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ID A H O ALASKA FEDERAL RE S E RVE BANK OF SAN F R A N C I S C O 1 TWELFTH FEDERAL RESERVE DI S T R IC T W A SH IN G T O N o R ECO N AAue UTAH Review of Business Conditions . . Cash Flows and Corporate Investment Review of Business Conditions in January were slightly above the Novemberbusiness activity during Janu December level, despite declines in sales of ary continued at about December levels, and the economy thus spent another month on department stores and some other types of retail outlets. Weather conditions were a fac the high-level plateau that has prevailed since tor in trade, as in production, and weekly fig last summer. Industrial production was 119 ures indicate sales rebounded somewhat in percent of the 1957-59 average, unchanged the first two weeks of February. The Census from the December index which was revised Bureau’s January survey of consumer buy downward from 120 percent; strikes and se ing intentions indicated that, compared with vere weather were factors limiting output in a year ago, more consumers plan to buy both of those months. The production index household appliances, used cars, and new and has varied fractionally between 119 and 120 old homes this year, while the proportion ex since mid-1962. Iron and steel production, pecting to buy new cars was about the same. which declined slightly in January on a sea Employment in nonfarm establishments sonally adjusted basis, rose during the last was little changed in January, on a seasonally week of the month and the first two weeks of adjusted basis, and remained at the peak level February, judging from unadjusted figures. of approximately 55.6 million that has existed Large steel producers noted a rising trend in since mid-1962. Manufacturing employment orders for both consumption and inventory. and the average workweek were somewhat New orders received by durable goods manu below last summer’s levels, and transporta facturers rose 4 percent in January, revers tion employment was reduced because of the ing a decline in the previous two months. The month-long strike of longshoremen at East gain was concentrated in primary metals, ma ern and Gulf ports. The rate of unemploy chinery, and aircraft industries. Durable ment in January rose to 5.8 percent of the goods manufacturers’ sales were unchanged civilian labor force, compared with 5.6 per from December to January. cent in December, and was at the same rela The value of new construction put in place tively high level as a year earlier. Personal in during January was at a seasonally adjusted come rose by an annual rate of $2 billion to annual rate of $62.5 billion, up somewhat $452.4 billion in January, but it would have from the revised December rate, and was lit shown little change if the Veterans’ Adminis tle changed from levels prevailing during tration had not made a special prepayment of most of the second half of 1962. The January dividends equivalent to $3.6 billion at annual increase was concentrated in residential build rates. ing, which rose 2 percent. Housing starts de In the Twelfth District, business activity clined sharply in January, however, with was much less affected by poor weather in much of the decline attributed to unusually January than in other parts of the nation. severe weather in most regions. Even though the construction and lumber in Automobiles remained a strong factor in dustries in certain areas of the District were the economy during January; assemblies re somewhat affected by the cold wave in the mained at the advanced level of the previous western United States during part of the six months, and dealer deliveries of new autos month, the impact on activity was undoubted rose somewhat. Automobile sales continued ly less than in the nation. Housing starts, for example, rose in southern California, in con at a high level in February. Total retail sales N a tio n a l FEDERAL RESERVE BANK trast with a sharp decline in the national total. Aside from seasonal influences, construction activity remained an element of strength in the District economy during December and January. Construction employment increased and, on balance, the available indicators of future construction activity, including de mands for mortgage credit and the volume of construction contract awards, suggest a con tinued high level of building in the District. Retail trade, too, held up better in the Dis trict than in the nation. Department store sales in the District rose slightly in January on a seasonally adjusted basis. Auto sales con tinued at a record pace, as indicated by regis trations in California. Employment expanded in the District in December, and there was a sizable increase during January in the number of jobholders in the populous Pacific Coast States. Unem ployment on the Pacific Coast declined for the third consecutive month, and the rate of unemployment was back to its prerecession level for the first time. Nationally, the unem ployment rate in January was at its 1962 high. Another area of contrast between the Twelfth District and the nation was reflected in the loan, investment, and reserve figures of commercial banks. The January decline in loans of weekly reporting member banks in the District was less than seasonal, and rela tively less than the decline nationally, par ticularly in business loans. At the same time, however, there was a greater decline in de mand deposits at District banks, thereby put ting the banks under some reserve pressure. Holdings of short-term Treasury securities declined and purchases of Federal funds rose. Nationally, bank holdings of Government se curities increased in January, and there was less tightness in the reserve positions of banks outside the Twelfth District. OF SAN FRANCISCO Nonfarm employment on Pacific Coast has expanded more rapidiy than in nation M illio n ! of P e r s o n Source: United States Department of Labor and State depart ments of employment More people at work, fewer unemployed in January January data for the Pacific Coast States indicated an increase of 0.8 percent in non farm payroll employment, following a gain of 0.5 percent in December1. The most substan tial increases were in contract construction, manufacturing, and services. There were