The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
FEDERAL RESERVE BANK OF SA N FRANCISCO M ON TH LY REVIEW IN THIS ISSUE W II® Brakes Mil ill Easier Money? Simmer Sisisiess Summer iirrswiig NOVEMBER 19 6 S Will the Brakes Hold? . . . "W a if 'fil nexf year" is now the cry of the pundits who predicted in June that Congress' braking action would have immediate results. Easier Money? ... The third quarter showed a modest but distinct shift in monetary policy away from the rather stringent posture of early 1968. Summer Business .. . The Western economy, in line with the national pattern, remained generally healthy during the summer and early-fall period. Summer Sorrowing . .. Twelfth District banks channelled about three-fourths of their third-quarter increase in total credit into security purchases. Editor: William Burke MONTHLY November I960 REVIEW Will the Brakes Hold? ost business pundits expected in early summer that Congress’ heavy foot on the brake pedal would have immediate re sults, but now that summer has turned into fall, they are still waiting for the brakes to hold. Indeed, in most forecasting circles, it seems agreed that the test lies ahead some time in early 1969. Meanwhile, the business indices, including the price indices, continue to rise rapidly. And Wall Street, which spent most of the early summer adjusting uncom fortably to the tax impact on earnings esti mates, has spent the rest of the summer and early fall adjusting its sights upward again. During the third quarter, GNP rose by about $18 billion to an $871-billion annual rate. Although this was somewhat below the $22-billion rate of rise of the preceding quarter, much of the difference resulted from the smaller (and healthier) rate of inventory increase. Summer-quarter statistics showed continued strength in spending by and for consumers— on the part of both individual households and (collectively) state and local governments — and renewed strength in spending by businesses for new capital goods. Other sectors showed a little less buoyancy— residential construction, for example — and Federal Government spending, as it was sup posed to, grew at a somewhat slower pace. But, just as in earlier quarters, roughly half of the GNP increase was due to an uncom fortably high and rising level of prices. M Reasons for restraint The consumer-price index increased at a whopping 6-percent annual rate in June and July, but then showed smaller increases in August and September. Yet, in September, the index was 4.4 percent above the year-ago level for the largest year-to-year increase since the Korean War period. Over the past year, prices of consumer services have increased 6 percent. Medical costs jumped sharply over this entire period, partly because of Medicare and partly be cause of the 1967-68 increases in the min imum wage, which especially benefited poor ly-paid health workers. The third-quarter increase was also characterized by a jump in housing costs, specifically by a rise in mort gage-interest costs generated by moneymarket pressures and by legislative increases in mortgage-rate ceilings. Prices of durable and nondurable goods also increased sharply over the year — much more at retail than at wholesale, incidentally. These boosts reflected heavy demand (as in autos), supply restrictions (as in fruit and vegetables), and marketing-cost pressures (as in everything, because of even higher wage boosts in distributive industries than in manufacturing). The wholesale-price index fluctuated dur ing the third quarter, but still by late summer showed a 2.7-percent increase over a year ago, largely because of last spring’s strong price upsurge. Industrial commodity prices —up 2.7 percent over a year ago—have increased only 1.5 percent at an annual rate since last spring. This shift to moderation reflected improvements in supply— in partic ular, the drop in copper prices following the strike settlement in that industry—reduced price pressures for imports, and weak market anticipations in some areas. But then, in the early fall, pressures on industrial prices be gan to build up again in sucji sectors as ma chinery and construction materials. Continued price pressures during the sum mer quarter, however, lent some substance to the comment found in the annual report of the International Monetary Fund, that it is 209 FEDERAL 210 RESERVE BANK “necessary” for the U.S. economy to be held “well below” its 4-percent potential growth rate through the workings of the fiscal pack age. Most observers, in fact, here as well as abroad, have seen the necessity of conscious ly sacrificing some output and employment in the near term in order to gain extra out put and employment over the longer run. But whether the strong pressure on the brakes— that is, the shift from a $25-billion to a $5billion (estimated) Federal deficit between fiscal 1968 and 1969—will have a major effect within the near future can only be guessed from an analysis of the major com ponents of the late ’68 economy. Defense: slackening Defense spending rose by almost $1 bil lion, to an $80-billion annual rate, during the summer quarter, and other federal spend ing was up slightly to a $21 Vi -billion rate. These increases amounted to roughly half the size of recent quarterly gains, as the spending curbs included in the fiscal-restaint package went to work. In keeping with the intentions of the fiscal-restraint program, the Federal Govern ment may well be a major force for mod eration as the economy moves into 1969. Moreover, Federal pruning may affect the inexorable growth of state-local government spending, since Federal grants to these sec ond-level governments will rise considerably more slowly than heretofore. Military prime-contract awards, a major indicator of future defense spending, have moved practically sideways over the past two years after a two-thirds increase