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REC’D APR 5 1965 y F E D E R A L RESERVE B A N K OF SAN F R A N C IS C O MONTHLY REVIEW ANNUAL REVIEW I SSUE Millennium or Mirage? Elusive Balance Policy— 1964 Style Financing the Upswing The Banking Story Paradox in the West Western Money , 1964 . . . Annual Review Millennium or M irage ? N 1964 the numbers that made the head lines on the business page looked very good indeed. Because of the stimulus of an expan sionary public policy and a strong response by businessmen and consumers, the national economy at this mature stage of a prolonged cyclical expansion behaved just as briskly as it did during the early days of the boom. Con sider, for example, these gains in some of the broad measures of business activity: Gross national product— up $39 billion in 1964, to $623 billion for the year; After-tax income of individuals— up $29 billion, to $432 billion; After-tax profits of corporations— up $5 billion, to $32 billion; Non-farm employment— up IV 2 million, to 58 million. And in all cases the increases were at least a third greater than the gains recorded in pros perous 1963. The breadth and strength of the 1964 ex pansion were attributable in large part to a major breakthrough in economic policy— a massive tax cut enacted when the budget was already in deficit. To some observers, the m an ifest success of this tactic suggested that the millenium was nearly at hand. At least, the year’s record of rapid growth, achieved within a context of declining unemployment and of relatively stable prices, gave some support to the optimists’ contention that a given mix of public and private policies can greatly alleviate our economic ills. r Youth and zest The record of 1964 thus led a former chair man of the Council of Economic Advisers, Walter Heller, to claim: “The tax cut has brought youth and zest to a lengthy expansion without sowing the wild oats of inflation.” But the same record led another former Council chairman, Raymond Saulnier, to argue: “The American economy is as close to overheating as it is safe to get.” Critics such as Saulnier contended that the policy goals attained in 1964 were achieved only at the expense of future policy failures. They admitted, of course, that expansionary policies had stimulated the sharp gain in GNP and had helped push the unemployment rate down to a more bearable level. Yet, at the same time, they argued that too many stresses had accumulated in the process. The environ ment at year-end, in particular, gave rise to fears that future pressures on manpower, ma terials, and money would create an uncon scionable strain on the domestic price level and on the international value of the dollar. In this view, 1964 represented not the em bodiment of prosperity but rather a mirage. Nonetheless, the crucial point for most business analysts was that the economy re sponded in 1964 just as the President’s Coun cil said it would. When the tax-cut proposal was first broached, early in this business ex pansion, the Council claimed that it would help close the gap between the nation’s actual output and the potential output attainable un der conditions of full employment. In the wake of the tax cut, the fiscal stimulus did pre cisely this, by putting resources to work and thus lowering the jobless rate from 5.6 to 5.0 percent between the final quarter of 1963 and the corresponding period of 1964. By late 1964, in fact, joblessness among married men was reduced almost to 2Vi percent. Broad-based expansion The strength of the boom varied from sec tor to sector, as the tax stimulus affected some activities more than others and as weaknesses developed in some of the sectors that had led off the expansion several years before. But, all in all, the economy continued to develop an already substantial and broad-based ex pansion. Between the last cyclical peak and the end of 1964, consumption spending in real terms increased at a 3.7-percent annual rate, or somewhat faster than in either of the FEDERAL RESERVE BANK T ax cut stim ulates broad-based expansion and helps close GNP gap Bil lio n * of Dollars -3 -2 Annual Rate of Cha nge 'I 0 I 2 3 4 5 two preceding cycles. Investment spending in the 1960-64 period grew at a slightly faster pace than consumption, and government spending at a slightly slower pace; both of those sectors, however, grew far more rapidly in this cycle than in other cycles of the past decade, in real terms. To a large extent, the 1964 expansion was interlinked with the continued steady growth of basic spending by consumers and their lo cal governments— that is, consumer purchases of food, nondurable goods, and services, plus state-local government purchases. This vast, cyclically unresponsive area of the economy, which amounts to more than two-thirds of total spending, increased more than $30 bil lion in 1964, as compared with a $20 billion gain in the preceding year. Consumer spend ing for food and for other goods and services increased rapidly, on the basis of continued growth in the number of consumers and, more OF SAN FRANCISCO important, in the number of dollars at their disposal. State and local government spending also expanded, on the basis of the rapidly growing population’s demand for new schools, highways, and health and welfare activities. Nonetheless, the strengths ( and weaknesses) of the 1964 expansion could be discerned more clearly in the achievements of several other sectors which typically generate the expansions and recessions of the business cycle. The record in these categories was somewhat mixed. Briefly, the year recorded substantial strength in consumer spending for big-ticket items (although not for homebuilding), similar strength in business investment (especially plant and equipment spending), and some present and future reductions in de fense spending. Fickle consumers The same factors that stimulated consumer spending for daily necessities spurred their buying of items such as automobiles. Auto purchases grew about 7 percent during the year, to a total of more than $24 billion. The total undoubtedly would have been even larg er if production schedules had been main tained at the beginning of the 1965-model year; as it was, about 500,000 units failed to reach the market because of prolonged auto labor troubles at model-introduction time. But even so, auto sales reached new heights for the third consecutive year. Total sales, includ ing imports, rose to more than 8 million units, as more consumers (especially younger con sumers) entered the market, as more dollars found their way into buyers’ hands through income gains or through auto loans, and as more and more older cars found their way to the auto graveyard. Housing, another major consumer “invest ment,” represented one of the few weak spots in the 1964 picture. Although residential con struction spending rose 3 percent (to $26 bil lion) for the year as a whole, this sector expe- March 1965 MONTHLY REVIEW rienced a persistent decline from the begin ning to the end of the year. The weakness was due to market factors and not to lack of fi nancing. In other business cycles of the post war period, the housing boom was cut off eventually by tightening credit as well as weakening demand; throughout this cycle, however, mortgage credit has consistently been available at low rates. Nevertheless, the appetite of consumers for new housing evi dently was somewhat weaker than their appe tite for new cars. Declines occurred in both single-family and apartment construction, but the decline in the latter category was the most noteworthy housing news of the year. The number of starts in multiple dwellings rose from about 250,000 units in 1960 to almost 600,000 units in 1963, but the expansion then began to ta per off. In fact, by late 1964, permits for new apartments were running 20 percent below the year-ago level. Pentagon and other businessmen Another question-mark in the 1964 record was defense spending. The Federal Govern ment spent about $55 billion for this function —about the same as in 1963— yet here, as in housing, the trend of expenditures was down throughout much of the year. Downward C ap ital g o o d s, au to sp e n d in g dominate '64 upsurge Source: Department of Commerce pressure on defense spending reflected, of course, the Administration’s desire to control expenditures at the same time that it reduced tax revenues. The effort was highlighted by Secretary M cNam ara’s far-famed attack on “gold-plating” and other activities where Pen tagon costs could be held down. Basically, however, the reduction in defense spending simply reflected the successful completion of many of the programs which were designed to give the nation a strong military posture throughout the coming decade. Unlike the businessmen in the Pentagon, business leaders elsewhere in the economy were still in the midst of modernization and expansion programs in 1964. Spending for new plant and new machinery increased more than 10 percent above the already high 1963 level, to $58 billion in 1964. Moreover, the carryover of expenditures on projects already underway grew from $7 billion in late 1962 to almost $12 billion in late 1964. The capital spending boom has been stimu lated by a strong profits situation; profit mar gins have risen much longer than in earlier ex pansions and in 1964 were at the highest levels since the mid-50’s. In addition, the rate of capacity-use in manufacturing has re mained high for an unusually long period; from 82 percent in 1961, the utilization rate moved steadily upward to 87 percent in 1964. Business firms have also been encouraged to expand because of the wide availability of im proved technological processes, the spur of domestic and foreign competition, and the stimulus of Federal tax policy. Businessmen, although ready and very will ing to spend on plant and equipment, were somewhat reluctant to spend on inventories in 1964. Inventory accumulation amounted to less than $4 billion during the year— substan tially less than in either 1962 or 1963. The stock-building picture shifted toward the end of the year, however; at that time, the recoil in auto production and strike-hedge buying FEDERAL RESERVE BANK OF SAN FRANCISCO S tro n g g a in in m an ufactu rin g jobs highlights 1964 employment picture . . . average earnings rise at slower pace than in earlier expansions Average E a rn in g s Annua l C h a n g e (Percent) 0 1.0 2.0 M i l l i o n s of W o r k e r s Ratio Scale 3.0 M A N U F A C T U R IN G 1960-64 M A N U F A C T U R IN G T 1957 - 6 0 1953 - 5 7 O it l ri bution Distribution Service Government g _____ i_____ i_____ i_____ I_____ i_____ i____ i_____ i__ ___ i_____ I__ 19 5 3 19 5 5 19 5 7 1959 1961 I9S3 S ources: D e p a rtm e n t of L abor, D e p a rtm e n t of C om m erce, F ederal R eserv e B a n k of San F rancisco of steel created a scene reminiscent more of the fluctuating 50’s than the stable 60’s. But throughout most of the year the low levels of inventory-sales ratios indicated a tight sched uling of production and purchasing— and, in many cases, a level of final demand exuberant enough to sweep the shelves clean. Growth and problems The generally strong situation in the cyc lical areas of the economy and the definitely strong picture in non-cyclical sectors added up to a very satisfactory growth record for 1964. The continuing expansion helped to bring about (in real terms) a 'bVi -percent an nual growth rate or better in each of the major sectors— consumption, investment, govern ment— between the preceding (1960) peak and the end of 1964. Moreover, the year also boasted further progress toward the attain ment of other economic goals, despite the still-limited success in dealing with unemploy ment, and despite year-end worries about the domestic price level and the international bal ance of payments. In the labor field, the very respectable gain in employment and the drop in joblessness were darkened somewhat by the need to find jobs for a flood of entrants into the labor market. The problem was seen at its worst in the area of teenage unemployment; where as only about 2 Vi percent of married men were left without jobs at the year-end, the rate among teenagers was about 15 percent. And the problem will continue, of course, since the number of teenagers in the labor force will in crease by about a million between 1964 and 1966— or almost as much as in the entire pre ceding