Full text of Economic Review (Federal Reserve Bank of San Francisco) : November 1972

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FEDERAL
RESERVE
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Monthly Review

In this issue
Competitive Outlook in Banking
Rapid Expansion (U.S.)
Rapid Expansion (West)
Faster Loan Pace

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November 1972

Com petitive @yfl@©k In lin k in g
. .. The President of the Federal Reserve Bank of San Francisco
outlines the profound changes at work in our financial system.

Rapid iH[p€imgi@Gi CU.SJ
.. . Business activity continued expansive this summer and fall,
although lagging behind the overly rapid second-quarter pace.

Rapid Expansion CWestl
.. . The Western economy this fall boasted a farm boom, a housing
boom, and thicker order books for aerospace producers.

Faster l © m Poe©
.. . Western banks experienced heavier credit demands in an atmo­
sphere of rising money rates and increasing reserve pressure.




Sdlf@rs W illie ™ lurk©

MONTHLY

November 1972

REVIEW

Competitive Outlook in Banking
By John J. Balles, President
Federal Reserve Bank of San Francisco

Remarks at the Annual Intermountain Banking Seminar,
Utah State University, Logan, Utah, November 9, 1972.

he management of the American Bank­
ers Association undertook an opinion
survey at its recent Dallas convention to
ascertain what business problems are upper­
most in the minds of bankers. President
Eugene H. Adams reports that the most
often-mentioned problem was the competi­
tive climate facing the banking industry.
More specifically, bankers are concerned
about the structure of the banking industry,
competition between large and small banks,
competition between banks and thrift insti­
tutions, and the implications of the Hunt
Commission’s recommendations.
Your program committee obviously is at­
tuned to these problems, since they have
designated the competitive outlook for bank­
ing a major subject for this seminar. They
may not have been so wise in inviting me to
handle the subject, since this is a tall order,
and I don’t pretend to have all of the an­
swers. Nevertheless, I welcome the opportu­
nity to share my thoughts on this most im­
portant topic with you. Hopefully, this will
stimulate further discussion and considera­
tion on your part.
Profound forces for change are at work in

T




our financial system. Today I would like to
review with you the nature and implications
of some of the key developments that are
bound to alter existing competitive relation­
ships within banking, and between commer­
cial banks and their principal nonbank com­
petitors :
. . . The vital thrust within the commercial
banking system itself for innovation;
. . . The drive by other financial institu­
tions increasingly to share the func­
tions and m arkets of comm ercial
banks;
. . . The technological revolution occurring
in the payments system;
. . . The emerging change in social values
which is likely to impact on financial
institutions.
Taken individually, the existence of these
trends is not unknown to any of us. But as
I began to think about the interrelations and
the combined impact of them on the competi­
tive outlook for banking, it seemed to me
that many of us have underestimated the
degree of synergism at work. Hence my be­
lief that they constitute a profound change
when viewed as a package.

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Thrust for Banking Innovation
First, as to the vigorous thrust toward
greater innovation within the commercial
banking industry itself, several leading exam­
ples are worth reviewing.
New Financial Instruments — Nondeposit
Funds. One innovation represents a response
to movements in general credit conditions in
the economy. A case in point is the develop­
ment of new or modified financial instru­
ments during the past decade; witness the
massive recourse taken by commercial banks
in the nation to nondeposit funds in 1969
and early in 1970. This was a result of the
impact of intensive borrowing demands in a
situation in which bank access to deposit
funds was limited by Regulation Q. Thus,
in spite of a net loss of $4 billion in deposits
in 1969, banks were able to extend credit by
about $16 billion— $12 billion through loans
and investments on their own books and $4
billion through sales of loans to affiliates. This
was made possible largely by tapping some
$20 billion in funds from non-deposit sources,
including Eurodollars and sales of commer­
cial paper by bank affiliates. At present, in­
creasing use is being made by bank holding
companies of notes and debentures as a
source of funds.
The Growth of Bank Holding Companies.
A second type of innovation centers on the
proliferation of bank affiliates through the
creation and active use of bank holding com­
panies. Part of this movement was generated
by the search for ways of cushioning the im­
pact of tight money, to which allusion was
just made; part, by the search for ways to
escape the geographic limitations on branch­
ing imposed by some states; and part, by the
search for new and profitable ways to offer
services to the public that commercial banks
are not permitted to provide directly.

4

The number of bank holding companies is
likely to grow, particularly in states where
sharp restraints exist over branching. The




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reason for this stems from economic advan­
tages of the holding company form of organ­
ization, as demonstrated by its success in
those states where it has had an extended
period of operation, and from the greater
range of services, closely related to banking,
that holding companies can offer. The inevi­
table result will be to bring about a signifi­
cant change in banking structure and com­
petition.
Colorado furnishes a good illustration. At
the end of last year, the seven multiple-bank
holding companies operating in that state
held 47 banks with $2,727 million in de­
posits, representing some 54 percent of all
Colorado bank deposits. This was up from
roughly 23 percent five years before and
from less than 7 percent at the end of 1962.
Altogether, there were 5 8 holding companies
headquartered in Colorado on December 31,
1971. Already, in that state, overtures have
been made for mergers of holding companies
to gain even further advantages. Moreover,
I understand that two requests have been
placed before the Colorado Bankers Associa­
tion seeking broad banking legislation, and
increasing numbers of bankers are becoming
restive for change in the existing geographical
restraint.
Other New Services. Commercial banks
have also pioneered in the widespread pro­
vision of new services both to business, in
the form of corporate cash management ser­
vices and other matters, and to consumers.
A prime example of the latter is bank credit
cards. Contrary to some beliefs, credit cards
are not in the direct line of evolution toward
a paper-less financial system; indeed, they
generate even more paper than before in the
provision of payments convenience to the
public. In so doing, however, they helped
precipitate the introduction of technology
that will be giving a further boost to bank
competition.
Expanding International Business. Finally
we should note the vast expansion in inter­

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MONTHLY

national services and overseas banking activ­
ity of some of the nation’s leading banks.
Induced largely by a desire to follow their
customers abroad in an era of development
of major multinational companies, this trend
not only has been profitable but also has
given a com petitive edge to those banks
which have engaged in expanded interna­
tional activity.
The Drive by Nonbank Institutions—
Implications of the Hunt Commission
Late last year, the President’s Commission
on Financial Structure and Regulation issued
its report and recommendations. This group,
more commonly known as the Hunt Commis­
sion, proposed sweeping changes in the pow­
ers, functions, and regulation of banks and
competing financial institutions. To a consid­
erable extent, the recommendations are said
to be aimed at providing more competition
among the nation’s financial institutions, and
less regulation of them, to the extent con­
sistent with safety; and at providing equal
ground rules for various classes of competi­
tors. One of the major proposals is to offer
commercial bank-type powers to thrift insti­
tutions (mutual savings banks, savings and
loan associations, and credit unions) if they
also assume approximately the same regula­
tory and tax burdens as commercial banks.
Thus far, the banking industry has not
taken a position on the Hunt Commission
recommendations, probably because the in­
dustry faces a dilemma regarding them. If
adopted pretty much in toto (which appears
highly unlikely), the recommendations would
entail major changes in competitive relation­
ships affecting banks. On the other hand, if
adopted only in part through piecemeal leg­
islation at the Federal or state level (which
appears more likely), the results may be even
more profound for commercial banking. Why
do I say this? Because the ability of the here­
tofore specialized thrift institutions to com­
pete against banks would likely be increased



REVIEW

if their lending and fund-raising powers were
broadened and made more comparable to
those of commercial banks but if their tax
burdens, reserve requirements and regulatory
structure were not.
Suppose, for example, that savings and
loan associations in various states succeeded
in getting consumer loan powers and the
authority to offer checking accounts to indi­
viduals and non-business entities. Also sup
pose that they were not required to maintain
the same reserves against checking accounts
as member banks must do, but at the same
time were permitted to continue benefitting
from preferential Federal tax treatment. In
that case, their ability to provide services at
advantageous rates vis-a-vis comm ercial
banks would be increased, since the ability of
any intermediary to compete for deposits re­
flects the return it can earn on its assets.
Hence, to the extent that differing reserve
requirements, regulatory limitations, and tax
burdens influence asset mix and earnings,
the ability of the various types of institution
to compete for deposits will also vary.
Thus, if thrift institutions are to be pro­
vided with broader lending, investment, and
deposit powers (including checking accounts)
that are more akin to those enjoyed by com­
mercial banks, it will be vital, in the interest
of competitive equality, that they assume in
commensurate degree the same burdens as
commercial banks — i.e., reserve require­
ments, ceilings (if any) on interest rates pay­
able on deposits, regulatory constraints, and
tax treatment.
Changes Now Taking P la c e Thrift Institutions
But while the debate on the Hunt Com­
mission report goes on, a number of changes
in the powers and functions of thrift institu­
tions are even now taking place, and it is
to these that I wish to call your attention.
Regulatory Actions of the FHLBB. The
first development which I would like to em­