during the first eighteen months of the Vietnam build up. Contract awards, moreover, have weak ened slightly this year, running 3 percent be low the year-ago level during JanuaryAugust 1968. Nonetheless, the $30-billion annual cost of Vietnam will not disappear even if that conflict tapers off; the need to rebuild military inventories, to make up for postponed projects (such as military hous OF SAN F R A N C IS C O ing), and to develop new weapon systems, could keep the military budget close to its present level for years to come. Investment: spotty Business investment spending rose to a new high during the third quarter, increasing by $3 billion to a $9 0-billion annual rate through heavy purchases of producers’ dur able equipment. Spending for bricks and mortar remained below earlier peaks. The Commerce Department’s quarterly survey of business spending plans projects a modest advance for the entire second half and for 1968 as a whole. Still, because of sharp price increases, 1968’s projected AV2 percent increase in dollar spending translates into a zero increase in real spending. (Last year also failed to post any real increase in spending.) Several recent private surveys anticipate that 1969 will, like 1968, show a modest gain in dollar spending for fixed investment, but at this point no one forecasts any boom comparable to that of the 1965-66 period, when increases of 15 percent or more were recorded for two years in a row. Indeed, business capital spending right now looks somewhat spotty. Some industries are still spending heavily; airline, trucking, and utility firms are all expanding their fa cilities sharply, with 1968 expenditures roughly one-third above the levels of two years ago. On the other hand, manufacturers are cutting back on their spending, both in current and real terms, evidently because they see no need to expand their facilities at the present time. Manufacturing firms are utilizing their present facilities at less than 83 percent of capacity (down from 91 per cent two years ago) and expansion needs are reported by firms holding only 41 percent of total manufacturing assets (down from 51 percent two years ago). Business inventory policy continued its seesaw trend during the summer quarter as the accumulation rate slid to roughly $8 bil- November 1968 MONTHLY REVIEW S@wa@ ©MP §@@f@rs move sideways during third quarter, but m©sf sh©w ©©ntSnued (and unexpected) growth Billions of Dollars quarters, accumulation has shifted from $5 billion up to $8 billion, down to $2 billion, up to $11 billion, and now down to the present level.) This sector is now strongly influenced by steel consumers’ enforced re duction of inventories, but the possibility of only modest spending increases in defense and business investment suggests that stock building also may proceed at a modest pace in coming months. And even if consumer markets remain strong enough to require ex panded inventories, the cost of carrying such stocks remains strikingly high. C o n su m e rs! sp lu rgin g Nonetheless, most of these uncertainties have recently been overshadowed by the third-quarter upsurge in the massive consum er sector. Spending rose by more than $13 billion to a $541-billion annual rate, and this increase was eclipsed only by the sharp gain in the first quarter of this year. This surprising increase in consumer spending, carried out in the face of the stronger tax bite, was made possible largely by increased borrowing and reduced saving. During the summer, instalment-credit exten sions ran almost 15 percent ahead of the one percentage point from the high 7.5percent figure of the preceding quarter, and this $7-billion shift nearly offset the increase in consumers’ withheld taxes. Moreover, payrolls continued to expand during the summer quarter, as a Federal pay boost occurred at midyear and as strong gains continued in most components of the private economy except steel. Employment continued to expand, even though the month ly gains lagged behind those recorded in the early part of the year. (Trade, services, and state and local governments showed substan tial increases, while manufacturing employ ment was relatively stable.) Besides, the labor market exhibited continued tightness as the labor force grew slowly In the face of heavy labor demand. Thus, the jobless rate, averaging 3.6 percent for the third con secutive quarter, remained at the lowest level of the last fifteen years. In coming months, consumer incomes probably will reflect less substantial wage increases— and, hopefully, price indexes will reflect reduced labor-cost pressures. In 1969 there will be a smaller number of major wage negotiations than this year, and the FEDERAL 2 12 RESERVE BANK wage increases already provided for in pre viously negotiated contracts will tend to be smaller than in the initial years. Moreover, there will not be a significant increase in the minimum wage in 1969, as there was in each of the two preceding years. Consumer incomes will also feel the tax pressure that is slated to increase early next year. Consumers will first have to absorb an increase in social-security taxes amount ing to about $ 1Vi billion, and will then have to pay out roughly $ 1 V2 billion (in addition to withholdings) to meet their final income tax bills for 1968. Thus, it is still possible that consumer purchases, especially for dur able goods, will reflect the continued fiscal pressures on discretionary incomes. Detroit: speeding In the sunny summer of 1968, however, this possibility was only a cloud on the fardistant horizon. In the rip-roaring auto mar ket, in particular, total sales of autos and parts rose more than $2 billion to a $38billion annual rate. For the year to date, unit sales of Detroit’s products were 10 percent above the 1967 figure and import sales were 32 percent over a year ago. August and Sep tember especially