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O / ) ! i /]£-' FEDERAL RESERVE HANK DF SAN FRANCISCO Monthly Review 5T ill In this issue Widespread Advance Regional Advance Brisk Loan Expansion August 1972 W id e sp re ad A d van ce . . . Consumers, businesses and governments all contributed to the second-quarter upsurge — and helped spur inventory building too. Regi@n€sl Advene© . . . The W est expanded roughly in line with the national pace, despite the first signs of weakening in the housing boom. Brisk l© an £^p@nsi@fii . . . Bank lending expanded much faster in the W est than in the rest of the nation in recent months, but security holdings fell. Editor: W illiam iu rk e MONTHLY August 1972 REVIEW Widespread Advance he national economy grew rapidly and broadly during the spring and early summer months, with GNP rising to an $1,13 9-billion annual rate during the second quarter. Current-dollar GNP grew at a more moderate pace because of a sub stantial slowing in the rate of inflation — but in real terms, growth increased from a 6.5percent annual rate in the January-March period to an 8.9-percent rate in April-June. Consumers, businesses and governments all contributed to the rapid pace of recovery, and their increased buying plans helped stimulate a long-awaited buildup in inven tories. The only minus sign in the national accounts was the continued deficit in the foreign-trade sector. Industrial production finally (April) sur passed the peak first reached two and a half years earlier, and it continued to ad vance during May and June. The production indexes showed the impact of heavy business spending in the increased production of pro ducers’ durable goods; the impact of the housing boom in the higher production of construction materials, furniture and house hold goods; and the impact of the auto boom in the high level of new-car assemblies, especially in the early part of the quarter. However, the upsurge in overall demand has not yet bumped up against the economy’s ability to expand supply. During the second quarter, almost 6 percent of the labor force remained unemployed, and over 23 percent of manufacturing capacity remained unused. T Inventories to rise? The growth in inventories was up from practically zero in the first quarter to a $4.3-billion annual rate in the April-June period. This may be only the beginning, since past relationships suggest that inventory buying could rise to $12 billion or more, as the economy expands further. During the early spring period, producers holding 15 percent of manufacturing inventories de scribed them as too high; this contrasts with a 20-percent rate through most of 1971, and a 23-percent rate in 1970. Inventory-sales ratios in manufacturing and trade have fallen sharply during the past year and are now relatively low — below the level of 1968, the last strongly pros perous year of the past half-decade, though not necessarily too low considering tech nological changes in inventory control. The ratio fell to 1.51 this spring as against a peak of 1.70 in late 1970. The upturn in durable-goods orders and the end to earlier weakness in the defense and capital-goods sectors have brought heavy orders for such items as aircraft, computers and electronics, which involve many complex components with long production lead times. Inventories R e a l G N P s tr e n g th e n s as recovery expands, while prices rise less rapidly A n n u a l R a t e o f C h a n g e (P e rc e n t) FEDERAL RESERVE BANK of this type have been liquidated over the last two years, so the turn-around should boost inventories at all levels, especially goods in process. 4 Defense spending turns around Government spending in the GNP ac counts continued to strengthen during the second quarter. Defense expenditures rose by $1.9 billion to a $78.6-billion rate; this gain was in line with the first-quarter expan sion after adjustment for changes in pay schedules. (Defense spending overall is up sharply from last summer’s low, in the fastest increase since the 1966 Vietnam buildup.) Federal non-defense spending was up $0.7 billion to a $29.6-billion rate, and state-andlocal government spending was up $2.7 bil lion to a $ 146.4-billion rate. In the latter case, however, the gain was below the his torical uptrend. Further increases in Pentagon spending appear to be in the cards, because of rising prices, rising procurement to replace stocks used up in Vietnam, and a $2-billion pay increase scheduled for next January. Al ready, the statistics show substantial in creases in defense-industry backlogs and in Defense Department obligations. Secretary Laird, testifying before Congress on fiscal 1973’s $83.4-billion defense budget, claimed that the Vietnam escalation could add $3 billion to $5 billion to budgeted spending, because of increased requirements for munitions, fuel, equipment and aid to the South Vietnamese. On the other hand, the strategic-arms pact should cut $550 mil lion net from the budget, because of the reduction in ABM sites from the original twelve to only two. However, the actual size of the budget also depends on how Congress votes on procurement of certain bargainingchip items, such as the B 1 long-range bomber and the Trident missile-firing submarine, which the Administration feels should be de OF SAN FRANCISCO veloped to spur the USSR into further limita tions on strategic offensive arms. Government construction spending showed some strength in early 1972, after a pro longed period of sluggishness. Some of this increase represents a delayed response to the heavy borrowing by state-and-local gov ernments in the last two years, the proceeds of which were first used to rebuild liquidity before new construction programs were un dertaken. This year should see heavy spend ing by local units for roads, bridges, sewers and water-supply facilities. In addition, new Federal legislation could lead to a $1-billion increase in Federal building programs over the next two years, in a program designed to reduce the backlog and streamline the financing of previously authorized buildings. New forces on business spending The business-spending boom continued with a $4.0-billion second-quarter increase to a $120.1-billion annual rate, concentrated mostly in the durable-equipment sector. In real terms, however, the increase was some what slower than in the fast-expanding January-March period. The spending boom began last year with the help of Administration tax incentives, and it has been stimulated further by the sharp improvement in corporate profits and the rising needs of a rapidly expanding economy. The upsurge has been supported by the rise in internally-generated funds and by the relatively favorable cost of borrow ing — and also by the lower effective cost of new equipment because of the reinstate ment of the investment tax credit. B u s in e ss -c o n stru c tio n spending has shown divergent trends, in contrast to the upsurge in the durable-equipment sector. This year so far has witnessed a sharp rise in construction of stores and health facilities, related mainly to the housing boom, but somewhat less strength in other areas such as office-building construction. August 1972 MONTHLY