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phasize involves the numerous regulatory
changes implemented over the last year or so
by the Federal Home Loan Bank Board,
which were designed to strengthen the posi­
tion of savings and loan associations.
1. Broadened Lending Authority. These
changes not only em brace substantially
broadened lending powers in the field of real
estate financing, but also permit savings and
loan associations to make loans for major
home appliances and built-in equipment (up
to 5 percent of assets, as authorized by the
HUD Act of 1968). Included in the latter
group are loans for the financing of wall-towall carpeting, central air conditioning, food
freezers, lawn sprinkler systems, water sys­
tems, and installed workshop equipment—
items that comprise a large portion of con­
sumer-durables financing.
2. Third-Party Payments. Still other regu­
lations, adopted in 1971, authorize savings
and loan associations to make non-negotiable
transfers from savings accounts to third-party
payees for a wide range of transactions more
or less related to housing and home occu­
pancy. They cannot, however, arrange such
payments for food, clothing and automobiles.
(Similarly, although not subject to the
FHLBB regulations, mutual savings banks
and credit unions in a number of states are
now offering, or are seeking to obtain author­
ity to offer, a wide range of third-party
payments services— including checking ac­
counts. )
3. Capital Structures. Through yet an­
other regulatory action the Federal Home
Loan Bank Board has proposed approval for
savings and loan associations to issue subor­
dinated debentures, and has lifted the mora­
torium on conversions from mutual to stock
associations, in order to provide increased
flexibility in the raising of funds.
4. B ra n c h in g R e g u la tio n s. F in a lly ,
branching regulations have been adopted
that will give savings and loan associations
a number of new possibilities to serve the



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public. These are worth reviewing in greater
detail in view of the competitive implications
for commercial banks.
Limited Facilities and Satellite Offices. The
new regulations will permit the establishment
by savings and loan associations of so-called
“limited facilities” and “satellite” (or “mini”)
offices. A “limited facility” is subject to the
branching regulations, but differs from a
branch by having specific restrictions placed
upon it as to personnel, physical size, capital
investment, a n d /o r functions perm itted.
However, the only practical such constraint
is simply “what the market will bear,” ac­
cording to Federal Home Loan Bank Board
Director Thomas Clarke. Such facilities are
envisioned as a particularly powerful vehicle
for penetrating low-density rural areas.
“Satellite” offices, on the other hand, are
provisionally approved entities that offer full
service within restraints of other sorts. For
instance, they must be located within five
miles of an existing S&L office, and are lim­
ited in number. No more than five satellites
can be established in total, and also no more
than two can be installed in any one year.
One type of “satellite,” the “counter in a
store,” will be confined to retail establish­
ments and may not occupy more than 500
square feet, with a maximum of four teller
stations. At these offices, customers may
deposit their paychecks, make mortgage pay­
ments, or obtain cash — right in the store
where they have come to shop.
The second type of “satellite” is the “fully
automated” facility, an electronic device op­
erated by a special card given to customers.
These machines may be located in a wide
range of places such as in retail stores, shop­
ping center malls, office buildings, or trans­
portation depots. Open 24 hours a day, 7
days a week, 365 days a year, such facilities
will receive deposits and accommodate cash
withdrawals.
The characteristic shared by each of these
three new types of offices is that they will

November 1972

MONTHLY

enable an S&L to pinpoint and accommodate
small, local markets in both rural and urban
areas at a fraction of the cost involved in the
establishment of a full-scale branch. As Fed­
eral Home Loan Bank Board D irector
Thomas Clarke has claimed, “An S&L can
now be just as convenient— even more con­
venient—than a commercial bank, and so
there is no longer any reason to settle for
commercial bank passbook savings rates.”
The key to the great promise of the auto­
mated facility in particular is its “kinship
with the new breed of electronic and data
processing technology which will transform
financial transactions in this country . . . to
an electronic funds transfer system.” “Such
a system,” he notes, “is absolutely inevita­
ble.” Consequently, the FHLBB is urging
the savings and loan industry to “begin lay­
ing the groundwork for conversion to an
electronic funds transfer system at the oppor­
tune moment. This means developing pres­
ent third-party payment authority to its full
capacity.”
Let me now turn to the subject of com­
puter technology and the payments system,
as it affects the competitive outlook for bank­
ing.
The Impact of Computer Technology
Until the advent of the computer, the
banking business was little affected by tech­
nological change, but these changes are now
occurring with the prospective impact “on
the figurative order of a megaton bomb,” to
use the words of Governor George W. Mitch­
ell of the Federal Reserve Board. The tech­
nology for a completely integrated and auto­
matic payments system is known, is being
developed, and is becoming operational. Ob­
viously, this has major implications in the
competitive outlook for banking.
First Steps: Regulation J and RCPC’s.
This month, for example, with the imple­
mentation of the revisions in Federal Re­
serve Regulations D and J, you will feel the



REVIEW

effects of one step of the sweeping changes
which are to take place. As you know, the
new Regulation J has the twin objectives of
helping to expedite and rationalize the checkcollection process while at the same time
reducing Federal Reserve Float. The simul­
taneous lowering of reserve requirements
under the new Regulation D is intended to
minimize the transitional impact on member
banks.
Another significant development in Fed­
eral Reserve activities affecting the payments
mechanism over the past year has been in
the area of Regional Check Processing Cen­
ters. Each Federal Reserve Bank has either
proposed, planned, or implemented one or
more “RCPC’s” in its District. At the Fed­
eral Reserve Bank of San Francisco, we ex­
pect to have RCPC’s operational at each of
our five offices by early 1973.
As you know, the basic function of an
RCPC is to provide the m anpower and
equipment, geared to later deposit deadlines,
at locations where large concentrations of
check volumes can be expeditiously pro­
cessed and collected. Our goal is to furnish
the earliest practical availability of funds to
our depositors and ultimately to the public.
Furthermore the Federal Reserve System is
beginning to look ahead to the next steps in
improving the payments mechanism.
SCOPE. Ancillary changes in the pay­
ments system, which are in the early process
of development or in the implementation
stage, include the much-publicized SCOPE
project in California, initially conceived and
promoted by ten major banks in the state.
The system provides for pre-authorized
paperless entries to effect payments in lieu
of checks. The nerve center of this project
lies in two automated clearing houses, locat­
ed in the San Francisco and Los Angeles
offices of the Federal Reserve Bank of San
Francisco. For the bank customer, the sys­
tem involves both credit entries to his check­
ing account in the form of payroll depositing,

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and debit entries in the form of regularly re­
curring payments of such items as utility
bills, mortgage loans, and insurance. Now
in the process of being implemented by some
145 banks which account for 90 percent of
the banking business in California, SCOPEtype projects are under active consideration
by banks in some 20 or more other areas in
the nation. Significantly, the possibility of
participation in such programs by depart­
ments and agencies of the Federal Govern­
ment is being carefully studied.
The Atlanta Project. Other significant de­
velopments in the electronic funds transfer
area include the Atlanta payments project,
which, in addition to the automatic deposit
of payrolls and a pre-authorized, paperless
system for paying bills, has proposed to offer
“bill-checks.” These bill-checks will use
machine-processable documents on which
the payor endorses a bill and stipulates the
amount and date on which his bank is to
debit his account and effect payment to the
creditor or the vendor-payee.
Computer Terminals in Retail Stores. Go­
ing beyond these projects is the point-of-sale
computer terminal in retail stores, activated
by a consumer’s card, and providing a direct
hookup with a bank’s computer and authori­
zation terminals. Indeed, as envisioned by a
number of observers, what these arrange­
ments eventually will entail is a system of
computerized telecom m unications linking
home and business with the market, includ­
ing vendors and those institutions which ad­
minister the payments mechanism. These in­
stitutions — commercial banks and possibly
other financial and non-financial institutions
—will be grouped into a series of local sys­
tems, with access to a central data bank con­
taining a variety of information on customers.
The local systems will be linked into regional
centers which in turn will be linked to an
integrated national system of computerized
telecommunications.




