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Evaluating Money Market Conditions , . , Monetary aggregates, not interest rates, should be watched for policy signs Oil From the Arctic . , . Development of North Slope oil should have a major impact on Alaska's future Recovery in Washington , , , Four crucial export industries have helped Washington State recover from its earlier slump Business Review is edited by William Burke, with the assistance of Karen Rusk (editorial) and Janis Wilson (graphics), Copies of this and other Federal Reserve publications are available from the Administrative Services Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, California 94120. II i I: _ •••• J IIIIIlI. By John J. Balles, President Federal Reserve Bank of San Francisco Remarks to the Southern California Chapter o/the Bank Administration Institute Pasadena, California, September 12,1973 I appreciate this opportunity to share with you some of my thoughts on an issue which is dear to the hearts of commercial bankers, bond dealers, brokerage firms and Federal Reserve watchers throughout the worldhow to evaluate Federal Reserve actions on the basis of current money market conditions. It is my opinion that there continues to be a great deal of confusion in both banking circles and the general public about how the Federal Reserve participates in money markets in the process of achieving its economic stabilization goals. There are two major groups of opinion about how to interpret and evaluate money market conditions. One group looks at the price of money and credit measured by interest rates, and the other group looks at the quantity of money and credit. If we lived in a world of complete knowledge about the structure of our economic universe, both the interest rate approach and the money and credit approach would give us substantially the same information. Unfortunately, such is not the case. We live in a world where we have an overabundance of facts, and a scarcity of understanding, about various markets in the economy and their interaction with one another. In these circumstances, we need guidelines, based upon experience and research, to serve as indicators of the effects of one market on another-in this case the effect of money markets on the rest of the economy. Money market rates Those who focus on short-term interest rates in evaluating money market conditions have a view of the world which goes something like this: Rising interest rates increase the cost of borrowed funds, and thus reduce the demand for those goods which are sensitive to interest rates, such as business investment in plant and equipment, and consumer spending for durable goods-automobiles, major appliances, and, of course, the most durable consumer good of all-housing. According to this view of the world, high interest rates forecast a slowdown in economic activity, while low rates are associated with an expansion in economic activity. At the same time, interest rate watchers believe the primary cause of interest rate movements is related to the behavior of the Federal Reserve in controlling the supply of funds. They believe that high or rising interest rates are due mainly to restrictive Federal Reserve actions, while low or 3 ~ q falling interest rates are due to easing Federal Reserve actions. This interest rate approach to analyzing money market conditions was widely accepted until recent years. However, it has gradually lost favor as a measure of both Federal Reserve actions and an indicator of monetary influences on the rest of the economy, because the evidence simply has not supported this relationship. Until very recently, the highest interest rates in recent U.S. history were experienced in the 1969 credit crunch. That should have been translated, according to this prescription, into the worst recession in recent U.S. history. As a matter of fact, although 1970 was a period of recession it was by historic standards a mild one. Going back further, we observe that high and rising interest rates were only weakly related to slowdowns in the economy. The great depression of the early 1930's was associated with the lowest interest rates in U.S. history, and they did not do much to stimulate an economic recovery. Why are interest rates such a poor indicator of the effects of the monetary sector on the rest of the economy? The reason is fairly straightforward. Interest rates, as the price of money, are determined not only by the supply of funds made available by the Federal Reserve System but also by the demand for funds determined by various sectors of the economy. This demand can be broken into two components -a business cycle element and an inflation expectations element. Over the business cycle, the demand for funds to meet the needs of trade and finance tends to push rates up sharply during the boom and to push them down during a business recession. The research evidence developed on this issue strongly suggests that the cyclic variations in money market rates are dominated by business demand rather than by Federal Reserve policy. However, the systematic countercyclic movement of short rateshigh in boom periods and low in recession periods-has misled many people into interpreting it as a reliable indicator of Federal Reserve actions. The second element in determining money market rates is inflation expectations. Various researchers have found that under most circumstances every one percent increase in inflation 4 expectations is associated with roughly a one percent increase in interest rates. Interest rates now, and in 1969 at the peak of the last business cycle, are much higher than in previous business cycle peaks, due to the much higher level of inflation we have had over the last five years in comparison with previous business cycles. In this circumstance, high interest rates are not as depressing on business investment or other interest sensitive spending. The borrowers of these funds expect to pay back with dollars of a lower purchasing power, and the higher interest rate merely compensates the lender for the decline in the real value of his capital. Thus, the real interest rate, the market rate adjusted to eliminate the inflation premium, is only moderately higher now than in previous business cycles. Let me give you some examples using the four to six months commercial paper rate-the market rate peak in October 1959 was 4.7 percent; in October 1966, 6.0 percent; in December 1969, 8.8 percent; and August 1973, 10.3 percent. However, if we make the reasonable assumption that expectations of inflation over the next three to six months are approximately determined by the actual inflation of the past year, then the real interest rate w o u ld have been abo u t as fo llo w s : In O ctober, 1959, 4 percent; in O cto b e r 1966, 4 percent; in De cem ber 1969, 4 p ercent; and in August 1973, 5 percent. These calculations should n o t be taken as exact because they are on ly in d ire ct measures o f in fla tio n expectations. Nevertheless, they provide a rough indicatio n of the increasing gap betw een the o b served m oney m arket interest rate and the real rate in this period o f long-term in fla tio n . It is the existence