Producers’ durable-equipment spending has been boosted by heavy truck sales, helped by the general economic expansion and by the repeal of the 10-percent excise tax. Truck sales in the spring of this year were running about one-third above the year-ago level. However, much of this may be consumer demand — although the figures show up in the business statistics — because consumers have been buying large numbers of lightweight pick-up and panel vans for use as second or third cars. Corporate spending, according to this spring’s Commerce Department survey, is expected to grow at a slower pace during the second half of 1972. Manufacturers and non-manufacturers alike expect a 4-percent annual rate of increase in the second half, as against their first-half increases of 10 per cent and 20 percent, respectively. Some sectors which recorded very substantial gains during the first half (such as the aircraft industry and the airlines) expect declines as deliveries taper off, but the prolonged boom in public-utilities spending seems destined to continue. However, second-half spending may be stronger than anticipated because of the recent turnaround in business senti ment, with actual outlays exceeding earlier expectations in each of the last several quar ters. In the past, such a development has always signaled a strong cyclical growth in capital outlays. Consumers support the upturn Consumer spending was up strongly this spring, although with some shift in the con tents of the market basket. Durable-goods spending increased $2.6 billion to a $113.6billion annual rate — about one-half as large as the previous quarter’s advance. Nondur able spending increased $8.0 billion to a $296.3-billion annual rate — the strongest quarterly gain in years. Spending on services meanwhile increased $5.9 billion to a REVIEW $302.6-billion annual rate, in line with the usual uptrend. The upswing in retail sales this year has been broadly based, with strength apparent in furniture, appliance, apparel, and particu larly auto sales. The upswing has been backed by a very sharp expansion in con sumer credit, with outstanding instalment credit increasing at a $ 15-billion rate — double the 1971 pace — in the spring period. The auto boom, which began a year ago under the stimulus of the excise-tax repeal, continued this spring and early summer as new car sales reached 10.7 million units, at an annual rate — 10 percent above the year-ago level. About 9.2 million of the second-quarter sales represented domestictype units. Imports have fallen below earlier peak levels, but are still surprisingly high at a 1.5-million rate, inasmuch as prices of imports have risen roughly $250 over the past year, while prices of competing domestic subcompacts have increased hardly at all. Detroit has witnessed record sales of luxury cars this year, but also a broad shift from standard-size to mini cars. For the first time, the bottom of the line — inter mediates, compacts and subcompacts — has accounted for over one-half of all cars sold. The industry has built up substantial in ventories of new cars — about 1.8 million units, or a 52-day supply — but strong thirdquarter production plans indicate Detroit’s faith in the continuation of heavy consumer demand. The housing boom began to falter this spring as spending increased only $0.8 billion to a $52.4-billion annual rate — and in creased not at all in real terms. Housing starts, although reaching a very high rate of 2.2 million units, were off substantially from the previous quarter’s peak, and housing permits also declined. Yet with the con tinued high level of housing starts and the usual lag of construction activity behind FEDERAL RESERVE BANK Stro n g em ploym ent gro w th contrasts with earlier weakness C h a n g e : J u n e — J u n e (T h o u s a n d s ) —6 0 0 i— r -4 0 0 -2 0 0 0 200 401 D u r a b le G o o d s M fg . N o n d u r a b le G o o d s M fg . T ra d e S t a t e — L o c a l G o v ’t. starts, dollar spending seems bound to re main strong for the rest of the year. Even so, builders have cause to worry because of the record number of units now reaching completion, especially since the market has been slower and slower over the past year in absorbing the new homes and apartment units being placed on the market. How much saving? The consumer saving rate fell considerably below the unusually high (8.1 percent) aver age rate of the last two years, declining to 6.6 percent in the second quarter on the heels of the first-quarter drop to 7.2 percent. This resulted partly from the strong upsurge in spending, but also from some temporary influences affecting consumer income. As sharp swings in income take place, fluctua tions in spending may not be precisely equal, so that the brunt of the lags is borne dis proportionately by consumer saving. With out the special factors impacting on income, the saving rate in the second quarter prob ably would have been considerably closer to the earlier peak rate. Over-withholding of income taxes, by OF SAN FRANCISCO affecting consumer take-home pay, reduced the amount available for discretionary house hold disbursement throughout the first half of 1972. This situation will be reversed next spring, since the Treasury Department esti mates that tax refunds then will be almost twice as large as in early 1972. The over withholding, indeed, has acted as a form of temporary savings, but one on which the saver earns no return. Hurricane Alice, meanwhile, by sharply reducing property and p ro p rie to rs income in East Coast flood areas, cut back income gains somewhat dur ing the month of June. Future income trends may be influenced by the repercussions of a Federal Court decision in July, which enjoined the Cost of Living Council from exempting only work ers making $1.90 an hour or less from wage controls. Several major unions brought the suit, charging that the cutoff point should be $3.35, which is equivalent to $6,960 annually — the Labor Department’s stan dard in 1970 for a “lower level” budget for a family of four. (Actually, the latest official estimate was about 4 percent higher, at $7,214.) Soon thereafter, the Council boosted the wage cutoff for its poverty ex emption to $2.75 an hour. This increase, along with an earlier decision to exempt employees of most small businesses, means that 56 percent of the nearly 58 million pri vate nonfarm workers are exempt from the Pay Board’s 5.5-percent wage guideline. How much unemployment? Nonfarm payroll employment rose by 700,000 in the second quarter to a total of 72.5 million workers, in its second consecu tive quarter of very rapid advance. At that level, employment was almost 2 million (3 percent) above the year-ago figure. Trade, services and state-local government each added roughly one-half million new work ers, and durable manufacturing added a August 1972 MONTHLY quarter-million more, during this year-long upturn. Labor-force growth slowed somewhat during the spring months, but the unemploy ment rate still remained near the 6-percent level, before declining sharply to 5.5 per cent in the June-July period. (Moreover, the average duration of unemployment increased from 12.2 to 12.8 weeks during the second