decade. Among more hopeful signs, the drive toward full employment in 1964 was marked by a substantial gain in manufacturing jobs. Although comparable increases occurred in the fields of distribution, service, and govern ment, an increase by year-end of almost 500,000 jobs in manufacturing strongly suggested that basic industries cannot be written off as a source of employment for new job applicants. The improvement in employment— and a 3-percent gain in output per m anhour— went hand in hand with the favorable labor-cost situation which has characterized this entire cyclical expansion. Despite substantial wage March 1965 MONTHLY REVIEW settlements in several key industries, average earnings in most parts of the economy con tinued to rise at a slower pace during this ex pansion than during either of the two preced ing business cycles. Even more striking was the continued stability in unit labor costs. Throughout 1964, this indicator remained substantially below the level reached at the preceding cyclical peak; in earlier cycles, by way of contrast, labor costs per unit of output increased considerably after the first year of cyclical expansion. The 1964 boom also progressed within an environment of stable wholesale prices, but, again, with some pressures evident as the year went on. The wholesale price index con tinued to move sideways, just as it did during the preceding half-dozen years. But by yearend, spot prices of raw industrial materials were 16 percent above the year-ago level. This development reinforced the signs of pressure shown elsewhere— by near-capacity operations in several industries, by a 15-percent thickening of order backlogs in durablegoods manufacturing, and so on. Yet taken as a whole, 1964 was practically a textbook performance, combining as it did a strong fiscal stimulus and a strong consum er and business response to public expansion ary measures. In Mr. Heller’s words, “A t the core of our successful expansionary policy are fiscal measures which have successfully blend ed consumer and investment stimulus, and monetary measures which have successfully coupled relative ease domestically with rela tive tightness internationally.” But the expan sionary policy was validated by the consumers who clamored for goods in the marketplace and by the businessmen who moved swiftly to meet those consumer demands. 39 FEDERAL RESERVE BANK OF SAN FRANCISCO Elusive Balance 1964, our balance of payments position continued to impose constraints on domes tic monetary and fiscal policy, despite meas ures taken in the middle of the preceding year to reduce the deficit by discouraging capital outflows abroad into portfolio and liquid in vestments. As the following chronology indi cates, the recent behavior of our international accounts illustrates once again the constantly changing nature of the influences affecting those accounts and the pitfalls involved in relying on any single set of policy measures to achieve a cutback in the payments gap. Recent events also underscore the necessity for public and private policymakers to pay constant attention to all facets of our pay ments posture. n I Several measures taken in July 1963—the announcement of a proposed tax on U. S. purchases of most foreign securities, the in crease in the Federal Reserve discount rate, and the amendment of Regulation Q permit ting higher maximum rates on time deposits —contributed to a substantial and rapid con traction in our payments deficit on regular transactions. From a seasonally adjusted an nual rate of $5.3 billion in the second quarter of 1963, the deficit shrank to $1.5 billion in the third quarter. The improvement then ex tended into the first quarter of 1964; in that period the deficit reached a low of less than $ 1 billion, due partly to unusually large wheat exports to Soviet bloc countries and partly to the carryover of investment-income re ceipts from 1963 to take advantage of 1964’s lower tax rates. The improvement was not maintained, however, and the deficit widened again to an average of $2.7 billion in the second and third quarters of 1964. Moreover, preliminary figures for the final quarter of the year indicate a sharp worsening in the deficit because of exceptionally large capital outflows. The def P aym e n ts deficit continues, despite substantial trade surplus 1955 1957 1959 (961 1963 N o te : S pecial tra n sa c tio n s in clu d ed in “ a ll o th e r tra n sa c tio n s” S ource: D e p a rtm e n t o f C om m erce icit for the year as a whole consequently has been revised upward to $3 billion on regular transactions, compared with $3.3 billion in 1963 and the optimistic $2-billion deficit originally forecast for 1964. Some heartening progress Despite the sharp deterioration in the U. S. payments position in the fourth quarter of 1964, the year closed with some heartening progress. Most noteworthy was the rise in our trade surplus from $5 billion in 1963 to $6.5 billion in 1964. Even more encouraging was the fact that the commercial trade balance (excluding Government-financed exports) accounted for most of the gain in the export surplus, rising from $2.3 billion in 1963 to a $3.6-biIlion rate for the first three quarters of 1964. The almost 15-percent growth in exports was fairly evenly distributed among the various trading areas of the world on a percentage basis, although exports to western March 1965 MONTHLY REVIEW Europe and Canada accounted for about half of the dollar increase. The strong record compiled by U. S. ex ports in 1964 attested to the strengthening in the competitive position of American in dustry. All export categories showed gains, with shipments of capital equipment (particu larly machinery and vehicles) and industrial supplies accounting for four-fifths of the in crease in export value in the January-October period. U. S. automakers also expanded their sales abroad. Continued high levels of eco nomic activity abroad, exacerbated by labor shortages and production bottlenecks, and relative price stability here at home provided a strong stimulus to U. S. exports. Higher export earnings of primary producing coun tries also boosted American sales to those countries. Imports, meanwhile, rose only about twothirds as fast as exports during the year, al though the increase was again shared by most areas except Australia, New Zealand, and South Africa. Imports of capital equipment rose 20 percent as a reflection of the steady expansion in domestic economic activity, but imports of industrial supplies and materials C ap ital g o o d s manufacturers spark nation’s successful export drive EXPORTS IM PORTS P « rc « n la g e Change 1 9 6 3 -6 4 N o te : C om parisons based on te n -m o n th d a ta fo r exports a n d ninem o n th d a ta for im p o rts. *L ess th a n 0 .5 p ercen t. S ource: D e p a rtm e n t o f C om m erce increased more slowly (7 percent), in line with the relatively slow rate of domestic in ventory accumulation. Meanwhile, a $100million increase in imports of foreign cars somewhat offset the rise in U. S. auto exports. But, on the whole, imports generally increased more slowly than industrial activity, especially during the first half of 1964, and thus helped to swell our export surplus. The weakening U. K. trade balance con tributed to the improvement in the U. S. trade surplus, but at the same time added to pres sures on the British balance of payments. (Consequently, in view of the newly imposed system of import surcharges, U. S. exports may receive little support from this source during the current year.) On the other hand, 1964 also witnessed a substantial outflow of short-term capital from the U. S. to the U. K., and a reduced inflow from Britain to this country of longer term funds. The fruits of earlier U. S. investments abroad were garnered in significantly large amounts in 1964, as investment income rose about $700 million above the preceding year’s total. Income receipts from previous invest ments in the Middle East, Latin America, Europe, and Canada bulked large in the over all gain. The rate of new investments in Europe, however, still tended to outrun re turns on past investments, and thus consti tuted a current net drain on our payments position. On other service transactions, net payments to foreigners for transportation showed no further reduction over 1963, but the rate of increase in net tourist expenditures leveled off considerably, due partly to a rise in foreign tourism in this country. Investment in new foreign securities was probably affected more than any other cate gory by the special balance of payments measures announced in mid-1963. The un certainties produced by the proposed interest equalization tax and the subsequent enact ment of the tax in September 1964 effectively checked the outflow of U. S. capital into for FEDERAL RESERVE BANK eign securities. Net foreign-security sales in this country were about 30 percent below the $ 1-billion figure for 1963. (But new Canadi an issues, which were exempt from the tax, were as large as in the preceding year, while international institutions also floated securi ties in the U. S. capital m arket in 1964.) The tax also led to some net divestiture of out standing foreign securities by Americans. In addition, the special tax and more liberal ac cess led to a significant increase in the volume of foreign securities sold in European capital markets, and thus relieved some of the pres sure that had previously centered on the U. S. market. The net result of the financing of the pay ments deficit was more favorable to the U. S., even though the deficit was not very much smaller in 1964 than in 1963. The U. S. gold stock fell only $125 million, compared with a $461-million drop in 1963, while U. S. foreign currency holdings rose $220 million compared with $113 million the year before. Foreign bank and nonbank holdings of U. S. liquid-dollar assets increased substantially, and this tended to lessen pressures on our gold reserves. Nonetheless, France made size able gold purchases from the U. S., although this was offset by net acquisitions from the U. K., primarily as a consequence of Bank of England operations on behalf of the gold pool during the first half of the year. Some disappointments Two balance of payments accounts regis tered some, but still disappointing, progress in 1964. U. S. military spending abroad de clined only slightly, as efforts to reduce the drain from this source produced less of a result than anticipated. On the other hand, U. S. sales of military goods to foreign coun tries rose slightly. Prospects are good for fur ther increases in military sales and thus for a net reduction in the dollar drain from mil itary spending abroad. OF SAN FRANCISCO Government grants and credits to foreign countries continued to decline— from $4.5 billion to $4.2 billion. But net dollar pay ments on this account dropped less — from $0.9 billion in 1963 to a $0.7 billion annual rate in the first nine months of 1964. And some major setbacks Two developments in 1964 constituted major setbacks in the drive to strengthen the U. S. payments position: the sharp increase in term lending by U. S. banks to foreigners and the sizable expansion of short-term cap ital outflows. U. S. long-term bank loans to foreigners rose by more than $900 million, and over half of that gain was caused by Euro pean borrowers and by other countries sub ject to the interest equalization tax. A significant portion of these credits may have financed U. S. exports. On the other hand, the strong upsurge in longer term lend ing by U. S. banks indicates that these loans may have partly substituted— at least tempo rarily — for funds that might have been ob tained in the U. S. capital market. Other contributing factors were the stepped-up ac tivity by U. S. banks in the international area, the generally adequate availability of funds, and the strong demand from abroad for bank financing. A t any rate, the growth in such long-term lending effectively nullified the im provement in our payments position resulting from the cutback in new foreign security issues. Adding to the long-term capital out flow was an advance payment of $254 million to Canada for cooperative development of the Columbia River basin, which will be offset over the next 30 years by the receipt of goods and services from the completed project. The other major source of drain on the U. S. payments position was the rise of more than $1 