o f the in fla tio n prem ium tha t has convinced many observers th a t m oney m arket rates are p o o r indicators both o f Federal Reserve actions and of m onetary influences upon the econom y. Percent Money and credit aggregates O u r attention has been focused increasingly on m oney and cre d it aggregates as the m ore a p p ro priate measures o f m oney m arket c o n d itio n s a n d th e ire ffe c ts o n the econom y. It is the q u a n tity o f m oney and credit w h ich mea sures the amount o f fin a n cin g available. Leaving aside the th e o retical argum ents o f the Keyne sians and m onetarists, w hy should we rely upon the price o f m oney, w hich is o n ly an in d ire c t and im perfect in d ica to r, w hen we have the d ire ct evidence o f the activity in m oney and fin a n cial markets? In the present in fla tionary perio d , I believe that the H igher interest rates com pensate lenders fo r in fla tio n — fo r decline in real value o f capital 5 quantity of money and credit made available to the market, rather than its price, is the more reliable indicator in this regard.Under normal circumstances, money and credit move in the same direction over the business cycle and, therefore, transmit the same information about monetary influences. However, there have been specific episodes when measures of credit (such as bank loans and investments) and measures of money (such as the now-famous Ml-currency and demand deposits in the hands of the public) have either gone in opposite directions or, if in the same direction, at different rates of change. In these circumstances, money watchers and credit watchers may end up evaluating the actions of the Federal Reserve and the consequent effects on the rest of the economy differently. When such differences arise we need a criterion for selecting one over the other. A reasonable criterion is to select the aggregate which is least influenced by special institutional factors. On this basis a monetary aggregate would seem to be superior to a credit aggregate. Bank credit Total credit is often measured in terms of bank credit, but banks are not the only source of credit available to the economy. Other sources include the commercial 6 paper market, savings and loan associations, investment banks and capital markets. Bank credit represents a sufficiently large share of the total that it is typically a useful indicator of the total movement of credit. However, when there are major institutional forces at work which make bank credit either unusually attractive or unusually hard to get, it will not necessarily be a good measure of total credit. It is precisely at these times when credit and money move in different directions. Let me illustrate. Bank credit slowed sharply in 1966 and again in 1969. In the view of most observers this occurred because market interest rates increased above the ceiling rates on time deposits permitted under Federal Reserve Regulation Q. This caused a substantial runoff of commercial bank deposits into money market instruments which were not subject to Regulation Q. As a result of the runoff of deposits, bank credit in the second half of 1966 increased at only a 2 percent annual rate, down substantially from the 10 percent rate of the previous two and one-half years. In 1969, bank credit grew by 3 percent versus 11 percent in the two previous years. While this slowing in the growth of ban k credit may have been a severe handicap to small businessmen who only had commercial banks as a source of financing, large businesses with access to the commercial paper, money and capital markets were able to meet their needs. For example, in the second half of 1966, the volume of commercial paper increased at a 43 percent annual rate, up from 18 percent in the previous two and one-half years. In 1969, commercial paper increased 52 percent, more than double the growth of the previous two years. Thus, the major effect of Regulation Q was to distort the normal channels through which credit was made available to the economy, rather than changing the total amount of credit. A person viewing bank credit in 1966 or 1969 would have asserted that the degree of Federal Reserve restriction on the economy was quite severe. While the Federal Reserve was in fact being restrictive, it was not as restrictive as the movement in bank credit implied. The 1967 downturn in the economy was so mild that it was not even labeled a recession and the 1970 downturn was the mildest of all the postwar recessions. .E f , I. p In early 1973 bank credit also was a misleading indicator, but in the opposite direction from the two previous cases. I n the first quarter of this year money market interest rates rose relative to the prime rate, making bank credit the cheapest alternative source of funds. As a result, we saw a rapid 18 percent rate of growth in total loans and investments at commercial banks. This was a substantial acceleration from the 12 percent growth rate of the two previous years. During the same six month period, however, there was virtually no growth in commercial paper and only a moderate supply of new corporate debt. While the overall expansion of credit was rapid, it certainly was not as rapid as bank credit figures indicated. Money stock This leads us to the last money market indicator, which is the money stock. There are a number of alternative measures of the money stock: M, which is currency and demand deposits in the hands of the nonbank public, M2 which adds to M, the time deposits of commercial banks exclusive of large CD's, and M3 which adds to M2 the time deposits of thrift institutions. In recent years, the M2 and M3 definitions of money have suffered from the same institutional problem as bank credit. Thus, M, is the preferred measure at this time. The money stock is determined by the interactions of three groups of decision makers: 1) the Federal Reserve, 2) the commercial banks and 3) the general public. The role of the Federal Reserve is to determine the monetary base for the entire financial system. The term monetary base refers to the balance sheet of the Federal Reserve. On the asset side it is dominated by the portfolio of government securities which the Federal Reserve buys and sells in the open market. On the liability side it consists mainly of Federal Reserve notes (cu rrency) and the deposits of member banks which represent their basic required reserves against their own checking accounts and time deposits. The unique role of the Federal Reserve is its ability to expand or contract its balance sheet as a deliberate act of policy. The Federal Reserve as a central bank has responsibility for issuing currency and regulating the reserves of member banks. It performs this function mainly by monetizing government debt, that is, buying government securities and paying for them with newly created deposits which become the reserves of member banks. In this way, the Federal Reserve provides the underlying source of liquidity to the entire financial system. The behavior of banks and the general public, in response to the actions of the Federal Reserve, leads to an adjustment in their portfolio of assets. The banks have a desired level of