quarter.) Administration spokesmen now count on a continued decline in unemploy ment, under the impact of rising employ ment and an expected slowdown in the growth of the labor force. Over the past year more than one-sixth of the labor-force increase has been due to a reduction in the armed forces, which is not likely to be re peated in the next year. The problem of a sticky unemployment rate in the face of strong employment growth was highlighted by T. Aldrich Finegan in the Monthly Labor Review of February 1972. Finegan contends that the rapid in crease in the adult population over the last decade, at roughly 1.7 percent a year, will continue for several years yet. He further expects, in contrast to official projections, that the rise in the female labor-force partici pation rate will also continue, because of such factors as a declining birth rate, a declining percentage of women with pre school age children, and the rising impor tance of the service industry and other in dustries which are dominated by women workers. This analysis implies that an unprece dented growth in employment would be re quired to cut the unemployment rate to 4.5 percent by the end of next year. An in crease of between 5.9 and 7.1 million work ers would be needed between the second quarter of 1971 and the fourth quarter of 1973 to bring this about — far ahead of the record of most postwar expansions. Indeed, the only period when growth of REVIEW Some se c to rs show whopping price increases over past year P e rc e n t C h a n g e ( J u n e — J u n e ) 0 5 10 15 20 this kind occurred was the demobilization period of 1945-47. Unemployment might be lowered, of course, with a slowdown in pro ductivity improvement, but that would tend to create new problems for the nation’s in flation fighters. Better price news . . . During the spring and early summer months, the inflation news was generally good. In particular, the price deflator in the private economy rose at only a 2.0percent rate in the second quarter, in con trast to the 4.2-percent rise of the JanuaryMarch period. The consumer-price index decelerated during the spring period with a 2.2-percent rate of increase, partly because declines in meat and vegetable prices from last winter’s stratospheric levels held food prices stable, while apparel prices rose at a slower pace than heretofore. Since the beginning of Phase II, the CPI has risen at a 2.7-percent rate, in contrast to the 3.8-percent increase of the pre-freeze period of 1971. Much of 7 FEDERAL RESERVE BANK the recent increase has come from items exempt from Price Commission regulations, such as raw agricultural products, used cars, houses, mortgage rates and taxes. The wholesale price news has been less cheery, however, and has had serious impli cations for the future of the consumer-price index and for the international competitive ness of the dollar. Over the course of Phase II this index has risen at a 5.7-percent rate, even faster than during the pre-freeze period of 1971. Looking over the past year as a whole, a lengthy list of disturbing price signs can be compiled from the wholesale-price index: livestock, plus 26 percent (and meat, poultry and fish, plus 14 percent); hides and skins, plus 86 percent (and leather, plus 21 percent); lumber, plus 13 percent; cotton products, plus 10 percent; electric power, plus 8 percent, and so on. 8 . . . except meat, hides, lumber Meat prices again were in the news at mid-year after their earlier decline. At that time a potentially explosive increase devel oped because of heavy consumer demand, sluggish retail supplies of red meat, and the build-up of cattle on the feed lots instead of in the butcher shops. To combat the supply problem, the President removed quotas on meat imports for the rest of the year and the Defense Department cut in half its normal meat inventories. Little could be done, however, about another major con sumer item — coffee — since frost damage in Brazil has already led to sharp increases in the wholesale price of the national beverage. Price increases in hides developed be cause of increased world demand, Argentine export quotas, and lower-than-expected beef kills in this country resulting from the con centration of cattle in feed lots. Heavy ex ports of hides then developed because of price controls in this country and heavy overseas demand. But then the Commerce OF SAN FRANCISCO Department imposed a ticket system of export controls, effective September 1, in a move designed to reduce hide exports to year-ago levels. The Cost of Living Council meanwhile moved to get control of lumber prices, which have been rising steeply under the stimulus of strong housing demand and strike-caused supply problems. The Council reimposed price and wage controls on all manufacturers and dealers with annual sales in excess of $100,000. These concerns had raised their prices rapidly during the period of exemp tion, and thus in some cases may be forced to roll back their prices to the levels of last May. In view of their expanding role, the con trol agencies this spring boosted their com bined staff by one-third to a total of 770 employees, and also assigned one-half of the 3,000 Internal Revenue agents involved in the program to the monitoring of largefirm price compliance. Moreover, the Price Commission began to think in terms of the “impact test” and the “basket clause,” in its desire to control the gyrations of the whole sale and consumer price indexes. Under the impact criterion, the Commis sion may apply stricter-than-normal rules for processing price-increase applications whenever a rise threatens to lift the index more than 0.1 percent. The Commission al ready has moved in the shoe industry, by ruling that shoemakers may pass on leathercost increases only on a dollar-for-dollar basis. The auto industry may be another candidate for this test, since the major pro ducers have applied for price increases of 1.9 percent or more on 1973 models to cover the cost of government-required equipment, although a rise of 1.5 percent would serve to generate a 0.1-percent rise in the overall wholesale-price index. (However, much of the requested 1.9-percent increase may not affect the index, because of being defined August 1972 MONTHLY as “quality improvement.” ) The “impact test” tends to act as a trigger for application of the “basket clause” — which involves whatever is necessary to hold the overall economy-wide increase within the guideline of 2.5 percent a year. What size deficits? On the fiscal side the Administration released new budget figures in June, which indicate that a strong fiscal stimulus will con tinue for some time yet. (In the fiscal year just ended, the stimulus as measured by the full-employment deficit amounted to $3.6 billion.) The figures indicate a $27-billion overall deficit in fiscal 1973 (unified basis), but later developments suggest a far higher deficit figure, perhaps on the order of $37 billion. Moreover, unofficial observers argue that the full-employment deficit might ap proach the highly inflationary figure recorded in 1967-68. Major expenditure increases which were not included in the June budget figures in clude expanded Defense