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Implications for Banks of
Electronic Payments System
In assessing the implications of an elec­
tronic payments system for the competitive
outlook in banking, the first and basic con­
sideration to you as bankers must be the
great opportunity it will afford for expanding
the scope and variety of your services. There
is little doubt that banks (or their competi­
tors) will be in a position to accommodate a
very wide range of bill-paying and account­
keeping functions of consumers, businesses,
and governments alike.
Larger Banks and Fewer Banking Offices.
At the same time, the era of less-checks and
instant communications between businesses,
consumers, vendors and bank computers is
likely to witness at least some tendency to­
wards the concentration of business in large
or regional banks. The reason is that such
banks will be able to serve customers that
are not in close geographical proximity to
them, and hence will offer more competition
to small local banks.
Consequently, the development of an elec­
tronic payments system may be a force work­
ing toward a decline in the number of small
banks and of branch offices. An electronic
transfer system reduces the need for the bank
customer to visit his bank office, either in the
capacity of a depositor or borrower. If the
customer can bank through his telephone and
have his bills paid and funds deposited auto­
matically, proximity to a bank office per se
will become less relevant. By the same token,
an electronic payments system is certain to
break down geographical barriers, and in the
process render obsolete many existing legal
barriers to competition such as branch re­
striction and home-office protection laws.
Changing Role for Correspondent Banks.
What, then, of the correspondent banker?
Clearly, a very important function of the cor­
respondent today— clearing checks and other
cash items—will greatly diminish in impor­

November 1972

MONTHLY

tance. Yet, the new and varied services that
are likely to develop in connection with an
electronic payments system could result in
new correspondent ties in the way of special­
ized services. Consequently, one key to the
survival of the small bank may depend upon
its ability—perhaps through pooled facilities
and leasing arrangements—to work out with
its city correspondent the means of partici­
pating in the new services and markets of­
fered by an electronic system, without inde­
pendently having to undertake the costly
investment involved in the necessary hard­
ware and personnel.
Competition from Non-Banks. The elec­
tronic funds transfer system is also likely to
impinge upon commercial banks as competi­
tive nonbank financial institutions enter the
third-party-payment field and utilize the latest
technological developments in the process.
It is the view of some observers that nonbank
firms increasingly will attempt to move into
the payments system, which has long been
the nearly exclusive domain of commercial
banks. These potential entrants include not
only savings and loan associations and mu­
tual savings banks but also data processing
firms, specialized service bureaus, large re­
tail firms, and possibly some elements in the
communications industry itself. Not over­
looking the advantages of modern technology
in their own operations, they will deny to the
banking industry the luxury of doing business
just the way it was done before.
Changing Social Values
Finally, there is another fundamental force
for change which is increasingly evident in
our body politic and which has an important
bearing on the competitive outlook for bank­
ing. I caution you against underestimating
the potential impact of it. For better or
worse, some groups in society are raising
questions as to the appropriate balance be­
tween social ends and means. More specif­
ically, questions are being raised regarding



REVIEW

the consistency of traditional economic goals
— high and rising levels of income, output
and consumption — and considerations re­
garding environmental and ecological bal­
ance.

Effect on F in a n cia l Institutions. This
growing concern has important implications
for the nation’s financial institutions as well
as for economic policy. As examples I would
cite the growing support for construction
moratoria in some areas, and the increasing
antagonism towards development.
This is, of course, a matter of concern both
to financial institutions and to policymakers
simply because economic growth — which
means more jobs and more income— is re­
lated to the pattern of real-resource alloca­
tion, which is affected by the pattern of finan­
cial flows. The latter, in turn, is influenced
by the structure of financial institutions and
the rules under which they operate.
The outcome of the growing debate is not
certain. However, it would appear that, part­
ly under the impact of the environmental
movements, a stabilization— and even de­
cline— in homebuilding and other forms of
construction already is occurring in some
areas. If environmental concerns become

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more pervasive, then types of activity which
involve a heavy throughput of materials
(such as construction) will be viewed with
progressively less favor. If so, this clearly
has implications for the likely course of ac­
tion by heretofore specialized thrift institu­
tions which have been primarily engaged in
financing these types of activity. More spe­
cifically, pressures on their part for diversifi­
cation into other fields— including several
fields dominated by or reserved to commer­
cial banks— can be expected to increase.
Need for Flexibility. It is partly for this
reason— the fact that the social priorities of
the future may well differ from those of to­
day— that the increased flexibility in opera­
tions envisioned for banks and their nonbank
competitors by the Hunt Commission would
appear to some observers to have consider­
able merit. In their view, such a system
would be preferable to the present one, which
induces thrift institutions to specialize in
real estate lending and which offers less free­
dom of action to commercial banks. In any
event, it is clear that maintenance of the
status quo is not one of the options open to
commercial banks.
Summary and Conclusion
With these remarks, I have attempted to
identify the nature and the implications of
some of the major forces in the competitive
outlook for banking. Stemming from inno­
vations within the banking industry itself,
from the drive by thrift institutions for banktype powers, from the technological revolu­

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tion in the payments system, and from chang­
ing values in our society, these forces for
change are certain to exert an increasingly
powerful influence upon the competitive en­
vironment in which you, as banks, are going
to live.
More specifically, the changes now in the
air suggest an increasing reliance by banks
on non-deposit sources of funds; a growing
importance of bank holding companies, both
in banking and in “closely-related” fields; a
continued proliferation of new and imagina­
tive services by banks to business, consumers,
and governmental bodies; a further growth
in importance of international banking; a ma­
jor drive by thrift institutions (mutual savings
banks, savings and loan associations, and
credit unions) in directions that have the po­
tential of sharing increasingly in the functions
and markets of commercial banks; a major
revolution in the payments mechanism of the
country and in the role of banks in that mech­
anism, with an inevitable impact on the func­
tions of correspondent banks; and changing
social values which may have an important
effect on banks and other financial institu­
tions. I urge that you be prepared to cope
with these changes when they come.
A famous economist and former banker,
the late Joseph Schumpeter, once described
the capitalist system as one characterized by
“a perennial gale of creative destruction.”
The assessment may seem a little severe to
those seeking solace, but certainly changes
are in the air, and most assuredly, they are
not just of a seasonal nature.

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November 1972

REVIEW

Rapid Expansion (U.S.)
usiness activity continued expansive in
the summer and early fall months, al­
though the pace was not up to the unsustainably rapid pace of the second quarter, which
was just about the fastest growing period of
the last 13 years. During the July-September
period, GNP rose to a $1,164 billion annual
rate on the strength of a 6.3-percent increase
in the real rate of growth and a quite mod­
erate 2.4-percent rate of inflation.
Most sectors of the economy contributed
to the rapid third-quarter advance, with
strength being most apparent in housing,
autos and other consumer durables. Business
spending for new equipment rose rapidly,
and business inventory expansion continued
at a somewhat accelerated pace. On the other
hand, the year-long recovery in defense
spending received a temporary check during
this period. Meanwhile, purchasing agents
reported a higher level of confidence in future
business prospects than they had at any other
time in the ten years of this survey.
Industrial production rose at a 5-percent
rate— a somewhat slower pace than in earlier
quarters of this year. Output gains were mea­
ger in the early-summer period because of
East Coast floods, but production strength­
ened in late summer. Gains were widespread
in such areas as steel, business equipment,
and defense equipment, but auto assemblies
were below the early-spring peak. Future
strength in output seems assured, since new
orders for durable goods (except defense
equipment) have increased at a 26-percent
rate— double the year-ago pace— to date in
1972.

