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FEDERAL RESERVE BANK OF SAN FR A N C ISC O MONTHLY REVIEW IN THIS ISSUE Diseases of Middle-Age Manpower to the Fore Vigor in the Credit Markets MAY 1 965 Diseases of M iddle-Age . . . An ostensibly healthy middle-aged patient — the four-year-old cyclical expansion — shows signs of hypertension and other ills. M anpow er to the Fore . . . W ill the defense sector produce enough jobs on the factory floor? W ill the farm sector produce enough workers to tili the fields? Vigor in the Credit Markets . . .T h e supply of loanable funds accommodates a faster spending pace at interest rates only slightly above late-1964 levels. Editor: W illiam Burke May 1965 MONTHLY REVIEW Diseases of Middle-Age learned doctors who watch over the health of the business cycle are now look ing rather quizzically at their ostensibly healthy m iddle-aged patient. O ne diagnosis is that the four-year-old expansion is showing signs of hypertension as a result of too many middle-aged excesses. A conflicting diagnosis is that the patient is slowing down w'ith age. But a detailed exam ination may show that the patient— with the help of the m odern econo m ist’s pharm acopoeia— is still bursting with good health. The symptoms of hypertension, according to some diagnosticians, include the torrid pace of activity in industries such as autos and steel. O ther symptoms include manpower pressures— for example, a continued decline in the unem ploym ent rate (although it is still too high) and the lowest rate of insured un em ployment in almost a decade. Then, again, there are price pressures— for example, an upw ard drift in the wholesale price index, am ounting to about IV2 percent since last h e T H yperactive expansion stimulated by autos, inventories, capital goods S ource: D e p a rtm e n t of C om m erce. summer, and a rise in the brokers’ loan rate from AV2 to 4 3A percent. B ut some observers claim th at the econ omy in future months will be plagued, not by hypertension, but rather by middle-aged slug gishness. They point, for instance, to the fact that new orders for durable goods leveled off during the first quarter of the year, and that sales during that period were somewhat arti ficially inflated— auto sales by m akeup p ur chases and steel sales by strike-hedge buying. Developments of this type thus led the C oun cil of Econom ic Advisers to warn against “assuming that continuing gains at the recent rate are assured.” Robust good health The conflicting diagnoses were made against a backdrop of an extremely strong first-quarter perform ance. In that period, gross national product rose to $649 billion, at a seasonally adjusted annual rate. The quarterly rate of increase was $ 1 4 ‘/ i billion — almost equal to the entire gain of the p re ceding two quarters and the strongest gain s in c e e a r l y in th e 1961-64 expansion. Over the past half year or so, the strength of this m iddle-aged e x p a n sio n h a s been concentrated in con sum er durables buy ing and business fixed investment — both of which increased about 5 percent over the p e riod — and in a sharp b u ild u p in b u sin ess in v e n to rie s. D u rin g the same period, oth FEDERAL RESERVE BANK OF SAN F R A N C I S C O er consum er buying continued rising (as al w ays), while residential construction rose about 2 percent from its 1964 low point. In the governm ent sector, meanwhile, a drop of about 2 percent in Federal defense spending was offset by a com parable rise in state and local governm ent expenditures. The m ajor questions about the continuing strength of this expansion center around those sectors that have recently shown the most ebullience. In the next several months, will the inventory buildup reach an unsustainable level, as auto dealers and steel m anufacturers attem pt to respond to their custom ers’ exag gerated dem ands? In the next several q u ar ters, will m anufacturers’ fixed investment con tinue rising in the event that their orderbooks lose some of their recent thickness? Volatile once again Consider, first, the short-term situation in inventories. This sector obviously will be m uch in the limelight in coming m onths. U n til recently, this norm ally volatile com ponent of the national economy has shown more m oderate fluctuations and less perverse tim ing than in any other postw ar expansion. M ore recently, however, there have been signs of the m ost rapid inventory buildup since the period following the 1959 steel strike. In com parison with January-Septem ber 1964, when business inventories increased at a $3 billion annual rate, the buildup in the two succeeding quarters was at a $6 billion rate— and currently it may be even higher. T he buildup has been based mostly upon three factors: strike-hedge buying by steel consum ers, restocking of auto dealers in the afterm ath of the la te -1964 auto strike, and catch-up buying by other retailers in the afterm ath of the post-taxcut consum er-spending boom. T he present inventory situation has led business analysts to look again at the record of earlier postw ar expansions. In those pe riods, unlike 1961-64, inventories began to outm atch final sales fairly early in the cycle’s expansion phase. In each case, after about the sixth quarter of expansion, inventories in creased even after the sales trend w arranted little further growth. M ounting im balances between inventories and sales then brought about higher costs and risks of inventory hold ing, and thus set the stage for a sharp liqui dation when final sales eventually turned down. By way of contrast, the generally stable in ventory situation of the 1961-64 period was based not only upon a steady rise in final sales bu t upon several other im portant factors as well. Im provem ents in inventory control— for example, the use of com puters— becam e w idespread enough to dam pen the usual vola tility of inventories. M oreover, expansion be yond current needs seemed unw arranted: speculative buying was unnecessary because of price stability, and reasonably prom pt de livery was assured because of am ple m anufac turing capacity. A re those conditions still present? The next several m onths should tell. Hard-driving sectors The inventory picture will depend prim arily upon developm ents in autos, steel, and other hard-driving