billion in short-term capital outflows. Acceptance financing— generally tied to U. S. exports but also used for trade between third countries— rose only about one-third as much as in 1963, largely due to a decline in Japan March 1965 MONTHLY REVIEW U p su rge in p rivate capital outflow s weakens U.S. payments position . . . problem centered in short-term credits and investments and in term loans M i l l i o n s of D o l l a r s Dollar C hange 0 (M illio n s) 250 500 -i-----------r 750 1000 BANK CREDIT Acceptances Short-Term Loan* Long-Term Lo a n s N o te : L in e c h a rt show s Ja n u a ry -S e p te m b e r 1964 d a ta , a t seasonally a d ju ste d a n n u a l rates. S ources: D e p a rtm e n t of C om m erce, D e p a rtm e n t of th e T re a su ry . ese financing needs during the course of the year. New short-term bank loans, however, were about $600 million larger— distributed almost equally among Europe, Latin Amer ica, and Asia. Even larger outflows were recorded for U. S. short-term capital into foreign liquid investments (acceptances, commercial and finance company paper, and other money market instrum ents), mainly in Canada and the United Kingdom. As sterling weakened after the first half of the year, interest in liquid sterling assets waned, but U. S. investors con tinued to place sizable sums in Canadian fi nance company paper and in Canadian time deposits at favorable rates of return. As in the case of longer term bank credits, some of the short-term capital outflow helped to fi nance U.S. exports. But the shift into foreign liquid assets was largely dictated by the more attractive yields that were obtainable abroad than on comparable U. S. investments. Accentuating these two sizable setbacks in the U. S. payments position were several other developments: the continued rise in U.S. di rect investments in Europe and Latin Amer ica (offset partly by a reduced rate of invest ment in C anada), a $250-million decline in foreign long-term investment in this country, and an increase in unrecorded net outflows abroad. Some new, and some old, techniques Because of the rapidly shifting nature of our payments problem, U. S. authorities not only remained on guard against speculative pressures on the dollar, but also remained alert to any additional steps that might be taken to redress the payments imbalance with out disruption of the international economy or interruption of the domestic expansion. For the first time, the U. S. drew foreign curren cies from the International Monetary Fund, in a technical operation designed to reduce pressures on the dollar arising from repay ments to the Fund by other countries. By the end of the year, the U. S. had drawn $525 million in foreign currencies, but its net draw ings totaled only $231 million because other countries simultaneously drew dollars from the Fund. The Federal Reserve discount rate was raised, and Regulation Q again amended, to minimize the possibility of disturbing shifts from dollars into sterling after the British FEDERAL RESERVE B A N K OF S A N F R A N C I S C O Bank rate went up to 7 percent in November. The Federal Reserve swap arrangements were also utilized during the sterling crisis, as they were earlier in the year to bolster the Italian lira and on other more routine occasions when temporary exchange facilities were needed by either party to the arrangements. These op erations were often undertaken in conjunction with the Treasury. Total swap facilities avail able to the Federal Reserve were raised to $2.35 billion by year-end. The U. S. also participated in the massive $3-billion aid package extended to the U. K. in November. Treasury debt-management authorities con tinued to heed balance of payments require ments by helping to maintain the Treasury bill rate at levels not conducive to capital out flow and at the same time not discouraging to domestic economic activity. Federal agen cies also continued their efforts to encourage exports and to reduce the net drain of dollars occurring through other types of transactions. On the international level, the Kennedy Round of trade negotiations moved toward the goal of significantly lower tariff and nontariff barriers. International cooperation moved forward in other fields to o : the Group of Ten countries introduced “multilateral surveillance” procedures to improve balance of payments adjustments, and IM F members agreed in principle to a general increase in IM F quotas to meet future needs for increased international liquidity. Some hope for the future After all the debits and credits were added up, attainment of payments balance contin ued to elude the United States in 1964. Some of the favorable developments were attribut able to temporary circumstances, but other developments— such as the increase in ex ports, domestic price stability, and produc tivity gains— were more than just transitory phenomena, although the gains must now be 44 consolidated and extended. Some of the ad verse developments also were due to tempo rary factors— for example, the bunching of some foreign security sales due to uncertain ties earlier in the year regarding the provisions of the interest equalization tax, and possibly some diversion of borrowing to U. S. banks pending development of substitute sources of financing. W hat impact the U. K. situation will have on the U. S. balance of payments is difficult to foresee. The import surcharges may cut U. S. exports both to Britain and to other countries hard-hit by the U. K. levy. On the other hand, for example, the long, hard task of restoring fundamental balance to the U. K. international accounts may inhibit move ments of American short-term capital into the U. K. The net effect of these divergent movements is hard to forecast. Restoration of internal and external equilibrium will be the primary concern of the U. K. in coming months. The success of these efforts will bene fit the U. S. dollar as well as the pound. To ensure a significant reduction in our payments deficit in 1965, the Administration announced early in February a comprehen sive series of measures designed to implement this goal. The interest equalization tax was extended to bank loans of over one-year m a turity under standby authority already granted to the President; direct-investment firms were requested to work with the Departm ent of Commerce to reduce capital outflows; and new tax legislation was to be introduced to encourage foreign investment in the United States. The Administration also reaffirmed its intention to continue and intensify current efforts to hold down the dollar drain. The Administration, moreover, asked the Federal Reserve System (in cooperation with the Treasury) to work with the banking commu nity to limit outstanding credits to foreigners to no more than 5 percent above the Decem ber 1964 level of outstandings. March 1965 MONTHLY REVIEW Policy—1964 Style It would be difficult, if not impossible, to at problems confronting the monetary and fiscal authorities in 1964 tribute specific weights to the reductions in were not distinguished by their novelty. The corporate and personal income tax rates as domestic economy continued to be troubled causal factors behind the spending boom. On with under-utilization of human resources and the other hand, it would be foolhardy to argue industrial facilities; meanwhile, our accounts that the increases in disposable personal in with the rest of the world remained in deficit. come and in corporate cash flows that resulted Although these problems were not altogether from the tax cut had nothing to do with the overcome, sustantial progress was made on higher levels of consumer and business ex the home front, and for that blessing fiscalpenditures. By increasing disposable personal policy actions may claim a large measure of income and the cash flows of business, the tax credit. And although monetary policy was cut effectively increased the total demand for less easy in 1964 by the usual measures, it goods and services, even as might a rise in did not preclude a considerable expansion government expenditures independent of a of bank credit. tax cut. Moreover, the tax stimulus was self Perhaps the most remarkable development reinforcing, as a rising demand for goods in in the field of public policy was the general duced additional business spending to provide acceptance of actions that were deliberately the capacity to meet this demand. designed to increase the rate of growth of The Revenue Act of 1964 provided for re economic activity. Tax reductions were enact ductions in tax liabilities of $11 billion for ed in 1948 and 1954, of course, but the rea individuals and $3 billion for corporations soning underlying those reductions was quite over a two-year period. Initially, a $6.7 billion different from that advanced for the 1964 cut in liabilities of individuals and a $1.7 action. The earlier actions were largely under billion cut for corporations were scheduled taken for the purpose of reducing tax rates for 1964, but the withholding rate on wages from the abnormally high levels reached dur and salaries was lowered to the final 14-pering the World W ar II and Korean emergen cies; the fact that the cuts became effective T ax cut reflected during recession periods was more or less a in larger budget deficit happy coincidence. But the 1964 reduction B i l l i o n * of D o l l a r * and the proposed cuts in excise taxes this year presage the increasing use of tax policy as an anti-cyclical weapon. he T p r in c ip a l Blessings of tax relief If the power to tax is the power to destroy, the ability to reduce taxes can also be viewed as the power to create. Thus, the tax reduc tions which became effective M arch 1, 1964, played a significant part in making the annual gain in GNP almost 40 percent larger than the preceding year’s increase. The largest part of this increase was in consumer spending and business outlays for plant and equipment. FEDERAL RESERVE B A N K OF S A N F R A N C I S C O W id e sp re a d ta x reductions add to strength of expansion user-costs, such as gasoline, motor vehicle, or tire taxes— the proceeds of which are some measure of the benefits received from a sys tem of public roads— there are many other excises which provide relatively little revenue for the amount of expense and bother in volved in their collection. But whatever the reasons for the initial imposition of these excises, one major purpose of their reduction or removal will be the creative one of eco nomic expansion. B i l l i o n s of D o l l a r s | EF FE C T IV E 1 Effectivt 19 6 4 1965 Effective 1962 10 Tola I C or po r at e In co m e Per so na l In co m e Excise N o te : R e d u ctio n s in 1962 in c lu d e new d ep reciatio n guidelines a n d a n in v estm en t tax c re d it; p roposed ch an g es in excises in 1965 in clu d e a n in crease in h ig h w ay tax es a s w ell a s a $ 1 .75-billion c u t in o th e r excises. S ource: D e p a rtm e n t o f th e T re a s u ry cent level in one step rather than in two. This measure thus concentrated about $9 billion of the individual tax reduction—and the main thrust of the spending boost— in the year 1964. Nonetheless, the total impact should be somewhat greater. According to the Council of Economic Advisers, the final effect on con sumer spending will be nearly double the orig inal tax cut— or $18 billion— through suc cessive cycles of spending and respending. The Council calculated that the initial $9billion tax reduction boosted spending by a $ 13-billion annual rate by the end of the year, so that a potential $5-billion increase in spending may be attained before the stimulus of 1964’s first-stage reduction is exhausted. F or fiscal 1966, the Administration has proposed a reduction of about $1.8 billion in various (but as yet unidentified) excise taxes. The present structure of Federal excises is a catch-all of taxes imposed for a variety of reasons. Many are holdovers from wartime emergencies designed either to raise a little more revenue or to discourage consumption. Aside from certain taxes which are essentially Debt managers and the Red Queen What of the problems of the tax collector? A major Treasury worry, of course, is debt management— a situation best summarized by the Red Queen in Through the Looking Glass, where she tells Alice, “ It takes all the running you can do to keep in the same place . . . (and) . . . if you want to get someplace