liquidity on the basis of interest rates and the volume of deposits. The public has a desired level of liquidity on the basis of a variety of factors related to interest rates, the frequency of salary payments, etc. As the banks and the public respond to changes in the monetary base, the money stock is uniquely determined. Most observers have been impressed by the research of recent years which indicates that Federal Reserve actions in determining the monetary base play the dominant role in determining the money supply. There is only one major episode when the actions of the public rather than the Federal Reserve dominated the money stock. This was during the bank panic of the early 1930's, when the public had a substantial and permanent increase in its demand for currency relative to other assets. As a result, the increase in the monetary base all went into meeting the currency 7 Percent C h a n g e needs o f the p u b lic rather than reserve needs o f the m em ber banks. A t all other tim es, Federal Reserve co n tro l of the m onetary base has dom inated m ovem ents in the m oney supply. The evidence o f Federal Reserve co n tro l of m oney and the im pact of m oney on the econom y has been developed in an im pressive way, not on ly w ith respect to the U nited States in the postw ar pe riod, b u t back as far as reliable data on the nation's m oney and incom e go. In add itio n , studies using the data o f oth e r industrial countries also strongly su p p o rt the strategic role o f m oney as an im portant central bank to o l in influ e n cin g general econom ic activity. » 1967 1 » 1969 B » 1971 Federal Reserve, by c o n tro llin g m onetary base, determ ines M i grow th and thus influences econom y 8 H 1973 In spite o f the im portance w hich is increasingly accorded to m oney, we must try to avoid a n m oney myopia. Some people l f J n treat every w iggle in the m oney supply series as a source o f im portant in form ation about the fu tu re course of th e econom y. This is w ro n g and should be avoided. The w eekly and even m o n th ly m oney supply data con tain a large random elem ent. The m oney supply behaves like a dog being w alked by his master. The dog w ill dart in and o u t, to and fro , always straining at its leash tc get to the nearest fire hydrant or bush, w h ile the man w ill walk 1 I " I I I I I I , I I I , ~ I I. I i! straight on his course. If we follow the weekly and monthly data we are following the dog's path, when we should be concentrating on the man. That requires us to look at the money supply data in perspective, averaging out its weekly and monthly erratic variations to understand the underlying trend which alone has an important impact on the economy. Our research and that of others in the Federal Reserve System indicate that it t,akes at least a six months sustained change in the growth of the money supply to cause a change in general economic activity. For this reason, the Federal Reserve has not attempted to rigidly control the money stock over a period of one or two months. Such short-run control would have led to very sharp swings in interest rates, with the possibility of damaging the structure of financial markets. There have been a few occasions when even a longer-run measure of money growth has been misleading. We had such an example in the first half of this year. In the first quarter of 1973, the money supply grew at a 1.7 percent annual rate, and many people interpreted this as monetary overkill and excessive Federal Reserve restriction on the economy. Consequently, when in the secondquarter the money supply grew in excess of a 10 percent annual rate, many people were surprised and disturbed at the apparent erratic behavior of the Federal Reserve, and expressed heightened fears about inflation. However, this specific episode was not due to a change in Federal Reserve policy. If one looked at the rate which the Federal Reserve was expanding its assets-in the form of the monetary base-he would have found that the underlying forces which determine the money supply were developing at the same rate in both the first and second quarters. Nor was there a permanent shift in the desire of the public or the banks to hold more liquidity. The most probable cause of this stop-go movement in the money stock was a statistical fluke related to Treasury deposits commercial banks. Treasury deposits are not included in the money supply data for the simple reason that they are not a measure of the liquidity of the private sector of the economy. speculation took the form of selling dollar demand deposits to, for example, the German central bank to acquire Deutschemark deposits. The German and other central banks purchased Treasury bills with these newly acquired dollars, causing an inflow of funds to the U.S. Treasury and a consequent increase in Treasury deposits at U.S. banks. In the first quarter, this transfer of deposits from the public to the U.S. Treasury reduced the money supply. In the second quarter the Treasury worked its balances down to more normal levels, resulting in a rise in private demand deposits and hence a rise in the money supply. If one focused on money supply figures alone during the first half of this year, he would have obtained a misleading impression regarding Federal Reserve intentions. However, if one focused on the monetary base, which is dominated by the Fed's portfolio of financial assets, he would have gained a much clearer view of the System's ultimate influence on the money stock. In the first quarter of this year, there was an international monetary crisis which caused many people, including some who held U.S. dollar deposits, to speculate about-a-dollardevcHuation. Thi s .......iIIII Current developments My intention to this point has been to clarify the various ways of looking at money market conditions and to give you my reasons for considering one way superior to another. I would now like to apply this information to an analysis of current money market conditions. Short-term interest rates have in the last month reached their highest level in this century. The Fed funds rate has ranged between 10112 and 11 percent. The prime rate has reached 934 percent and even the Federal Reserve discount rate of 7112 percent is at an historic high. These rates all represent substantial increases from those reported as recently as early July. We have always had sharp increases in money market interest rates during the expansion phase of the business cycle. That is what is happening now. What is new about the current situation is that the levels these rates are reaching represent historic highs. Concern has been expressed in some quarters about what this implies about the future course of the economy. In light of what 1 have said previously, the current historic high interest rates would appear to be related to the current high rate of inflation which people expect to 10 continue over the next six to twelve months. It is only natural that lenders will demand, and borrowers will be prepared to pay, a high rate of interest on short-term funds when both groups of people expect a high rate of inflation over the life of the money market instrument. As