were a sales manager’s dream, as new cars (including imports) rolled out of the showrooms at a 10-million unit annual rate. The fast cleanup of the ’68 models was followed by an equally fast start on the ’69s. Accordingly, automakers this fall scheduled a record rate of production: almost one million cars for October, and 2.5 million cars for the entire fourth quarter. October traditionally is a heavy production month be cause of the need to fill dealers’ inventories and to meet fleet orders, but the recent activ ity in the showrooms suggests that buyers are waiting for every car coming off the pro duction line. Detroit, however, will now have to combat both the slowdown in consumer disposable incomes and a speed-up in its own price ac OF SAN F R A N C IS C O tivity. Car buyers can expect to pay some what more for the new models than for the ’68s, and they may get somewhat less for their money because of a major roll-back in warranty coverage. To the statisticians in Washington, a $41 average increase in suggested retail prices this year includes only a $ 1 net improvement in “quality” — safety, reliability and the like — since this year’s reduction in warranties offsets almost all of a $24 gross quality im provement in the average car. (General warranties covering 24 months or 24,000 miles were cut in half with the ’69 models.) In contrast, last year’s $ 116 average increase in the retail sticker price included a $58 in crease in quality because of new safety and pollution-reduction features. The average new-car buyer — someone turning in a ’65 model, say—will see a sticker price $325 higher than what he paid several years ago, as a result of five rounds of price increases over the past three years. Still, the early shoppers seemed willing to pay the tab; in fact, one automaker reported that half of his customers were anxious to spend another $500 each for air-conditioned models. Housing: mortgaging Another consumer-oriented industry, resi dential construction, held steady during the summer quarter at a $29V2 -billion annual rate. This sector, although advancing only slowly since last winter, operated at a con siderably healthier pace than two years ago. Housing starts this summer, as during the first half of the year, remained in line with the 1962-65 annual average of about 1.5 million units. Builders generally expect some further growth during 1969, not only because of the underlying strength of consumer demand, but also because of their belief that mortgage funds will become more abundant and there by offset some of the depressing fiscal impact on consumer incomes. November 1968 MONTHLY The industry ardently believes that a great underlying strength for housing exists, espe cially in view of the sharp drop in vacancies in recent years. At midyear the rental vacan cy rate was 5.7 percent and the owneroccupied rate was 1.0 percent— the lowest figures of the past decade. But effective strength in 1969 may also depend upon an adequate flow of funds into mortgage-lending institutions and upon the ability of buoyant consumer attitudes to offset the tax impact on consumer incomes. Brakes: holding? If the brakes of fiscal restraint should take hold in early 1969, the annual growth of the economy, in real (price-adjusted) terms, should slow down to somewhere between zero and 4 percent. According to the official arithmetic, the economy should slacken just enough to assure that prices and wages de celerate, but should also run fast enough to avoid recession and the excessive costs asso ciated with substantial unemployment. Of course, the growth rate conceivably could REVIEW fall below 4 percent even without the appli cation of these fiscal brakes, partly because of the gradual effects of the earlier period of monetary restraint, the expected slowdown in capital spending, and the present cutback in steel output and inventories. When, in addition to those factors, fiscal policy is tight ened more suddenly than it has ever been before, the prescription of the experts, both here and abroad, should be amply fulfilled. Still, at this stage, the business pages are full of the controversy over whether the brakes will actually hold. For those who “read the monetary tea leaves” (in Professor Walter Heller’s phrase), this past year’s rapid increase in the nation’s money stock implies a continued increase in spending. For those who follow the leading indicators of manufacturers’ new orders, Wall Street indexes, and the like, the slowdown is not yet in sight. Yet for those who swear by the memory of John Maynard Keynes, 1969 should surely testify to the efficient braking action of fiscal restraint. William Burke Easier Money? n early summer, there was a modest shift in monetary policy away from the rather stringent posture that had characterized pol icy earlier in the year. But then, much of the earlier ease was wiped out by mid-Septem ber, and the banking system was still record ing net borrowed reserves in October. Still, the Federal Reserve did reduce the discount rate by Va of 1 percent in August, and commercial banks did cut their prime rate on business loans from Va to V-i of 1 per cent in September. The commercial banks— and other financial institutions as well—were under less pressure as the level of moneymarket yields declined and the threat of disintermediation waned. One of the major reasons for the some what easier tone in the money and capital I markets was the marked improvement in the Treasury’s cash position. The Treasury’s esti mated deficit for the third quarter was in the neighborhood of $3 billion, compared with $9 billion for the same three months last year. (Happily, the outlook for the months ahead is for more of the same; after raising an additional $3 billion through the issue of tax anticipation bills in October, the Treas ury later announced that it would need no more new cash on a net basis for the re mainder of 1968 and only $1V6 billion in the first half of 1969.) In perspective, this summer period witnessed a shift in the mix between monetary policy and fiscal policy subsequent to the June enactment of the fiscal-restraint package. 