else, you must run at least twice as fast as that.” Extending the maturity of the outstanding public debt is a source of constant concern to the Treasury. The passage of time inevita bly brings outstanding securities to the date that they are due regardless of their original maturities. Thus, since 1960 the Treasury has had to face a “floating debt”, that is, debt due within one year, ranging between 38 per cent and 46 percent of the total marketable debt. Against this background, the year 1960 represents a watershed of sorts in Treasury debt management. In June of that year, and eleven more times thereafter the Treasury used a new debt-management technique: the advance refunding operation. This operation was designed to refund near-term issues be fore the maturity date and to push debt fur ther out in the maturity range, so that the Treasury would not have to come to market so often. From 1960, when the average ma turity of the outstanding debt fell to a post war low of 4 years, 4 months, the average maturity was lifted above 5 years in 1963 and 1964. March 1965 MONTHLY REVIEW In 1964 two advance refundings, conduct ed in January and July, moved a total of $ 12.3 billion of securities falling due in 1964-1967 out into issues maturing from 5 to 23 years. The most recent (and highly successful) ad vance refunding, carried out in January 1965, swept $9.7 billion of 1965-1967 issues out into maturities ranging from 5 to 22 years. Consequently, less debt will come to redemp tion in 1965 than in any year since World War II, as only about $13 billion of publiclyheld notes and bonds must be refunded. However, in spite of these efforts to extend the debt, the average maturity of the out standing marketable public debt at the end of 1964 was an even 5 years, down a month from the end of 1963. This development re flected the Treasury’s difficulties in reconcil ing seemingly contradictory policy objectives. In addition to extending maturities, the Treas ury has operated to increase the supply of short-term issues, in order to maintain short term interest rates at levels consistent with balance of payments objectives. But in order to stiffen short-term rates, the volume of bills outstanding was increased by nearly $ 17 bil lion from the end of 1959 to the end of 1964. In addition, in 1964 the certificate of indebt edness was dropped as a public debt instru ment and its slot in the short-term area was absorbed by Treasury bills. With the excep tion of tax-anticipation bills, the volume of outstanding bills was maintained almost auto matically through the weekly tenders of 3month and 6-month bills and the monthly auction of one-year bills, which replace ma turing issues. Consequently, the proportion of bills to total marketable debt due within one year increased from 49.6 percent at the end of calendar 1959 to 69.3 percent at the end of calendar 1964. On balance, the average maturity of the outstanding debt has lost much of its sig nificance as a measure of the maturity struc ture of the debt, in view of Treasury policies of the past five years designed to move ma turing and near-term maturities further out in the maturity spectrum, while increasing the supply of Treasury bills in the market. If adjustment is made for the increase in the volume of Treasury bills outstanding, the regular and advance refunding operations of the past five years have certainly extended the average maturity of Treasury coupon issues outstanding and given the debt man agers sufficient freedom of action so that they no longer have to run twice as fast to get someplace. A policy for all seasons Monetary policy in 1964 was again called upon to perform double duty: to support an expansion in domestic economic activity and to attempt to bring about some improvement A V ER A G E M A T U R IT Y AND P E R C E N TA G E D IS TR IB U T IO N OF M A R K E TA B L E P U B L IC D E B T, 1959-1964 End of Year Under 1 year 1959 5 to 10 years 4 2 .5 3 2 .7 1 1.8 8.8 4 .2 1 0 0.0 4 4 1960 3 9 .8 3 7 .5 9.9 7 .0 5.8 TOO.O 4 7 1961 4 3 .8 3 3 .0 10.1 6 .2 6 .9 1 0 0.0 4 7 1962 4 3 .1 3 0 .4 1 6 .7 2 .2 7 .6 10 0.0 4 11 1963 4 3 .1 2 8 .2 1 7 .2 4.0 7 .5 1 0 0.0 5 1 1964 3 8 .3 3 4 .0 17.1 2 .9 7.7 10 0.0 5 0 Source: Treasury Bulletin. 10 to 20 years Over 20 years Average Length Years Months 1 to 5 years Total FEDERAL RESERVE B A N K OF S A N F R A N C I S C O in our balance of payments deficit. In the realm of domestic monetary policy, free re serves of the member banks averaged $171 million in 1964, or about $30 million below the level for the previous year. Moreover, a move in the direction of less ease developed in the second half of the year, so that net borrowed reserves were registered in Novem ber for the first time in over four years. Late in November, two actions were taken in quick response to the increase in the British Bank rate. The discount rate was raised from 3 Vi percent to 4 percent, and maximum interest rates payable on time and savings deposits under Regulation Q were in creased. These moves were . . aimed at countering possible capital outflows that might be prom pted by any widening spread between interest rates in this country and the higher rates abroad and also at ensuring that the flow of savings through commercial banks remains ample for the financing of domestic investm ent. . according to an official state ment of the Board of Governors made at the time. In a separate but related statement, Chairman M artin emphasized that the hike in the discount rate did not signal a move in the direction of credit restraint in the domestic economy. Credit available . . . price right Bank credit rose by over $20 billion in 1964, increasing by about 8 percent for the year— the same relative increase as in 1963. Banks continued to acquire securities, prin cipally tax-exempt issues, but their holdings of state and local securities increased less than in 1963, while their portfolios of U. S. Government issues contracted less than in the preceding year. Business loans increased by a greater amount than real estate loans for the first time since 1960. Consumer borrow ing from banks expanded at a slower pace than in 1963. The costs of credit were virtually un changed in 1964. For the year, the structure of interest rates showed the greatest degree of stability of any year in the present expan sion. Only in the latter part of the year was there any noticeable upturn in rates, and this was largely confined to the short-term area in the wake of the discount-rate increase. The flows of long-term investment funds were sufficiently abundant to absorb the sup ply of mortgages and Free re se rve s n a rro w du rin g 1964, as monetary policy tax-exempt securities works to curb payments deficit while supporting expansion without change in the M i l l i o n s of Dol to rs level of yields on these i n s tr u m e n ts . T h e competition for mort gages among banks and non-bank finan cial institutions, cou pled with the weak ening in residential construction, contrib uted to some soften ing in mortgage rates. Meanwhile, yields on top-quality corporate b on d s m oved up a b o u t n in e b a s is Source: Federal Reserve Board March 1965 MONTHLY REVIEW points in the course Interest rates ste a d y across board in 1964, of the year, with most until November change in discount rate of this increase occur Percent Per A n n u m ring in the first and fourth quarters. The average yield on U. S. Government bonds was about unchanged from the first of the year. Short-term interest rates increased during the year, but as noted, much of the rise took place in late Novem ber and December following the change in the discount rate. C o m m ercial p a p e r and finance paper, the issuing rates for which are keyed to the yield on 3-month T re a su ry b ills, f o l lowed the bill rate up wards in December after moving within a narrow range throughout the pre ceding twelve-month period. The most re absorb the volume of new debt instruments markable evidence of stability in the short offered to the market during 1964. In any term area was provided by the average in event, since interest rates considered as a terest rate on short-term bank loans to busi price in the credit markets reflect the balance ness. This rate has centered about the 5-per of demand and supply forces, it would appear cent level ever since 1961, varying only two that a quite satisfactory equation of those or three basis points on either side of that forces was reached in 1964. figure. Like money in the bonk The relative stability of interest rates in the fourth year of a cyclical expansion is most The total amount of liquid assets held by unusual. This stability may be due partly to a the public increased by $34.6 billion in 1964, monetary policy which has provided the bank or about $1.7 billion less than in 1963. The ing system with adequate reserves through smaller rate of gain in 1964 was almost en the course of the expansion. It may also be tirely due to a reduction in public holdings due to the large flow of savings funds into of U. S. Government securities maturing with financial institutions, which was adequate to in one year. The bulk of the increase in public FEDERAL RESERVE B A N K OF S A N F R A N C I S C O liquidity found its way into time deposits of commercial and mutual savings banks and shares of savings and loan associations. As a consequence of the overall increase, the ratio of liquid assets to GNP reached 82.9 percent in the fourth quarter of 1964, the highest level in ten years. The narrowly defined money supply (de mand deposits plus currency) as a percentage of GNP continued its downward trend. How ever, that is not the whole story. The money supply as thus defined contributed nearly 19 percent to the public’s increased store of liquid assets in 1964— the largest relative gain for any year in the current expansion. (In abso lute terms, the money supply increased $6.2 billion — the largest gain in over a decade.) Although bank time deposits and savings and loan shares accounted for most of the 50 gain in liquidity, the growth of savings-type institutions was no greater than in 1963. This development has interesting implications, in view of the rise in disposable personal income and business cash flows brought about by the tax cut. Obviously, the recipients of tax relief did not put all of their gains in after-tax in come into savings. The relative rise in active cash balances (that is, demand deposits plus currency) suggests that the public is quite willing to translate income gains into spend ing; if so, the tax cut would appear to have been successful in raising the level of total demand in the economy. Yet in spite of the hesitation in savings-type flows, the ratio of public liquidity to GNP increased. This sug gests that there remains a margin of potential demand that has not yet been tapped by the tax cut or by other inducements to spend. March 1965 MONTHLY REVIEW Financing the Upswing businesses, and governments All sectors increase g ro ss de bt all participated with vigor in the nation’s to help finance expanded purchases credit markets in 1964, just as they did in B i l l i o n s of D o l l a r s the preceding year. All sectors enjoyed higher levels of income, but they continued to sup plement their earnings with increased borrow ings to help finance their purchases of goods and services. On balance, the $39-billion rise in gross national product was accompanied by an increase in debt of approximately $75 billion— about the same as in the two pre ceding years and equal, in percentage terms, to the 6.5-percent rise in GNP. Consumers, notwithstanding a $29-billion rise in disposable income, added about $25 Source: Department of Commerce billion to their debt. Corporations, in spite of a $5-billion rise in net earnings, also in Conspicuous consumers creased their debt by about $25 billion, and Consumers added to their debt with as other businesses increased their borrowings much zeal in 1964 as in the preceding year, by about $12 billion. The Federal govern despite the substantially larger increase in ment supplemented a slight rise in its receipts their disposable income. The composition of this growth in household debt also was much with some $6 billion in new borrowings, while like that of the preceding year; mortgage debt state and local governments augmented a $5rose by about $16 billion, and short- and billion rise in revenues with