Arthur Burns, Chairman of the Board of Governors of the Federal Reserve System, said on August 3, before the Joint Economic Committee of Congress, "the underlying reason for the high level of interest rates is the persistence of inflation since 1965.1 nflationary expectations have by now become fairly well entrenched in the calculations of both lenders and borrowers." When this inflation premium is subtracted from the current money market rates, the real rate of interest no longer looks so high. year and a half. This has been fueled by an 8 percent growth in the monetary base. Thus, the underlying thrust of monetary policy and, therefore, the underlying availability of money and credit to the economy did not slow down in the first half of 1973. It is this expansion which concerned me. Very recent evidence indicates a slowing in the growth of the monetary base and money stock. In the months of July and August the growth rate in both indicators was down to a 5.5 percent annual rate. If this slowdown continues, the second half of 1973 may represent a real period of monetary restriction and, therefore, a slowdown in the growth of credit made available to the private sector and, eventually, in the rate of inflation. Credit crunch I believe that under the present circumstances the M, definition of the money stock-currency and demand deposits in the hands of the non-bank public-is the best overall measure of money market conditions. As with any indicator, it is not perfect and can, on occasions, give misleading information as in the first quarter of this year. However, if we look at the money stock in perspective, it has grown in excess of 8 percent in the last I would like to close with a comment on the so-called "credit crunch" phenomena. High interest rates should not be confused with a credit crunch. A crunch is a condition where funds are not available to many classes of borrowers at any price. High interest rates on the other hand are merely a way of rationing the available funds to those who are willing to pay the higher prices. We had a severe credit crunch in 1966 and a less • • a I 'f severe but, nevertheless, painful one in 1969. While both of these were associated with relatively high interest rates, they were not directly caused by high interest rates. Rather, they were caused by the fact that certain financial regulations and institutions impeded the smooth allocation function of financial markets. In the case of commercial banks it was Federal Reserve Regulation Q which caused a severe disintermediation when market rates exceeded the Q ceilings. The 1"966 crunch was eased only when the banks were able to tap an alternative source of funds not subject to Q ceilings, the Eurodollar market, and the crunch was eliminated only when interest rates fell below the Q ceiling. A similar experience occurred in 1969. However, the crunch was less severe then because the banks, haVing already gone through this experience once, were prepared to shift to the Eurodollar market rather qUickly. In addition, they developed domestic institutional devices, specifically, by issuing commercial paper through onebank holding company subsidiaries to ease the constraints of Regulation Q. In 1973 the Federal Reserve has suspended Regulation Q ceilings on large deposits -the type most sensitive to interest rate change. Thus, a major cause of past credit crunches has been eliminated for many commercial banks. Conclusion I have tried in the time allotted to give you a brief overview of how money market conditions translate themselves into broader statements about monetary policy and its effects on economic activity. We have found that money market interest rates have become an unreliable guide because of the emergence of a long-term inflationary trend and the resulting inflation premium in interest rates. A 10% percent interest rate simply does not mean the same when the inflation rate is 6 percent or more as it does when the inflation rate is 2 or 3 percent. Nevertheless, the remarks of Chairman Burns are worth repeating, "the simple truth (is) that inflation and high interest rates go together and that both the one and the other pose perils for economic and social stability in our country." The movement in the money and credit aggregates is a more reliable indicator of both Federal Reserve actions and their impact on the rest of the economy. On those few occasions when money and credit transmit different information about money market conditions, the money series is superior to the credit series because institutional factors tend to distort the credit measure more than the money stock. The underlying movement in the money stock is dominated by the monetary base which, in essence, represents the assets of the Federal Reserve System, and is the financial constraint on the entire economy. The Federal Reserve, by controlling the monetary base, determines the trend growth in the money supply and through this control has its influence on general economic activity. With regard to the larger question of what monetary policy should be, I think the growth in money must be targeted in terms of our overall financial and economic goals. On this issue, the role of informed judgment is at the heart of monetary policy decision making. 11 ALASKA .. I if ,I 'I I I I ¥ ; Alaska, Land of Paradox, is the smallest state economically and the largest geographically. With personal income of less than $2 billion annually, it has only two percent as much income as the largest state (California); with an area of over one-half million square miles, it is twice as large as the next-largest geographical unit (Texas). At the same time, it is both one of the poorest and one of the richest states. Oneseventh of Alaska's total population (and half of the native population) are below the poverty line, and the state is plagued by the highest living costs in the nation. Yet it has tremendous unexploited wealth in its forests and fisheries, and especially in its petroleum resources. Most of this wealth is centered in the Prudhoe Bay field on the North Slope facing the Arctic Ocean. To a nation which runs on oil and is increasingly worried about the cost and availability of oil imports, the discovery of a major new field within its borders comes as a godsend. Although petroleum accounts for almost one~half of the nation's energy requirements, the U.S. today cannot meet its requirements from its own resources. (Indeed, three-fifths of the world's total reserves are found in the politically unstable Persian Gulf area.) Nonetheless, five years after the discovery of the Prudhoe Bay field, not a drop of oil has reached the markets in the lower 48 states, largely because of the environmental controversy over the construction of the pipeline designed to deliver the oil. With the impending passage of Congressional legislation governing pipeline rights of way, construction finally may begin early next spring. Oil would begin flowing about three years after that, and in the process, would help transform this now problem-ridden state. The benefits from this oil bonanza are discussed below, as are also the economic and ecological costs of exploiting this