213 FEDERAL 214 RESERVE BANK Policy .. . and problems By many of the usual measures, monetary policy appeared to be less restrictive during the third quarter. The average level of net borrowed reserves was just under $200 mil lion (compared with about $350 million in the second quarter), and the average level of member-bank borrowings from the Re serve Banks was $531 million (compared with $715 million in the preceding quarter). The average effective rate on banks’ Federalfunds transactions dropped from as high as 614 percent in July and August to just above 53 percent in September. A The total reserves of the member banks increased at a 9-percent annual rate in the third quarter, which was about in line with the 1967 pace but was considerably above the performance of the second quarter, when reserves remained unchanged. On the other hand, the money supply (narrowly defined) increased at a 4.5-percent annual rate in the third quarter—just about half the preceding period’s 8.7-percent rate. The timing and magnitude of the reduc tion in the discount rate in August argues against the interpretation of this action as a significant shift in monetary policy. Most money market rates had already fallen sharp ly in late July, prior to the cut in the discount rate. The decline in interest rates was simply a reflection of the change in market expecta tions brought about by the fiscal-restraint program’s expected impact on financial mar kets. The estimates of the Federal deficit for fiscal 1969 were scaled down drastically from around $25 billion to a more manageable figure of $5 billion or so. There were wide swings in bank reserves, bank credit, and the money supply in the third quarter. A good part of these variations can be explained by Treasury financing oper ations. In the third quarter the expenditures of the Federal Government ran well ahead of receipts, as usual, and this drain was met by drawing down cash balances and by borrow OF SAN F R A N C IS C O ing to raise the bulk of the needed cash. The Treasury, conducting major financing opera tions in July and August, raised a total of about $7 billion of new cash for the entire quarter. The banking system was the princi pal underwriter for these financing opera tions, and deposits and required reserves of the banks rose as payment was credited to the Treasury’s account. The money supply grew at an annual rate of 12.8 percent in July and fell at an annual rate of 5.8 percent in September. Here again, a part of these swings can be traced to the ebb and flow of the Treasury cash position. The cash balances of the Treasury are not included in the money supply, which consists of demand deposits of the public and cur rency outside of banks. Federal expenditures in July drew heavily upon Treasury deposits, and the transfer of ownership of deposits to the public thereby increased the money sup ply. Conversely, as Federal taxes were paid in September, the deposits of the public de clined (as did the money supply) and Treas ury balances were replenished. Security blanket? Commercial-bank credit (total loans and investments) rose at a 17-percent annual rate in the third quarter, or nearly three times the preceding quarter’s rate of increase. A large part of this expansion was due to bank acquisition of U.S. Government and S e c u rity p u rc h a se s help spur rapid bank-credit growth Billions of Dollars November 1968 MONTHLY municipal securities. During the summer period, banks expanded their holdings of Governments and tax-exempts at annual rates of 19 percent or more, in contrast to second-quarter increases of 1 and 14 per cent, respectively, in those two categories. The banks held on to a good share of the issues that they obtained in underwriting Treasury and state-local financing operations during the quarter, and they also increased their Treasury-bill holdings, adding to the bills acquired in the July financing. They were persuaded to keep these issues in their portfolios because of the general expectation of declining interest rates, which would be reflected in higher prices of securities and capital appreciation. Meanwhile, banks were able to support their increased purchases of securities be cause of a sharp increase in time-and-savings deposit inflows, which jumped from 3 to 18 percent (anual rates) between the second and third quarters. The change in the trend of interest rates helped explain this steppedup inflow, for as the yields on money-market instruments declined, the rates paid by banks on these deposits became relatively more at tractive. Large-denomination negotiable cer tificates accounted for well over one-thiird of the increase in total time-and-savings de posits. Changes in the level of outstanding CD’s also reflected the availability and cost of Eurodollars, which the larger banks re gard as an alternative source of funds. Total commercial-bank loans increased at an annual rate of over 15 percent in the third quarter, nearly double the secondquarter rate. This gain was attributable in part to a very large ($3.5 billion) rise in loans to security dealers. Large speculative positions in securities— mostly Governments — were built up and carried through most of the quarter by securities dealers, banks, and other investors in anticipation of capital ap preciation. The third-quarter demand for business REVIEW Downtrend Ira interest rates lasts through most ©f summer Percent at a 9-percent annual rate as against the 12Vi-percent pace of the second quarter. Improved corporate liquidity was a factor here, since tax borrowing was very small over the July tax date and not