sectors. In autos, the testing time m ay be near at hand, as dealers begin to con front their basic m arket instead of simply catching up with last fall’s hungry m arket. In steel, the testing time m ay be postponed sev eral months, in view of the extension of the steel labor contract from M ay 1 to Septem ber 1. The recent strength of auto sales has con founded even the norm ally optim istic sales m anagers of D etroit. In the early m onths of 1965, domestically produced cars were sell ing at a 9 Vi-million annual rate, although February seemed to m ark a tem porary peak. This perform ance eventually persuaded the industry’s leaders to up their 1965 sales fore cast to about 9 million cars— or perhaps even MONTHLY REVIEW May 1965 Autos, steel boost production index with 20-percent gains within year 1957-59 = 100 190 I960 1961 1962 1963 S ource: F ed eral Reserve Board. more if the excise tax on passenger cars should be reduced at midyear. So, while sales m an agers cheer, production lines hum along at a very busy pace as m anufacturers attem pt to keep abreast of dealers’ inventory needs as well as consum ers’ clam oring demands. In steel, an inventory buildup may well con tinue for several months longer, since many steel users had smaller stocks than desired when the strike deadline was set back four months. The contract extension, incidentally, involves placing IIV 2 cents an hour in an in form al escrow fund for each hour worked by the steel union’s 425,000 members. The agreem ent am ounts to a labor-cost increase of roughly 2.7 percent per year— as com pared with the 3.2-percent figure recom m ended in the A dm inistration’s guidelines, the 3.5-per cent figure achieved recently in the steel u n ion’s contract with can m anufacturers, and the even greater increase achieved last fall by the auto w orkers’ union. A t the tim e of the c o n tra c t e x te n sio n , steel output was run ning about 50 percent a b o v e th e 1 9 5 7 -5 9 average and about 20 p e r c e n t a b o v e th e year-ago level. M uch of the strength, how ever, was simply due to the ebullience of fin al c o n su m e r d e m and, and so inven tory building has been not much m ore sig n ific a n t th a n in th e s im ila r c o n tra c t-n e gotiation periods of 1962 and 1963. Even so, steel c o n su m e rs l have added about 4 1964 1965 million tons to their stocks of steel within the past half-year. Thus, if an early settlem ent is reached in contract negotiations and if out put should slow in autos and other overheated fields, the next half-year may witness sub stantial cutbacks in steel inventories. Bricks, mortar, machinery Consider, also, the longer-term situation in business plant-equipm ent spending. This sec tor now appears quite strong, on the basis of the 12-percent year-to-year increase projected in the Com m erce-S.E.C. survey, and the even s tro n g e r g a in sh o w n in th e m o re re c e n t M cGraw-Hill survey. According to the Com merce-S.E.C. survey, this sector will show an increase for the fifth straight year and (unlike earlier years) the gain will outpace the rise in G N P for the second consecutive year. The survey highlights several factors favor able to the continuation of the boom. F o r one thing, expenditures on new plant are sched uled to rise faster than expenditures on equip ment; in other words, the em phasis will be FEDERAL RESERVE BANK OF SAN F R A N C IS C O on the expansion of capacity rather than sim ply the m odernization and replacem ent of facilities. M oreover, m anufacturers’ carry over of uncom pleted investm ent projects was about 40 percent higher at the beginning of this year than a year before, while new orders for m achinery and equipm ent have been somewhat stronger than in the big investment boom of the m id-1950s. The anticipated expansion of plant-equipm ent spending comes on top of an almost 50-percent increase over the earlier course of the four-year long expansion. Investm ent spending has responded to a gradual rise in operating rates; capacity utilization has in creased from about 82 percent to 87 percent during this expansion. Spending has also risen in response to the grow th in dem and for final products; total sales in m anufacturing and trade have risen from $61 billion to $73 bil lion over the last several years. Again, spend ing has responded to improved rates of profits and cash flow, augm ented by the new depre ciation guidelines, the investm ent tax credit, and the reduction of tax rates; internally gen erated funds have risen from $30 billion to $41 billion between 1961 and 1964. In addi tion, this sector has expanded in response to the continued availability of credit at rela tively stable rates of interest; last year, cor porate issues for new capital approached the 1957 peak, while the corporate bond yield has held stable at about 4.3-4.4 percent for several years now. Waflch the laggards In the present testing period, diagnosti cians searching for clues as to the future health of this business cycle may find some answers by exam ining inventory behavior and fixed-investment spending plans, and perhaps by examining other “lagging” cyclical indi cators as well. In the terminology of the N ational B ureau of Econom ic R esearch, m an ufacturers’ inventories and plant and equip m ent spending— along with such indicators as unit labor costs, bank rates on business loans, and consum er instalm ent debt— tend to lag som ew hat behind the m ovements in the broad aggregates of econom ic activity, and to lag even further behind the “leading” cyclical indicators. N onetheless, these indi cators are valuable for cyclical analysis in th at they warn of excesses that frequently de velop in a m ature cyclical expansion. Several of the lagging indicators measure costs— that is, the cost of m oney o r the labor cost p er unit of output. O thers m easure costs along with business risks— th at is, inventories and consum er debt. A nd, since excessive costs generally tend to bring an expansion to an end, the pre-condition for a business decline is a significant rise in lagging indicators. In the typical case, rising costs and slower increases in volume lead to shaved profit m ar gins, and the financing of burdensom e inven tories creates additional problems. E xpecta tions diminish, com m ercial failures rise, and