resource. First, however, it is useful to review the background to the North Slope discovery, including the long and still-unsettled controversy over the best means of bringing oil to market. land of oil Alaska's petroleum wealth first entered the news a half-century ago, when several firms began investigating oil seepages along the Arctic coast reported by Eskimos and early traders. President Harding in 1923 set aside 37,000 square miles of the North Slope as Naval Petroleum Reserve #4, and exploration continued in a desultory fashion in 13 that area for many years. Still, the industry's main interest centered for some time around the major Texas, Oklahoma and California oil discoveries. The real beginning of the state's petroleum industry occurred in 1957 with the discovery of oil in the Kenai Peninsula near Anchorage. A decade later, five fields were producing crude oil and nine fields, natural gas. At the beginning of this decade, production in the Kenai area and in the nearby Cook Inlet amounted daily to 240,000 barrels of oil and 600 million cubic feet of natural gas-in each case, a relatively small percentage of the nation's total production. Yet, with about $275 million in total output annually, petroleum has become Alaska's leading industry, by a considerable margin. In addition to raw material production, processing has become increasingly important, especially with the construction of a petrochemical complex in the Kenai area. This includes two petroleum refineries producing jet, diesel and heating fuels, plus an ammonia-urea plant and a natural-gas liquefaction plant servicing the Japanese market. ,i I, 14 Production in the Kenai area was approaching its maximum level when, fortuitously, a major find in the Prud hoe Bay area occu rred in July 1968. Announcement of the find set off a rush reminiscent of the Klondike Gold Rush of 1898. Estimated reserves in the field came to 10 billion barrels of crude oil, as against Canada's 8 billion barrels and Texas' 15 billion barrels. Moreover, total recoverable reserves (with new technology) were estimated at 50 billion barrels of oil and 300 trillion cubic feet of gas. Problems of geography Nonetheless, none of this oil is likely to reach market until the latter part of this decade, despite all the discussion of shortages throughout the nation. Several factors have defeated efforts to exploit the Prudhoe oil field, beginning with geography. Almost all of Alaska's prinCipal geographic features are arranged in an east-west orientation, and this affects the present structure of the transportation network and the future location of oil and gas carriers. Only 3 companies (Atlantic Richfield, Humble and British Petroleum) originally had a stake in this bonanza, on the basis of three state lease sales in the 196467 period. But the much-publicized September 1969 sale of leases drew many more bidders, as 450,000 acres were set aside for exploration. Based on earlier transactions, this offering was expected initially to elicit only about $11 million in bids, but instead it gave the state a $900million windfall, enough to cover the entire cost of state government for almost half a decade. The North Slope is a flat flood plain with the water table practically at the ocean surface, and is marked by sediment-filled streams and numerous glacial lakes. The entire area usually is frozen solid from the two-foot level down to about 300 feet. South of that are the foothills and then the Brooks Range, stretching in an east-west direction across most of the state, with only two low-level passes, one of them across the border in Canada. Farther south is the Yukon Basin, consisting of a dry plateau around Fairbanks and, to the east, a vast area of semifrozen peat bog and muskeg that is hundreds of feet deep in places. Next comes the Alaskan earthquake belt-a sweeping arc that is the continuation of the Aleutian Islands-and south of that are the towering mountains of the Alaskan Range. Two difficult surface routes cross the mountains between Fairbanks and the port cities of South Central Alaska. One of these routes, between Fairbanks and Valdez, rises 2800 feetin one short 20mile stretch. This contrasts sharply with the relatively flat Alaska highway route, which stretches southeast into Canada. Problems of environment Bringing oil to market through such terrain is a difficult but not insuperable technological task. What complicated the situation was a development which took place in the same year as the Alaska oil-lease sale-the passage of the National Environmental Policy Act of 1969. The act stipulates that when Federal agencies undertake actions with possible environmental consequences, they must file an environmental-impact report. In this statement, known as a 102(c) report, the agency involved must analyze and quantify the effects of proposed actions on the environment, and also consider alternatives where irreversible deleterious effects are found. Transportation experts proposed a number of possible transportation modes-sea, air, rail, truck and pipeline-to bring the oil to market. The approved proposal, however, was a 789-mile transAlaska pipeline route developed by the Alyeska Pipeline Service Co., a consortium of seven oil companies. This route, as originally proposed, would be from Prudhoe Bay through Anaktuvuk Pass in the Brooks Range, across the Yukon River to Fairbanks, and then through the difficult terrain of the Alaskan Range, along the route of the Richardson Highway into Valdez. From Valdez, supertankers would carry crude oil to Puget Sound and California ports, and pipelines then would deliver the oil to the nation's major markets in the East. Several legal actions were filed against the U.S. Department of Interior (USDI) to enjoin the granting of the pipeline permit to the oil companies. One major piece of litigation, concerning the settlement of native land claims, was eased by Congressional action in 1971. This act set aside 40 million acres of presumably mineral-rich land for Alaskan natives, and involved also the payment of $962 million in cash, to be disbursed indirectly to 12 regional and 200 village corporations. Most of the litigation, however, centered around the environmental issue. The Interior Department issued a preliminary impact statement early in 1971, and the pipeline companies followed up in July of that year with their own 29-volume environmental study. After issuance of a further detailed USDI study in early 1972, Secretary Morton granted a pipeline construction permit, but this was then appealed to the courts by several environmental groups. In early 1973, the Federal Court of Appeals in Washington ruled that the Secretary could not grant a permit unless Congress amended a 1920 law governing pipeline rights-of-way across public land. The Supreme Court refused to review this lower-court ruling, and the problem ended up in the hands of Congress. The appropriate legislation is now nearing passage, but further litigation could develop before construction actually begins. Canadian alternative? Much of the controversy has centered around the feaSibility of an alternative pipeline route through Canada to Edmondton and then on to