B




The farm boom has contributed substan­
tially to the nationwide air of prosperity.
Gross farm income in the third quarter was
10 percent higher than a year ago, and net
income per farm (in real terms) was 6 per­
cent higher. These gains reflected the upsurge
in grain sales to the drought-stricken U.S.S.R.
and the rise in meat sales to the increasingly
prosperous U.S.A. The farm boom has sup­
ported other sectors as well; for instance, unit
sales of farm tractors have jumped 31 per­
cent over the past year.
Equipment buying spree
Business firms continued on a buying spree
for new equipment, as spending rose to a
$79.0-billion annual rate in the July-September period. But spending on business struc­
tures eased to $41.8 billion; in real terms, the
Farm b@@m contributes to
nationwide air of prosperity
Billions of Dollars

Dollars

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investment in bricks and mortar was no
higher than a year ago and was below the
1969 peak. This discrepancy reflects in part
the availability of the investment tax credit
for equipment but not for business structures.
The latest Commerce Department survey
of plant-equipment spending plans (mostly
taken in September) indicates a 9.6-percent
rate of increase in the current half-year, on
top of a 12.2-percent annual rate of gain in
the January-June period. Manufacturing in­
vestment, which had actually declined for
several years, began to recover in early 1972,
and is now expected to jump 17.8 percent
(annual rate) in the current half-year, with
heavy spending by nonferrous metals, non­
electrical machinery, petroleum and food
manufacturers. Outside manufacturing, a
modest pace of expansion is anticipated on
the heels of very heavy spending during the
first half by electrical utilities and transporta­
tion and communications firms.
Increased expenditures by industrial firms
are indicated by the rising number of firms
reporting inadequate facilities and by the ris­
ing dollar volume (up one-third in one year)
of new starts on manufacturers’ investment
projects. The data also show a strong rise
in the carryover of expenditures on projects
started previously, especially in the utilities
field.
New orders for capital goods, which gen­
erally lead capital-goods spending by some
months, have been in a strong uptrend for
the past year. Considerable manufacturing
capacity is still unused, with the utilization
ratio at about 83 percent in the third quarter,
but the continuing rise in real output should
create pressure on resources and bring about
further new investment. As for financing,
corporate cash flow could rise 20 percent this
year over 1971 ’s $78.2-billion figure (net of
dividends), on the basis of a rapid rise of
profits and an expansion of depreciation al­
lowances. As in past business recoveries, this
rise in cash flow should provide a solid under­




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pinning to the ongoing investment upsurge.
Business inventories meanwhile increased
strongly in the third quarter, at an $ 8.0billion annual rate. But with stock-sales ra­
tios at relatively low levels, the accumulation
rate should rise as final sales expand during
the current quarter, thereby adding to GNP
growth.
The increase in factory inventories has not
been evenly distributed among stocks at all
stages of fabrication. Inventories of materials
and supplies actually have trended down over
the past year, while finished-goods stocks
have been increasing. The unwillingness to
add inventories at the initial stage of produc­
tion underscores the caution (or cost con­
sciousness) still evident among many manu­
facturers.
Government: mixed trends
In the government sector of GNP, defense
spending fell significantly to a $75.1-billion
rate in the July-September period, represent­
ing a continuing decline in the number of
men in uniform and a fall-off from the heavy
bunching of purchases in the January-June
period. Spending on goods and services by
Federal non-defense agencies reached a
$30.2-billion rate, and state-and-local gov­
ernment spending reached $150.4 billion,
both increases being in line with their usual
uptrends.
State and local governments are enjoying
a respite from their prolonged financial
squeeze, because of growing federal grants,
rising revenues from the economic recovery,
and a significant slowdown in wage increases.
Spending in this area should now rise further
in response to the bounty of revenue sharing.
Some 39,000 localities will receive an initial
$2.6-billion pay-out in early December, and
will then receive an equal sum a month or
two later, representing retroactive payments
covering the two halves of calendar year
1972. For the most part, the recipients will
use these funds for tax relief (mainly to

November 1972

MONTHLY

property owners), for salary increases, and
for capital improvements.
Congress recently passed a $74.4-billion
defense appropriation bill for fiscal 1973—
the highest total since World War II. The
final figure was still $5.2 billion below the
Defense Department’s request, because of
Congressional cuts for manpower, research
and certain weapons systems. However, the
Administration won most of its requested
funds for big-ticket procurement items, such
as the B1 bomber, the Trident missile sub­
marine, and a new nuclear-powered aircraft
carrier. Early planning for fiscal 1974 sug­
gests further spending increases, but with
partial offsets through the closing of unneed­
ed military bases and the reduction of sup­
port troops.
A u fo buying spree
In the consumer sector, durable-goods
spending rose sharply to a $ 118.6-billion rate
in the third quarter; expenditures for services
($308.0 billion) were also strong, but spend­
ing for consumer nondurables ($302.0 bil­
lion) was up only modestly. Auto sales domi­
nated the news, but furniture and appliance

sales also expanded rapidly during recent
months in line with the continued high rate
of new housing completions. Backing up
this spending spree was a rise in consumer
confidence— evident in surveys of consumer
attitudes and spending intentions— as a con­
sequence of the slowdown in the inflation



REVIEW

Housing and furniture
sales continue to expand
B i l li o n s o f D o l l a r s

M illio n s

rate and the pickup of jobs and incomes over
the past year.
Auto sales were helped by the smooth
transition from the hot-selling 1972 models
to the equally attractive ’73s, as sales rose
about 10 percent in the third quarter. The
continuing boom was fueled by liberal credit
terms, with some easing of downpayment re­
quirements on auto loans.
The auto boom got underway about a year
ago, with the introduction of new ’72 models
sold at frozen prices along with expectations
of elimination of the auto excise tax. Thus,
in the ’72-model year, sales of domestic
models jumped 20 percent — and perhaps
would have increased more but for some endyear shortages — while import sales fell off
slightly. Altogether, Detroit sold 9.2 million
’72-model cars, and in addition reported very
heavy sales of 2.5 million trucks. The ’73
models got off to a good start, partly reflect­
ing the Price Commission’s refusal (at least
initially) of a price-boost request from the
big automakers.

FEDERAL

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Residential construction continued to rise
in the third quarter at a $54.4-billion rate,
which is about 75 percent above the reces­
sion low of two years ago. Housing starts,
at a 2.28-million rate, remained on the high
plateau maintained throughout most of the
past year, and in addition, mobile-home ship­
ments held at about a 600,000-unit rate this
summer.
The housing boom continued to receive
help from an exceptionally heavy inflow of
funds into thrift institutions. During the first
half, this inflow supported a very strong ex­
pansion in mortgage commitments, and this
has practically guaranteed the availability of
funds for the immediate future. Even so,
rising inventories of unsold single-family
homes and a decelerated growth of multi­
unit construction have been marked in recent
months, suggesting some weakening of the
basic demand factors involved in the boom.

14

Income and jobs
Personal income flows accelerated during
the third quarter, reflecting continued in­
creases in employment and hours. Takehome pay advanced at an even faster pace
as tax deductions rose only modestly, but
only a relatively small share of this income
increase went into savings, most being allo­
cated instead to consumer spending. The
personal-saving rate amounted to 6.4 percent
of disposable income for the second consecu­
tive quarter, marking a return to the saving
pattern of the 1960s and a shift away from
the very high rate of 1970-71.
Expanded consumer spending plus exces­
sive tax withholdings recently have cut sharp­
ly into the savings rate, but the rate should
rise during the present quarter to the extent
that the substantial increase in social-security
payments is (at least temporarily) held out
of the stream of consumption spending. This
jump in social-security benefits and early
1973’s refund of overwithheld taxes, each
amounting to about $8 billion at an annual




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rate, should raise the level of savings and
also give an added fillip to the consumer
spending boom.
The expansion has continued to generate
new jobs, although not quite so rapidly as
earlier in the year, with nonfarm employment
rising from 72.5 million to 73.0 million dur­
ing the third quarter. (To date this year, non­
farm employment has increased at a 3.8-per­
cent annual rate, or triple the 1971 pace.)
The unemployment rate meanwhile has con­
tinued on its slow downward track, falling
slightly to 5.5 percent during the third quar­
ter. The rate has now dropped slightly in
each of the last four quarters.
Job market strength
The 2.4-million growth in civilian employ­
ment over the past year represents a larger
relative rise than during any previous eco­
nomic recovery of the post-war period. The
growing strength of the labor market is also
seen in the sharp year-long decline in the
layoff rate in manufacturing, as well as the
substantial rise in factory new-hires. The
factory workweek, although roughly stable
since last spring, is about one hour higher
than a year ago, at 40.7 hours in September.
Labor market analysts are now looking
with some caution at the 1973 calendar, in
view of the scheduled sharp increase in major
labor-contract negotiations. Overall, these
contracts will affect over 4.1 million workers
— more than twice the 1972 figure— in such
major industries as autos, trucking, construc­
tion and electrical equipment.
Yet, with the recent subsidence of inflation
pressures, rank-and-file demands for outsized wage settlements may diminish next
year, especially in view of the growing use
of wage-escalator clauses in labor contracts.
Moreover, even in the face of a decelerating
trend in compensation per man-hour, the
prolonged downtrend in real earnings has
been reversed over the past year. Average
weekly earnings in manufacturing (adjusted

