services used in farm production. The advance in wage rates, however, was insuf ficient to prevent large numbers of capable and experienced farm workers from being attracted into more lucrative off-farm employ ment. Farm operators as a consequence were forced to choose between depending upon the labor that could be obtained at prevailing rates or adding more power and equipment to compensate for the decline in number of workers. A majority chose the latter alterna tive, with the result that farm mechaniza tion was precipitately speeded up. The total component of power and machinery on farms was recently estimated by the U. S. Depart ment of Agriculture to be nearly 75 percent greater than in 1941. This addition of power and equipment and the widespread adoption of technological im provements in agriculture (such as more lib eral and better placement of fertilizers, soil and moisture conservation practices, hybrid seed, chemical weed control, antibiotics, pro duction testing, and artificial insemination) permitted fewer workers to turn out a larger volume of output. The result was an increase in output per man-hour of more than 35 per cent over the past ten years. An increase in output per man-hour of those proportions was a strong influence against a rise in the expense ratio. Nevertheless, the fact remains that the expense ratio has risen, suggesting that the advance in per unit cost outweighed 4 I.e., they were rising from a starting point in the early postwar period which had reflected an unusually favor able situation. 13 the gains stemming from a higher output per man-hour.5 Impact on Management. Those in the po sition of managing a farm enterprise during a rise in the expense ratio have been required to think in terms of expanding gross farm income in order to maintain the net return. For some farm operators, this has meant horizontal expansion in the form of more acres, more cows, or larger flocks; for others 5 This outcome may have been due partly to a proportion ately greater advance in prices of substitutes for manhours than occurred for prices of farm products; likewise the decline from postwar highs has not been as marked for the “ substitutes” as it has been for farm products. it has taken the form of vertical expansion, such as the production of a higher value product or preparing and possibly delivering the product directly to the ultimate con sumer. In each instance, of course, the man agement skill must be adequate to meet the added responsibilities or else the potential expansion in gross income is not forthcoming. Those farm managers who have been most successful in meeting the problem of an up ward trend in the expense ratio have attained a high degree of efficiency in the use of all four factors in agricultural enterprises, namely land, labor, capital, and management. SUMMARY OF NATIONAL BUSINESS CONDITIONS By the Board of G overnors of the Federal Reserve System Business activity generally continued stable in July. Over-all measures o f industrial production, em ployment, prices, and retail sales changed little. Con struction activity rose further. Farm crop prospects deteriorated owing to unusually hot, dry weather. Credit availability generally remained easy. Industrial production The B oard’s preliminary seasonally adjusted index o f industrial production held steady in July at the May-June level o f 124 per cent o f the 1947-49 aver age. Plantwide shutdowns for vacations and other purposes, which have become widespread in the post war period, resulted in about the usual seasonal drops in most industries. Durable goods production in July rose slightly, reflecting mainly further strength in output o f major household goods. Television set production showed much less than the usual seasonal decline in July, partly because important work stoppages were termi nated. Output o f furniture rose further. Following a high rate o f output in the second quarter, auto pro duction declined in July to a level well below the exceptionally high rates o f last year. Steel output also fell by more than the seasonal amount in July; mill operations for the month were at 63 per cent o f rated capacity. In early August steel output has been sched uled at around 64 per cent o f capacity. Lumber production was lower in July as work stoppages con tinued. Nondurable goods output in July was unchanged for the third month at 116 per cent o f the 1947-49 average, as compared with a low o f 112 last winter 14 and 121 a year ago. Substantial recovery in leather and rubber products industries in May and June was interrupted in July by an important work stoppage, while output o f paper and chemical products appar ently continued very strong. Activity at petroleum refineries was curtailed moderately further in July with inventories continuing at advanced levels, and there was also a reduction in crude oil production. Construction Expenditures for new construction in