also January employment gains in primary metals and lumber and wood products, two indus tries in which employment did not expand in 1962. The increase in the primary metals in dustries was the first since June 1962, al though the number of jobholders was still less than a year ago by 3 percent, or 2,000 work ers. Employment in lumber and wood prod ucts establishments rose from December to January and was above year-ago levels in all three states. In contrast, there were some cut backs in employment in the defense-related industries during January. Ordnance employ 1 All data are seasonally adjusted unless otherwise noted. February 1963 MONTHLY REVIEW ment in California declined by 1,600 work ers, the first monthly decline since April 1961. This drop was caused, in part, by lay-offs in the Los Angeles area due to the cancellation of the Skybolt Missile Program. Aircraft em ployment declined by 1,500 workers to 247,900, with decreases in both California and Washington. However, the electrical equipment industry, mainly electronics, con tinued its rapid growth of 1962 with a gain of 1.2 percent from December. A significantly reduced rate of unemploy ment accompanied the employment gains of December and January in the Pacific Coast States. The January unemployment rate of 5.4 percent represented the lowest for these states since April 1960, just before the onset of the 1960-61 recession. While January data for the entire District are not yet available, nonfarm payroll em ployment rose 0.5 percent in December. This increase was a continuation of a steady month-to-month gain in the number of job holders during most of 1962. Department store sales at high level in January Twelfth District department store sales during the first five weeks of 1963 were 6 per cent above the year-ago period. All of the major metropolitan areas within the District shared in the increases. The seasonally adjust ed Twelfth District department store sales index for January equalled the previous high set in November 1962. This represented an increase of 1 percent (and 1 index point) over December and was 8 percent above the year-ago month. California auto registrations hit record in January During January, there were 65,476 new cars registered in California, a record for that period. This averaged 2,518 registrations per day, 1 percent higher than in December and 31 percent above the year-ago month. In the nation as a whole sales were also at record levels for January, being 13 percent above the same month last year. December rise in consumer credit at District banks Total instalment debt at Twelfth District commercial banks rose $40 million in De cember, largely as a reflection of Christmas buying. Auto credit outstanding increased by $ 17.4 million. This was a smaller growth than from October to November, primarily as a result of lower extensions. Personal loans and other consumer goods paper outstanding, which include financing of Christmas goods, rose $14.8 million and $7.5 million, respec tively. Extensions for these loans were up sharply from November, bringing total exten sions up to about the August level, the pre vious high. Construction aw ards rose in December Construction contract awards in District states (excluding Alaska and Hawaii) to taled $797 million in December, after sea sonal adjustment.1 This was a gain of 1.7 percent from November. Although this was less than the rise in the nation, the compari son is substantially influenced by one large public utilities contract in the national total. District residential contracts declined fracionally, as gains in apartment contracts did not quite offset a decline in those for single family homes. Housing starts in January rose in the West, particularly in southern California, according to the Census Bureau. Work started on pri vate dwellings declined in the nation as a whole by substantially more than is usual for the season, and the drop-off was greatest in 1 Based on data reported by the F. W, Dodge Corporation. Seasonally adjusted unless otherwise stated. FEDERAL RESERVE BANK Trends in conventional m ortgage rates reflect am ple availability of funds P ercen t Per Annum mortgages. The Federal Housing Administration series is based on a monthly survey of its insuring directors as of the first day of every month. Data from the 74 regional offices are combined into regional and national averages. The “West” includes Montana and Wyoming in addition to the nine Twelfth District states. The Federal Home Loan Bank Board series is based on a survey of over 200 large savings and loan associations across the coun try. These associations are asked to report rates charged on the conventional mortgage loans they make in the first ten days of each month. The rate data are weighted averages and are strongly influenced by responses from the large associations located in California. Source: Federal Housing Administration ajid Federal Home Loan Bank Board. those areas affected by severe weather during the month. FHA-insured housing activity declined in December Applications in December to the District offices of the Federal Housing Administra tion for mortgage insurance on new-home loans fell about 2 percent below their No vember level and were almost 9 percent less than a year earlier. The same pattern held for FHA-inspected housing starts, which de clined by 14 percent from November to De cember, and were 16 percent below a year ago. New-home applications and inspected housing starts in the nation also showed month-to-month and year-to-year declines, but these were considerably greater than in the District, possibly due to a relatively stronger seasonal influence. OF SAN FRANCISCO M o rtgage credit conditions remain stable There was little change in mortgage loan rates or in prices for mortgages between Jan uary and February, either in the District or in the nation as a whole. The monthly survey conducted by the Federal Housing Adminis tration indicated that conventional mortgage rates in the West on February 1 averaged 6.15 percent for new homes and 6.20 percent for existing homes. Secondary market prices for FHA-insured home mortgages rose $0.10 to $97.80 per $100 for 514 percent, 25-year new-home mortgages with a 10 percent down payment. Rates on conventional mortgages