stock prices and new incorporations fall. A t tem pts to reduce inventories are soon re flected in declines in new orders and in sen sitive comm odity prices. In addition, hiring slows down, layoffs rise, and the average workweek declines as overtim e is eliminated and short-tim e is instituted. M oreover, if con fidence becomes sufficiently im paired, m ajor business decisions to invest may be post poned. U ntil recently, this dire sequence of events was only a dim possibility, since the striking feature of this business expansion to date has been the slow response of lagging indicators. T he excesses which were com m on during the advanced stages of previous expansions sim ply were not visible. B ut the laggards will be watched closely in coming m onths, however, as the doctors now hovering over the incred ibly long-lived business expansion continue to probe for signs of excesses which could bring on a decline. — William B urke MONTHLY REVIEW May 1965 Manpower to the Fore d e v e lo p m e n ts d o m in a te d ing decline in defense-related m anufacturing. the W estern business scene as the fifth Consequently, the region’s total m anufactur year of a prolonged cyclical expansion goting em ploym ent rem ained below the earlyunderway. D uring early 1965, employment 1964 level, in contrast to a 4-percent year-toexpanded strongly in m ost Twelfth District in year increase elsewhere. dustries and unem ploym ent correspondingly The first-quarter drop of 5,000 in defense declined. B ut the m ost newsworthy items em ploym ent was com parable to the fourthwere the following: quarter decline, but was far sm aller than the U nem ploym ent declined m ore rapidly in declines recorded earlier in 1964. W estern the District than in the rest of the country, aircraft, missile, electronic, and shipbuilding even though the D istrict’s first quarter job firms thus now employ 563,000 workers, or less rate of 5.5 percent rem ained high above almost 15 percent less than at the Decem berthe national figure of 4.8 percent; 1962 peak. This drop has reflected a num ber Em ploym ent in defense-related m anufac of worrisom e factors — principally a sharp turing kept declining, but at a lower rate than 25-percent decline in D istrict defense con heretofore; tracts between 1963 and 1964, in contrast to T he farm labor controversy rem ained un a slight increase in contract placem ents else settled, as growers received som e— but far where. from all— the foreign contract laborers they The defense decline in the first quarter requested. centered in California, where 1,000 shipyard Overall, the W estern em ploym ent picture workers and 5,000 other defense employees improved significantly during the first quarter were laid off. W ashington, on the other hand, of the year. N onfarm em ploym ent increased recorded a 1,000 gain in em ployment. This 1 percent in the D istrict— the same as in the gain reflected an increase in study contracts rest of the nation— although the pattern of involved in competitions fo r m ajor produc em ploym ent growth varied from industry to tion contracts, and it also reflected a substan industry. The distribution, service, and gov tial increase in new orders for commercial ernm ent categories all expanded m ore rapidly in the D istrict than elsewhere. Construction District jobless problem continues also expanded substantially, although more despite sharp employment gain slowly than in the rest of the nation. The level of employment in W estern m anufacturing firms, however, increased only slightly above the late 1964 level. (All data seasonally ad justed.) M a n p o w e r On the factory floor D is tric t sta te s, w hich h a v e a re la tiv e ly m inor autom otive sector, did not receive as much benefit as other regions did from the first-quarter recovery in auto production-line employment. These states, moreover, were affected by the drag imposed by the continu 196! S ources: D e p a rtm e n t of L a b o r; F ed eral R eserve B a n k of San F rancisco. FEDERAL RESERVE BANK OF SAN F RA N C IS C O Tw o-year decline in defense employment shows signs of easing Thou»and» of P«r«on» S o u rces: S ta te e m p lo y m e n t rep o rtin g agencies. short-range jet aircraft. (D efense-related em ploym ent includes employees m anufacturing commercial aircraft.) In the fields O n the farm front, there was no question of the need for additional workers, but there was strong disagreem ent about where the nec essary w orkers would be procured. Despite the ending of the “bracero” program at the end of 1964, m any D istrict growers argued that foreign contract workers would still be needed for the hard w ork of planting and harvesting the region’s 1965 crops. (A bout 17,000 were em ployed in California and A ri zona in M arch 1964— and considerably more at the harvest peak.) A p a r tia l s o lu tio n to th e p ro b le m w as reached in late A pril, when L abor Secretary W irtz accepted the report of a special study panel which recom m ended the im portation of some foreign w orkers under existing immi gration legislation. The panel’s aw ard recom m ended the use of 1,500 M exicans and 1,000 other foreign workers in California asparagus, straw berry, and lettuce fields. (G row ers had requested 6,700 such w orkers.) In m aking its award, the panel acted on the understanding that the transition now underw ay to exclusive use of domestic workers “will produce a m ini mum am ount of economic and job disloca tions.” Even at that, however, the im plem en tation of the panel’s aw ard was ham pered by delays in obtaining M exican governm ent exit perm its for farm laborers. B ut w hat of the needs for w orkers (d o mestic or foreign) later in the planting and harvesting season? W eather will be a m ajor factor in this situation. T he early-1965 rainy and cold w eather in Southern California and A riz o n a a lle v ia te d som ew hat th e la c k o f bracero labor at that time. In coming m onths, however, the dem and fo r farm labor m ay in tensify as harvesting needs for crops such as strawberries overlap the labor requirem ents for other crops. W eather m ay be im portant in another way also. A lthough tom ato acre age in California has been considerably re duced, according to D epartm ent of A gricul ture forecasts, abundant supplies of m oisture have im proved prospects