Department outlays (especially those related to Vietnam), flood-relief spending, and the major part of the recently enacted 20-percent social-se curity benefit increase. The latter alone should boost the 1973 deficit by at least $4 billion. Treasury financing was eased this spring by a sharp improvement in the Treasury’s cash position, as the $39-billion (1972) deficit projected in January became trans formed into an actual $23 billion at the end of the fiscal year. Some improvement in the Treasury’s cash balance developed be cause of smaller-than-expected spending, but more of it came about because of the unex pectedly large tax intake resulting from the expanded economy and the over-withhold ing phenomenon. In addition, there was an extra inflow of foreign funds, as central banks which had taken in dollars in ex REVIEW change-support operations invested part of those proceeds in Treasury special issues. During the second quarter, debt managers paid down the debt instead of borrowing heavily as they had been expected to do. This condition of ease has extended into the third quarter — partly because of the issu ance of roughly $3 billion in special issues to foreign central banks who have recently been soaking up dollars. But the large size of the projected deficit for fiscal 1973 indicates very heavy financing in the fourth quarter and thereafter. However, total cash needs during the July-Becember period may fall below the $21.5 billion raised in the like period of 1971. As a reflection of its continuing strong cash position, the Treasury in late July off ered a 3 Vi -year note priced to yield 5.96 percent, a 7-year 6.25-percent note at par, and a 12-year bond priced to yield 6.45 percent, in exchange for notes and bonds maturing during the remainder of 1972. The longer note and the bond also were made available in an advance-refunding operation designed to help the Treasury level off the large amounts maturing several years hence. The public’s good response to this offering exceeded the Treasury’s initial expectations. Slower growth, higher rates As the economy strengthened, the Federal Open Market Committee decided at its April meeting to seek somewhat more mod erate growth of the monetary aggregates. (The Committee noted that the moderation probably would be associated with “some further tightening of money-market condi tions.” ) As it turned out, the money supply (demand deposits plus currency) grew at a 5.1-percent rate during the second quarter — as against the 9.3-percent rate of the pre ceding quarter — despite an especially fast FEDERAL RESERVE BANK M o n e t a r y In d ic a to rs point to moderation in growth path 10 growth occurring during April. Also, time deposits advanced strongly, with large cor porate CDs increasing rapidly in the early part of the quarter and other time-and-savings deposits accelerating later in the period. Commercial bank credit increased at a 7-percent rate during the spring period — as against a 15-percent rate in the first quar ter — as security investment slackened but loan expansion continued strong. Businessloan demand strengthened at least during May and June (except at the large New York banks), while demands for consumer and mortgage loans increased very rapidly on the basis of the auto boom and the hous ing boom. Money-market rates advanced (except during April), continuing the uptrend evi dent early in the year. The 90-day Treasurybill rate exceeded 4 percent early in July — a full percentage point above its Febru ary level — and the Federal-funds rate in creased to AV2 percent in the same period. On the basis of this rise in market rates and the stronger loan demand, bank businessloan rates moved up in the same fashion, and reached a range of 5 X A to 5V2 percent OF SAN FRANCISCO in July. Loan demand was very heavy out side of New York as many large firms went to regional banks for their working-capital financing. By early August, however, short term rates began to soften. In the long-term sector, Treasury bond rates dropped temporarily because of the Treasury’s easing cash position, but then stif fened and held at around 5V2 percent in July. Corporate Aaa bond rates remained high, at over 7 percent in July, as investors remained relatively timid because of infla tion fears, the international situation, and the prospect of a very large Treasury deficit in fiscal 1973. But external financing by corporations was fairly light, since firms had ample cash flow to support their heavy spending on new plant, equipment and inventory. Even with the sharp rise in short-term rates and the relatively stable level of long term rates, a wide spread between moneymarket and capital-market rates still existed at midyear. Apparently, investors remained unconvinced of the likelihood of wage-price stability or balance-of-payments equilibrium, and therefore continued to demand an infla tion premium. Yet another crisis Yet another international crisis developed in late June when the United Kingdom floated the pound in response to a specula tive attack, even though it held a record level of reserves at the time. The major causes of the crisis were the U.K.’s falling balance of trade, its chronic inflation problem, and labor turmoil which climaxed in late July with a nationwide dock strike. To combat the re sultant movements of capital funds, a num ber of nations then resorted to expanded exchange controls. The U.K. itself extended its existing controls to cover flows to the overseas sterling area, limiting banks in their foreign-exchange dealings to investment pur August 1972 MONTHLY poses, and permitting firms to buy foreign currency only for import-export purposes or for approved investment abroad. West Germany, the major recipient of the unwanted inflow of weaker currencies, im posed a series of controls, although at the cost of the resignation of Economics and Finance Minister Schiller. The government ordered German-based nonbank corpora tions to deposit with their banks, at zero interest, 50 percent (up from 40 percent) of the funds they borrowed abroad; also, it raised further the marginal reserve require ments on Deutschemark-denominated de posit liabilities to nonresidents. The Japanese government steeply increased reserve re quirements on yen deposits that have been converted from dollars and held by non-resi dent foreigners. Switzerland prohibited non resident foreigners from buying Swiss real estate or securities, imposed a negative-inter est charge of 8 percent on nonresident Swiss franc deposits, and banned all borrowings abroad by Swiss firms without central-bank approval. To help restore order in foreign-exchange markets and to help uphold the Smithsonian agreement, the Federal Reserve intervened in the market in mid-July, purchasing dol lars with Deutschemark balances held by the Treasury. According to Federal Reserve Chairman Burns, the operation will continue on whatever scale and whenever such trans actions are deemed desirable. At the same time, the Chairman said that last August’s suspension on the use of swap lines was now lifted. Trade breakthrough On the foreign-trade front, most of the big news recently came from Eastern Europe instead of Western