Chicago, servicing the Oil-hungry Midwest. Those favoring this route included conservation organizations, commercial fishermen, academic specialists, Midwestern 15 A nnual Flow (M illio n Bbls.) Trans-Alaska p ip e lin e , starting operations w ith in several years' tim e, could ease oil shortage m uch m ore than trans-Canada line Congressmen and state officials, and also some Canadian in te r ests. Arrayed against them were the m ajor oil producers and trade associations, Federal and Alaska state officials, and, presum ably, m ost residents o f Alaska. Environm entalists argued that a hot-oil p ip elin e could create se rious dangers in crossing the seismically active zone in the southern part of the route, not to m ention the w ide expanses o f perm afrost in oth e r stretches. In add itio n , fisheries could suffer from unavoidable leaks and spills occuring at term inal facilities and in the narrow and fog-laden sea routes near Valdez. In rebuttal, Alaska-route supporters argued that the Canadian route, being several tim es longer, w ould have several tim es the environm ental im pact o f the Alaska route. The Canadian route w o u ld not cross as much seismically active terrain o r create dangers fo r marine transportatio n, but it w o u ld in volve many m ore crossings o f large rivers. M oreover, each side claim ed th a t its pipelin e was much safer fo r caribou (bears, moose, muskrats, otters, etc.) than the o p p o sitio n 's line. In term s o f m arket analysis, the Canadian route's supporters argued that the U.S. W est Coast (D istrict 5) w o u ld not be able to absorb all o f the crude oil 1 6 shipped there by the Alaska route, necessitating the marketing of the surplus elsewhere. Exporting the oil would have been extremely profitable under then-existing oil-import regulations, but this is no longer true with the recent easing of such regulations. More importantly, given the developing shortages in all sections of the country, it is unlikely that there will be any surplus in the West Coast when the oil finally starts flowing three or four years from now. Inconclusive choice Cost-benefit analyses were developed by both sides in the controversy, but with rather inconclusive results. The Canadian route's supporters pointed to the fact that crude-oil prices are higher in the upper Midwest than in California, and that present transportation-cost calculations indicated that the value of North Slope oil would be greater if delivered to Chicago rather than to Los Angeles. This conclusion favoring the Canadian route, developed in several studies by economist Charles Cicchetti (Resources for the Future), was challenged by a Treasury study which Deputy Secretary William Simon presented to the Senate Interior Committee last May. The Treasury study followed the same benefit-cost approach uti- lized by Cicchetti, but came out with quite different results. "Benefits" were defined as the cost of alternative sources of supply less the resource cost of North Slope oil delivered to the same market; "resource costs" were defined as the total cost of goods and services required to bring either North Slope or foreign oil to U.S. markets. In the Treasury projections, the delivered resource cost of Middle Eastern crude oil in 1980 would be roughly $4.58 in Los Angeles and $4.88 in Chicago. (Future market prices would be higher than these resource costs.) In contrast, the delivered resource cost of North Slope crude oil, by either pipeline route, would be roughly $1.30 in Los Angeles and $1.60 in Chicago. So the net benefit to the U.S. economy from either pipeline from the production of North Slope crude oil would be $3.28 a barrel-the difference between the resource costs of foreign and Alaskan oil. The difference in conclusion stemmed from the fact that Treasury analysts assumed that any North Slope oil would displace foreign oil in either market, whereas Cicchetti assumed that it would displace an even mixture of domestic and foreign crude in Los Angeles and a five-sixth one- sixth mixture in Chicagoperhaps unrealistically in view of the shortage of domestic crude, as seen from the recent upsurge in imports and the U.S. industry's current peak capacity production. Basically, however, the Treasury concluded thattotal benefits (if not benefits per barrel) would be greater from the Alaskan route simply because of the earlier availability of oil from that source. Alaskan choice In evaluating the various environmental and economic arguments supporting the two alternative routes, the Senate Interior Committee refused to accept either set of arguments as conclusive. However, the Committee determined that "the transAlaska pipeline is now clearly preferable because it could be on-stream two to six years earlier than the comparable overland pipeline across Canada." Because of the much more advanced planning on the Alaska route, that pipeline could probably deliver a total of 8.6 billion barrels by 1990, as against 5.0 billion barrels via the Canadian route. This argument apparently has been convincing to Congress, especially in the present crisis atmosphere, and thus has helped speed the necessary right-of-way 17 legislation through the legislative process. Yet in view of the large unexploited resources available on the North Slope, and in view of the arguments favoring the Canadian route, an ultimate solution might involve the construction of both pipelines. Already planning is far advanced for construction of a natural-gas line from the North Slope through Canada to the Midwest, and a frequently mentioned alternative, the construction of a rail-pipeline corridor along this route, looks increasingly promising. Railroad alternative The rail-transportation mode has strong advocates, especially among those taking a long-range view of resource development. This view has been outlined by economist Richard Rice (Carnegie-Mellon Institute) in a recent article in Technology Review. Rice argues in favor of a high-capacity rail-pipeline route along the Yukon Corridor, or preferably along the Mackenzie Valley, in place of the transAlaska pipeJine, partly in terms of short-term cost advantages but also in terms of its long-range value. The cost estimates for the transAlaska pipeline, in his view, would total about $9.2 billion$3.0 billion for the crude-oil pipeline, plus the costs of a nat18 ural-gas line, tanker fleet and port facilities. I n contrast, the estimated cost of the rail-pipeline system would be about $7.5 billion on the Yukon route and $5.6 billion along the Mackenzie route. Moreover, this system would yield greater residual value after the Prudhoe field is finally exhausted. Rice's proposal is apt to be overlooked in the present rush to get the oil flowing, yet over the longrun, a rail-pipeline system may become a necessity. The U.S. and Canadian Arctic contains, in addition to 10 billion barrels of proven reserves in the Prudhoe field, a great deal more that could ultimately become recoverable with improved technologyperhaps 10 billion barrels in Navel Petroleum Reserve #4,20 billion barrels in the area around the Mackenzie Delta, and another 30 to 40 billion barrels to the east ofthe delta in Canada. Most of these