for a num ber of other labor-intensive crops, such as tree fruits. C o m in g m o n th s , th e r e f o r e , m ay b rin g about an increased, and not a smaller, de m and for agricultural w orkers. To date, how ever, there has been little evidence of strong upw ard pressures on farm wages. California farm wages, for example, have increased only about as fast as the national average over the past year. (O n the other hand, average farm wages in California have already reached $1.36 an hour — considerably above the av erage for m ost other states.) With the bulldozers W estern construction activity has exhibited considerable strength in recent m onths, de spite continued weakness in housing. C on struction awards in early 1965 reached a $9.3-billion annual rate — 7 percent above the fourth-quarter average and equal to the record year-ago figure. The year-long housing decline continued into the first quarter of 1965. In relation to the early -1964 peak, the num ber of contract MONTHLY REVIEW May 1965 awards was down about 25 percent for single family housing and about 40 percent for multi-family structures. The continued de cline partly reflected recent increases in va cancy rates; during 1964, for example, rental vacancies in the W est rose from 9 to 11 p er cent. A hopeful construction indicator was the first-quarter stability in new housing starts; in fact, new residential starts advanced in M arch to their highest level of the last eight months. A nother hopeful indicator was the recent strength in heavy construction awards, which increased 60 percent in value in the first quarter of the year. Electric-utility con struction awards doubled during that period. In addition, street and highway awards (the largest single heavy-construction category) also increased significantly, so that 1965 spending plans for this category are now up in almost every state of the District. With shovels and saw s Heavy construction provided the under pinning for a record-breaking first-quarter perform ance by the W estern steel industry. Unlike m anufacturers elsewhere, the District industry derived little benefit from the rapid N ation’s housing slump centered in California, other Western states Thoutondi of Units iooo r IR q tic Seol«) 800 600 400 200 C A LIFO R N IA 100 Other District 50 -I____ ■ 1359 ' I960 L. 1961 1962 I9S3 1 I i 1 1964 N o te : C h a rt show s sem i-an n u al average of residential b u ild in g p erm its, a t a n n u a l ra te s ( u n a d ju s te d ) . S o u rce: D e p a rtm e n t of C om m erce. first-quarter pace of auto m anufacturing and inventory building. B ut the D istrict industry derived substantial support from the con struction of m ajor power projects, industrial plants, and office buildings, as well as from repair w ork resulting from the year-end floods in the N orthw est and the year-ago earthquake in Alaska. M eanwhile, the domestic supply situation rem ained tight, and foreign steel im ports thus found ready m arkets throughout the West. N o n fe rro u s -m e ta ls p ro d u c tio n w as also strained during this period, as producers at tem pted to keep up with a record pace of orders arising from the heavy-construction and durable-goods booms. C opper shortages were aggravated at U.S. and foreign refineries by the E ast Coast dock strike. Yet, despite the shortages, producers of copper and other nonferrous metals resolutely attem pted to hold their prices constant in order to restrain con sumers from shifting to substitute materials. In early May, however, when Chilean govern ment pressure brought about an increase in the w orld-m arket price of copper, producers in this country were forced to boost their price from 34 to 36 cents a pound. On the other hand, the stability of metals m arkets in the near future should be assisted by the sched uled release of 100,000 tons of copper and 150,000 tons each of lead and zinc from gov ernm ent stockpiles. The W estern lum ber industry in recent months presented a different picture from the metals industry. Prices had increased rapidly in January because of production cutbacks resulting from year-end flood damage and a subsequent wave of speculative buying. Since early February, however, lum ber prices have trended downward, partly because of a rapid recovery of production from mills in the flood areas and partly because of a slowdown in consum er dem and related to a declining hous ing m arket. In fact, lum ber prices recently have fallen below the low levels prevailing a year ago. FEDERAL RESERVE BANK OF SAN F RA N C IS C O W est, like nation, pushes steel output to record heights S o u rces: F ed eral R e serv e B o a rd ; F e d e ra l R eserve B a n k of San F rancisco. In the countinghouse On balance, W estern business was just as strong as business elsewhere at the outset of a fifth year of a prolonged cyclical expansion. Despite problem s of too few jobs in defense m anufacturing and perhaps too few workers in agriculture, first-quarter production gains throughout the D istrict were quite substan tia l. E m p lo y m e n t, as a lre a d y in d ic a te d , m atched the nation’s 1-percent employment gain during the first quarter, and personal in come grew in step with the national rate, (D istrict personal income in early 1965 was roughly 7 percent above the year-ago level.) Substantial gains in income supported sub stantial gains in consum er spending. Retail sales in early 1965 were m ore than 6 percent above the year-ago level — in line with the national trend — despite weakness in several sectors, such as apparel, furniture, and ap pliances. The W est also participated in the nation’s auto-buying spree, as new car regis trations in D istrict states increased 10 p er cent above the year-ago level. As the spring progressed, then, there was little doubt of the continued ebullience of con sum er spending. T he m ajor questions con fronting W estern businessm en rather con cerned the strength of activity in certain specific industries. In other words, how m any jobs and how much incom e will be generated in coming months by the recent limited inflow7 of defense contracts? A t the same time, will enough farm workers be available to bring the D istrict’s crops to m arket? W hen these and related questions are answered, a better fix will be available on the shape of the W