much stronger over the September tax date. The reduction of borrowing to carry steel inventories in antici pation of a steel strike at the end of July also helped diminish the business demand for bank accommodation. Rates down .. „then up The term most often— and appropriately —used to describe the course of interest rates in the third quarter was “indecisive,” particu larly in view of the absence of a clearly de fined trend. Money-market rates, after peak ing in May, declined through the first half of August, because of the prospect of a de clining trend of interest rates. By early Au gust, the market yield on 91-day Treasury bills had fallen by just over one percentage point from the May high of 5.92 percent, and the decline for other types of short-term instruments was also fairly large. Yet the trend was soon reversed, and much of the euphoria that characterized mid-summer ex pectations was dissipated by mid-October, when most yields were back to where they were at the beginning of July. 215 FEDERAL 2 86 RESERVE BANK Meanwhile, several exceptions to the gen eral direction of rates became apparent. Even as the bill rate was dipping below 5 percent in early August, the Federal-funds rate re mained consistently at or above the 6-percent level, and the rate on bank loans to Govern ment-securities dealers remained close to its May peak. The strength in these rates re flected the heavy demand for Federal funds and securities loans to carry the unusually heavy inventories of Government securities that overhung the market during most of the quarter. Dealers were forced to balance off the prospects of capital gains in the event of falling interest rates against their “negative carry,” represented by the difference between the yield on bills and other security holdings and the day-to-day costs of financing these issues. They could of course have sold se curities to reduce borrowing costs, but this would have put downward pressure on se curity prices and thereby reduced the pros pects of capital appreciation on their remain ing holdings. The course of interest rates in the long term markets differed by the type of bor rower. The yield on seasoned top-quality corporate bonds fell by 34 basis points be tween May and early September, and then recovered about a third of that decline by the middle of October. The average yield on long-term Treasury obligations decreased by 44 basis points between the end of May and the first half of August, and then climbed about half of the way back by early October. The average yield on outstanding municipal bonds declined the most between late May and early August (62 basis points) but also rebounded the most, regaining nearly threequarters of its decline by the first half of September. The rather different behavior of corporatebond yields and tax-exempt yields can be explained in great part by the supply condi tions in the two markets. Public offerings of new corporate bonds in the third quarter OF SAN FRANCISCO ($2.6 billion) were down almost $0.5 billion from the second-quarter figure, while offer ings of municipal bonds ($4.4 billion) were up nearly $0.6 billion. A large share of the municipal securities coming onto the market were industrial-revenue issues, which at yearend will lose their tax-exempt status for new issues larger than $5 million. The third quarter was one of those awk ward moments in time in which develop ments do not unfold in the neat sequence in which they are written into the script. A crucial development was the failure of con sumers to pay heed to the “conventional wis dom” and reduce their expenditures in the face of higher taxes. The absence of the anticipated slowdown in total spending in the third quarter dispelled fears of “fiscal overkill” that might lead to recession, but it also introduced a note of uncertainty about the ultimate effects of the July fiscal package and thereby complicated the formulation of a complementary monetary policy. Monetary policy makers also had a num ber of technical problems to cope with, most ly as a consequence of their support of the Treasury’s efforts to raise $7 billion of new cash in the securities markets. The buildup of dealer inventories of Treasury securities imposed certain constraints upon Federal Reserve actions. If money were to be made easier, borrowing costs would become cheap er and the prospects for capital appreciation would become greater; conversely, if money were to become tighter, dealers would have had to make very large sales of securities and put a great deal of upward pressure on in terest rates. In either event, there was the possibility of the emergence of a disorderly market in Government securties. Then, in addition to all those complications, the Fed eral Reserve had to contend with the Septem ber changeover in the method of bookkeep ing for reserve purposes. Herbert Runyon November 1968 MONTHLY n line with the national pattern, the West ern economy seemed generally healthy at the end of the third quarter. Construction, raw-material production, and agriculture posted good gains, but aerospace manufac turing continued to be rather sluggish. Total employment in District states in creased by 0.5 percent over the second quar ter—more than double the increase in the country as a whole. Nonagricultural employ ment gains were somewhat larger, and agri cultural employment decreases somewhat smaller, than in the nation. (There were some mixed trends— construction jobs rose in the West while declining elsewhere, and the reverse was true in the field of Federal employment.) At the same time, the District unemployment rate edged up slightly to 4.6 percent, while the national rate remained unchanged at 3.6 percent of the civilian labor force. Partial data on retail sales suggest that the West kept up with the fast national pace in this category. Consumers in major Western cities