November 1972

MONTHLY

Inflation p®e@ decelerates, but
wholesale price trends worrisome
A n n u a l C h a n g e (Percent)

for rising prices) increased by 6 percent be­
tween September and September.
Prices: the food impact
The news was generally good on the price
front — at least according to the broadest
measure of prices, the implicit GNP deflator.
This index rose at a 2.4-percent annual rate
in the third quarter, roughly in line with the
previous quarter’s experience and less than
one-half the rate of advance of the 1969-71
period.
On the other hand, consumer prices accel­
erated during the third quarter on the heels
of an upsurge in food prices. Thus, to date
in Phase II, the CPI’s 3.5-percent rate of
increase has approached the 3.8-percent rate
of the pre-freeze period of 1971. (During
Phase II, food prices have risen at a 4.9percent rate and other commodity prices at
a 3.0 percent rate, roughly in line with the
pre-freeze trend, but price increases for
services have decelerated significantly to a
3.5-percent rate.) Wholesale prices also
accelerated in the third quarter because of



REVIEW

the rocketing price of food. Consequently,
the wholesale price index has increased at a
5.2-percent rate over the Phase II period,
matching the increase in the pre-freeze period
of 1971.
The food problem has centered in the two
categories of meat-poultry-fish and fruits and
vegetables. Over the past year, retail prices
in these two categories have increased by
9.9 percent and 7.8 percent, respectively.
Some easing of beef prices, perhaps tempo­
rary, may now occur because of the 10-percent year-to-year increase in the number of
cattle on feed, largely attracted out of pastureland by the highest prices of the last two
decades or pushed out of pasture by drought
in the Southwest grazing areas. But now a
sharp rise in flour prices has occurred as a
by-product of the mammoth grain sales to
the U.S.S.R., and has threatened to end the
past year’s stability in retail prices of cereal
and bakery products. Just between July and
September, the farm price of wheat jumped
by about 30 percent.
Prices: controls and trends
Meanwhile, with wholesale lumber prices
running about 13.2 percent above a year ago,
the Cost of Living Council moved this sum­
mer to extend its reporting requirements to
lumber firms with sales over $5 million annu­
ally. With the revocation of an earlier smallbusiness exemption, the Council extended the
controlled section of the industry from 10 to
30 percent. Auto prices also got into the
news as the Price Commission turned down
price-boost requests from General Motors
and Ford— designed to cover the cost of
mandated safety and emission eq u ip m en ton grounds of possible violation of profitmargin limitations. (But the automakers then
returned to the Commission with new price
proposals in November.) Despite the re­
jection of the initial request, however, retail
new-car prices this September averaged 3.8
percent higher than a year ago, reflecting the

FEDERAL

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strength of the auto-spending boom.
In industry generally, lessened price pres­
sures have shown up in a reduced rate of
increase of unit costs, both fixed and vari­
able. With the rebound in output following
the cyclical trough, fixed costs have been
spread over a growing volume of produc­
tion, so that unit-nonlabor costs have tended
to stabilize or even decline following the very
rapid rise during the sluggish 1969-70 pe­
riod. Unit-labor costs have moved in similar
fashion, reflecting mainly a speedup of pri­
vate nonfarm output per man-hour— up at a
rapid 5.6-percent rate in the past half-year.
Indeed, unit labor costs in the private non­
farm sector have actually declined for two
successive quarters, for the first decline of
the past seven years.

16

Fiscal deficit
In the fiscal arena, Federal-government
spending declined below the spring-period
pace during the third quarter, mostly because
of the above-mentioned setback in defense
spending, and the Federal deficit (nationalaccounts basis) thus narrowed somewhat.
However, there should be a different story
in the current quarter, because of the first
payout of revenue-sharing funds and the
sharp boost in social-security payments,
along with normal increases in spending for
goods and services. The budget deficit thus
is expected to be substantial, giving rise to a
danger of overheating the national economy.
Congress adjourned in mid-October after
rejecting the Administration’s request for au­
thority to impose a $250-billion ceiling on
budget spending for the current fiscal year.
A compromise bill specifying areas for pos­
sible reduction was passed by the House but
then voted down by the Senate. After Con­
gress adjourned, Administration experts set
to work to cut about $6 billion from budget­
ed expenditures, so as to meet the selfimposed $250-billion spending limit and presumably to avoid a tax increase next year.




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Also in the adjournment rush, Congress
increased social-security taxes to help pay
for a large number of new social-security and
medicare benefits— all on top of the major
20-percent boost in benefits voted just last
June. (The June legislation also included a
tax increase.) In 1973, the social-security tax
rate will rise to 5.85 percent on the first
$10,800 of a worker’s income, for a maxi­
mum tax of $632 as against this year’s $458.
With both the tax rate and the wage base
rising over time, the maximum payment in
1978 will rise to at least $720—probably
more, because last June’s legislation involves
a tax escalator clause tied to the consumerprice index.
Congress, as noted, passed a scaled-down
$ 74-billion Defense Department appropria­
tion bill before adjourning. In addition, it
appropriated $30 billion in revenue-sharing
funds over a five-year period to states and
localities, with few strings attached. Twothirds of the money will go to local govern­
ments, with heavily urban and poor rural
sections generally making out better than
the affluent suburbs. A massive highway
bill meanwhile was killed when Senate-House
conferees could not agree about tapping the
$7-billion highway trust fund for urban masstransit purposes.
In view of the substantial Federal deficit,
the Treasury now estimates that about $12
billion in gross borrowing may be needed
through early 1973, with cash needs con­
centrated in early December and early Janu­
ary. About one-fourth of the needed funds
will be achieved through an early November
auction of 6 Vi -percent four-year notes.
Other funds will come from additions to the
weekly bill cycle, sales of two-year notes, and
sales of tax-anticipation bills maturing in
April and June 1973.
Money: moderate growth
The Federal Open Market Committee, in
its latest reported meetings in June and July,

November 1972

MONTHLY

Short-term interest rates
move sharply upward ...

decided to achieve bank-reserve and moneymarket conditions that would support a
moderate growth of the monetary aggregates.
As it turned out, most of the key aggregates
grew more rapidly over the third quarter
than they did over the preceding one. The
money stock (narrowly defined) rose at an
8.5-percent rate during the third quarter,
considerably higher than the second quarter’s
5.3-percent figure but still below the firstquarter pace. Even at that, the third-quarter
figure largely reflects a very sharp bulge in
monetary growth in early July. Time-andsavings deposits, except for large negotiable
CD’s, rose relatively slowly in early summer,
but accelerated later in the quarter. Conse­
quently, the broadly defined money stock
(including such time deposits) increased at
a 9.3-percent rate in the third quarter. Net
sales of large time CD’s continued to expand
sharply during the July-September period.
Meanwhile, member banks shifted to a net
borrowed reserve position, reflecting accel­
erated borrowing at the Federal Reserve dis­
count window.
Commercial-bank credit expanded strong­
ly throughout most of the third quarter, with



REVIEW

most of the expansion showing up in loans
rather than in security portfolios. In par­
ticular, the brisk pace of economic activity
resulted in a long-expected improvement in
business and other short-term credit de­
mands. Business loans were very strong dur­
ing August, and consumer and real-estate
loans expanded significantly throughout the
entire quarter. Bank holdings of municipal
and Federal-agency issues rose modestly, but
holdings of Treasury issues weakened.
Short-term interest rates advanced sharply
throughout most of the summer and early
fall. The three-month Treasury bill was bid
at around 4.80 percent at mid-October, as
against 3.85 percent just two months earlier.
This surge in rates reflected selling pressures
associated with Federal Reserve open-market
operations and some liquidation of bill hold­
ings by foreign central banks, as well as an
increase in Treasury new bill offerings. With
short-term rates rising and long-term rates
showing little change, the unusually wide
spread that had developed earlier between
long- and short-term rates began to narrow
considerably.
. . . while long-term rates
remain relatively stable

1970

1971

1972

17

FEDERAL

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BANK

The October rise in the prime businessloan rate, to 5% percent at most banks,
brought this key rate one full percentage
point above its low point of the past year.
Most of that increase occurred just between
June and October. Federal Reserve Chair­
man Burns, in his role as chairman of the
Com m ittee on Interest and Dividends,
“viewed with concern” the recent increases
in the prime, although he saw little indication
that these increases would be transmitted to
the rates in the long-term sector, such as
home-mortgage and consumer-loan rates.
Indeed, pressure on long-term rates could
remain rather mild, in view of such factors as
the high level of savings flows and the
strength of corporate liquidity and cash flow.
At any rate, the Committee now plans to
extend its surveillance to the earnings of fi­
nancial institutions, and will not limit itself
to the monitoring of interest rates.