est ern business situation for the rem ainder of the year. Foreign Investment Copies are again available of the article, “ C an We Afford to Invest A broad?” , which appeared in the Septem ber 1964 M onthly Review . The article provides a background analysis of the role of private capital flows in the U .S. paym ents picture. The discussion includes definitions of different types of private capital investm ents, the location of our investments abroad, the short- and long-run im pact of private capital outflows on the balance of paym ents deficit, and the implications of private capital exports. Copies of the article are available on request from the A dm inistrative Service D e partm ent, F ederal Reserve B ank of San Francisco, 400 Sansome Street, San F ra n cisco, California 94120. MONTHLY REVIEW May 1965 Vigor in the Credit Markets into these investm ent outlets by financial in business activity continued to term ediaries. be accom panied by vigorous financial activity in early 1965. Business concerns in Strongest development particular, but consum ers and state-local gov A strong and w idespread expansion in ernm ents as well, increased their credit de b u sin ess b o rro w in g u n d o u b te d ly w as th e mands in order to finance higher levels of m ost significant financial developm ent of the e x p e n d itu re s . T h e F e d e ra l G o v e rn m e n t, January-M arch period. In particular, business meanwhile— notw ithstanding a slight reduc lo a n s a t th e n a ti o n ’s c o m m e rc ia l b a n k s tion in outlays— also increased its borrow jum ped by a record $4 billion — well over ings in order to finance a cash deficit and to double the average quarterly gain of 1964 m aintain its operating balances. (seasonally adjusted d a ta ). D uring the January - M arch quarter, the supply of loanable funds rem ained adequate T he sharp rise in business borrowing sug to accom m odate the higher level of expendi gests at first glance a decline in corporate tures at a level of interest rates only slightly liquidity m argins, in the face of continued above the late-1964 level. B ut some rate in gains in business sales and profits. But other creases occurred in the short-term end of the indicators suggest almost the reverse. F o r ex m aturity spectrum , and the yield spread thus ample, total holdings of negotiable certificates continued to narrow. of deposit at weekly reporting m em ber banks rose $1.3 billion during the January-M arch The m arket yield on 90-day Treasury bills period— substantially m ore than the average rose by about 16 basis points (alm ost to 4 1964 gain— and a large part of these were percent) between the beginning of the year held by corporations. This increase no doubt and late February — partly because of at reflected the increased yields obtainable on tem pts to m aintain short-term rates at a level such investments, but businesses also boosted that would discourage substantial outflows of their holdings of other liquid assets, such as short-term funds, and partly because of ex tax-anticipation bills. pectations of reduced credit availability in the O ther signs also pointed to the continued context of a continued vigorous expansion. adequacy of internally generated corporate B ut the rate then declined to the neighbor fu n d s. W hile tu rn in g in c re a sin g ly to w a rd hood of 3.89-3.94 percent in April and early bank loans, businesses approached the capi M ay, as a reflection of the m ore confident ta l m a rk e t w ith som e r e s tra in t; th e firsttone which developed in the money m arket quarter volum e of debt and equity offerings after the announcem ent of the A dm inistra was less than the quarterly average of each tion’s balance-of-paym ents program . of the three preceding years. Perhaps m ore Yields on other short- and interm ediatesignificant, the ratio of funds raised exter term m arket instrum ents also moved upw ard nally to business investm ent outlays was during the first quarter, but yields on m ost lower in the first quarter than during most of 1964. long-term debt instrum ents rem ained rela tively stable during this period. R ates on Other signs of vigor mortgages, corporate bonds and long-term Consumers also stepped up their borrow Treasury issues all moved sideways, as a con ing to finance sharply increased expenditures tinuing heavy flow of savings was directed V ig o r o u s FEDERAL RESERVE BANK OF SAN F R A N C IS C O Yield spread continues to narrow as rate increases occur at short-term end of maturity spectrum P «rc«n t P t r Annum S o u rce: F ed eral R eserve Board* 100 during the quarter. B ut they also reduced sharply their savings out of disposable in come; the quarterly savings rate (6.8 p er cent) was the lowest of the past year and a half. O n the other hand, public holdings of liq u id a sse ts in c re a s e d s u b sta n tia lly , w ith m ost of the gain showing up in interest-bear ing claims on com m ercial banks and other financial intermediaries. B oth extensions and repaym ents of con sum er instalm ent credit rose significantly in the January-M arch period. Consum er b o r rowing increased in all categories, b u t the active auto m arket generated about 37 p er cent of all new extensions, on a seasonally adjusted basis. The Federal G overnm ent’s net cash d e m ands on the m arket were fairly small d u r ing the first quarter, considering the fact that that period typically is a deficit period for the May 1965 MONTHLY REVIEW Treasury. In a highly successful advance re funding in January, the Treasury swept $9.7 billion of 1965-67 issues further out into the m aturity spectrum. Notes falling due on F eb ruary 15 which were not exchanged in the January operation were refunded into an 18m onth note in a com bined cash-exchange offering. M oreover, the T reasury raised $2.9 billion in new cash through the sale of June tax-anticipation bills in January and through an increase in the weekly bill tender. So, in view of the redem ption of $2.5 billion of M arch tax-anticipation bills, the Treasury raised net new cash of only $0.4 billion dur ing the quarter. Several other indicators also attested to the favorable state of Federal finances. T hrough out the quarter the Treasury balance ran con sistently ahead of year-ago levels. Then, an A pril recheck of budget figures