July, season ally adjusted, rose slightly further from the advanced level o f earlier months, as most types o f private construction showed small increases. Value o f con tracts for new construction was at a new high for July, with increases from June in both private and public awards. The number o f new housing units in cluded in appraisal requests to the Y A continued un usually large in July and was more than twice the year-ago number. Employment Seasonally adjusted employment in nonagricultural establishments declined slightly in July to 48 million, reflecting largely work stoppages in the lumber and rubber industries and a further reduction in metal working employment. Employment was relatively stable in nonmanufacturing industries. Unemploy ment, at 3.3 million, continued at the May-June level. Agriculture Hot, dry weather over much o f the nation’s agri cultural area reduced crop prospects during July. Total volume is now officially forecast at about 5 per cent below last year and about the same as in 1950, the most recent year in which production re strictions were also in effect on all major crops. Distribution Retail sales were generally maintained in July after allowance for seasonal variation. Auto sales receded from the sharply advanced June level but sales o f most other merchandise held steady or increased. At department stores the seasonally adjusted sales index rose to 115 per cent o f the 1947-49 average, 3 per cent above June and 2 per cent above July a year ago. Department store stocks in June showed little change at a level 5 per cent below a year ago. Commodity prices Wholesale prices generally continued to change little in July and early August. Prices o f livestock and products declined somewhat further during July as marketings showed a more than seasonal expan sion. Grain and soybean futures rose, reflecting ad verse weather conditions, but weakened in early August as more favorable weather developed. A m ong industrial commodities, aluminum prices were raised and steel scrap advanced, but copper scrap declined slightly. Prices o f some petroleum products strength ened in early August following earlier decreases. Lumber prices, despite the continued work stoppage, declined somewhat from the advanced levels o f early July. A slight rise in the consumer price index in June reflected chiefly seasonal increases in fresh fruits and vegetables. All groups other than foods were un changed or down slightly. Fresh fruits and vegetables rose somewhat further to mid-July, but meat prices have declined since then. Bonk credit and reserves Bank holdings o f U. S. Government securities in creased substantially in early August reflecting pri marily bank purchases o f part o f the 3.7 billion dollars o f tax-anticipation certificates sold by the Treasury. Agricultural loans at commercial banks de clined sharply as a result o f the redemption o f Com modity Credit Corporation paper. Excess reserves o f member banks averaged about 900 million dollars in late July and the first part o f August with borrowing at the Federal Reserve gen erally less than 100 million. About 900 million dollars o f reserves were made available to banks through reductions in reserve requirement percentages, of which only part was absorbed by reduction in Fed eral Reserve holdings o f IT. S. Government securities, increases in Treasury deposits at the Reserve Banks, currency outflows, and increases in member bank de posits. Reserve positions tightened at banks in the money centers in the second week o f August, how ever, reflecting largely shifts o f funds due to Treas ury operations. Security markets Yields on most Government securities advanced moderately from mid-July to mid-August. In early August holders o f the 7.5 billion dollars o f certifi cates maturing in August and September were offered in exchange a 1-year 1% per cent certificate or a 6-year and 3-month 2% per cent bond. Exchange into bonds totaled 3.8 billion dollars, and cash redemp tions were less than 3 per cent. Yields on high-grade municipal bonds continued to decline during late July and early August, while corporate bond yields were steady. Common stock prices increased further in the latter part o f July, but declined somewhat early in August. Announcement The Fidelity Trust Company, Pittsburgh, Pennsylvania, upon opening for business August 7, 1954, became a member of the Federal Reserve System. Fidelity Trust Com pany is the bank resulting from the merger of The Colonial Trust Company and Fidelity Trust Company, both of Pittsburgh, Penn sylvania. The merged bank has a capital structure of more than $27,500,000, comprising com mon capital of $4,187,500, surplus of $19,812,500, and undivided profits of $3,590,730.23. C. A. McClintock is chairman of the board of directors and John A. Byerly is president of the new bank. 15 TOLEDO Fourth Federal ReserveDistrict ■ M A IN O FFIC E ★ B R A N C H O F F IC E S
@FedFRASER