18

Export deficit
In the world economy, U.S. exports of
goods and services increased during the third
quarter— but imports also rose, so that the
nation continued with a net deficit on mer­
chandise-trade account. Even so, the $3.4billion rate of deficit was the lowest since the
devaluation of last December.
The trade outlook should improve signifi­
cantly, and not just because of the unex­
pected boom caused by heavy grain sales
to the U.S.S.R. and more recently to China.
Farm exports increased about 4 percent to
a record $8 billion in fiscal 1972, and the Sibillion Russian grain deal should boost the
figures even higher in 1973. Indeed, the
U.S.S.R. expects to be a major importer of
American wheat, feed grains and soybeans
for at least the next several years.
The upswing in the U.S. economy has in­
duced a strong demand for imports, while
the business slowdown of its major trading
partners has been holding down the demand
for U.S. exports. But as the European na­




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tions and Japan improve their economic per­
formance in coming months, they should buy
more from the U.S. In addition, this nation’s
better record recently in combatting inflation
— with an inflation rate only about half that
of the Common Market countries— should
act to stimulate exports while curbing the
flow of imports.

Government leaders of the nine Common
Market countries (including the three candi­
date countries) met in Paris in October and
set the goal of transforming the present sep­
arate states into a European union by 1980.
They agreed to set up a European Monetary
Cooperation Fund by next April, to be ad­
ministered by central-bank governors for in­
tervention in foreign-exchange markets. The
purpose would be to narrow fluctuations be­
tween members’ currencies, already supposed
to operate within one-half the band observed
elsewhere. A report due by the end of 1973
would deal with the pooling of central-bank
reserves within this fund, leading to the de­
velopment of an embryonic central bank.
The cause of increased European cooper-

November 1972

MONTHLY

ation was threatened by the latest crisis of
the pound, which created uncertainty in
world monetary markets throughout the sum­
mer and fall months. The pound was set
afloat from its $2.60 parity rate in June, and
since then it has been weakened by a number
of domestic problems, as well as by the ex­
pected payments drain resulting from the
U.K.’s entry into the Common Market next
January 1. A lagging growth rate, lagging
investment, a high rate of inflation and bitter
industrial relations have plagued the U.K. in
recent years, and the pound’s weakness has
now been accentuated by the gradual subsi­
dence of inflation in this country. Also, the
U.K. is scheduled to set a new fixed rate as
a part of the Common Market’s integration
plan, and some observers feel that rate should
be as low as (or lower than) the October
low of $2.32. To combat its many problems,
the Government in November took a leaf

REVIEW

from the American book and imposed a 90day freeze on prices and incomes.
To combat a completely different set of
problems, Japan in October unveiled its
“Third Yen Defense Program.” This pro­
gram, like its two predecessors of the past
year and a half, is aimed at reducing the sub­
stantial surplus that Japan has built up in
its payments dealings with other nations. De­
termined to prevent a second revaluation,
Japan instead has relied on a 20-percent re­
duction in import tariffs on industrial, min­
ing and agricultural products, and on restric­
tions on exports in 18 major areas, including
autos, radios, cameras, and machinery. Ja­
pan’s efforts to stave off revaluation, along
with Britain’s efforts to stabilize its currency
rate at an equilibrium level, should influence
international money markets for some time
to come.
William Burke

The Pacific Trade Basin
The United States and the Pacific Trade Basin is a monograph prepared by
Donald R. Sherk, Associate Professor of Economics at Simmons College, under the
sponsorship of the Federal Reserve Bank of San Francisco. The study, which is
aimed at an academic and financial audience, focuses upon the degree to which
the nations bordering the Pacific have become meshed within a fairly complementary
economic region over the course of the past quarter-century. Among other topics,
the study analyzes the prewar and postwar patterns of trade in the Pacific Basin,
and discusses the development of U.S.-Pacific trade in terms of international-trade
theory.
Single copies of the Sherk monograph are available upon request. Write to the
Administrative Service Department, Federal Reserve Bank of San Francisco, P.O.
Box 7702, San Francisco, California 94120.




19

FEDERAL

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Rapid Expansion ( W e s t )
he Western economy continued to ex­
pand at a good clip during the summer
and early fall months. Civilian employment
exceeded 12.5 million during the third quar­
ter, and employment gains were widespread
throughout the nine westernmost states. All
major industries scored strong gains, and all
except the aerospace industry reached new
employment peaks.

T

As a consequence, there was a further
reduction in unemployment in the West.
Jobless workers accounted for 6.2 percent
of the Western labor force during the JulySeptember period— still higher than the na­
tion’s 5.5-percent figure, but still a percent­
age point below the year-ago regional level.
The strongest improvement occurred in Cal­
ifornia and Washington, the states that were
worst hit by aerospace cutbacks of several
years ago. In little over a year’s time, Caliifornia’s rate has dropped 1Vi percentage
points to 5.9 percent, and Washington’s rate
has fallen 3 full percentage points to 8.7 per­
cent.

20

Farm prosperity
Western farmers participated in the na­
tionwide farm boom during the summer and
fall months, although not to the same ex­
tent as their counterparts elsewhere. Market­
ing receipts at mid-summer were 6 percent
above a year ago— about one-half of the
gain scored in the rest of the nation. The
slow er-than-national pace reflected the
West’s limited production of some commodi­
ties (hogs, soybeans, and feed grains) that
have been scoring rapid price gains.




The third-quarter growth in Western farm
receipts was based largely on the nationwide
upsurge in livestock prices. Yet, despite the
high levels of fed beef prices, profit margins
were reduced drastically because of rising
costs of feeder cattle and feed grains. Egg
prices meanwhile strengthened substantially
in California, in response to cutbacks in­
volved in a new marketing-control program
and to the liquidation of flocks affected by
the widespread Newcastle disease.
Farm returns during the present quarter
should rise substantially because of the $1billion Soviet grain sale. The Pacific North­
west’s wheat harvest did not begin until the
deal with the U.S.S.R. had been publicized.
N orthwest farm ers, unlike many of their
counterparts in the Southern Plains area, thus
were able to benefit from the skyrocketing
price of wheat — up 30 percent in two
Em ploym en t— especially in W e s t rises sharply over past year

P ercent C h a n g e (Sept.— Sept.)

1 9 7 0 -7 1

November !972

MONTHLY

months’ time— as well as from an expan­
sion in wheat output.
Total crop output in the West is sched­
uled to rise slightly during the present crop
year, despite a sharp weather-caused decline
in output of deciduous fruits. Strong in­
creases are expected in field crops, such as
cotton and wheat, and in processing vege­
tables, especially tomatoes.
Aircraft take-off
The improved situation in aerospace
brought about a 10,000 gain in employment
over the third quarter, to 534,000 in Sep­
tember—the best performance since the turn­
around in the industry’s fortunes a year ago.
Aircraft production (especially commercial
aircraft) accounted for most of the recent
improvement in business. In California the
expansion was strongest in the electronics
industry, while in Washington the expansion
was strongest in aircraft production. Con­
tinued funding of defense projects also
helped to bolster employment; the $2 billion
in defense prime-contract awards recorded
during the second quarter was one of the
largest quarterly gains of the past four years.