revealed that the fiscal 1965 deficit will be about $1 billion less than anticipated in January, because of h ig h e r-th a n -e x p e c te d re v e n u e s as w ell as low er-than-expected Federal expenditures. In the state and local governm ent sector, higher spending levels during the quarter were accom panied by a $2.5-billion rise in debt offerings. This was slightly above that of Banks show net borrowed reserve position for first time in expansion M illio ns of Dollars S o u rce: F ed eral R eserve B oard. the preceding three m onths but was less than the 1964 quarterly average volume of taxexem pt issues. The m ajor p art of the new issues went for the financing of highway con struction. Com mercial-bank role Com m ercial banks played a leading role in the nation’s active credit m arkets during e a rly 1965. C o m m e rc ia l-b a n k c re d it ro se $8.5 billion (seasonally adjusted b asis), and thus substantially exceeded 1964’s average quarterly gain. Loans increased even faster— $8.8 billion, or twice the 1964 pace. The in crease was financed partly by a drop of almost $2 billion in Treasury security holdings— a drop, however, that was largely offset by a substantial gain in other security holdings. Business borrowing, as already indicated, was the principal cause of the increased ac tivity in bank lending departm ents. T he business-loan gain reflected the need for larger w orking balances attendant to the financing of higher levels of output. But other factors were also im portant— for example, com m od ity dealers’ financing of goods held up in transit during the early-1965 dock strike, steel custom ers’ financing of strike-hedge buying o f in v e n to rie s, and (especially) foreign ers’ sharply increased borrowing prior to the F e b ru a ry a c tio n by banks lim iting their a n n u a l in c re a se s in such lending to 5 perc e n t. M e a n w h ile , re a l-e s ta te lo a n s in creased at a rate com parable to the average 1964 gain, and con s u m e r lo a n s o u t m atched their average 1964 gain. On the other side 1 of the ledger, bank de posits rose by about FEDERAL RESERVE BANK OF SAN F R A N C IS C O $8.3 billion, including a $ 2.6-billion net in crease in U.S. G overnm ent deposits. D eposit growth failed to m atch the grow th in ou t standing credit, however. D uring the first quarter, bank borrowings from the Federal Reserve System tended to increase, while ex cess reserves tended to decline. Consquently, average free reserves declined from their fourth-quarter level, until in M arch the banks recorded net borrow ed reserves of $76 million. F i r s t - q u a r t e r m o n e y s u p p ly s ta tis tic s showed a slight decline in dem and deposits and a slight increase in currency, but a sharp $5.7 -b illio n in c re a s e in c o m m e rc ia l-b a n k time and savings deposits. This developm ent clearly reflected the attractiveness of the in creased rates on tim e and savings deposits which many banks have paid since the be ginning of this year. The higher rates, which were perm itted under last N ovem ber’s am endm ent of F ed eral R eserve R egulation Q, have helped im prove the com petitive position of commercial banks vis-a-vis other depositary institutions. Com m ercial banks accounted for 66 percent of the total first-quarter savings gain at sav ings institutions, as com pared with only 45 percent of the gain in the year-ago quarter. M oreover, savings growth at savings and loan institutions was sm aller during the first q u ar ter than during the com parable periods of the last several years. Contra-seasonal District rise In the Twelfth D istrict credit dem ands also increased vigorously in the first quarter of 1965. T otal credit at District weekly report ing m em ber banks rose $336 million, or one percent, during this period. Loans increased m ore than $500 million— double the gain in the year-ago quarter. (B ut even this gain was relatively less than at banks elsewhere, which overcame their norm al pattern of a sharp first-quarter loan decline.) M eanwhile, in the se c u ritie s c ate g o ry , b a n k s in c re a s e d th e ir holdings of “oth er” securities at twice the na tional rate of increase, and thus offset a large part of their net reduction in holdings of U.S. G overnm ent securities. Business-loan dem and accounted for over one-half of the total first-quarter loan expan sion at D istrict weekly reporting banks. Busi ness borrowing declined slightly in January, but then increased fairly constantly through- District banks’ loan expansion falls short of national pace business and consumer loans account for most of District gain U.S. MI NUS T W E L F T H T W E L F T H DI STRI CT M illions of Dollars - 0 + 200 -200 T M illio n s of D ollars -0+ DISTRICT 200 Commercial and Industrial Loans Real Estale Loans A g ricultural Loans Nonbank Financial Institution Loans Other Loans (M a in ly Consumer) 102 Sources: F ed eral R eserv e B o ard ; F ed eral R eserve B a n k of San F rancisco. 1965 First Quarter Net Change 1964 First Qugrttr Not Chang* MONTHLY REVIEW May 1965 S E L E C T E D B A LA N C E S H E E T IT E M S O F W E E K L Y R EPO R TIN G M EM B E R BA NK S IN LEADING C IT IE S (dollar amounts in millions) U. S. Minus Twelfth District Twelfth District Net change First Quarter 1965 Dollars Percent Outstanding 3/31/65 $3 2,65 0 23 ,413 7,8 54 7,5 69 1,000 1,551 51 f 330 4,9 8 8 9,2 37 5,1 76 4,061 + + + + — + + + + — — + 336 507 273 24 13 26 55 24 131 171 52 0 34 9 + 2.2 + 3.6 + 0.3 — 1.3 + 1-7 + 12.1 + 7.8 + 2.7 — 1.8 — 9.1 + 9.4 — 0.3 + 1-2 — 0.6 + 2.7 — 2.0 — 2.3 + 27.0 + 10.5 + 0.9 — 3.5 — 5.9 + 0.5 $ 1 1 9 ,3 1 7 8 1 ,4 0 4 3 6 ,7 6 6 12,757 542 7,346 5,9 38 1,244 18,716 3 7 ,913 19,789 18,124 + 0.5 + 2.6 + 6.5 + 2.4 — 6,2 — 2.1 — 4,6 — 0.8 + 1.4 — 3.7 — 10.0 + 4.2 — — __ + — — — + + — — + 2.6 1.6 1.4 2.7 8.6 5.3 10.6 6.7 0.7 4.4 7.8 0.6 12,343 19,396 14,321 2,5 3 0 — + + + 507 818 418 46 4 — 4.0 + 4.4 + 3.0 + 22.5 — 4.3 + 3.3 + 1.9 + 20.7 5 1 ,0 6 2 5 1 ,7 4 4 2 8 ,0 0 2 15,926 — 7.5 + 7.1 + 4.5 + 11.1 — + + 8.6 3.9 1.5 Outstanding 3/31/65 ASSETS Loans adjusted and investments1 Leans adjusted1 Commercial and industrial loans Real estate loans Agricultural loans Loans to nonbank financial institutions Loans for purchasing and carrying securitie Loans to foreign banks Other loans (mainly