Europe, as the U.S. be came involved in both a major wheat deal REVIEW and a major technical-assistance project with the USSR. The U.S. agreed in July to sell $750 million of wheat and other grains to the USSR over a three-year period, with standard financing by the Commodity Credit Corporation. (This would amount to a 17percent increase in total U.S. grain exports over the average exports of the 1969-71 period.) Also in a multi-firm deal, U.S. par ticipants announced that they would become involved inside the Soviet Union in the ex ploration and production of natural gas and crude oil, the design and building of hotels, the production of agricultural fertilizers and chemicals, and various other projects. The net balance on foreign transactions in goods and services continued at a record deficit level during the second quarter. In the GNP accounts, imports exceeded exports at a $4.9-billion annual rate during this period, slightly worse than in the January-March period. Imports of goods recently have re mained on a high plateau, reflecting partly the rising demand for industrial foreign prod ucts from an expanding domestic economy and partly a slowdown in imports of nonfood consumer goods other than autos. Exports have also remained fairly flat, as demands for U.S. goods have not responded to the slow upturn in foreign economic activity. U.S. shipments of agricultural commodities, however, held at a very high level in the second quarter. Despite considerable arguments as to the timing and magnitude of future changes in American foreign trade, practically all ob servers expect an improvement in the poor trade showing experienced so far this year. However, the overall improvement resulting from devaluation may not be fully realized before late 1973 or early 1974. William Burke FEDERAL RESERVE BANK OF SAN FRANCISCO Regional Advance he Western economy expanded roughly in line with the national pace during the spring and early summer months, even in the face of a slackening in the housing boom and the continued low level of activity of the aerospace-manufacturing industry. But the vast regional economy, which re cently has been generating $140 billion in income annually, had other sectors which took up the slack and kept the recovery moving along. Nonfarm payroll employment rose at a 4-percent annual rate — somewhat faster than the first-quarter rate — and exceeded 10.7 million on average during the spring period. The gains were broadly based, with all major sectors — manufacturing, con struction, distribution, services, and govern ment — advancing at the same pace. Despite this improvement, the unemploy ment rate in Pacific Coast states declined only slightly, from 6.6 to 6.5 percent, be tween the first and second quarters. (The California rate actually edged up slightly, to 6.2 percent, but in Washington the rate fell a full percentage point over the quarter, although to a still high 9.2 percent.) Yet because of the sharp declines in joblessness in late 1971 and early 1972, the regional rate is now considerably below the 7.8-percent peak figure reached a year ago. T 12 Recovery: government finance The Western economy benefitted this spring from the fiscal stimulus arising from the Federal budget deficit. State-government finances also benefitted, as income and salestax receipts advanced strongly. California in particular received a stimulus not only from rising incomes associated with the recovery but also from the initiation of its own in come-tax withholding system, so that the state found itself at the end of fiscal 1972 with a $256-million budget surplus. And despite an expected rise in state spending from $6.9 billion to $7.7 billion between fiscal 1972 and fiscal 1973, California au thorities project a $550-million surplus in the new fiscal year on the basis of current trends. Western governmental units issued about $1.2 billion in bonds during January-May 1972, or one-fifth less than in the comparable 1971 period, when they had borrowed heavily to rebuild their liquidity. The aver age yield on these borrowings was 5.23 per cent, as against an average of 5.63 percent in last year’s more crowded market. Local governments accounted for over one-half of the total bonds issued in the 1972 period, and state governments and special districts accounted for most of the rest. Mixed trends: housing, aerospace The boom in residential c o n s tru c tio n slackened this spring from the exceptionally high levels reached in late 1971 and early August 1972 MONTHLY E m ploym ent in all major sectors rises at roughly the same pace REVIEW flected mixed trends in the co m m ercial aircraft sector, with heavy demand develop ing for Boeing 727s — and some Chinese in terest reported in 707s — but with relatively weak demand for the wide-bodied jumbo jets. The space agency awarded a $2.6-billion development contract on the space shuttle to North American-Rockwell in late July. The award means a 9,000 increase in jobs at North American’s facilities over the next three years, but it also means cutbacks by some firms that lost out in the competition. Vandenberg Air Force Base in California has already been chosen as one of the two launching sites for the shuttle. 1972, as housing starts dropped 20 percent from the phenomenal first-quarter figure to 488,000 units at an annual rate. However, this was about equal to 1971’s record an nual figure. Residential construction awards also fell steeply to a $7.4-billion rate, but this was still ahead of the peak annual figure ($6.5 billion) recorded last year. In addi tion, the pace of mobile-home sales (ship ments) remained far ahead of last year’s record 79,000 units. Activity also declined in the nonresidential and heavy c o n s tru c tio n categories, with awards dropping from the record firstquarter pace to a $6.4-billion rate. But here again, the second-quarter figure was ahead of the strong 1971 pace. Awards increased for educational and hospital facilities, as well as for water and electric-power facilities, but awards fell for manufacturing plants, com mercial buildings, streets and highways. Employment in aerospace manufacturing increased modestly during the second quar ter, rising by 3,000 to 523,000 workers. This relative standoff reflected mixed trends in de fense contract awards during the previous quarter, with Washington gaining a sub stantial number of new contracts but Cal ifornia falling off considerably. It also re Rising trends: extractive industries Because of supply difficulties as well as the demand generated by the still-strong housing boom, prices rose sharply this spring for Pacific Northwest lumber products. For Phase II to date, wholesale prices of soft wood lumber and softwood plywood have risen by 13 and 21 percent, respectively. Recently, a new labor contract provided for a 9-percent first-year wage increase for mill workers, adding pressures on the cost side, and shortages threatened because of vaca tion shutdowns at domestic mills and a strike in British Columbia forests. Prices rose sharply in early 1972, because of the absence of controls on raw timber and the loopholes in the term-limit-pricing agree ments affecting major lumber producers — and they rose even faster this spring, after the Cost of Living Council lifted wage and price controls for small firms in all sectors of the economy. Because these firms — manufacturers and dealers with 60 em ployees or less — account for a large share of the total lumber sales, they were able to push up prices substantially during the pe riod they were decontrolled. To overcome this problem, the COLC eventually reim- FEDERAL 14 RESERVE BANK posed controls on producers with annual gross sales of $100,000 or more. Western steel producers boosted output sharply this spring to meet the economy’s growing demand and to make up for losses sustained in a six-week strike early this year at Kaiser Steel’s plant at Fontana, California. By July, production was running well ahead of year-ago levels. Steel imports meanwhile surged during the January-May period to a record volume in Pacific Coast states, while declining elsewhere in the nation. However, producers expect that the new quota agree ment signed this May will now reverse this trend. The agreement provides for foreign producers to reduce their imports to the U.S. in 1972, and also calls for Japan to hold its Pacific Coast shipments to no more than one-third of its total imports into the U.S. Pacific Northwest aluminum p ro d u c e rs brought some of their idle capacity back into production, as demand improved and in ventories fell to more normal levels. But so m ew h at paradoxically, the industry this spring lowered the list price of aluminum in got — the primary form of the metal — from 29 to 25 cents a pound. This was done because of the unrealistic nature of the list price, which was considerably out of line with the lower market quotation, but a major consideration was the industry’s commitment to pay the list price in purchasing 350,000 tons from the government stockpile by 1973. After midyear, copper producers lowered their price for the refined metal by 2 cents to 50V2 cents a pound — about one-sixth below the peak figure reached in 1970. This move primarily reflected the lagging demand for copper in sluggish industrial markets overseas. Western oil-refining activity in c re a se d slightly during the second quarter to a point 6 percent above the year-ago level. But since new capacity increased even faster over this interval, refineries continued to OF SAN FRANCISCO H o u sin g s t a r t s remain high, despite fall from record first-quarter pace T h o u s a n d s o f St a rt s operate considerably below their rated ca pacity in most spring months. With the con tinued d o w n tren d in crude output from domestic sources, refineries increased their dependence on Canadian and other foreign sources to meet rising consumer demand. The development of Alaska’s North Slope would eventually deliver two million barrels/ day of crude to Western refineries — a vol ume far in excess of the current level of for eign imports. Interior Secretary Morton has announced himself in favor of the pipe line that would bring the oil to market, but development is three years or more away, because of the legal disputes still surround ing the project. Farming: boom, drought, freeze Marketing receipts of Western farmers were 5 percent above year-ago levels during the winter and early-spring months, as the livestock boom brought about a sharp yearto-year gain in prices received by farmers. But judging from prices paid by farmers, expenses were also up, so that farmers may encounter difficulty in matching their 1971 net income this year. August 1972 MONTHLY Persistent drought conditions in the Pa cific Southwest stimulated the movement of cattle off the range into feedlots. Yet despite heavy feeding activity, marketings from Western feedlots now appear to be little above year-ago levels, which suggests the continuation of recent upward pressures on beef prices. Meanwhile, untimely frosts this spring led to a sharp drop in output of de ciduous fruits, especially in the Mountain states, which suffered almost complete fail ure. Current estimates suggest that the West’s total deciduous fruit output will drop 20 per cent below the 1971 figure, to the lowest level of the postwar period. REVIEW On balance, the Western economy ap pears solidly based for at least the remainder of 1972. Even if the housing boom continues to taper off, other sectors should come for ward to take up the slack — perhaps the aerospace industry, as new orders develop out of the now-rising Pentagon budget, or perhaps the extractive industries, responding to the increasing demands of a stronger na tional economy. The quickening pace of con sumer spending also should provide solid support to the regional economy in the months ahead. Verle Johnston, Yvonne Levy, and Donald Snodgrass Western Economic Association The Annual Conference of the Western Economic Association, celebrating the Association’s fiftieth anniversary, will be held on August 23-25 at the University of Santa Clara. Governor Andrew F. Brimmer of the Federal Reserve Board of Governors will discuss “Recent Developments in U.S. Monetary Policy” at a plenary session. Other sessions will feature discussions of economic theory and econometrics, economics of health and pollution, money and banking, international economics, industrial organization, labor and human capital, and regional and urban economics. For details of the conference program, write to W.E.A. Local Arrangements Committee, c/o Department of Economics, University of Santa Clara, Santa Clara, California 95053. Publication Staff: Karen Rusk, Editorial Assistant; Janis Wilson, Artwork. Single and group subscriptions to the M onthly Review are available on request from the Administrative Service Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, California 94120 FEDERAL RESERVE BANK OF SAN FRANCISCO Brisk Loan Expansion 16 s the Western economy continued to im^ prove in the second quarter, credit at Twelfth District commercial banks expanded $1.2 billion — a 6.8-percent annual rate of increase (seasonally adjusted), or about one percent below the national rate. But the loan component expanded $1.9 billion for a 14.5-percent annual rate — far exceeding the national pace. The loan expansion was broadly based, with strength evident through out the business, mortgage and consumer sectors. Business demand for credit was somewhat stronger in the West than in New York, as District banks increased their com mercial and industrial loans at double the first-quarter rate. In addition, mortgage lend ing accelerated further, and consumers fi nally discarded their long-held reluctance to expand instalment debt. Although the second quarter as a whole was buoyant, by mid-year the banks began to feel the effects of the April firming in monetary policy. In June, District banks re corded the first monthly decrease in total credit so far this year, as the loan expansion slowed from the rapid pace of preceding months and security holdings declined at an accelerated rate. Some of the funds for loan expansion were obtained from a reduction in banks’ hold ings of securities, in contrast to the national pattern. Both U.S. Government securities and municipals declined; however, most of the reduction in