meanwhile saw no let-up in the up ward trend of retail prices, although early autumn brought hints of future relief. Cali fornia’s major metropolitan areas recorded a 4.4 percent annual rate of price increase— somewhat below the overall national increase — while Seattle posted its largest quarterly increase since the Korean War era. Con sumers encountered higher price tags in every major budget category, but the most significant increases this summer were in homeowner costs, particularly mortgage in terest rates. The key industries District aerospace employment continued to weaken during the third quarter, as the industry’s workforce was reduced by 9,000 to a total of 724,000. The bulk of the decline was in California, but losses were also felt in Washington. In contrast, aerospace employ ment generally strengthened elsewhere in the nation. I REVIEW Summer Business Thus far in 1968, District aerospace em ployment has declined by 33,000—wiping out much of the 48,000 gain in 1967— and the present order inflow does not suggest any significant improvement by year-end. The third quarter ended on one high note, how ever, as 26 stewardesses sent 26 champagne bottles hurtling toward the fuselage of the first 747 jumbo jet — the massive plane ca pable of carrying 490 passengers non-stop for 6,000 miles at 625 miles per hour. About 100 of these transports will be built over the next two years, and orders are on hand for more than double that number. Construction activity expanded in the Dis trict during the summer months, and housing activity showed particular strength as the quarter came to a close. Actually, thirdquarter housing starts failed to exceed the second-quarter rate, but the direction of ac tivity was strongly upward after a sluggish early-summer period. Successive strong gains in August and September carried starts to a 330,000 annual rate in the West— about 25 percent above the year-ago figure, in contrast to an 8-per cent year-to-year gain in the rest of the nation. This strength of housing activity was fairly wide-spread throughout the District, and was particularly notable in view of the continued climb in mortgage interest rates to new record highs. (But some easing in bor rowing costs was reported in California as the quarter came to a close.) Other regional construction activity showed some let-up, however, in contrast to fairly sharp gains in the rest of the nation. Com bined awards for the construction of nonresidential buildings and for heavy engineer ing projects dropped about 3 percent below FEDERAL RESERVE BANK OF 218 the previous quarter’s level, but the strength in housing contributed to a gain in District construction employment. Less encouraging, however, was a continued rise in construc tion costs, as both construction wage rates and construction material prices showed sub stantial increases. The basic Industries The Western lumber industry was hard pressed to keep up with the heavy demand for its products emanating from all sections of the country. Mills succeeded in raising production slightly above high second-quar ter levels, but prices nevertheless spiralled upward to new yearly peaks under the pres sure of tight supplies. Prices of Douglas fir, Ponderosa pine, and softwood plywood all rose sharply above year-ago levels. The Western steel industry began to cool its furnaces in July in preparation for a pos sible steel strike, and it cut back production further following the labor settlement at month-end, as customers began to liquidate excess inventories accumulated as a strike hedge. Western steel production neverthe less declined by only 4 percent during the summer quarter, compared with a 25-percent decline in steel production nationwide as a FRANCISCO result of the inven tory run-off. The July 30 agreement between the United S te e lw o rk e rs of America and 11 of the nation’s major steelmakers, includ ing two District pro ducers, called for a 90-cent hourly in crease in wage and fringe benefits over a three-year period. This increase, about 6 percent annually, was similar to re16 cent settlements in 98 the automobile, can, and aluminum indus tries, but it was the largest steel wage boost since 1956’s 7 Vi-percent increase. Aluminum production in the Pacific North west was affected by a strike at the Wenat chee (Washington) reduction plant, which lasted through July. Shipments of ingot and aluminum mill products dropped below their record second-quarter pace, but still re mained above the year-ago figures. Despite the loss of production and the relatively high level of demand, prices reportedly weakened somewhat because of strong import compe tition. The Western copper market was healthy during the third quarter, and relatively free of the wild fluctuations characteristic of the past year or so. Shipments of refined copper to fabricators picked up after the vacation lull, but in September were slightly below the level of shipments reached in April (im mediately after the strike settlement) and a full 20 percent below their pre-strike level of June 1967. As a result of the improvement in U.S. and foreign demand, the spot quota tion on the London Metal Exchange rose from 47 to 50 cents a pound betv/een June and September. S o i s t a e f c r a a c t iv it y expands In District, but at slower pace than elsewhere In nation Millions of Dollars SAN November 1968 MONTHLY Petroleum refining activity c o n tin u e d strong during the- third quarter. In fact, for short periods of time the area’s refineries operated above their rated capacity— a rare occurrence in the West. But to add to the area’s refining capacity, a $ 100-million, 100,000 barrel/day refinery was announced for construction near Bellingham, Washing ton, in a move related to the rich oil strike on Alaska’s North Slope. Also on the draw ing boards are a railroad and a pipeline to tap the new Arctic oil