consumer) Toial securilies U. S. Government securities Other securities LIABILITIES Demand deposits adjusted Total time and savings deposits Savings accounts Other time deposits (PC Net change 1st Qtr. 1st Qtr. 1964 1965 Percent Percent 1st Qtr. 1964 Percent + i.o -f* 6.8 1 E x clu siv e of lo an s to dom estic com m ercial b a n k s an d a fte r ded u ctio n of v a lu a tio n reserves; ind iv id u al loan item s a re show n gross. N o te : Q u a rte rly changes are co m p u ted from th e D ecem ber 30, 1 9 64-M arch 31, 1965 a n d from D ecem ber 31, 1963-A pril 1, 1964. S ource: B o ard o f G overnors of th e F ed eral R eserve S ystem ; F ed eral R eserve B a n k of San F rancisco. L r out February; in fact, the February gain ex ceeded the large M arch increase, even though the latter was inflated by heavy credit de mands over the M arch 15 corporate-tax date. Some of the special factors which influenced national credit developm ents— for example, heavy foreign borrowing prior to the volun tary restraint program initiated in February, along with financing needs associated with the dock strike and steel inventory buildup— also appear to have influenced the pattern of D istrict lending. All m ajor categories of business borrowers, except public utilities, increased their bankheld debt at m etropolitan oflices of m ajor banks. Loans to durable goods m anufactur ers increased $61 million, largely due to credit needs of m achinery m anufacturers. Loans to nondurable goods producers rose by $38 million-—in sharp contrast to a $91million decline in the year-ago period. The p e tro le u m in d u s try re c o rd e d h e av y c re d it needs for oilfield operations and other p u r poses. T he dock strike, meanwhile, contrib u te d to a le s s -th a n -s e a s o n a l re d u c tio n in bank-held debt of food, liquor, and tobacco m anufacturers. B ut in contrast to these plus factors, the dow nturn in D istrict construction activity contributed to a smaller net increase in construction loans than in the com parable year-ago period. C ontrary to assum ptions, the cost of busi ness borrowing did not increase as bankcredit demands strengthened. A ccording to the Federal Reserve quarterly interest-rate survey, ra te s p a id o n s h o rt-te rm b u sin ess loans m ade in the first half of M arch declined from the D ecem ber level, both in the Twelfth District and nationally. T he decline in the average D istrict rate for all-size loans, from 5.25 percent in D ecem ber to 5.11 percent in M arch, was due mainly to a very substantial increase in the proportion of the total loan volume extended to borrow ers who qualify 103 FEDERAL RESERVE BANK OF SAN F R A N C IS C O for the prim e rate (currently AV2 percen t). B ut average rates on loans in the smaller loan-size groups were som ew hat higher than reported in the D ecem ber survey. M oreover, bank policies tended to be firmer on nonprice term s of lending, particularly in regard to com pensating balances. M ortgages, consumers, dealers 104 While business lending increased at Dis trict banks, mortgage lending weakened. The net expansion in real estate loans for the first quarter was only $24 million; the gain in the corresponding period of 1964 was $192 mil lion. W eekly reporting banks outside the Dis tr i c t, o n th e o th e r h a n d , m a tc h e d th e ir year-ago m ortgage perform ance even while recording a very large increase in business loans. Since last fall, District weekly reporting banks have slowed down their acquisitions of mortgages and have stepped up their sales of m ortgages out of bank portfolios. District banks norm ally m aintain a fairly constant ratio of real-estate loans to savings deposits, but the accelerated inflow of savings since D ecem ber so far has not been reflected in m ortgage lending. O ther factors — particu larly the relative weakness of mortgage de m and and the ample availability of funds for real-estate investm ent by com peting institu tions— have tended to limit bank participa tion in the m ortgage m arket. But even so, D istrict banks still hold a far higher pro p o r tion of their total loan portfolios in real estate loans than do banks elsewhere in the nation. C onsum er dem and for bank credit helped push up loan totals in the first three months of 1965. T he rise of $131 million in the “other loan” category, where these loans are reported, was three times as great as in the com parable year-ago period. The rate of gain at District banks was nearly double the rate recorded at other weekly reporting banks. As in early 1964, the net increase in this loan c a te g o ry e x c e e d e d th e gain in re a l-e s ta te loans. Obviously, the higher interest costs th at banks m ust m eet in 1965 has enhanced th e a ttra c tiv e n e s s o f c o n su m e r in s ta lm e n t loans, with their relatively high effective rate of return. D uring the January-M arch period, D istrict banks provided a large volume of credit to brokers and dealers fo r financing and carry ing securities. In this, as in the preceding quarter, some banks frequently took advan tage of the arbitrage in rates on Federal funds (excess reserves on deposit wih a Federal R e serve B a n k )— buying funds from other banks and reselling at higher rates to G overnm ent securities dealers. Record deposit inflows T otal tim e deposits chalked up a record first-quarter gain of $8.8 million at D istrict weekly reporting banks, in response to the higher rates authorized by last N ovem ber’s re v isio n o f R e g u la tio n Q. (S o m e D is tric t banks immediately increased rates paid on time certificates of deposit, but m ost waited until January to increase rates paid on sav ings deposits.) The total dollar increase was greater in early 1965 than in the first quarter of 1962, when D istrict banks also raised in- Higher rates induce sharp gains in time and savings deposits Index, Fourth Qtr 1961 = 100 S ources: F ederal R eserve B o ard ; F ed eral R eserve B a n k of San F rancisco. May 1965 MONTHLY REVIEW terest rates by Vi percent following a revi sion in R egulation Q, but the percentage gain was somewhat sm aller— 4.4 percent vs. 5.6 percent. A num ber of m ajor banks that had for m erly issu e d savings c e rtific a te s w ith 12m onth m aturities at 4 percent recently offered time certificates to individuals