Treasury issues was in ma turities over 5 years, while the decrease in tax-exempts was in short-term warrants and bills. The run-off in the latter securities more than offset the additions to short-term mu nicipal issues a c q u ire d during the first quarter. A credit expansion was a $2-billion increase in total deposits (daily average basis). This 13.2-percent annual rate of gain was well above the first-quarter rate, after seasonal adjustment. Deposit gro w th was h eav ily weighted toward time deposits, which in creased at a 16.3-percent annual rate, two and a half times the first-quarter pace. Pri vate demand deposits, on the other hand, grew at only a 7-percent annual rate, less than half the preceding quarter’s pace. Time deposits rose in each month of the quarter, but more than two-thirds of the gain occurred in May, when California banks received extraordinarily large amounts of public time deposits as a consequence of the newly instituted withholding of State income taxes. (These funds were invested in rela tively short-term maturity certificates.) In addition, rate differentials were favorable to investment in corporate-type time certificates at that time. Passbook savings decreased seasonally in April, when individuals withdrew funds to pay income and property taxes, and they increased only modestly in May and June. Nevertheless, Western banks held their rate on regular passbook accounts at 4 percent — the reduced rate which became generally effective last February. On the other hand, other consumer-type time deposits expanded in volume during the March-June period, as some banks that had previously lowered rates or discontinued offering longer maturities again began to offer long-term certificates at ceiling rates. Large-denomination certifi cates also increased during the quarter, as offering rates on these corporate-type de posits moved upward in line with other money-market rates. Rapid time-deposit growth Sustaining the s e c o n d -q u a rte r b a n k - Mixed borrowing pattern The reserve position of District banks re- MONTHLY August 1972 Loan u p su rge dominates 2nd quarter statistics . . . security holdings decline A n n u a l C h a n g e (P e rc e n t) -6 -3 0 3 6 9 12 fleeted the second quarter’s somewhat firmer policy stance. Still, the increase in total de posits was heavily weighted by time deposits, which carry lower reserve requirements than demand deposits, so that the total reserves maintained with the Federal Reserve Bank increased by only $109 million (daily aver age) from the first quarter’s level. But banks reduced their excess reserves to rough ly $12 million, from $15 million in the pre ceding three-month period, while their bor rowing from the Federal Reserve Bank rose slightly, to roughly $5 million from $2 million. Thus, their net free-reserve posi tion dropped to about $6 million from the previous quarter’s $ 14-million average figure. In contrast, large District banks became net interbank sellers (lenders) of Federal funds, with their net sales of $568 million being about two-thirds larger than the January-March figure, on a daily-average basis. In a reverse pattern, they became net bor REVIEW rowers from U.S. securities dealers, and this narrowed their net sales of funds on total transactions to $393 million. (Disaggregated data disclose, however, that many District banks remained net Fed-funds purchasers during the quarter.) The swing to a net sales position may appear paradoxical, but it should be considered against the large in crease in funds borrowed by banks under repurchase agreements with public agencies and corporations. Borrowing from this source increased more than one-sixth above the firstquarter figure to reach nearly $2 billion, and a large portion was resold in the Fed-funds market as banks took advantage of arbitrage possibilities. Stronger business demand Loans at Western commercial banks rose in each month of the April-June period. Most major loan categories contributed to the expansion, and the increases were widely distributed geographically as well. Business demand for credit was strong in April, slackened in May and then strength ened again in June. Altogether, business loans increased $473 m illio n during the quarter (seasonally adjusted) — a 10-percent annual rate of growth, nearly double the national rate. Public utilities accounted for the largest increase in business borrow ing, in contrast to the first quarter, when a major public utility repaid bank debt with the proceeds of a capital offering. Increases were also registered by wholesale and retail trade, mining, construction and foreign com mercial firms. In manufacturing, borrowing by the durable-goods sector declined because of net repayment of debt by transportationequipment manufacturers, and the nondur able-goods sector also generally reduced its borrowing except in the textile and apparel industries. While demand strengthened for short term business credit, demand weakened for term loans (maturities of one year or more). FEDERAL RESERVE BANK OF SAN FRANCISCO Sources and Uses Large Twelfth District banks registered an expansion of slightly over $2 billion (daily average) in their sources of funds in each of the first two quarters of 1972. (Data unadjusted for seasonal variation.) While these gains were well below the $2.7-billion expansion of fourth-quarter 1971, they equalled the average quarterly increase for 1971. Time deposits, demand deposits, and capital accounts were the major sources of additional funds in the first quarter, with time deposits accounting for 76 percent of the total. Sources of funds were more varied in the second quarter, with time deposits accounting for only 39 percent of the total increase. Net demand deposits contributed 20 percent of the April-June increase — about double the proportion in the first three months. Also, District banks raised substantially less funds through capital issues during the spring period, although the amount was still relatively high, accounting for 6 percent of the gain. The major change from earlier in the year was the large amount of new funds (15 percent of the total) obtained through borrowing under corporate and other repurchase agree ments, mainly from public agencies. Banks also made net reductions in their holdings of both U.S. Treasury and other securities, and this produced 19 percent of their additional funds for the quarter. In the first half of 1972, a much larger proportion of new funds was channeled into loans than in the comparable 1971 period. Regular loans absorbed 48 percent of banks’ expanded funds in January-March, and this rose to 78 percent in the second quarter. (When net loans in Federal funds are added, these figures rise to 75 and 96 percent, respectively.) Also, banks used 16 percent of their funds to expand holdings of U.S. Treasury issues in the first quarter, but reduced their holdings in the second quarter. In both quarters, as deposits expanded, banks allocated some funds for higher required reserves and some funds to repay Eurodollar borrowings. N e t C h a n g e ( M i l l i o n s o f D o l la r s ) ;— O ther Securities U.S. G o v e rn m e n t Securities C a p ita l A ccounts D