were generally stable during 1962 (see c h art), and FHA-mortgage prices drifted upward throughout the year. These patterns reflect ample availability of funds relative to the rise in demands for mortgage credit. Insured savings and loan associations in the Twelfth District showed gains both in their savings accounts and in mortgage holdings during January, and loan commitments also increased. Lumber orders exceeded production in December and January; prices rose Lumber production declined during De cember in the Douglas fir and Western pine regions. Orders in each region exceeded pro duction, however, and average lumber prices rose. In the Douglas fir region, December or ders were fractionally higher than in No vember, and substantially higher than a year ago. Production was reduced by 15 percent, largely because of the Christmas holiday, bringing output well below orders. Unfilled orders rose by 15 percent. In the Western pine region, a 7 percent increase in orders ac companied by an 8 percent cutback in pro duction also put production below orders. January production, orders, and ship ments in the Douglas fir region surpassed their February 1963 MONTHLY REVIEW December levels. Production was less than orders but exceeded shipments, so that un filled orders and inventory both increased. Preliminary weekly data indicate that, in the Western pine region, January production, or ders, and shipments declined from Decem ber. However, orders still outran production. Crow’s average lumber prices rose 0.2 percent in December to $73.73; a further rise brought the average to $74.41 by February 1, about 1 percent above the year-ago level. Western steel output declined slightly in January Western steel production declined 1.7 per cent from December to January, while na tional output advanced 3.8 percent. The de cline in District production in January ap peared to be attributable to producers meet ing their orders during the first part of the month out of inventory. There was a pickup in production in the latter half of the month. Western mills stepped up their operations further in the early part of February, and out put reached its highest level since the week of April 7, 1962. However, steel production in creased more briskly in areas outside the District, where the automobile industry is a more important factor in the market for steel products. Copper shipments rise; prices hold steady Producer shipments of refined copper to domestic consumers rose in January to their highest levels since last June; mine produc tion and scrap intake increased, and stocks declined. Through mid-February, orders ap parently continued at the January level. Brass mills, however, reported some decline in or ders from January to mid-February. Prices remained steady for the year to date, except for some weakness in scrap copper toward mid-February. The producers’ price for re fined copper has held at 31 cents a pound for over 20 months. Work stoppages in Katanga and at other African mines during January and the first part of February continued to limit increases in world copper supplies. Farm returns continue at record level Cash receipts of District farmers from mar ketings set a new record for the month of December, although they declined season ally from the unusually high level in Novem ber. For the entire year, they totaled a record $5.5 billion, with the volume of receipts in creasing from 1961 in all District states1 ex cept Nevada. New records were established in three District states— California, Arizona, and Idaho. Heavy marketings contributed to the 1962 advance in District returns, but there was also some increase in prices re ceived by farmers. Nationally the flow of re ceipts from marketings also reached a record high in 1962, but the rate of increase was somewhat less than in the District. January decline in District bank loans less than seasonal Bank loans normally decline in January as funds borrowed in connection with De cember tax payments and other temporary year-end needs are repaid. In the last half of January this year the decline in total loans2 outstanding at weekly reporting member banks in the Twelfth District was larger than in the comparable weeks of 1962. For the month as a whole, however, the reduction in total loans was about one-third less than in January 1962 and two-thirds less than in 1961; moreover, loans increased during the first week of February. The relatively larger decline in the last part of January, therefore, appears to indicate only a lag in timing of seasonal loan repayments rather than a weak ening in loan demand. The January decrease of $77 million in commercial and industrial loans was only 1 Excluding Alaska and Hawaii, for which data are not available. 2 Adjusted to exclude loans to domestic commercial banks and less valuation reserves. FEDERAL RESERVE BANK OF SAN FRANCISCO S E L E C T E D B A L A N C E S H E E T I T E M S O F W E E K L Y R E P O R T IN G M E M B E R B A N K S IN L E A D IN G C I T I E S (in millions of dollars) Twelfth District Change from Dec. 26,1962 to Jan. 30, 1963 Jan. 30, 1963 Dollars Percent $28,071 — 262 — 0.9 — 2 7 ,7 3 9 18,328 — 288 — 89 — 1.0 — 0.5 6,1 54 6,382 909 — + + 77 76 17 1,026 + 6 260 197 3,731 — — — 52 11 25 332 6,3 28 3 ,0 83 1 2 ,036 15,403 Outstandings ASSETS: Total loans and investments Loans adjusted and invest ments Loans adjusted1 Commercial and industrial loans Real estate loans Agricufurai loans Loans to non-bank finan cial institutions Loans for purchasing and carrying securities Loans to foreign banks Other loans Loans to domestic com m ercial banks U. S. Government securities Other securities LIABILITIES: Demand deposis adjusted Total tim e deposis Savings deposits United states Change in corre sponding year-ago period 12,222 Change in corre sponding year-ago period Change from Dec. 26, 1962 to Jan. 30, 1963 Dollars Percent 0.4 — 2,791 — 2.1 _ _ J.8 — — 15 0 .8 — 2 ,5 4 9 — 2 ,8 5 4 — 2.0 — 3.5 — — 2.1 3 .6 — 1.2 + 1.2 + 1.9 — + + 2 .6 — 0,4 + 122 — + 2 .8 0.2 6 .0 — 2 — 2.5 + 0.8 — 0.1 + 3.7 + 0.6 — 4.7 — 577 — 8.2 — 10.1 — 16.7 + — 6 .6 — 0.7 + 0.9 — 1,268 + 1 — 84 — 21.8 + 0.2 — 0.5 — 2 1 .8 5.3 + 26 — 158 — 41 + 8.5 — 2.4 — 1.3 + 135.1 — 2.7 + — 2.2 + 242 178 127 — 11.3 + 0.6 + 0.8 + 2 2 .3 — — 468 + 271 + 92 — 3.7 + 1.8 + 0.8 — 3.7 + 2 .3 — 2.7 + 2.6 + 1*1 — 1,768 + 1,291 + 431 — Percent o 871 + 1.2 Percent — 4.4 + 0.2 + 0.7 — 0.5 — 3.0 + 3 .4 + 1.9 1 Exclusive of loans to domestic commercial banks and after deductions of valuation reserves; individual loan items are shown gross. Source: Board of Governors of the Federal Reserve System and Federal Reserve Bank of San Francisco. about half the decline in January 1962. Trans portation equipment manufacturers account ed for the largest proportion of seasonal re payments by durable goods manufacturers, as they had in January of 1962. Loan repay ments by food and liquor processors were nearly one-third less than in January 1962, but wholesale trade firms (other than com modity dealers) made far larger reductions in their bank-held debt than a year earlier. Mortgage holdings of District weekly report ing banks increased $76 million in January, offsetting the decline in business borrowing. It appears that the steady upward trend in real estate loans, which began in mid-1961, is continuing into the new year. The “other loan” category, mainly consumer loans, which expanded in the fourth quarter of 1962 largely as a result of increased automobile financing, declined in January despite a con tinued high level of automobile sales. During January, District banks extended sizable amounts of credit to brokers and dealers for purchasing and carrying United States Gov ernment securities, but by the end of the month these loans had been repaid and total outstandings in this loan category were re duced to $17 million. Loans to brokers and dealers for carrying other securities, however, increased about $18 million over year-end outstandings. Banks in District outpace nation in loan performance The more favorable loan performance of weekly reporting member banks in the Twelfth February 1963 MONTHLY REVIEW District compared with those in the nation which prevailed during 1962 appears to be continuing in 1963. The 0.5 percent reduction in loans in January at District banks contrasts with a 3.5 percent decline nationally. While District banks in the last few years have had a much smaller percentage total loan decline in January than other banks, the margin in favor of the District widened this year. This disparity was also evident in business loans which declined only 1.2 percent in the District compared with a 2.5 percent reduction in the nation. One of the sustaining factors in Dis trict loan performance was the continued in crease in real estate mortgage holdings, up 1.2 percent in January. District banks reduce holdings of short-term securities District weekly reporting member banks reduced their investment in United States Government securities by $158 million in January. The reductions were largely in hold ings of Treasury bills, but these banks also sold notes and bonds maturing within one year, while adding to intermediate and longer term maturities. The decline of over 2 per cent in holdings of Treasury issues contrasted with a small percentage increase nationally. District banks also reduced their portfolios of securities other than Treasury issues, while nationally there was an increase in such hold ings. In the District, bank portfolios of other securities have tended to decline seasonally in the first part of the year, and therefore the January drop may be only a temporary re versal of the sharp upward trend in this type of investment which prevailed throughout 1962. January decline in dem and deposits results in reserve pressure on District banks Weekly reporting banks in the District had a loss of 3.7 percent in demand deposits ad justed in January. This decrease was slightly greater than in January 1962 and was more than 1 percentage point above that nationally. The decline in demand deposits adjusted was accompanied by a reduction of $300 million in United States Government deposits. There is normally a leveling off in the rate of increase in time deposits in January and, in some years, there has been a net decrease. Withdrawals are usually large after crediting of year-end interest and there is customarily some switching of funds among competing types of investment. This year there was a substantial increase in savings deposits at District banks in the first week of January, reflecting crediting of interest, and in the suc ceeding week a net decrease of $8 million. In the last two weeks in January savings rose slightly so that for the month as a whole sav ings deposits at weekly reporting banks in the District increased $92 million. This rate of gain, however, was under that nationally, as was the percentage increase in the other time deposit categories. Largely as a result of the loss in total de posits, District banks were under reserve pressure throughout the month of January. This was reflected in net sales of United States Government securities, some borrow ing from the Federal Reserve Bank, and sub stantial net purchases of Federal funds (ex cess reserves which one bank loans to an other). Toward the end of the month there appeared to be some easing in reserve posi tions, but District banks continued to be net purchasers of Federal funds. 21 Cash Flows and Corporate Investment are two main sources of funds for nonfinancial corporations which enable them to pay for additions to plant and equip ment or inventories. Firms can obtain funds through the money or capital markets or can use internally generated funds to finance their capital expenditures. In addition, non financial corporations may use funds to add to their financial assets, or they may dispose of such assets to obtain funds for other pur poses. The purpose of this brief article is to examine in broad outline the trends in the sources and uses of funds by nonfinancial cor porations during the postwar period. The ba sic figures that have been used are the flowof-funds data prepared by the Board of Gov ernors of the Federal Reserve System. An examination of these data for nonfinan cial corporate enterprises as a group indicates several broad trends during the postwar pe riod. Internally generated funds, that is, net retained earnings and depreciation and deple tion allowances, have shown a generally up ward trend since World War II. Although the total declined in a few individual