at rates above 4 percent, and thereby im proved their com petitive situation vis-a-vis savings and loan associations. In response to these rate de velopments and to a deceleration of growth in their own savings inflow, a num ber of Dis trict savings and loan associations outside of California increased dividend rates at the be ginning of the year, and a few more moved upw ard at the end of the first quarter. But California associations, which were already paying a prevailing rate of 4.85 percent, held their ground at the first of the year. Then, at the end of the quarter, several Southern Cali fornia associations announced increases to around 5 percent. B ut the Federal Hom e L oan B ank Board immediately ruled that associations increasing rates above locally prevailing rates (if over 4.25 percent) would not be eligible for advances for loan expan sion. Since this ruling, no further increases have been announced. D istrict weekly reporting banks took ad vantage of the unusually large first-quarter increase in total time and savings deposits to decrease their dependence on large-denom ination negotiable C D ’s. The $90-million firstquarter increase in outstanding C D ’s was less than a third as large as the increase in the com parable year-ago period. D istrict banks, unlike New Y ork City banks, apparently did not seek to offset the large volume of C D ’s m aturing on the M arch 15 corporate-tax date, and consequently they recorded a net reduc tion in this category in M arch. But the growth in this type of deposit instrum ent exceeded that at Chicago D istrict banks and the San Francisco D istrict continued to hold third place am ong the Districts in the volume of outstanding C D ’s. Less reserve pressure The record net inflow of time and savings deposits exceeded the seasonal first-quarter decline in dem and deposits by about $300 million, and the supply of lendable funds available to D istrict banks consequently in creased. Because of this favorable expansion in deposits, D istrict banks were under som e what less reserve pressure than were banks elsewhere. R equired reserves of D istrict m em ber banks during the January-M arch period were $134 million higher, on a daily average basis, than in the corresponding period in 1964. B ut excess reserves were also greater, and daily average discounting at the Federal Reserve B ank of $16 million was only half the volume of borrowing in the first quarter of 1964. Thus, excess reserves exceeded b or rowings by a daily average of $4 million, in contrast to average net borrowed reserves of $ 1 8 m illio n in th e c o m p a ra b le y e ar-ag o period. In A pril, however, D istrict bank re serve positions tightened, and their net bor rowed reserves were larger than in April 1964. In spite of favorable loan and deposit per form ances in the first quarter of 1965, the substantial increase in interest costs on sav ings and time deposits tended to depress Dis trict bank earnings. T he im pact of the interest rate adjustm ent was intensified for District banks because they hold a relatively high pro portion of their total deposits in time and sav ings deposits. 105 FEDERAL RESERVE BANK OF SAN F RA N C IS C O Condition Items of All Member Banks — Twelfth District and Other U. S. Recession Periods BHlions of Dollars 50 40 30 500 400 300 200 1955 1957 1959 1961 1963 1965 '955 JmKS : 195? i . : •B 8 H fw B W T O 5 » W B W T O W «* 2 0 1959 1961 I9«3 l»65 S ource: F ed eral R eserve B a n k of San F rancisco. (E n d -o f-q u a rte r d a ta shown through 1962, and end-of-month data th e re a fte r; d a ta not ad ju ste d for seasonal v a ria tio n .) BANKING AND CREDIT STATISTICS AND BUSINESS INDEXES— TWELFTH DISTRICT1* (Indexes: 1957-1959 = 100. Dollar amounts in millions of dollars) Condition items of all member banks1 Seasonally Adjusted Year and Month 106 Loans and discounts3 U.S. Gov’t. securities Demand deposits adjusted4 Total time deposits Bank rates Bank on short-term debits business Index 31 cities5, 6 1oans7, 8 Industrial production (physical volume)5 Total nonagricultura 1 employ ment Dep't. store sales (value)8 Lumber Refined4 Petroleum Steel* 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 3.95 4.14 4.09 4.10 4.50 4.97 4.88 5.36 5.62 5.46 5.50 5.48 5.48 84 86 85 90 95 98 98 104 106 108 113 117 120 73 74 74 82 91 93 98 109 110 115 123 129 139 101 102 101 107 104 93 98 109 98 95 98 103 109 90 95 92 96 100 103 96 101 104 108 111 112 115 92 105 85 102 109 114 94 92 102 111 100 117 132p 1964 M arch April M ay June Ju ly August September October November December 23,691 23,929 24,126 24,443 24,912 24,965 25,282 25,165 25,339 25,561 6,961 6,563 6,493 6,380 6,161 6,212 6,480 6,519 6,685 6,492 14,272 14,215 14,199 14,376 14,369 14,377 14,689 14,587 14,503 14,450 19,566 19,773 19.813 19,896 20,152 20,235 20,473 20,602 20,792 21,300 167r 17Cr 168r 169r 168r 172r 167r !70r 172r 168r 5.47 5.48 119 119 119 119 119 120 120 121 121 122 133 134 139 137 141 143 137 139 150 142 114 102 106 105 113 107 108 111 106 106 113 111 112 114 115 118 121 117 113 115 149 140 139 131 p 121 p l21p 129 p 132p 149p 140p 1965 January February M arch 25,853 26,120 26,539 6,337 6,659 6,538 14,430 14,453 14,714 21,669 21,878 21,996 179 176 181 152 146 140 110 109 116 117 5.44 122 123 123 137p 142p 150p 5.46 5.51 1 Adjusted for seasonal variation, except where indicated. Except for banking and credit and departm ent store statistics, ail indexes are based upon d ata from outside sources, as follows: lumber. N ational Lumber M anufacturers’ Association, West Coast Lumberman’s Association, and Western Pine Asso ciation; petroleum, U.S. Bureau of Mines; steel, U.S. D epartm 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 month. 5 T otal loans, less valuation reserves, and adjusted to exclude interbank loans. * T otal 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 politica 1 subdivisions. Debits to total deposits except interbank prior 1942. 6 Daily average, 7 Average rates on loans made in five m ajor cities, weighted by loan size category. 8 N o t adjusted for3 easonal variation. ’ Banking data have been revised using updated seasonal factors. M onthly d ata from 1948 available on request from the Research D epartm ent of this Bank. p —Prelim inary. r — Revised.
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