Washington’s aerospace industry expects
a 15-percent improvement in employment by
mid-1973, largely because of increased back­
logs of orders for Boeing commercial jets.
The firm’s commercial backlog, after a sharp
deterioration during the previous four years,
jumped from $1.0 billion to $1.6 billion just
between March and September. The orderbook encompasses a historic breakthrough in



REVIEW

the China market, with the $ 150-million sale
of ten 707-model jets, and it also includes
another historic first, the sale of the 1,000th
plane in the very successful 727 series.
July’s award of the $2.6-billion spaceshuttle contract generated little immediate
activity. Initially, it had been expected that
California’s aerospace employment would
show a small net increase by late 1973, with
layoffs in certain firms offsetting the new
hires at contract-winning North AmericanRockwell. The latest information reinforces
this picture, since NASA has announced that
total outlays for fiscal 1973-74 combined will
not exceed $ 140 million for the entire shuttle
project.

Housing and environment
Housing activity accelerated in the West
this summer and fall after a second-quarter
downturn. During the third quarter, residen­
tial construction contracts jumped 12 percent
to a record $ 8.4-billion rate, and housing
starts rose 6 percent to a high but not record
rate of 525,000 units. Industry leaders con­
tinued to express anxiety about overbuilding,
in view of apartment vacancy rates ranging
as high as 7 percent and above in some West­
ern markets. Mobile-home shipments mean­
while continued at a rate ahead of last year’s
record of 79,000 units.
Nonresidential and heavy construction ac­
tivity gained about 3 percent over the quar­
ter to a $6.6-billion annual rate, measured
by the dollar volume of construction awards.
The pace was still behind the peak first-quar­
ter rate, however. Contracts increased for
construction of streets, highways, bridges,
dams and rivers-and-harbor work. These
gains were offset by declining activity in
public-utility projects and commercial and
manufacturing plants.
The major building news this fall was
September’s ruling by the California Supreme
Court that environmental-impact statements
must be filed with requests for building per-

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s ta rts reach peak
for second straight year
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$5 million annually. It also asked the Agri­
culture Department to increase timber sup­
plies, and asked the Justice Department to
investigate pricing practices within the in­
dustry.
Some producers began taking steps— in­
cluding price refunds and production cut­
backs— to prevent profit margins from ex­
ceeding acceptable levels under the pricestabilization program. Two of the largest
firms in the industry actually reduced prices
voluntarily to keep prices down, but the
strong-demand, tight-supply situation kept
the overall level of prices rising nonetheless.

mits on all private construction where a
“significant” im pact occurs. The C ourt
agreed with environmentalists that the same
type of statement already required for public­
building projects should also be required for
private projects. The decision threw the
state’s building industry into a turmoil —
some comm unities even stopped issuing
building permits—but it created a bonanza
of new business for environmental consult­
ing firms.

22

Housing and lumber
The housing boom’s unrelenting pressure
on the Northwest’s forest-products industry
continued, as lumber and plywood prices
rose sharply despite the presence of Phase
II controls. By September wholesale prices
of softwood lumber were 12 percent, and
softwood plywood 17 percent, above yearago levels.
Price pressures continued despite a num­
ber of steps taken by the Cost of Living
Council to bring the lumber industry under
tighter controls. In July the Council revoked
a small-business exemption and reimposed
price and wage controls on lumber producers
and dealers with sales in excess of $100,000
a year. In October it extended reporting requirements to firms with sales in excess of




Metals strengthening?
Western steel production declined more
than seasonally this summer, but it then
picked up sharply in September. A rising
tide of imports helped account for the re­
gional industry’s problems. During the Jan­
uary-August period, imports into the West­
ern market were up 34 percent over a year
ago, as against a 12-percent decline na­
tionally.
With help from the recuperating aircraft
industry, N orthw est aluminum producers
boosted their operating rate during the third
quarter. In the process, one leading producer
announced a shift of production from an
Alabama plant to more modern facilities at
Troutdale, Oregon.

November 1972

MONTHLY

Western copper producers experienced a
greater-than-seasonal decline in demand dur­
ing the third quarter. Refined copper deliver­
ies ran above the 1971 level, but only be­
cause a strike affected the year-ago figures.
The basic problem was overproduction in the
world market, which helped bring world
prices well below the U.S. producer price of
50V2 cents a pound.
The Cost of Living Council excepted silver
from price controls in August, enabling do­
mestic producers to benefit from the sharp
increase in world silver prices. The Council
said that the existing $1.61-an-ounce ceiling
price, which reflected the depressed market
conditions in the prefreeze period, would
tend to discourage domestic production and
divert U.S. supplies overseas. In the two
months after the decision, the U.S. producer
price rose to $1.79 an ounce.
Refining activities at Western oil refineries




REVIEW

continued to rise during the third quarter, to
7 percent above year-ago levels. Western
crude production meanwhile declined, so
refineries utilized larger supplies of imported
oil. Imports of foreign crude jumped sharp­
ly over the quarter, in September amounting
to 40 percent of total crude supplies. Also,
imports of foreign refined products increased
somewhat above year-ago levels.
The Western economy in the late fall of
1972 generally anticipated a prosperous
1973. The very strong situation of most
farmers and ranchers, the thicker order books
of aerospace producers, and the surprisingly
high level of the housing market— all pro­
vided a solid underpinning to the regional
economy. The metals industries also looked
forward to expanding in line with the growth
of the national economy.
Donald Snodgrass, Verle Johnston and
Yvonne Levy

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Faster L©ao Pace

24

After mid-year, as the economy continued
to gather momentum, Western banks
experienced heavier credit demands in an
environment of rising money-market rates
and increasing reserve pressure. Commer­
cial-bank credit at Twelfth District banks
increased $1.8 billion in the third quarter—
a larger gain than in the first two quarters
of the year. Yet, this 9.9-percent (season­
ally adjusted) annual growth rate fell con­
siderably below the nation’s 13.9-percent
rate, mainly due to different movements in
security holdings. District bank loans rose
$2.6 billion, for a substantial 19.8-percent
rate of gain. (Still, this was only slightly
above the national pace.) The loan expan­
sion was broadly based and included, for
the second successive quarter, a large gain
in business loans as well as a further acceler­
ation in mortgage and consumer lending.
Less favorably, however, the pace of de­
posit expansion fell off sharply during the
July-September period. As a result of this
slower deposit growth, District banks re­
duced their holdings of securities to meet
the heavier loan demand. Portfolios of U.S.
Treasury issues decreased $529 million —
largely in issues of l-to-5-year maturities —
despite some additions in longer-term ma­
turities. District banks also reduced their
holdings of “other” securities by $258 mil­
lion, in contrast to a build-up in such hold­
ings at banks elsewhere. They sold off
longer-term issues for the most part, largely
because of expectations of price declines in
long-term tax-exempts on the part of some
portfolio managers.




Slower deposit growth
Total deposits of District member banks
expanded at a 3.9-percent annual rate dur­
ing the third quarter (seasonally adjusted,
daily average basis). This was less than half
the rate of increase in the first two quarters
of the year. The $613-million increase was
almost entirely in the time-deposit com­
ponent, but even this was only half as large
as the second-quarter gain. A major factor
in the diminished inflow was a greater-thanseasonal reduction in public time deposits.
These withdrawals followed an unusually
large buildup in May, when California banks
received record amounts of public funds be­
cause of newly-instituted state withholding
of income taxes.
Rates paid by District banks on passbook
savings and consumer-savings instruments

L@@ns expand strongly, both in
West and in rest of nation

November 1972

MONTHLY

remained generally unchanged during the
quarter. Thus, the relatively wide spread
c o n tin u e d between savings-and-loan and
bank offering rates.
Savings in the form of consumer-type timedeposit instruments (not seasonally adjust­
ed) expanded at a substantial rate through­
out the third quarter, approximating the
relatively large second-quarter gain. On the
other hand, passbook savings increased only
nominally, except in September when quar­
terly interest was credited. An increase of
$565 million in large negotiable time cerficates meanwhile provided large District
banks with a substantial source of funds; in
both July and August, CD’s rose over $225
million, and in September District banks
successfully replaced those CD’s which ma­
tured at the mid-month tax date.
Net demand deposits (seasonally adjust­
ed) remained virtually unchanged in the
third quarter, as a $442-million increase in
private demand deposits was offset by a
comparable decrease in U.S. Government
deposits, which reflected the unusually low
level of Treasury cash balances. Private de­
mand deposits grew more rapidly than in
the second quarter, but U.S. Government
deposits declined at a much faster rate.
Increased reserve pressure
Since most of the deposit increase was
concentrated in time deposits, the increase
in District banks’ required reserves amount­
ed to only $53 million in the July-September
period (daily average basis). But because of
an increasingly firm monetary policy, banks’
borrowings from the Federal Reserve Bank
of San Francisco rose to $26 million from
the second quarter’s $5-million figure. They
also recorded average net borrowed reserves
of $5 million, compared with net jree re­
serves of $6 million in the preceding quarter.
Many large District banks were net pur­
chasers of Federal funds — that is, bor­
rowers of unused bank reserves — in the