areas are not accessible to the trans-Alaska pipeline route, but they can conveniently be served by the Mackenzie route proposed in Rice's study. The railway would also have an essential role in developing other natural resources of interior Alaska, an area which could produce as much as two million tons of iron ore, one million tons of coal, one-half million tons of other minerals, and, in addition, over two billion board feet of lumber every year. More than that, in view of the nation's increasing need for new energy sources, the Mackenzie route would be strategically located for exploiting two of the three largest known oil deposits in the world. Recoverable reserves in the Athabasca tar sands of Alberta are estimated at 370 billion barrels of oil, about the same amount as in the the entire Persian Gulf area, and the shales of Colorado, Utah, and Wyoming might contain another 600 billion barrels. As technology develops to a point permitting exploitation of these resources, marketing development should not lag far behind. Impact of pipeline However valid these considerations may be in the distant future, the present emphasis is on bringing North Slope oil to market through the trans-Alaska pipeline. The oil will not start flowing immediately; after construction begins, it will take three years to bring the first shipment to market, and several more before production reaches its targeted flow of two million barrels a day. But as the project goes on stream, it will make an important contribution to U.S. energy supplies, since the North Slope field by itself adds one-third to the nation's oil reserves. The impact on Alaska will be farreaching, and will mark a basic shift in the state's passage from a military-based economy to a resource-oriented economy. Even at the beginning of this decade, twice as many individuals were on military payrolls as on the payrolls of commodity-producing industries (farms, fisheries, forests, oil, construction and manufacturing), but the state's economic structure should be quite different in another decade or two. The process of growth will be very uneven and accompanied by sharp cyclical swings in employment and income, but it will lead eventually to a better-integrated and prosperous economy. North Slope oil already has brought about one abortive boom, caused by the euphoric belief that the pipeline would be built immediately after conclusion of the $900-million lease sale. The state for the last several years has lived with the let-down from that burst of activity, with the unemployment rate hovering around 10 or 11 percent throughout the past several years, as against 9 percent or less during most of the preceding decade. (However, total employ19 ment has grown somewhat faster over the past half-decade than in the preceding period.) But now that the pipeline is closer to reality, a major construction boom is likely to occur. This period might last about three years, with pipeline-related employment peaking at around 24,000 jobs in the second year and falling off rapidly thereafter. However, the higher-paid jobs will probably be filled by specialized workers hired "Outside", and not from the Alaskan labor force, although the state government is making every effort to see that Alaskan residents get first consideration for construction jobs. It is even considering re-opening an information booth at the Seattle airport which was used during the slump several years ago to warn Outsiders away. Impact of oil Despite the bonanza in company profits and tax revenues expected from exploitation of North Slope resources, it may not produce much in the way of permanent employment of Alaskan workers or direct business for Alaskan firms. The fields in the Kenai-Cooke Inlet area have generated fewer than 3,000 permanent jobs, and with the exploitation of North Slope fields, perhaps no more than 20 5,000 permanent workers may be needed for drilling, production, pipeline and harbor work throughout the state. Thus, petroleum's long-run contribution to the state's economic development will not depend primarily on the jobs or the directly-related business generated by the industry. Its contribution instead will be determined largely by the amount of revenue the state receives from oil and gas leases and taxes, and the way in which it spends this revenue. It should be added that the petroleum industry differs considerably from other commodity-producing industries, such as the salmon and forestry industries, whose Alaskan operations have been primarily seasonal and concentrated in production. The oil firms have established an executive and administrative component inside Alaska, giving an Alaskan flavor to their main oper~ ating and planning functions, and they also have relied heavily on contracting for various supporting services within the state. Even so, the oil boom in itself will not solve the state's major problems of rural poverty and high (9.8 percent) unemployment. These problems, according to Arion Tussing (University of Alaska) are not caused by lack of jobs in the ordinary sense, but by two peculiarities of the state's industrial structure: the existence of seasonal industries, such as salmon and construction, and the serious mismatch between the location, education and life styles of most natives (who make up one-fifth of the population) and the qualities required by modern economic development. The oil boom nonetheless has stimulated the settlement of the native-claims question, by hastening the payment of $962 million in cash and 40 million acres of land to poverty-afflicted groups. In addition, the $900 million received from the 1969 lease sale has gone into the state's general fund to finance construction and maintenance of public facilities. But the state has also counted on severance taxes and royalty income from oil production, and these revenues have not yet materialized. This s,ituation has led to charges that the state would "face bankruptcy" in several more years, and it has led to proposals in the governor's 1974 budget to develop new revenue sources and to reduce the rate of growth of state spending. II II Benefits of proprietorship Despite these recent difficulties, the prospects for the state government's finances-and for a further attack on the state's poverty-will brighten considerably when oil begins to flow. This evaluation is based on one crucial fact: unlike other oil-producing states, Alaska owns major subsurface rights, and so can participate in development revenues from all mineral exploitation within the state. The oil firms and the state government have argued for some time over the future shape of the oil-taxation system. Basically, however, the state will collect a royalty on the wellhead price per barrel produced, and itwill also impose a sliding-scale production tax, depending on the producing rate of each well. Since the Prudhoe Bay wells generally will produce at a high rate, the state's tax take could approximate 20 percent of the wellhead price per barrel. In a University of Alaska study (The Alaska Pipeline Report) produced for the U.S. Department of the Interior, the wellhead price was estimated at $2.42 to $2.52 per barrel, which at