a $ 6-billion in intermediate-term debt rose by about $7 crease in outstanding debt. billion. These changes were accompanied by a con The increase in mortgage debt primarily tinued sharp rise in holdings of financial reflected 1964’s high but stable level of ex assets. Moreover, two sectors— consumers, penditure on new housing, but the continued and to a much lesser extent, state and local disproportionate growth of such debt showed governments— recorded a greater increase in that other factors were involved. One such financial assets than in borrowings. This re factor was the continued use of mortgage flected the “surplus” of these sectors on in money for non-housing purposes— that is, the come account, that is, the margin by which financing of new automobiles, travel, educa their earnings exceeded their outlays for tion, and medical expenses. Not surprisingly, goods and services. These surpluses— either much of the growing concern over the “qual directly, or indirectly through financial inter ity of credit” centered on the tendency of mediaries— largely “financed” the net deficits some institutions in the mortgage lending field (or excess of expenditures over income) of to encourage borrowing for such non-housing businesses and the Federal government. The purposes. Real-estate financing developments provided the main source of worry, however, latter sectors also increased their holdings of and this worry was heightened by a rise in financial assets, but by a smaller amount than foreclosures to a 26-year high. their borrowings. onsum ers, C FEDERAL RESERVE B A N K OF S A N F R A N C I S C O A t the same time, consumer loan delin quencies at commercial banks fell to a rate considerably below that of the early postwar years. This development, along with the strong rise in financial savings, suggests that house holds generally have not found the burden of their debts excessive. (The significance of any such aggregate phenomenon is complicated, of course, by the consideration that borrowers and savers generally are quite different peo ple.) In any event, consumer short- and in termediate-term debt increased by a substan tial $7 billion in 1964—a gain that was slightly faster than the 1963 pace, despite a smaller rate of gain in the key auto-loan and personalloan categories. In the face of rising debt levels, consumers added roughly $24 billion (net) to their finan cial assets in 1964. This was a new record, well above the previous highs of about $20 billion in 1962 and 1963. A larger portion of the additional assets took the form of demand deposits and currency, and (in contrast to 1963) consumers also added to their corpo rate stock holdings in the face of a relatively low level of yields. A t the same time, con sumers continued to show a heavy preference for such liquid but high-yielding assets as savings deposits. Busy business Rising expenditures by consumers, govern ments, and indeed, by business itself, meant more sales— and higher profits—for the na tion’s corporate enterprises during 1964. In fact, preliminary data indicate that both preand after-tax profits recorded their sharpest gains since the beginning of the current ex pansion. F or the year as a whole, pre-tax profits increased roughly 12 percent, while after-tax profits responded to the tax-cut stimulus with a whopping 18-percent gain, to $32 billion. Equally significant was the widespread na ture of the profits boom. Virtually all business sectors reported widening profit margins S p e n d in g an d s a v in g both increase in each year of expansion H O U SEH O LD S C O R P O R A T IO N S B i l l i o n s of D o l l a r s 0 20 40 B i l l i o n s of D o l l a r s 60 80 too 0 20 40 Source: Federal Reserve Board (measured in terms of net earnings to sales), to levels unheard-of since the mid-1950’s. Moreover, preliminary data indicate wider margins than in 1963 for every one of the twelve major durable-goods industries. This happy profits picture has been based on sev eral important developments— for example, the sustained rise in business sales, the re duction in Federal taxes and, in the manu facturing sector at least, continuing stability in unit labor costs. Stockholders were delighted by this profits surge, as dividend payments registered the largest increase on record ($1.7 billion) to almost $20 billion. But corporate treasurers were also pleased, since retained earnings rose to $12 billion and— with assistance from ris ing depreciation allowances — boosted the total volume of funds generated internally to a record $41 billion. A t that level, internal funds again exceeded corporate outlays for plant and equipment, in spite of the headlong advance in business capital spending. The corporate demand for funds from ex ternal sources naturally was limited somewhat by the continued outsize growth of cash flow, but other developments nonetheless led to substantial activity in 1964 in the credit and March 1965 MONTHLY REVIEW equity markets. Thus, corporate issues for new capital and refunding totaled about $ 13 billion, 6 percent more than in 1963. Bond offerings, although smaller than in 1963, again generated most of the proceeds; stock offerings, on the other hand, were about dou ble their 1963 level. But a large part of the increase in total corporate securities resulted from two special issues in the communications industry and from a large volume of offerings by financial corporations. Otherwise, several major industry sectors, including manufactur ing, issued a smaller volume of securities than in 1963. Government issues In the public sector, the Federal govern ment’s happy news for the nation’s taxpayers had other implications for the tax collector. While the continued business expansion made possible a $2.4-billion rise in cash receipts (notwithstanding the tax cut), this amounted to only half the 1963 revenue gain. Combined with an even greater rise in outlays, this re sulted in a $5.8-billion cash deficit and a slightly smaller deficit on income and product account. In financing this deficit, net acqui sitions of Federal obligations by individuals, state and local governments, nonprofit institu tions and pension and trust funds more than offset a net reduction in holdings by banks, insurance companies, and corporations in general. State and local governments enjoyed an even larger rise in receipts than in 1963, and, thanks to increased transfers from the Fed eral government, they again recorded a small surplus ($2.4 billion) on income and product N e w security issues rise moderately despite growing corporate cash-flow B i l l i o n s of Dollars 1955 1957 1959 1961 1963 S ource: S ecurities a n d E x change Com m ission account. Nonetheless, 1964 was another record year with respect to external financing, as sales of municipal obligations exceeded $10 billion and net outstanding debt grew by more than $6 billion. School bonds accounted for about one-third of the volume of new tax-exempts, and water and sewer bonds for another one-sixth. Prices of tax-exempt securities held fairly steady through 1964, but with some updrift noticeable by year-end. Several factors could have been expected to undermine this price firmness and to push yields upward— for ex ample, the reduction in Federal income-tax rates, the lower volume of purchases of mu nicipal securities by commercial banks, and the rise in the discount rate. Nevertheless, a continued active interest on the part of the public generally— including a stepped-up in terest on the part of individuals— was suffi cient to bring about a firming of prices and an attendant decline in yields. 53 F E D E R A L R E S E R V E B A N K OF S A N F R A N C I S C O The Banking Story nation’s commercial banks found 1964 to be in many respects a retelling of the 1963 story. But the story certainly was far from dull; 1964, like 1963, was a year of intense competition for commercial banks, and many of them responded by introducing new financing techniques as well as by utiliz ing proven techniques more efficiently. Yet the conclusion of 1964’s banking story was not at all unhappy, as was evidenced by the generally rosy hue of the year-end earnings reports. The banks apparently accounted for a slight ly smaller proportion than in 1963 of the total volume of funds supplied to the nation’s credit markets. But the net gain in total bank credit outstanding—loans adjusted and investments — nonetheless was substantial. A t $20 billion, the rise in bank credit exceeded 1963’s in crease by more than $1 billion, and roughly matched the 1963 percentage gain of 8 per cent. he T Businesses borrow more In terms of its composition as well as its broad dimensions, the gain in bank credit generally followed the pattern of both 1962 and 1963. Total loans (exclusive of interbank loans) rose by $17.5 billion, topping 1963’s increase by a respectable margin. Perhaps the most significant gain was a $5.6-billion rise in business loans; credit demand from business firms not only was stronger than in 1963 but was also stronger than any other loan category in 1964. Most of this increase occurred during the latter half of the year, as a reflection of a stepped-up rate of inventory accumulation, and possibly also as a reflection of expectations regarding reduced credit avail ability and firmer borrowing terms in the months ahead. While the buoyancy in business loans dur ing 1964 was itself noteworthy, the increase was really no greater than that recorded dur ing several other expansionary years, such as 1956 and 1959— and it was considerably less than the gain in 1955, when both the level and the increase in business spending for plant, equipment, and inventories were less than in 1964. The explanation lies partly with the sus tained growth of internal funds (retained earn ings and depreciation allowances), which have remained at a high level in relation to fixed capital expenditures. Unlike other postwar cycles, the recent expansion has benefited from the ample supply of funds available to corpo rations from internal sources, but this factor also has moderated business demands for credit at banks as well as in the credit markets generally. Financing needs of specific industries also varied during the year, so that the pattern of business borrowings differed from the 1963 pattern. Several major industry sectors which had borrowed heavily a year ago— notably commodity dealers, trade concerns and textile and apparel producers— either reduced their new borrowings or effected a net reduction in their outstanding loans. On the other hand, several industries which in 1963 had been net repayers of bank loans or small net borrowers — notably the metals and petroleum industries — increased their borrowing very substantial ly. In any event, preliminary data indicate that banks accounted for a larger proportion of the total volume of funds supplied to business than they did in 1963. Other borrowers less demanding Banks also continued to expand their m ort gage loans at a vigorous pace, but the $4.4 billion increase fell short of 1963’s record gain. The reduced rate of expansion reflected a commensurate slowdown in the growth of time and savings deposits— the primary source of the funds which banks normally commit to March 1965 MONTHLY REVIEW Stro n g g a in in bu sin ess loan s dominates bank-credit picture . . . mortgage and consumer loans rise at slower pace; security loans decline 1 0 0 = V o l u « at T r o u g h 1 0 0 = V a l u e at T r o u g h S ource: F ed eral R eserve B oard long-term assets such as mortgages— and it also reflected the leveling off in homebuilding, following 1963’s strong expansion. Neverthe less, the increase in total mortgage debt held by all lenders during 1964 almost exactly matched 1963’s gain, so that the commercial banks’ share of the total declined slightly, from 16 to 15 percent. A t year-end, after the Federal Reserve Board (and the FD IC ) raised the maximum permissible ceiling on interest rates which banks may pay on their time and savings deposits, some renewed interest in mortgage lending became evident. This development pointed up the possibility of increasingly vig orous competition for mortgages among vari ous lending institutions in the months ahead. But even during 1964— which incidentally, was the third consecutive year in which the net gain in mortgage financing exceeded ex penditures on new housing— the pressure of such competition was