years, this was due entirely to fluctuations from yearto-year in the amount of net retained earnings; depreciation allowances rose steadily. In terms of dollar amounts, these cash flows matched fairly well the expansion in capital expenditures (plant and equipment spending plus inventory changes). There has also been an upward trend, though at a much slower rate, in net sales of corporate stocks and bonds, which are “outside” sources of perma nent funds for these corporations. Finally, nonfinancial corporations as a group have made net additions to their “financial assets” as distinct from productive equipment; these include cash balances, securities holdings, ;ind trade credit. Although changes in corpo rate holdings of these financial assets have at times been sources of funds for other opera tions, they have for the most part absorbed T h ere funds in the postwar period; expansions in trade credit outstanding have absorbed espe cially large amounts of corporate cash flows as well as inflows of “outside” capital in re cent years. Corporate investment and its financing in the postwar period The relationship between “outside” and “inside” sources of funds to changes in the fixed capital (plant and equipment) of non financial business corporations will be exam ined first. Data for these items for the years 1946-61 are shown in Table 1. In accordance with economic usage, the term “investment” refers to changes in capital equipment and in ventories rather than to the total values of these assets held by the corporations at any given time. The data shown in Table 1 indicate several significant developments during the postwar years. We can note that there was, up to about 1955, a fairly steady upward trend in the total amount of capital spending, for plant and equipment especially. Since 1955, however, there has been some leveling off of expend iture of this type. Changes in inventories, as we have indicated elsewhere, have been large ly associated with fluctuations in the level of general business activity.1 For present pur poses, we are not concerned with the rela tionship of capital spending to the business cycle but rather with its generally upward movement. A comparison of these uses of funds with the particular sources listed in Table 1 indicates that with only two excep tions (1946 and 1956) the sources have pro vided more funds than were required for cap ital investment. The financing of the postwar reconversion in 1946 would have put a strain on both internal sources of funds and financing available at the time from the capital markets 1 “ Do Bank Loans to Business Predict Inventory Levels?” , M onthly Review, Federal Reserve Bank of San Francisco, June 1962. February 1963 MONTHLY REVIEW T able 1 IN V E S T M E N T AND IT S FIN A N C IN G , N O N F IN A N C IA L B U S IN E S S C O R P O R A T IO N S (Billions of dollars) Source or Use of Funds 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 Use of Funds (Investment) 17.8 16.8 19.7 14.0 21.7 28,8 22.9 23.1 19.5 29.1 34.2 33.0 23.8 34.0 33.5 32.1 17.2 14.9 15.8 20.0 20.2 21.8 20.5 23.5 28.9 31.6 25.0 26.3 29.4 28.1 0.8 1.1 0.2 0.5 0.5 0.9 0.7 0.4 0.7 1.4 1.6 1.3 2.2 -1 .7 4.8 8.6 2.2 0.8 -1 . 9 4.9 4.9 0.6 -2 .6 6.1 2.8 1.8 11.3 15.0 Other fixed investment 0.5 0.6 0.4 Change in inventories 6.0 1.2 2.1 7.5 18.3 23.8 19.7 27.3 29.8 23.6 26.0 22.8 34.7 31.0 35.1 33.1 41.0 36.9 41.9 5.6 14.3 18.6 15.5 24.3 24.3 16.6 20.8 17.7 29.9 25.0 26.3 25.0 35.6 31.5 34.9 Net retained earnings 0.6 8.1 11.2 7.3 15.3 13.8 4.8 7.4 2.6 12.4 5.9 5.3 3.1 12.3 6.5 8.3 Capital consumption allow ances 5.0 6.2 7.4 8.2 9.0 10.5 11.8 13.4 15.1 17.5 19.1 21.0 21.9 23.3 25.0 26.6 3.0 5.5 7.0 5.2 5.1 4.8 6.0 8.8 8.1 5.4 5.4 7.0 Plant and equipment Source of Funds (Financing) Cash flows 1.9 4.0 5.2 4.2 Increase in corporate stock 1.0 1.2 1.0 1.3 1.4 2.2 2.3 1.8 1.6 2.0 2.3 2.4 2.3 2.3 1.8 2.7 Increase in corporate bonds 0.9 2.8 4.2 2.9 1.6 3.3 4.7 3.4 3.5 2.8 3.7 6.4 5.8 3.1 3.6 4.3 Outside funds Note: In the interests of brevity, this table includes only data relating to principal sources of investment funds and their principal uses for “ real” investment. Other sources of funds (other liability items) and changes in financial assets (or use of funds, in general) are given in Table 2, with the exceptions shown in the note to that table. Source: Board of Governors of the Federal Reserve System, Flow of Funds/Savings Accounts, Supplem ent ■> (December 1961), Table 4D; Federal Reserve B ulletin, August 1962, p. 1060. had it not been for the ability of firms to ac quire additional finance by liquidating hold ings of United States Government securities built up during World War II. The other “ex ceptional” year, 1956, followed the very rapid economic expansion of 1955 and was a period in which business firms were responding to the large volume of business done in the prior year by making substantial additions to pro ductive capacity; again, firms drew upon their liquid asset holdings as well as other sources to supplement the investment funds obtained from cash flows and from sales of stock and bonds. There are several elements that have con tributed to the rising levels of capital expend iture since 1946. First, the replacement of capital goods has cost progressively more as a consequence of the rise in prices which has occurred until recently in the postwar period. Second, there has been, in addition to the re placement of equipment which is worn out or obsolete, some “net” or additional investment which has expanded productive capacity dur ing the postwar years. A third factor, the effect of which is more difficult to evaluate, is auto mation. It is probably a common impression that automation means a heavy capital invest ment and a more expensive stock of capital equipment than previously was being used. This may be true in many instances. However, it may sometimes be the case that replacement of old machines by “automated” equipment does not raise the value of the capital equip ment the firm owns, and it might, in some cases, reduce it, while at the same time the new equipment is capable of producing as much or more in a given time than the old. An examination of the ratio of total fixed capital investment to sales volume for man ufacturing corporations does not