isc o u n tin g C orp o ra te R e p u rch a se s D e m a n d D e posits Fe d e ral Fu nd s R eserve s August 1972 MONTHLY A second-quarter reduction of $100 million in term loans at large District banks fol lowed the national pattern. Reflecting April’s X A -percent increase in the prime rate, the average rate paid by busi ness borrowers in major West Coast cities rose to 5.60 percent on regular short-term loans and 5.57 percent on revolving credit loans in early May. These rates represented increases of 21 and 44 basis points, respec tively, from the average rates paid three months earlier. Farm, consumer demand Western farmers continued to expand their borrowing activities during the spring period. Loans outstanding at Production Credit As sociations increased above the year ago level in practically all District states, and were up considerably in California. Short-term com mercial-bank lending was also heavier than a year earlier, although lagging behind the pace set by the PCA’s. Mortgage lending of Federal Land Banks also increased further. Western consumers finally cast off their hesitancy toward incurring instalment debt during the spring period. At large District banks alone, instalment loans rose $441 mil lion in the April-June period — a record quarterly rise, and more than three times the first-quarter rate. Preliminary data indi cate relatively large gains in auto loans and in loans for other consumer goods, whether under credit-card plans or direct-loan terms. Active mortgage markets Commercial banks and savings-and-loan associations alike experienced a moderation in savings inflows during the second quarter, but the pace of their mortgage lending still accelerated. Large commercial banks in creased their savings deposits (passbook sav ings plus other consumer-type deposits) by about $369 million, only about one-half the previous quarter’s gain, while the S&L’s re corded a $ 1.7-billion net increase, more than REVIEW one-fourth below the winter period’s record inflow. Nevertheless, commercial banks expanded their mortgage portfolios by a record $722 million, and the S&L’s increased their out standing real estate loans by a record $1.6 billion. At the same time, both the banks and S&L’s increased their volume of loan commitments to levels which promised a continuing high volume of mortgage financ ing in the months ahead, and the S&L’s made further repayments to the Federal Home Loan Banks on earlier borrowings. The moderate slowdown in savings, in conjunction with a continuing high level of mortgage-loan demand, c o n trib u te d to a slight firming of mortgage interest rates in the West, as the average rate on a conven tional new-home loan rose by 15 basis points over the quarter to 7.70 percent. Concur rently, average loan maturities in most West ern markets remained fairly steady, while average down payments decreased slightly, apparently reflecting a growing proportion of 5-percent-down loans made by savingsand loan associations. W ide variations in income Earnings of individual District banks varied widely in the second quarter, just as they had earlier in the year, with declines as well as increases being widespread. Profit margins generally widened somewhat in early April, when Western banks followed the national trend by adjusting their prime rate on business loans to 5 percent from the 4% percent rate which had prevailed since late January. (The further increase to 5 X A -per cent at the end of June was too late to affect first-half income results.) The rapid expan sion in loans also was a favorable factor on the revenue side. On the other hand, bank costs for funds edged up slightly, as money-market rates in creased and general bank expenses continued 19 FEDERAL their inexorable rise. not realize securities of 1972, as they had was a limiting factor RESERVE BANK Also, most banks did gains in the first half in 1971, and this too on net income. Strong credit demand? Most Western banks held their prime rate to 5!4 percent in July — although a few banks elsewhere in the nation moved at mid-month to 5Vi percent before retreating to 5 Va percent in early August. Banks can expect somewhat higher loan revenues as the effect of the June increase in the prime rate is reflected throughout the loan rate structure. Business loans increased in June and ex panded further in the first half of July, but OF SAN FRANCISCO then weakened during the remainder of the month. (However, business demand for credit could accelerate in coming months if the expected upsurge in inventories materi alizes.) Also in July, real-estate loans ex panded at the high second-quarter rate, and consumer instalment loans held at the accel erated June pace. The net inflow of savings and consumer- type time deposits continued at the slower rate evident in the second quarter. Public time deposits were reduced in July, follow ing the normal third-quarter seasonal pattern of withdrawals, so District banks in coming months may have to rely more heavily on large negotiable CD’s as a source of funds. Ruth Wilson and Verle Johnston SELECTED ASSET AND LIABILITY ITEMS OF WEEKLY REPORTING LARGE BANKS Data Not Seasonally Adjusted (Dollar amounts in millions) TWELFTH DISTRICT June 28, 1972 Loans Gross A djusted1 and Investm ents Loans Gross A djusted1 Federal Funds Sold2 To Com m ercial Banks To Brokers and Dealers O ther Loans— Total C om m ercial and Industrial Loans Real Estate Loans C onsum er In stallm ent Loans A gricultural Loans Loans to N onbank Financial Institutions All O ther Loans Total Investm ents U.S. Governm ent Securities Obligations of States and Political Subdivisions O ther Securities Total Deposits (Less Cash Item s) Dem and Deposits Adjusted U.S. Governm ent D em and Deposits Total Tim e and Savings Deposits Savings Deposits O ther T im e Deposits IPC Deposits of States and Political Subdivisions (N egotiable C D ’s— $100,000 and over) C apital Accounts Total A sse ts /L iab ilitie s, Reserves and Capital Accounts 20 'Total loans minus loans to domestic commercial banks including securities purchased under resale agreements 63,475 45,984 2,464 2,166 186 45,910 16,628 13,708 7,017 1,614 2.501 4,442 17,491 6,310 9,131 2,050 62,185 19,165 1,121 40,817 18,174 15,381 5,451 5,240 5,102 81,744 OTHER U.S. Net Change Outstandings March 29, 1972 to June 28, 1972 Net Change March 31, 1971 March 29, to 1972 to June 30, 1971 June 28, 1972 Dollars Percent Percent Percent + 1,434 + 2,136 — 393 — 452 53 — + 2,060 579 + 722 + + 441 101 + 16 + 201 + _ 702 _ 284 — 460 42 + + 1 ,498 288 175 + : ,466 90 847 + 658 + + 366 85 + + 2 ,717 + 2.31 + 4.87 — 13.76 — 17.27 22.18 + 4.70 + 3.61 + 5.56 + 6.71 + 6.68 + 0.64 + 4.74 + 1.33 + 1.88 — 21.80 + 36.40 — 77.94 + 3.81 — 0.56 + 4.17 + 4.72 + 13.44 + 15.95 + 9.69 + 0.04 — 3.43 + 0.99 + 7.57 + 1.90 + 2.81 + 54.53 + 0.58 1.47 + 1.05 + 8.26 8.93 + 4.27 2.55 + + 2.66 + 4.26 — 4.00 — 5.46 + 4 7 .4 5 — 3.86 — 4.31 — 4.80 + 2.09 + 2.47 1.48 + 18.50 + 3.73 0.49 + 5.83 + 13.73 + 7.51 + 1.69 + 3.44 + + + + + + + 4.37 1.35 5.36 5.10 5.32 8.25 8.96 — 1.15 6.88 1.44 3.60 — + + + + + + + + + + + 1.72 0.64 0.71 3.16 0.81 5.70 1.36 7.38 1.88 1.68
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