field; these facilities, as well as the Bellingham refinery, should be in operation by late 1971. District farm returns rose about 4 percent above the year-ago level during the third quarter, while cash receipts elsewhere just matched their year-ago performance. Re surgence of crop marketings in California were primarily responsible for the year-toyear advance in District cash receipts, al though the comparison was affected by the REVIEW fact that 1967 was a poor crop year in that state. Crop returns were boosted by large harvests of deciduous fruits, processing to matoes, cotton, rice, and sugar beets; live stock returns meanwhile were boosted by increased prices for beef cattle, milk, and eggs. In particular, sharp increases in acreage and in crop yield led to a whopping 50percent increase in California’s processingtomato crop. On balance, the buoyancy of the regional economy matched that of the national econ omy during the summer and early fall months. Minor weaknesses developed in the key aerospace industry, and potential weak nesses could hie envisioned as the fiscalrestraint medicine worked its way through consumer markets and business activity gen erally, but the overall pattern of healthiness persisted as 1969 approached. Regional staff Summer Borrowing arge Twelfth District banks channeled ^ about three-fourths of their third-quar ter increase in total credit into security pur chases, in large part because they had access to ample funds and were faced with a sea sonal lull in business-loan demand. The 4.7 percent ($2 billion) expansion in total credit over the quarter was somewhat greater than the rate recorded by large banks elsewhere, and was substantially above the District’s performance in the comparable quarter of 1967. The credit expansion occurred against a background of higher average deposits and a shift in member-bank borrowing from the discount window to the Fed-funds market. Required reserves of Twelfth District member banks were $106 million higher than in the second quarter because of sub stantial gains in both net demand and total L time deposits. Excess reserves changed little over the three months, but borrowings from the Federal Reserve Bank fell $60 million to an average of $39 million for the quarter. As a result, net borrowed reserves shifted from the second quarter’s $67-million average to only $3 million during the sum mer period. Throughout the third quarter, large Dis trict banks were heavy net purchasers of Federal funds on interbank transactions—in sharp contrast to their net sales position dur ing the preceding three-month period. (Fedfund “purchasers” are borrowers of unused reserves of other member banks, and “sell ers” are lenders of such reserves.) Net sales of funds to Government securities dealers more than tripled, but did not quite offset net interbank purchases. On total Fed-funds transactions, therefore, District banks shifted FEDERAL from a net sales position of $224 m illio n to a n e t purchase position of $24 million in the summer q u a rte r. Borrowings under c o rp o r a te - re p u r chase agreements re m a in e d at the high level prevailing in the second quar ter. So despite a decline in activity at the discount win dow, District banks increased their total borrowings, and at least some of these funds were used to finance the substan tial expansion of their security port folios. 220 RESERVE BANK SAN F R A N C IS C O W estern banks exceed their '66 business-loan growth, but large banks elsewhere lag behind '66 pace Millions of Dollars 900 i— 800 700 600 500 400 300 200 - Jan. Millions of Dollars 6000 - other as. 5000 - Buying securities L a rg e D is tr ic t 4000 banks added $1.5 billion in securities 3000 to their portfolios d u rin g th e th ird 2000 quarter of 1968— more than double the th ird -q u arter 1000 ’67 increase. In the Government-securi 0 ties category, they invested in the short -|00° ............ end ($730 million Jon. Feb. Mar. in Treasury bills) and also in the long end ($235 million in 5-year-and-over maturities). These banks also added $635 million to their holdings of municipals, with the heav iest concentration being in short-term war rants and bills. Bank interest in municipals was kindled by this summer’s large volume OF Apr. May June July Aug. Sept. of new municipal offerings and by the ex pectation of future price appreciation. (In contrast, banks reduced their holdings in the July-September period a year ago.) The sharp gain in new municipal offerings was sparked by the possible enactment of restric tive legislation relating to bonded indebted November S968 MONTHLY ness. Over the quarter, District-bank hold ings of municipals increased by 10 percent, as against an 8-percent gain nationally; in short-term maturities, the increases were 57 and 26 percent, respectively. Financing securities . „ . and business Loans to finance Government securities dealers accounted for about one-third of the third quarter’s $589-million increase in total loans, while business loans showed only a nominal rise. Furthermore, business demand for bank credit was somewhat weaker in the West than nationally— in sharp contrast to the situation prevailing in the first half of the year. Nevertheless, business borrowing over the September tax date exceeded bor rowings in mid-June. This was a reversal of the normal District pattern (and the pattern elsewhere this year), which shows a heavier concentration of tax borrowing in June than in September. Large District banks witnessed a decline (for the second successive quarter) in credit demand from the durable-goods sector, but m a c h i n e r y and transportation-equipment manufacturers still remained among the heaviest borrowers over the September tax date. Food, liquor and tobacco firms were the single largest borrower-group in this period, coming in with a greater-than-usual demand for