show any obvious upward trend in the postwar period, such as might be expected if automation has had the effect of increasing the cost of cap ital equipment relative to production reve nues. Finally, changes in allowable methods of depreciating capital equipment for income tax purposes may have contributed, at least during certain postwar years, to faster addi tions to capital equipment than would other wise have taken place. FEDERAL RESERVE BANK C hart 1 Retained earnings are a dim inishing source of corporate saving B i l l i o n * of D o l l a r s N ote: Data are for nonfinancial business corporations only. Source: Board of Governors of the Federal Reserve System, The relative importance of funds obtained through sales of corporate stock and bonds diminished during the period from 1946 through 1961. In 1946, these sales accounted for about one-fourth of the sources of funds shown in Table 1, which does not include funds obtained on mortgage loans or from commercial banks or other lenders. In 1961, however, cash flows, the other major source of funds, represented about five-sixths of the sources of funds shown in Table 1, and nearly seven-eighths in 1959. Why have these inter nal sources of funds become so much more significant in the corporate financial picture? The interdependence of corporate savin g an d investment Cash flows are composed of two separate elements, which are largely, though not en tirely independent of each other so far as the causes of their movements are concerned. These elements are net earnings after Federal income taxes and payment of dividends to stockholders, and capital consumption allow ances (usually called depreciation or deple tion, depending on the nature of the capital OF SAN FRANCISCO assets on which they are b ased). Net retained earnings depend on a number of factors, such as general business conditions which affect sales and costs of production, dividend poli cies of boards of directors, and Federal cor poration income tax policies and rates. (The latter, of course, include depreciation allow able in computing taxable incom e). Chart 1 shows the movements in total profits of non financial business corporations in the post war years and indicates the changes in the component elements mentioned. Retained earnings have undergone substantial changes during this period. They are now a somewhat smaller proportion of total profits before taxes and dividends than in the earlier postwar years. This appears to have been due both to rising income tax payments and increased dividends. These factors have had, in general, the effect of making net retained earnings the residual element which fluctuates as do total profits. This is not necessarily inevitable; corporations could have chosen to let dividends be the residual element and hold a constant propor tion of total profits for investment purposes. However, this has evidently not been true to date. The reason for the heading given to this section refers primarily to the other main ele ment of cash flows— capital consumption al lowances. These allowances are a means for a firm to recover the value of its fixed invest ment, over the useful life of capital equip ment, from the revenues that such investment plays a part in earning. Given the procedure used to estimate the amount of the original (or replacement) value lost in any given year by a piece of productive equipment, deprecia tion is a deduction from gross sales revenues as long as the depreciation schedule is in ef fect. However, during the same period there need not be an outlay of funds for new equip ment to replace that which has been “used up.” The equipment may well continue to be useful throughout its life and then suddenly MONTHLY REVIEW February 1963 T able 2 C H A N G E S IN F IN A N C IA L A S S E T S AND L I A B I L I T I E S , N O N F IN A N C IA L B U S IN E S S C O R P O R A T IO N S (Billions of dollars) Changes In Financial Assets or Liabilities 1946 1947 1948 1959 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 Financial Assets — 1.9 7.7 4.8 4.7 15.5 7.7 5.2 2.2 4.6 16.8 4.0 4.1 9.8 11.7 2.1 10.9 Demand deposits and currency 1.1 2.2 0.2 1.1 1.5 1.8 0.7 0.2 2.0 1.0 0.1 • 1.5 — 1.0 — 1.2 0.9 Federal securities — 6.9 0.7 2.0 2.9 1.1 4.4 — 4.4 * -1 .2 -0 .8 1.6 — 2.3 — 0.2 4.4 — 3.0 — 0.9 Other financial assets 0.8 1.3 1.4 1.2 1.6 1.3 2.0 1.2 1.0 1.3 2.3 2.6 2.5 2.2 3.3 3.3 Trade credit 3.1 5-4 2.5 0.4 9.5 3.5 3.3 -0 .8 3.9 10.1 6.0 1.5 6.0 6.1 3.0 7.6 -1 .5 7.7 7.4 3.3 11.5 8.3 5.5 1.0 3.1 14.0 11.5 3.4 6.1 10.7 4.3 8.1 M ortgage s 1.3 1.5 1.3 1.4 1.8 1.4 1.3 1.2 1.8 2.0 1.8 1.8 3.2 3.4 3.1 3.5 Bank loans 2.6 2.2 0.6 -1 .7 3.1 3.3 1.0 * Other liabilities 0.2 0.2 0.2 0.1 0.3 0.2 0.2 0.1 Trade debt 3.6 3.5 1.2 -1 .3 6.3 3.4 3.0 - 0 . 3 Financial Liabilities — 0.7 2.8 5.3 2.0 0.4 3.8 2.6 1.6 * 0.3 O.l 0.5 0.1 0.5 1.5 0.6 2.0 8.9 4.3 — 0.9 2.4 3.0 — 2.9 2.4 •Less than $50 million. Note: This table supplements Table 1 by indicating some of the principal liabilities corporations other than through sales of stocks and bonds and also some of the funds. Some of the items omitted as not relevant to the present discussion are: “other loans” held as assets. Source: Board of Governors of the Federal Reserve System, Flow of Funds/Savings 4D; Federal Reserve B ulletin, August 1962, p. 1060. require complete replacement; or it may be like a fleet of trucks requiring that one truck be purchased every year to replace one which is worn out, thereby maintaining the fleet in existence. Assuming the latter of these two situations more likely (for many industries) than the former, it is still possible to argue that, on the average, “replacement” capital expenditure is at least fairly closely related to the volume of depreciation allowances generated each year. However, this assumes that the year in ques tion is not one in which there has recently been a burst of technological change, leading to considerable investment activity, which though nominally replacing outworn or ob solete plant and equipment, actually adds to capacity. Moreover, as a consequence of the rising price level that has prevailed during much of the postwar period and the overall expansion in productive capacity, the dollar expenditure on fixed investment by nonfinaneial corporations has