REVIEW

July-September period. As a group, how­
ever, these banks were net interbank sellers
(lenders) with daily-average sales of $909
million compared with $568 million in the
prior three months. On the other hand, they
continued to be net borrowers from securities
dealers, although on a reduced scale. On all
Fed-funds transactions, large banks were net
sellers of $863 million, compared with $393
million in the second quarter.
This Fed-funds position appears incon­
sistent in light of banks’ increasing reserve
pressure, but it is partially explained by the
further increase in the already record high
borrowings of funds (from corporations and
public agencies) under repurchase agree­
ments. Some of these borrowed funds, which
exceeded $2 billion during the quarter, were
resold in the Fed-funds market.
Expanded borrowing
The expanded demand for business loans,
already evident in the second quarter, con­
tinued in the July-September period. Busi­
ness loans rose in each month of the quarter
for a total increase of $569 million, only
slightly below the preceding quarter’s pace.
The same general theme was evident after
adjustment of the data to include loans sold
to affiliates, at least for the quarter as a
whole.
Loan demand still remained only moderate
from the durable-goods sector, except for
primary-metals manufacturers. Most non­
durable-goods manufacturers in contrast in­
creased their borrowings substantially, al­
though some of this (as in the food sector)
represented mainly seasonal borrowing. The
utilities sector — especially communications
— and the construction sector substantially
expanded their bank borrowings also.
The cost of business borrowing rose dur­
ing the quarter, as prime-rate increases by
District banks followed increases in other
parts of the country. Western banks raised
their prime rate by Va percentage point in

25

FEDERAL

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W e ste r n bon ks reduce holdings
©{ Treasury securities . =.

late June (to 5Va percent), and this rise
was reflected in higher average rates on
short-term business loans, as measured by
the Federal Reserve’s August survey. (In
major West Coast cities, the average weight­
ed rate on short-term loans was 5.82 per­
cent, 22 basis points above the May average;
on revolving-credit loans, the average rate
was 5.72 percent, up 15 basis points.) In
late August, Western banks again followed
the national trend, raising their prime rate
to 5V2 percent. A further increase — to 5%
percent — occurred just as the fourth quar­
ter began, in early October.
Consumer instalment loans continued to
expand during the third quarter, but the gain
fell somewhat short of the previous quarter’s
pace. Instalment loans (not seasonally ad­
justed) rose $306 million at large District
banks in July-September, compared with a
gain of $428 million in the preceding threemonth period. As borne out by recent con­
sumer surveys, individuals obviously have
overcome their earlier reluctance to make
purchases of autos and other big-ticket items
involving instalment credit.

26

Active mortgage markets
Western commercial banks and savingsand-loan associations continued to experi­




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ence a flood of savings inflows during the
third quarter, and the pace of mortgage
lending c o n se q u e n tly accelerated. Large
commercial banks increased their savings
deposits (passbook savings and certificates)
by about $766 million, while savings-andloan associations recorded a $ 1.9-billion net
savings gain, both before seasonal adjust­
ment. In both cases, however, recent gains
fell below last winter’s record inflow.
With savings continuing to roll in, the
pace of mortgage lending increased. During
the quarter, commercial banks expanded
their mortgage portfolios by $717 million,
and the S & L’s increased their portfolios
by a record $2.0 billion. At the same time,
loan commitments of S & L’s remained at
a high level.
The continued strength of mortgage-loan
demand contributed to a further slight firm­
ing of mortgage rates at Western S & L’s,
as the average rate on a conventional newhome loan rose by about 5 basis points
during the quarter to approximately 7.75
percent. However, average loan maturities
eased slightly, and downpayments decreased
slightly in most Western markets.
. o. and meanwhile sell off ©iher
securities, unlike banks elsewhere

1969

1970

1972

November 1972

MONTHLY

Favorable fourth quarter?
Western banks again showed an erratic
pattern in bank earnings in the third quarter,
both before and after securities transactions.
Large-bank performance ranged from heavy
net gains to heavy net losses, while medium
and small banks generally reported sub­
stantial year-to-year increases in income.
In the present quarter, the outlook for
bank earnings is generally favorable. The
latest Va -percentage-point increase in the
prime business-loan rate should, together
with the several earlier increases, improve
loan revenues. (However, mortgage and
consumer loans have been accounting for
the major part of the loan expansion, and
rates in these categories have remained re­
latively flat in recent months.) Meanwhile,
recent sharp increases in yields should in­
crease banks’ rate of return on securities.
On the other hand, the cost of bank funds
also has edged up recently. The rate on Fed­
eral funds again has moved up around the
5-percent level, and offering rates of banks
on large negotiable CD’s have risen around

REVIEW

30 basis points above rates quoted around
midyear. Revisions in Regulations D and J,
effective November 9, may inject some un­
certainties into the bank-earnings picture,
particularly during the changeover period.
Overall, however, the spread between rates
of return and costs should be at least as
favorable as in the preceding three-month
period.
So far this quarter, loan demand in the
mortgage and consumer sectors has con­
tinued at the accelerated pace of recent
months. Business demand for credit also has
been strong, and appears to be well dis­
tributed both geographically and among in­
dividual banks. But to maintain timedeposit inflows, District banks will have to
rely more heavily on CD’s to offset sea­
sonal declines in public deposits and payouts
of Christmas Club accounts. By December,
however, banks can expect the yearly sea­
sonal peak in deposits by states and political
subdivisions, with the deposit of December
tax receipts.
Ruth Wilson and Verle Johnston

Publication Staff: Karen Rusk, Editorial Assistant; Janis Wilson, Artwork.
Single and group subscriptions to the M onthly Review are available on request from the
Administrative Service Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco, California 94120




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Publications Awailable
The China Trade (40 pp. 1972)— An analysis of two centuries’ trade between China

and the West. The study describes the development of trade under Western auspices
during the 19th and early 20th centuries, and then describes the completely different
trading environment existing today. After analyzing the structure of China’s current
imports and exports, the study concludes with estimates of the future magnitude of
the China trade.
Silver: End of an Era (32 pp. 1972)— A revised version of an earlier study of the
politics and economics of the silver industry. The study describes a century of silver
legislation (leading up to the recent demonetization), the development of the
Western mining industry, world coinage and industrial demand, and the sharp price
fluctuations of the past decade.
Nation-Spanning Credit Cards (12 pp. 1972)— An analysis of the rapid growth of
bank credit cards, with emphasis on the nationwide coverage recently obtained by
two major card plans. The study describes the advantages to cardholders and
merchants from widespread credit-card usage, technological developments enhancing
the spread of a general electronic-payments system, and the increasing profitability
of card plans with the growing maturity of the industry.
W all Street: Before the Fall (36 pp. 1970)— An analysis of basic stockmarket de­
velopments of the past 15 years. The booklet describes the supply and demand
factors underlying general price trends, and analyzes the industry’s operational
problems and the expanded role of institutional buying in recent years.
Calibrating the Building Trades (20 pp. 1971)— An analysis of the unique features

of the construction industry and their effect on construction wage trends. The study
describes the Administration’s development of an “incomes policy” tailored to that
specific industry.
Aluminum: Past and Future (64 pp. 1971)— An analysis of the long-term growth of
the aluminum industry, with its eight-fold expansion in consumption over the past
quarter-century. The study describes the locational factors responsible for the
national and international spread of the industry, and analyzes the reasons for recent
fears over the industry’s sharp expansion of capacity.
Copper: Red Metal in Flux (56 pp. 1968)— An historical study of the copper in­

dustry, with emphasis on the growth of Western producers. The report describes
copper’s response to the competitive inroads of other materials in traditional copper­
using industries.
Law of the River (16 pp. 1968)— An analysis of present and future sources of water
for the Pacific Southwest. The report describes how Southern California and Arizona
are looking beyond the Colorado River to meet their 21st-century needs for water.

Individual copies of each publication are available on request, and bulk shipments
are also available free to schools and nonprofit institutions. Write to the Administra­
tive Service Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco, California 94120.