evident in a slight down ward pressure on mortgage yields, in general ly lower fees, and in some further liberaliza tion of non-price terms of lending. Consumer borrowing from banks, like mortgage borrowing, expanded at a reduced pace during 1964. At $2.6 billion, the gain fell short of 1963’s increase and was no greater than that of 1962. The major explana tion was 1964’s tax cut, which made it possi ble for consumers to finance a considerably FEDERAL RESERVE B A N K OF S A N F R A N C I S C O higher level of expenditures with an increase in total debt only slightly greater than that of 1963. Even so, the banks’ share of consumer debt financing decreased slightly during the year, to a little less than 40 percent of the total. Banks handled their investment portfolios in 1964 much as they did in the previous year. Holdings of U. S. Government securities reg istered a net decline, but at a little over $1 billion, the reduction was only about a third as great as in 1963. Furthermore, the reduc tion centered in intermediate and some longer term issues, as bank holdings of Treasury bills and other issues maturing within one year recorded a net increase. In part, this shift occurred in response to the narrowing of the yield spread between short- and longer-term debt instruments, but it also reflected port folio adjustments made out of deference to liquidity considerations. Bank holdings of other securities showed a substantial ($3.4 billion) increase, although the gain was ap preciably less than that of the previous year. The total volume of credit market instruments floated by state and local governments was somewhat higher in 1964 than in 1963, but the banks continued to absorb a very large part— almost two-thirds—of the debt issues emanating from this sector. Strong deposit gains On the supply side of the ledger, the banks’ principal source of funds — deposits — also showed changes much like those of 1963. De mand deposits (less interbank deposits and cash items in the process of collection) grew faster than in 1963, with an almost $5-billion gain. That increase, together with a further rise in currency, accounted for a greater-thanusual share (19 percent) of the public’s in creased holdings of liquid assets. This could be expected, however, in view of the larger work ing balances which consumers and businesses normally require during an economic expan sion in order to finance their rising levels of activity. Time and savings deposits, with a gain of $14.2 billion, again accounted for the vast bulk of the growth in total bank deposits. This substantial growth continued to exert an im portant influence upon bank credit policies, including the allocation of a substantial por tion of these high-cost funds into longer term and higher yielding assets such as mortgages and tax-exempt securities. Nor was the heavy growth in time and savings deposits without its implications for open-market policy; the relatively low reserve requirements for these deposits permitted the expansion in bank credit to be achieved with a considerably low er volume of open-market purchases of secu rities than would have been necessary had the deposit growth centered in the demand cate gories. The growth in total time and savings de posits, although substantial, was still about $1 billion short of 1963’s increase. In fact, the public’s total holdings of liquid assets in creased by about $1.7 billion less than in March 1965 MONTHLY REVIEW 1963, in spite of the higher levels of total financial saving by the public generally. This development reflects the previously mentioned decline in the public’s holdings of short-term Government securities, and it also reflects a falling off from 1963’s very rapid growth of negotiable time certificates of deposit. CD’s increased “only” by about one-third during 1964, partly because rising interest rates generally reduced their relative attrac tiveness as an investment outlet for businesses with surplus funds. But the still-substantial size of that increase attests to the continuing popularity of CD’s, especially in view of such features as flexible maturities and the avail ability of a secondary market for their pur chase and sale. Competitive moves On balance, commercial banks suffered some competitive deterioration in 1964 with respect to competitors capable of offering higher rates of return— savings and loan as sociations, and mutual savings banks in par ticular. The share of savings deposits acquired by mutual savings banks increased from less than 11 percent to almost 15 percent, in re sponse to an increase in rates offered by these institutions. Meanwhile, the savings-and-loan share declined slightly to 38 percent, and the commercial-bank share dropped somewhat more, to 48 percent. (The banks’ share had been as high as 56 percent in 1962.) Competitive pressures, along with earnings considerations, prompted a number of banks to introduce various new credit market instru ments during the year. One was the muchpublicized unsecured capital note, first intro duced by a major eastern bank during the third quarter of 1964. Like debentures, these notes represent a debt offering and thus con stitute a form of borrowing; unlike CD ’s, they are subject to neither reserve requirements, FD IC premiums, nor the interest rate ceilings imposed by Regulation Q. As of year-end, only a few banks had issued unsecured notes (in amounts probably aggregating somewhat less than $150 million). Their future may well depend upon favorable market developments as well as favorable changes in the laws gov erning their use by state banks. Perhaps the most significant recent devel opment— significant at least in terms of its implications for 1965—was the late-November change in Regulation Q. By increasing the maximum permissible rates which banks might pay on their time and savings deposits —from 3.5 to 4.0 percent on savings deposits held for less than a year, from 1 to 4 percent on other time deposits payable in less than 90 days, and from 4 to 4.5 percent on such de posits held for 90 days or longer— that action helped narrow considerably the rate differen tial between bank and non-bank financial in termediaries. In the context of an economic environment where (among other things) residential construction is relatively stable and the supply of new mortgages is not par ticularly plentiful, the altered competitive re lationship between banks and non-bank in stitutions suggests that 1965, like 1964, will be a year of interesting financial developments indeed. 57 F E D E R A L R E S E R V E B A N K OF S A N F R A N C I S C O Paradox in the W e st in 1964 represented Expansions and contractions something of a paradox. Personal in Retail merchants throughout the W est felt come in Twelfth District states made anotherthe full impact of the tax stimulus. Total re out-size leap to reach $80 billion during the tail sales expanded a healthy 8 percent over year, and this 7-percent gain substantially the 1963 level, whereas sales in the rest of exceeded the strong 5-percent gain recorded the country increased only about 5 percent elsewhere in the nation. Job opportunities during the year. The tax effect was felt in in also increased at least as rapidly as they did creased spending levels for food, apparel, and elsewhere— but with all that, unemployment other nondurable goods, but the strongest remained uncomfortably high, with 5.8 per gains occurred in the consumer durable-goods cent of the civilian labor force unsuccessfully sector. seeking jobs. New car registrations in the nine Western This paradoxical situation— an unprecestates reflected the buoyant sales trend; reg dentedly strong business boom taking place istrations increased about 12 percent above within a context of persistently high unem the 1963 level, while in the rest of the country ployment— largely reflected the diverse trends auto registrations ran only about 5 percent in the Federal budget. Employment, income, higher. The same story occurred in depart and sales in the West, as in the rest of the ment store sales; the District increase in this country, expanded strongly on the heels of category was about 12 percent, as compared 1964’s substantial tax cut— with of course the with roughly a 10-percent increase elsewhere. usual support from the West’s continuing population boom. At the same time, employ Employment gains outside of manufacurment in the District’s key “export” industry ing strongly supported the spending boom. — defense manufacturing— declined consid Finance and service activities employed 5 per erably in response to cutbacks on the ex cent more people than in 1963, and govern penditure side of the Federal Government’s mental agencies added 4 percent to their rolls. Trade and other distributive industries ex ledger. panded less rapidly, but still grew faster than W e st o b ta in s fe w e r defense dollars their counterparts elsewhere. while spending rises elsewhere This buoyancy looked all the more rem ark able in view of the employment cutbacks initiated by defense-contract reductions. Be tween the end of 1962 and the end of 1964, the work force in the West’s defense-space sector declined about one-eighth, to about 570,000 in December 1964. Job losses, which were concentrated in the most recent twelve month period, would have been even larger if there had not been a recovery in shipbuild ing after midyear. Moreover, the cutbacks caused a decline in total manufacturing em i.o ployment during the year — unlike 1963, .8 when total manufacturing jobs held up in the 1953 \ / 1955 1957 1959 1961 1963 S ources: D e p a rtm e n t of D efen se ; N a tio n a l A ero n au tics a n d Space face of the defense decline. A d m in istratio n W e s t e r n b u s in e s s . 58 March 1965 MONTHLY REVIEW Em ploym ent g a in s in other sectors of economy offset defense decline . . . but most Western areas see growth rate curbed as decline continues M i l l i o n s of W or ke r s .6 ' -20 Ratio Se a l* A n n u a l C h a n g e (P e rc e nt ) -10 -0 + M i l l i o n s of W or ke r s SO UTH ERN CALIFORNIA •r- .5 1964 'D E F E N S E 19 6 3 MFG. .4 NORTHERN CALIFORNIA 6.0 Other N o n f a r m NORTHWEST Defense Mfg. N o n d e f e n s e Mfg. E M PL O Y M E N T : T WEL FTH D I S TR I CT Other N o n f a r m 2.0 OTHER D IST R I CT ------- F = No n d e f e n s e Mfg. i.o1952 1954 1956 1958 I960 1962 1964 S ources: D e p a rtm e n t of L ab o r; S tate E m p lo y m e n t S ecu rity agencies Less money, smaller share The defense-space sector (excluding ship building) employed about 550,000 at yearend, after suffering losses of about 48,000 jobs during the year. Job losses were heaviest in California, where most of the District’s aerospace firms are located, but declines were also substantial in Washington and Utah. In fact, the 5,000-decline in Utah represented a loss of roughly one-third of that state’s defense employment. The employment cutbacks reflected both a decline in the nation’s defense budget and a deterioration in the West’s competitive po sition in aerospace manufacturing. District firms suffered a one-fourth decline (to $4.7 billion) in Departm ent of Defense primecontract awards between January-September 1963 and the comparable period of 1964; in contrast, the volume of awards to firms elsewhere increased slightly during the same period. Consequently, the District’s share of total defense contracts dropped from onethird to one-fourth during this recent period. One especially worrisome development is the reduction of the nation’s defense spending in several sectors which have been crucial to the West’s recent growth. Research and de velopment contracts— which are highly prized because production contracts generally follow in their wake—declined significantly in the District in 1964. Moreover, the proposed Federal budget for fiscal 1966 indicates spending declines both in this key sector and in the field of procurement, which similarly has been dominated by District firms. Some of the projected reductions should be offset by increases in space-spending, but Western firms, on balance, anticipate little improve ment in their sales and employment situation in the immediate future. . . . and fewer houses The ramifications of the defense decline were also felt in the District’s important con struction industry in 1964. Construction con tract awards dropped 7 percent during the year, to $9.1 billion, primarily because of a slump in