consistently ex ceeded their depreciation allowances in the postwar period, as indicated in Table 1. A through which funds were acquired by nonfinaneial financial assets whose acquisition Cjbsorbs corporate liabilities— “other loans” ; assets—consumer credit; Accounts, Supplem ent 5 (December 1961), Table rising level of new investment means a rising total of depreciation allowances to finance future investment needs. This should indicate why it is that the capital consumption component of total cash flows has been the element most responsible for their growth during the postwar years. Despite the fact that retained earnings, reflecting the vicissi tudes of general business activity, have fluctu ated considerably, there has been a steady, underlying upward trend in total cash flows; as long as at least some new investment takes place every year, this upward movement may be expected to continue, other things remain ing the same. However, recent changes in the tax laws allowing a credit for investment against Federal corporate income taxes, plus the proposed reductions in the rate at which corporate profits are taxed, may, if all these policies are implemented, accelerate the growth of cash flows in coming years. The interdependence of cash flows and new investment is that a rising level of new investment produces thereafter a larger vol ume of cash flows. Therefore, this creates a FEDERAL RESERVE BANK OF SAN FRANCISCO T a ble 3 C U M U L A T I V E C H A N G E S IN I N V E S T M E N T A C T I V I T Y , SA V IN G , A N D F IN A N C IA L A S S E T S AND L I A B I L I T I E S --------------------- ------------ ---- ------------ ------------------ -- - ~ - - - - - - - - - T ■— r - - - ------- -------- - - - - - - - - (Billions of dollars) Investment in Cumulative changes from Plant and Equipment Inventories Funds obtained from Trade credit Cash and U.S. Government securities Cash Flows Stocks and bonds Trade debt Bank loans 1946 - 1950 74.2 12.4 20.9 3.6 78.3 18.3 13.3 6.8 1951 - 1955 106.0 14.6 20.0 9.7 109.3 27.6 17.0 6.4 1956 - 1960 141.2 11.8 22.6 — 3.8 143.4 33.7 5.9 14.1 1961 28.1 1.8 7.6 0 34.9 7.0 2.4 1.6 1946 - 1961 349.5 40.6 71.1 9.5 365.9 86.6 38.6 28.9 Source: Calculated from data in Tables 1 and 2. need to find outlets for the funds generated by the new investment, which can, among other things, lead to still more new investment. In a sense, this is a self-generating process over time leading to larger investment in productive equipment, accompanied by higher levels of production, and so on. It assumes, however, that there will be sufficient demand to clear the market of the additional goods and services produced, thereby creating an incentive for the investment to take place. However, addi tions to inventories, or to plant and equip ment, are not the only means of utilizing the internal flows of corporate funds from inter nal savings of corporations. “Financial” investments of corporations We mentioned earlier that, in the early postwar years especially, internal and ex ternal funds both were needed to provide the financial support for investment programs ne cessitated by reconversion from wartime to peacetime patterns of business activity. Among other things, corporations drew down their accumulated liquid assets which had been held both as bank balances and in the form of securities, largely those issued by the United States Government to finance the war. However, this process could not go on for ever, and Table 2 indicates that, after the initial period of reconversion, corporations were adding, on the whole, to their cash and liquid asset holdings. 1956 was a notable ex ception; the volume of investment in produc tive equipment was unusually large that year following the boom conditions of 1955. Another form of investment in financial assets that has become increasingly important is represented by expanding the volume of trade credit that nonfinancial corporations grant to their customers. In only one postwar year, 1953, was there a decline in outstand ing trade credit. The cumulative increase in trade credit during the years 1946-50 was $20.9 billion; in the years 1951-55, a further $20 billion was added, and from 1956-60, $22.6 billion. In 1961 alone, $7.6 billion was added to the volume of total trade credit ex tended by nonfinancial business corporations. On the other hand, trade debt (the amounts obtained by the firms in question by indebt edness to other business firms) rose only $13.3 billion from 1946 to 1950, $17 billion during the next five years, and a mere $5.9 billion from 1956 through 1960. Over the whole period (1946-61), the net gain in trade credit exceeded the increase in trade debt for nonfinancial corporations by $32.5 billion; in other words, nonfinancial corporations were net lenders of funds during the period from 1946 through 1961 of nearly $33 bil- February 1963 MONTHLY REVIEW lion1 This is clearly a substantial use of funds and may be compared with the cumulative in crease in cash and Treasury securities held ($9.5 billion) or the cumulative change in inventories ($41 billion). Summary and conclusions The data examined in this article may best be summed up by consideration of the cumu lative changes in productive capital, financial asset holdings, and sources of funds— both in ternal and external. This is done, using fiveyear periods, in Table 3. The addition of those sources and uses of funds listed in the table indicates that the sources exceeded all of the various forms of real and financial investment shown by about $50 billion; this allowed other types of assets to be increased, or other lia bilities to be reduced, during the postwar period. It is also evident that the cumulative cash flows and the investment in plant and equipment were nearly equal in amount. We may, if we wish, then say that all of the expan 1 Since non financial corporations are only one sector of the economy, trade credit and debt figures include borrowing or lending from other firms, such as noncorporate businesses, finan cial concerns, and the Federal and state governments, in £/ldition to transactions within the sector itself. sion in plant and equipment for the nonfinancial corporations was financed by internal cash flows, with some funds left over for other forms of