bank financing in September, and trade and service firms also registered increased demand for credit during the quarter. According to the Federal Reserve’s quar terly business loan survey, borrowers paid a slightly higher (9-10 basis points) average rate of interest on short-term business loans in mid-summer than in mid-spring, despite the relative slackness of business-loan de mand in the first half of August, the survey period. But some downward adjustment in rates is now a possibility, since Western banks followed the national trend in reducing their prime rate by 14 percent— to 614 REVIEW percent—in late September. Consumer lending helped offset some of the summer sluggishness in business lending, as District banks posted a $ 148-million gain in installment loans during the third quarter — three times the gain in the comparable period of last year. Increased automobile financing and credit-card financing contrib uted to the quarterly rise in consumer debt. Financing mortgages The pace of activity in the Western mort gage market maintained its momentum dur ing the third quarter. This situation reflected a pickup in the flow of funds into District commercial banks and savings-and-loan as sociations, but also reflected a continuing high level of borrower demand in the face of a slight further rise in mortgage interest rates. District banks expanded their real estate loans by $255 million, surpassing their previ ous quarter’s gain, while District S&L’s added about $458 million to their mortgage portfolios, for a moderately smaller gain than in the spring quarter. At the quarter’s end, the volume of S&L commitments for future loans stood at $586 million— an increase of about $70 million from mid-year and the highest level since 1965. The increase in mortgage lending was ac- Bank-credit growth centered in security purchases THIRD QUARTER 1968 Percent Change FEDERAL RESERVE BANK companied by a further rise in the general level of mortgage interest rates to new record highs. However, a slight easing in rates oc curred as the quarter came to a close, and there were scattered reports that some pro spective borrowers were holding off in antici pation of a possible decline in borrowing costs. Saving money The continued expansion in mortgage lending was facilitated by an improved in flow of savings funds into both commercial banks and S&L’s— and by a reduction in the latter’s “liquidity” requirement, as set by the Federal Home Loan Bank. District banks showed a modest gain in their passbook sav ings and a very substantial increase in their “other time” deposits, as total time-andsavings deposits rose by over $1 billion. The S&L’s, too, recorded a larger net inflow of savings — about $297 million, or almost triple that of the spring quarter. The im OF SAN FRANCISCO proved flow of savers’ funds into both the banks and S&L’s apparently reflected the general decline in market rates of interest and an attendant increase in the attractive ness of the yields obtainable on time instru ments. In their savings behavior, Westerners ap parently were less affected than others by the surtax and by the summer spurt in consumer expenditures— at least as far as their bank savings were concerned. Large District banks posted an $81-million increase in passbook savings during the third quarter, in contrast to a $384-million decline at large banks else where. Furthermore, other consumer-type de posits rose by $475 million — a faster rate than nationally. Meanwhile, large District banks posted a relatively stronger increase in large negotiable time certificates, partly because of the absence of a run-off in the District over the September tax date. Ruth Wilson and Verle Johnston SELECTED ITEM S FROM W EEKLY CONDITION REPORT OF LARGE BAN KS IN THE TWELFTH FEDERAL RESERVE DISTRICT (do llar am ounts in m illions) U .S . M IN U S T W E L F TH D IS T R IC T T W E L F TH D IS T R IC T Net Change O utstanding 9/25/68 AS SETS Loans adjusted and investm ents’ Loans adjusted1 C om m ercial and industrial Real estate A gricultural To non-bank financial institutions For purchasing and carrying securities To foreign banks C onsum er instalm ent To foreign governm ents, etc. All other Total securities U. S. G overnm ent securities Obligations of states and political subdivisions O th er securities L IA B IL IT IE S Dem and deposits adjusted Total tim e deposits Savings O th er tim e, I.P.C. States and political subdivisions (N eg. C D ’s $100,000 and over) 222 $46,870 32,803 12,235 10,194 1,352 1,416 1,000 192 4,911 118 1,953 14,067 5,774 7,096 1,197 15,440 29,238 15,639 9,505 2,823 3,615 Net Change T h ird Q uarter 1967 Outstanding Percent 9/25/68 T h ird Q uarter 1968 1967 Percent Percent + 255 2 86 + 344 37 + 148 + 5 32 + 1,522 + 910 + 4.72 + 1.83 + .07 + 2.57 .15 - 5.73 +52.44 -1 6 .1 5 + 3.11 + 4.42 - 1.61 + 12.13 + 18.71 + 3.40 + 2.76 .27 + 2.98 + 1.98 + 2.35 +92.26 - 5.81 + 1.23 - 4.17 + .18 + 4.90 + 13.09 $170,522 118,515 57,190 20,824 667 8,757 8,072 1,186 12,968 978 10,546 52,008 22,841 + 4.52 + 2.60 + .52 + 2.71 .45 - 2.09 +25.46 + .59 + 4.00 .61 + 2.11 + 9.18 + 10.80 + 4.25 + 1.08 .69 + 2.80 - 2.53 - 1.39 + 12.83 + 1.76 + .37 + 6.41 + 3.31 + 7.64 + 11.80 + - + 10.14 - 3.31 .72 + 2.96 26,126 3,040 + 8.34 + 4.65 + 4.91 .46 + + + + + + 4.13 + 1.06 + 1.95 + 7.60 -1 3 .8 4 - 3.87 61,064 79,414 32,715 33,934 7,938 18,645 + + + + + + + + + + T h ird Q uarter 1968 Percent Dollars +2,111 + 589 653 41 + 392 + 1,089 + 81 + 977 68 + 581 2.60 3.87 .52 11.46 2.35 19.15 2.89 4.90 1.16 9.86 10.43 14.83 1 E xclusive of loans to dom estic commercial banks and a fte r deduction of valuations reserves; in d iv id u al loan item s are shown gross. N O T E : Q uarterly changes are computed from Ju n e 26, 1968 — Sept. 25, 1968 and from June 28, 1967 — Sept. 27, 1967. D a ta are not seasonally adjusted. 1.08 3.50 .96 6.19 4.24 5.41
@FedFRASER