homebuilding. The decline was not completely unexpected, since total construc tion spending had grown at a perhaps-unsustainable 13-percent annual rate over the 1960-63 period, but the situation pointed up the weakness in defense manufacturing. The housing decline was related to the employment losses in aerospace. In defense- FEDERAL RESERVE B A N K OF S A N F R A N C I S C O H o u sin g slum p pulls d o w n Western construction activity . . . apartment share of market rises M il li o n s of Do llar* Pe r c en t 1955 1957 1959 1961 1964 Sources: F. W. Dodge; Bureau of the Census oriented Southern California, which accounts for about half of District housing activity, residential construction slumped drastically over the year. In Washington, the drop in housing roughly matched the decline in aero space activity. But housing declines also oc curred in other parts of the District where defense-spending is less important. Apartment-building, which had dominated the previous housing boom, dropped 11 per cent during the year. But, strangely enough, single-family starts fell even more sharply. The latter decline reflected rising numbers of unoccupied houses, and perhaps rapidly in creasing land costs as well. But the vacancy problem remained concentrated in apart ments, and at year-end continued to cast a shadow on that segment of the market. Despite the 1964 decline, the Western housing industry remained optimistic about its future. It could count on rapid population growth, on continued high levels of income, and probably also on the availability of m ort gage financing. Moreover, the long-term fac tors which stimulated the recent apartment boom are still present in the outlook. These include the growth of younger and older age groups that prefer apartment living, new apartment ownership privileges (cooperatives and condom inium s), easier building-code and tax-law provisions, and higher land costs and commuter transportation problems. W estern contractors also remained opti mistic about nonresidential construction pros pects. Recent flood damage in Oregon and Northern California has added several hun dred million dollars to the construction back log. Highway damage may take up to two years to repair, and railroad, industrial, and utility installations must also be replaced or repaired. In addition, the plant-equipment spending boom should continue at the region al as well as at the national level— except of course in aerospace. In the public sector, meanwhile, a number of projects are either scheduled or likely to go on stream. These projects include a third power plant at Grand Coulee Dam, a Pacific Northwest-Southwest power intertie, an $ 800-million San Francisco Bay Area rapid transit system, and an aque duct system linking Northern and Southern California. Brighter notes The depressing 1964 record in aerospace and construction contrasted sharply with the bright situation in the metals industries. For instance, District nonferrous producers strained capacity throughout 1964 and yet found it difficult to keep up with the record pace of orders and consumption arising from the durable-goods boom. Nonferrous inven MONTHLY REVIEW March 1965 tories, which had been uncomfortably large in other recent years, consequently dropped close to the low levels of the mid-1950’s. The price of copper, which had remained at the 31-cent level for over two years, rose to 34 cents a pound during 1964 in response to a tight strike-aggravated supply situation. In like fashion, zinc, lead, and aluminum prices also increased sharply. District steel producers increased output sharply (13 percent) in response to the boom in manufacturing and commercial construc tion. This increase was particularly impressive since Western producers— unlike those in the rest of the industry— did not benefit to any great extent from the auto boom or from year-end inventory hedge-buying. The District lumber industry, despite the softness in residential construction, recorded a 5-percent increase in output for the year. Production and price increases narrowed toward year-end, however, as the housing downturn inevitably took its toll of new orders. The early 1965 picture, of course, was dominated by speculative buying created by flood damage to mills in California and Oregon; the disruption of transportation and the shortage of logs are expected to keep lumber prices firm for the next several months. Western petroleum refineries increased their operations slightly during 1964. The market for refined products was somewhat stronger, however, so that in-shipments from domestic and foreign refineries substantially exceeded 1963 levels. (Not surprisingly, the rate of growth in Western gasoline consumption con tinued to outpace gasoline usage nationally.) Meanwhile, District crude-petroleum produc tion failed to expand, so that refineries in the area relied more heavily on foreign supplies during the year. In fact, over one-third of the crude petroleum processed by District refin eries was from Canadian and other outside IN D EX ES O F IN D U S TR IA L P R O D U C TIO N — T W E L F T H D IS T R IC T (1957-59 = 100) 1958 1959 1960 1961 1962 1963 1964p 101 92 94 102 104 94 86 93 96 94 90 92 112 76 86 91 99 102 119 99 97 105 92 111 127 105 101 105 86 100 128 103 98 105 86 117 129 96 95 104 84 132 Alum inum Crude Petroleum Refined Petroleum Natural G as 87 98 96 96 101 96 10 1 104 10 1 95 104 112 97 96 108 121 107 96 111 126 118 97 112 T43 135 97 115 152 Cement Lumber W oo d Pulp D o u glas Fir Plyw ood 99 98 98 98 108 109 103 118 101 98 106 120 105 95 109 132 111 98 114 142 116 103 r 110 160 121 109 122 177 91 107 95 91 102 96 112 95 101 108 102 102 11 1 101 107 105 102 112 114 89 11 1 107 99 120 119 106 112 113 10 1 119 105 96 115 120 94 103 137 108 125 138 96 104 INDUSTRIAL PRODUCTION Copper Lead Zinc Silver Gold Steel Ingots C anned Fruit Canned Vegetables M e at Sugar Flour Cream ery Butter p— Preliminary. r—Revised. S ource: F ed eral R eserv e B a n k of San F rancisco. FEDERAL RESERVE B A N K OF S A N F R A N C I S C O sources. But even with the additional outside supplies, Western refineries operated at only about 80 percent of capacity. District canners took advantage of a bumper supply of raw materials to process a bumper pack of fruit and vegetables. A 20percent increase in the pack of clingstone peaches was only the most notable of the many increases reported by fruit packers, while a substantial gain in the output of to matoes and tomato products dominated the vegetable picture. M arketable supplies of both canned fruit and canned tomato products in creased significantly during the year, despite an unusually small carryover from the pre ceding year. The income of District farmers continued to advance during 1964. M arketing returns increased about 2 V2 percent during the year in the face of a slight decline elsewhere in the country, and a rising volume of govern ment payments helped boost the flow of gross farm income to a record level. Heavy crop marketings — especially in California and Washington— accounted for this rise in cash receipts, since livestock receipts declined slightly during the year. The rise in receipts, 62 along with a smaller-than-usual increase in production expenses, thus resulted in a net income considerably above the $ 1.6-billion figure recorded in 1963. But the income situ ation for many District farmers was clouded by the termination of the bracero program at the end of 1964. The ability to secure suitable replacements for the braceros will influence the crops to be produced and the eventual level of farm income, especially in Arizona and California, where most of these foreign laborers have been employed. In sum, the Western paradox remained un solved at year-end. Throughout most of the District, employment, income, and spending continued to grow at comfortably higher levels than elsewhere in the nation. A t the same time, unemployment remained at a level uncomfortably above the national rate. Cer tainly, the West’s strong orientation toward growth was a dominant feature of the 1964 scene, as it has been throughout the entire expansion of the 1960’s. Nonetheless, many observers feared that the softness in the cru cial aerospace and construction industries, if long continued, could eventually undermine that basic Western orientation. March 1965 MONTHLY REVIEW W estern M on ey District member banks turned in a solid performance in 1964, expanding their loans and investments by over $3 billion and their deposits by over $2Vi billion— and, in the process, breaking all previous profit rec ords. Yet, for the year, District banks re corded smaller percentage gains than did their counterparts elsewhere. Nonetheless, over the whole span of the 1961-64 expansion, they outperformed other banks in both loan and deposit growth. w e lfth T Stringency and liquidity District banks operated under slightly more reserve pressure in 1964 than in the preceding year. Borrowing increased at the Federal R e serve Bank discount window, from $16 mil lion in 1963 to $26 million in 1964 (daily average basis), and borrowed reserves slightly exceeded banks’ excess reserves. Thus, re serve positions shifted from average “free” reserves of over $6 million in 1963 to average net borrowed reserves of $4 million in 1964. Moreover, District banks were frequent net purchasers of Federal funds on interbank transactions during late 1964, and some of these borrowed funds were also used to meet their reserve requirements. Total deposits increased more slowly than total loan and security portfolios, so that the margin of funds available for lending was nar rowed. This tightening was reflected in a loandeposit ratio which reached 68.5 percent by the end of the year— up from December 1963’s already high level of 66 percent. But another measure of liquidity— the ratio of short-term U. S. Government securities to deposits— showed improvement in 1964. Banks’ net additions of short-term Treasury issues raised the security-deposit ratio to 6 percent— somewhat higher than in December 1963 and well above the low of 1.6 percent reached at the peak of the previous business cycle. Shifts in loan demand Loan expansion at District member banks, in 1964 as in 1963, was characterized by a more-than-seasonal increase in the first half of the year and by a less-than-seasonal gain in the last half. For the year as a whole, how ever, loans expanded at a slower pace than in 1963. Moreover, some shifts occurred in the distribution of credit among the various types of borrowers. Business borrowing at weekly reporting member banks showed unusual strength in the first six months of the year; after mid-year, however, demands from the business sector were somewhat less than seasonal, although borrowing over the quarterly tax dates re- W e ste rn b a n k s outperform others over whole span of 1961-64 expansion P e r c e n t ag e C h a n g e , 1 9 6 1 - 6 4 -1 0 | 0 i 10 20 30 ■ ■ i 40 i 50 60 i I 70 80 I I " TOTAL B A N K C R E D I T ! L o a n s Adjusted TW ELFTH D IST R IC T Ot her U.S. U.S. G o v e r n m e n t S e c u r i t i e s Other Se c u rit ie s IMNMi . -TOTAL D E P O S I T S De m a n d D e p o s it s A d j u s t e d Source: Federal Reserve Bank of San Francisco 90 | FEDERAL RESERVE BA N K OF S A N F R A N C I S C O mained high. F or the year as a whole, business loans increased by a third more than in 1963 —and they also increased more rapidly than at banks elsewhere in the nation. In 1964, as in 1963, the reduced volume of credit extended to transportation-equipment manufacturers reflected the cutback in Dis trict defense contracts. Other durable-goods manufacturers, however, borrowed more than in 1963, with demand strongest in the first half of the year. Demand for credit from nondurable-goods manufacturers, on the other hand, was concentrated in the last six months of the year, mainly as a result of heavier-thanseasonal borrowing by food, liquor, and to bacco dealers. But the year’s largest gains in the business-loan category were in bankers’ Business a n d consum er loans gain as mortgage lending pace slows . . . also, small net gain in securities B i l l i o n * of O o t l o r s Source: Federal Reserve Bank of San Francisco acceptances and in loans to construction and service industries. The most pronounced change in District lending patterns was the reduced rate of ex pansion of bank mortgage portfolios. Real estate loans