investment as well, such as the expansion of trade credit or the relatively small net addition to cash and United States Government securities that was made during the postwar period. Since this excess would not have been sufficient to accomplish these goals, stock and bonds were sold, bank and other forms of credit were used, and the firms became indebted to their suppliers about $40 billion more than at the end of the War. Still, a dollar is a dollar, and sources of funds cannot in reality be “lined up” with particular uses of funds in the manner indi cated. All that can really be done is to show, as has been attempted above, where the funds came from, and what was done with them. In the process of doing this, we have indicated that, although internal cash flows have become more important in the total finan cial picture for nonfinancial corporations, these firms still need to rely on “outside” funds from the money or capital markets and from those who sell them goods. 27 FEDERAL RESERVE BANK OF SAN FRANCISCO BANKING AND CREDIT STATISTICS AND BU SINESS IND EX ES— TWELFTH DISTRICT 1 ( X n d e z e s : 1 9 S 7 - 1 9 5 9 — 1 0 0 . D o l l a r a m o u n t s in m il l i o n s o f d o l l a r s ) Bank rates Condition items of all member banks2’ 7 Year and Month Loans and discounts U.S. Gov’t securities Demand deposits adjusted9 Total time deposits Bank debits index 31 cities1' 5 1929 1933 1939 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 2,239 1,486 1,967 9,220 9,418 11,124 12,613 13,178 13,812 16,537 17,139 18.499 495 720 1,450 6,639 7,942 7,239 6,452 6,619 8,003 6,673 6.964 8,278 1,234 951 1,983 10,515 11,196 11,864 12,169 11,870 12,729 13,375 13,060 14,163 1,790 1,609 2,267 7,997 8,699 9,120 9,424 10,679 12,077 12,452 13,034 15,116 19 8 14 69 71 80 88 94 96 109 117 125 1962 January February March April M ay June July August September October November December 18,646 18,622 18,906 19,070 19,328 19,625 19,669 20,017 20,165 20,460 20,589 21,102 8,082 7,820 7,776 7,811 7,582 7,689 7,532 7,309 7,471 7,471 7,501 7,608 13,671 13,163 13,235 13,706 13,945 13,101 13,535 13,255 13,446 13,969 14,012 14,431 15,448 15,647 15,939 16,091 16,352 16,511 16,587 16,655 16,772 16,934 16,827 17,093 136 133 138 143 140 145 145 138 143 146 135 1963 January 21,035 7,454 13,917 17,390 ■ Total nonagri cultural employ ment nnil O short-term business loans8’ ' Dep't store sales (value)* 18 11 19 74 74 82 91 93 98 109 110 115 123 53 34 38 93 93 92 94 97 101 101 103 104 119 120 123 118 121 123 123 124 122 121 128 127 105 105 105 105 106 106 105 105 106 106 105 106 4.14 4.09 4.10 4.50 4.97 4.88 5.36 5.62 5.46 ‘86 85 90 95 98 98 104 106 108 113 '86 84 90 96 101 96 103 103 103 109 .... 111 111 112 112 112 112 113 113 114 114 114 115 107 107 107 108 108 108 109 109 110 111 110 lllr 105r 105r 104 104 102r 102r 106 105 107 104r 102 r 101 r 116p lllp 5^50 5^52 5.49 5.50 food prices T, 1 127 Exports Steel’ Copper7 Electric power Imports Total Dry Cargo Tanker Total 13 11 17 61 69 73 82 89 95 97 107 115 124 96 55 82 S6 71 67 84 101 116 89 95 122 61 193 43 81 56 57 72 105 124 86 90 123 i90 102 113 96 116 91 96 96 108 116 20 12 16 33 51 44 51 75 95 92 112 132 42 60 70 71 80 86 93 95 113 115 18 41 28 35 69 97 91 112 136 Lumber Crude S4r 35r 62r lOlr 102 r 101 r 107 r 104r 93r 98 109r 98r 94r 91 54 70 112 114 111 111 109 106 98 96 95 96 96 61 39 49 90 95 92 96 100 103 96 101 104 108 111 34 17 35 77 82 83 90 97 93 99 108 101 105 111 i6 92 105 85 102 108 114 94 92 102 111 89 15 70 100 98 90 104 114 113 101 86 112 119 1961 December 94 r 96 110 95 107 126 125 138 150 105 119 117 120 1962 January February March April May June July August September October November December 91r 97r 97 r 93 r 96r 94r 97r 94 r 98r 98r 103 94 94 95 95 96 96 96 97 96 97 97 97 108 110 106 105 108 112 115 114 113 112 113 113 107r 96r 105r 113r lllr 94r 115r 117r 115r 120r 115r 121 119 120 112 98 107 103 84 89 90 88p 91p 124 138 130 140 136 130 112 115 119 128r 127p 132 126 130 129 131 128 128 134 134 124 137 133 107 134 104 82 131 143 124 121 145 121 85 102 123 130 67 103 59 74 125 94 120 140 137 156 111 107 128 117 138 132 132 86 116 154 137 171 1929 1933 1939 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 Cement Retail Waterborne Foreign Trade Index7' *> 10 Petroleum1 Refined Car loadings (number)5 110 56 83 108 103 112 112 103 96 101 95 94 104 Industrial production (physical volume)5 Year and month Total mf’g employ ment Dry Cargo 55 Tanker * " i 1 Adjusted for seasonal variation, except where indicated. Except for banking and credit and department store statistics, all indexes are based upon data from outside sources, as follows: lumber, National Lumber Manufacturers’ Association, W est Coast Lumberman’s Association, and Western Pine Association; petroleum, cement, and copper, U.S. Bureau of Mines; steel, U.S. Departm ent of Commerce and American Iron and Steel Institute; electric power, Federal Power Commission; nonagricultural and manufacturing employment, U.S. Bureau of Labor Statistics and cooperating state agencies; retail food prices, U.S. Bureau of Labor Statistics; carloadings, various railroads and railroad associations; and foreign trade, U.S. D epartm ent of Commerce. * Annual figures are as of end of year, monthly figures as of last W ednesday in month. * Dem and deposits, excluding interbank and U.S. Government deposits, less cash item s in process of collection. M onthly data partly estim ated. • D ebits to total deposits except interbank prior to 1942. D ebits to demand deposits except U.S. Government and interbank deposits from 1942. 6 D aily average. * Average rates on loans made in five major cities, weighted by loan size category. 1 N ot adjusted for seasonal variation. 8 A new index now combining not only Los Angeles, San Francisco, and Seattle food indexes but also Portland. Reweighted by 1960 Census figures on popu lation of standard metropolitan areas. ! Commercial cargo only, in physical volume, for the Pacific Coast customs districts plus Alaska and Hawaii; starting with July 1950, “special category” exports are excluded because of security reasons. 10 Alaska and H awaii are included in indexes beginning in 1950. p— Preliminary. r— Revised. * Less than 0.5 percent, 28
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