at weekly reporting banks in creased $416 million— less than one half the 1963 gain—and the year’s 6-percent growth rate contrasted with the 16-percent rate at weekly reporting banks elsewhere. For one reason, the supply of mortgages did not in crease in proportion to the funds available for mortgage lending, so that competition with savings and loan associations and other lend ing institutions intensified, and thereby con tributed to a slight easing in both rates and non-price terms of borrowing. A t the same time, a slowdown in the savings inflow damp ened the enthusiasm of many District banks for long-term assets of this type. Some of these banks sold off a larger-than-usual amount of real estate loans to nonbank financial institu tions, as part of a deliberate policy to curtail the rate of expansion in mortgage holdings. Consumer borrowing grew at about the 1963 pace, with auto financing again provid ing the major stimulus. The consumer-loan gain at weekly reporting banks was actually greater in 1964 than the gain in their real estate loans. In other categories, loans to non bank financial institutions increased some what but failed to match the rapid 1963 pace, while loans to Government security dealers increased substantially more than in any other recent year. In part, this financing took the form of arbitraging activity, particularly dur ing the third and fourth quarters, as banks purchased Federal funds from correspondent and other banks and sold them to security dealers at higher rates. In 1964, unlike 1963, District member banks recorded a small increase in total se curity holdings along with their substantial gain in loans. In both years banks reduced their portfolios of U. S. Government securi March 1965 MONTHLY REVIEW S E L E C TE D A S S E T AND L IA B IL IT Y ITE M S OF W E E K LY R EP O R TIN G M EM B ER BANKS IN T H E T W E L F T H FED ER A L R ESER V E D IS T R IC T (Dollar amount In millions) Outstanding Dec. 30, 1964 Total loans and investments Loans adjusted1 a n d investments Loans adjusted1 Commercial a n d industrial loans Real estate loans Agricultural loans Loans to nonbank financial institutions Loans for purchasing or carrying securities To brokers and dealers: To others: Loans to foreign banks Other loans (m ainly consumer) Total investments U. S. Government securities Treasury bills Treasury certificates of indebtedness Treasury notes and bonds m aturing: W ithin 1 year 1 to 5 years After 5 years Other securities Total deposits (less cash items) Total dem and deposits (less cash items) Dem and deposits adjusted Time and sav in gs deposits Savin gs Capital accounts Total assets/liabilities and capital accounts $32,835 32,314 22,906 7,581 7,545 1,013 1,525 Net Change Dec. 31, 1963 to Dec. 30, 1964 Dollars + 2,6 39 + 2,142 + 2,131 741 + 416 + 69 + 108 + Percent + + + + + + 320 136 30 6 4,857 9,408 5,696 1,107 0 + + + + + — + — 126 26 68 592 9 215 412 157 + + + + + — 787 2,208 1,594 3,712 32,720 14,142 12,850 18,578 13,903 2,801 39,918 + — + + + + — + 157 730 103 226 1,812 103 2 1,709 753 323 2,175 + — + + + Net Change Jan. 2 ,1 9 6 3 to Dec. 31 ,1 963 8.7 7.1 10.3 10.8 5.8 7.3 7.6 64.9 23.6 28.6 13.9 0.1 3.6 + 59.3 — 100.0 + + + + + + + + 24.9 24.8 6.9 6.5 5.9 0.7 10.1 5.7 13.0 5.8 Dollars + + + + + + + + + + 4* .— . — — — — + + + + + + + + + 1,663 2,056 2,295 560 809 45 345 16 14 35 504 239 604 117 210 245 119 87 365 1,678 79 273 1,599 946 178 2,139 Percent + + + + + + + 5.8 7.3 12.4 8.9 12.8 5.0 32.9 9.0 14.6 17.2 16.2 2.5 -— . 9.3 — 14.4 — 57.2 + + + + — + + + + + + + + + 28.0 3.9 6.2 11.7 5.5 0.6 2.2 10.5 7.8 7.7 15.0 1 T o ta l lo an s less v a lu a tio n reserves a n d lo an s to dom estic com m ercial ban k s. S ource: F ed eral R eserve B a n k of San F ran cisco , ties, but the 1964 reduction (2 percent) was considerably below the 9-percent decline of the preceding year. On the other hand, banks recorded a respectable (6 percent) gain in holdings of municipals and Federal Agency issues, even though it could not compare with 1963’s substantial rate of acquisition of such securities. CD’s lead the w ay On the deposit side, District member banks in 1964 recorded a slowdown in the rate of growth of private demand deposits— partly as a reflection of the slowdown in District manufacturing activity and the continuation of a difficult unemployment situation. But 1964 witnessed a slightly greater gain in total time and savings deposits, although District banks for the second consecutive year failed to match the national growth rate in this cate gory. Time certificates, particularly negotia ble CD’s in denominations of $100,000 and over, again accounted for a substantial por tion of the total deposit increase, especially in the first half of the year. At year-end, District banks had $1.3 billion of these certificates outstanding— a 56-percent increase over yearend 1963. The San Francisco Reserve District thus ranked next to the New York and Chi cago Districts in holdings of negotiable CD’s, although these certificates still accounted for a relatively small proportion (7 percent) of total time deposits at District banks. FEDERAL RESERVE B A N K OF S A N F R A N C I S C O The situation was different in the savings category. The net inflow dropped sharply in the first half of 1964; in fact, net withdrawals in April indicated that individuals were rely ing heavily on their savings to meet incometax payments and to exercise stock-purchase rights. While the savings inflow later acceler ated, the net increase for the year as a whole was about one-fifth less than the District’s 1963 gain. District savings and loan associations also experienced a slowdown in savings capital growth in 1964, but their net increase of $3.9 billion far exceeded the gain in savings at District banks. However, the competitive sit uation may have been altered toward year-end by the revision of Regulation Q. After that action was taken by the Federal Reserve Board, many banks throughout the District raised their interest rate on passbook savings to the 4-percent maximum, whereas most sav ings and loan associations posted no change in rate for the first quarter of 1965. Thus, the differential in rates of interest offered by banks and savings and loan associations was narrowed by a not-insignificant Vz percent. District banks, like their counterparts else where in the nation, made relatively large ad ditions to their capital accounts during 1964, mainly through the issuance of capital notes and debentures. In fact, the rate of capital ex pansion at weekly reporting banks was nearly double that of the preceding year. In view of the rising pressures on bank resources, banks undoubtedly have become increasingly aware of the need to readjust their capital structure to meet future growth requirements. In the immediate future, meanwhile, banks will also have to study how to realign their asset-cost structure, so as to absorb the greater interest costs which could result from the higher rates on savings and other time deposits. More growth for S & L’s Savings and loan associations continued to grow rapidly during 1964, as Federally-in sured S & L’s in District states increased their savings capital to $23.8 billion by year-end. However, this substantial 16-percent gain fell considerably below the increases registered in most other years of the past decade. M ort gage loan holdings meanwhile increased at about the same pace as savings, to reach $25.1 billion at year-end. The gap between outstanding mortgage loans and total savings continued to be bridged by Federal Home Loan Bank advances and by other borrowings. Borrowings by Western institutions, which exceeded $2 billion at year-end, accounted for about two-fifths of all borrowings from the Federal Home Loan Bank system. The large W estern mortgage market also generated a large volume of m ort gage participations; sales of such participa tions by District associations to institutions elsewhere resulted in a net capital inflow of over $500 million during the first three quar ters of 1964. The S & L ’s may now encounter some diffi culty in finding suitable outlets for their sav ings inflow, in view of the housing slowdown and the resultant scarcity of prime-quality mortgage investments. In this situation, Dis trict associations will be tempted to take ad vantage of the im portant new lending and investing powers granted by the Federal Home Loan Bank Board to associations within its jurisdiction. These new powers include au thorizations to make unsecured educational loans to college students, to make loans or investments in urban renewal areas, to loan regularly within 100 miles of an office (in stead of 50 miles, as previously), to loan up to 5 percent of assets in any metropolitan area irrespective of its distance from the associa tion’s office, and to invest in general govern mental obligations. March 1965 MONTHLY REVIEW Condition Items of All Member Banks — Twelfth District and Other U. S. S o u rce: F ed eral R eserve B ank of San F rancisco. (F .n d -o f-q u arter d a ta show n th ro u g h 1962, an d end-of-m onth d a ta th e re a fte r; d a ta n o t a d ju ste d for seasonal v a ria tio n .) BA N K IN G A N D CREDIT STATISTICS A N D BUSINESS INDEXES— TWELFTH DISTRICT1* (Indexes: 1957-1959 — 100. Dollar amounts in millions of dollars) Condition items of all member banks2 Seasonally Adjusted Year and Month Loans and discounts’ U.S. Gov’t. securities Demand deposits adjusted1 Total time deposits Bank rates Bank on debits short-term Index business 31 cities5/' loans7, * 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 8,712 9,090 9,264 10.816 12,307 12,845 13,441 15,908 16,612 17.839 20,344 22,915 25,561 6,477 6,584 7,827 7.181 6,269 6,475 7.872 6,514 6,755 7,997 7.299 6,622 6,492 10,052 10,110 10.174 11.386 11,580 11,384 12,472 12,799 12,498 13,527 13,783 14.125 14.450 7,513 7,994 8,689 9,093 9,356 10,530 12,087 12,502 13,113 15,207 17.248 19,057 21,300 59 69 71 80 88 94 96 109 117 125 141 157 169 1964 January February March April May J une July August September October November December 23.233 23,520 23,691 23,929 24,126 24,443 24,912 24,965 25,282 25,165 25,339 25,561 6,586 6,818 6.961 6,563 6,493 6,380 6,161 6,212 6,480 6,519 6,685 6,492 1 4,319 14,222 14,272 14.215 14,199 14,376 14,369 14,377 14,689 14,587 14,503 14,450 19,304 19,500 19,566 19,773 19,813 19,896 20.152 20.235 20.473 20,602 20,792 21,300 163 167 165 169 166 167 166 175 166 173 178 107 1965 January 25.853 6,337 14,430 21.669 3,95 4.14 4.09 4.10 4.50 4.97 4.88 5.36 5.62 5.46 5.50 5.47 5.46 5.51 5.48 Total nonagri cultural employ ment Industrial production (physical volume )6 Dep’t. store sales (value)6 Lumber Refined8 Petroleum Steel* 84 86 85 90 95 98 98 104 106 108 113 117 73 74 74 82 91 93 98 109 110 115 123 129 139 101 102 101 107 104 93 98 109 98 95 98 103 90 95 92 96 100 103 96 101 104 108 111 112 92 105 85 102 109 114 94 92 102 111 100 117 119 119 119 119 119 119 119 120 120 121 121 122p 135 137 133 134 139 137 141 143 137 139 150 142 115 114 114 102 106 105 113 107 108 111 106 111 115 113 111 112 114 115 118 121 117 113 110 117 149 140 139 131 p 121 p 121 p 129p 132p 149p 140 p 152 137 1Adjusted for seasonal variation, except where indicated. Except lor banking and credit and departm ent store statistics, all indexes are based upon data from outside sources, as follows: lumber, National Lumber M anufacturers’ Association, West Coast Lumberman’s Association, and Western Pine Asso ciation; petroleum, U.S. Bureau of Mines; steel. U.S. Departm ent of Commerce and American Iron and Steel Institute; nonagricultural employment, U.S. Bureau of Labor Statistics and cooperating state agencies. 2 Figures as of last Wednesday in year or m onth. 3 Total loans, less valuation reserves, and adjusted to exclude interbank loans. 4 Total demand deposits less U.S. Government deposits and interbank deposits, and less cash items in process of collections. 5 Debits to demand deposits of individuals, partnerships, and corporations and states and political subdivisions. Debits to total deposits except interbank prior 1942. 6 Daily average. 7 Average rates on loans made in five major cities, weighted by loan size category. 8 Not adjusted for seasonal variation. ‘ Banking data have been revised using updated seasonal factors. Monthly d ata from 1948 available on request from the Research Departm ent of this Bank. p — Preliminary. r — Revised.
@FedFRASER