full pipeline capacity of two million barrels a day would generate about one million dollars a day in state revenue. However, the study was based on 1971 prices, so that in view of the rapid price escalation resulting from the world-wide oil squeezeinvolving a 9.7-percent jump in the wholesale price of crude within the past year alone-the state's revenues (and the Alaskan economy) should benefit substantially as time goes on. The exploitation of North Slope oil will increasingly broaden Alaska's economic base. But to repeat, the long-term impact will come not from construction of the pipeline, but rather from the utilization of production revenues. (Most of the gains would occur, no matter what route were chosen to bring the oil to market.) The shape of Alaska's future will be determined largely by the state government, through its decisions on how and where to spend its oil revenues, while the Federal government's longdominant role will become only secondary. William Burke 21 £ Washington State is enjoying today an economic recovery that few could have foreseen in the summer of 1971. Total employment has increased 6 percent over the past two years, and now approaches the peak levels of early 1969. The unemployment rate meanwhile has dropped sharply, from nearly 12 percent down to the present level of 7.5 percent-still well above the current 4.8-percent national rate, but indicative nonetheless of considerable improvement. Moreover, the expansion has been broad-based, encompassing all sectors of the regional economy. Between 1965 and 1969, Washington enjoyed exceptional growth, far above the national trend and considerably better than Washington's own earlier performance. Personal income, the broadest regional measure of economic activity, rose 52 percent over that period, or onethird more than the national gain. The major key to this prosperity was the aerospace industry, which almost doubled its payrolls between 1965 and 1968to some 109,300 workers-and in the process increased its share of the state's total employment from 5 to 8 percent. Problems in aerospace The recovery can be best understood by focussing on developments in the several major industries which dominate the state's "export" sector-aerospace, aluminum, farming and forest products. These industries by themselves make up less than 15 percent of Washington's total employment, but their role is crucial because they account for the vast bulk of out-of-state sales, and thus generate a disproportionate share of the state's total income. At the same time, they are responsible for the major cyclical swings in the state's economy, because they are closely tied to national (and international) industries that are themselves susceptible to wide swings in demand. 22 The aerospace boom in Washington, unlike the situation elsewhere, was not attributable either to the Vietnam buildup or to the expanded space program. Rather, it stemmed from Boeing's resounding success in marketing its 707 and 727 commercial jet transports and developing the twin-engine 737 and the widebodied 747. With passenger traffic growing at 20 percent a year, the nation's airlines had gone on a spending spree, competing to outdo one another with new and expanded jet fleets. As a result, Boeing's commercial sales grew from one-third to twothirds of the company's total sales between 1964 and 1968. Not surprisingly, during this period Boeing itself engaged in the most extensive expansion program in its entire history, laying out $500 million of its own money for design and development, and spending about $250 million on outsized facilities for building the outsized 747. By increasing its involvement in the commercial field, Boeing had hoped to stabilize its economic base and reduce its dependence on defense work. But the commercial market proved to be even more volatile than the defense market. The annual rate of gain of airline traffic dropped from 20 to 8 percent by the end of the decade, while capacity continued to rise from 15 to 20 percent a year. Thus, the proportion of seats filled by paying passengers-the passenger-load factor-dropped to only 50 percent, and the airlines felt impelled to economize on staff and on equipment. In 1968, Boeing's commercial market practically disappeared, as the airlines cancelled orders right and left. In the following year, military and space business began to taper off in the wake of bUdget cutbacks. Then, the final blow came with the cancellation of the SST program in March 1971. Between 1968 and 1971, Boeing dropped almost twothirds of its workers in one of the most drastic cost-cutting campaigns in corporate history. Problems in other industries Conditions in the aluminum industry were equally serious. Aluminum, long known for its spectacular growth, had undergone a major nationwide expansion program during the 1965-69 period designed to raise capacity by one million tons. A large part of that new capacity was located in the Pacific Northwest, to take advantage of the huge supply of hydroelectric power offered by the Bonneville Power Administration; thus, new or expanded facil ities soon came on stream at Bellingham, Longview and Wenatchee. Meanwhile, producers announced plans to expand capacity through 1973 at an annual rate of almost 7 percent. The national industry thus was confronted with a serious problem of excess supplies in 1970, when shipments dropped by almost 7 percent in response to the slowdown of the national economy in general, and to the General Motors strike and the aerospace industry's woes in particular. Despite production cutbacks, aluminum output still rose 5 percent during 1970, leading to the buildup of 600,000 tons of producer inventories. This inventory buildup subsequently led to widespread price discounting, Percent 11 ,/' Washington 9 7 5 3 1967 1969 1971 1973 Washington's jobless rate falls from very high recession level 23 Percent Change -60 I -48 • -36 I -24 -12 0 Recovery in agriculture 12 • . 24 36 Jan.'68-Aug. '71 Washington Other U.S. ~tft~~ttt~Jttt~:ttttj}}JJtJt:tl Aug. '71-Aug. '73 I Aerospace slump much worse in Washington than in rest of U.S., but state has now recovered at least part of earlier job loss with market prices in late 1971 being quoted almost 20 percent below list prices. By that time too, the fall-off in orders from the aerospace industry had led to a production rate of only 80 percent of capacity in Washington's aluminum industry. Several other cyclical industries underwent milder setbacks of their own during this period. In the forest-products industry, the prime mover was residential construction. In the spring of 1969, housing starts began to turn downward, and lumber wholesalers rushed to liquidate their excess inventories. As production declined, employment dropped 8 percent between 1968 and 1970. Pulp-and-paper producers (like aluminum producers) had overinvested in new capacity on the basis of a misreading of earlier sales gains, and in addition had spent heavily for envi24 ronmental outlays. When demand slowed and prices declined in the face of rapidly rising expenses, several mills were forced to close, and industry employment dropped 10 percent over the 1969-71 period. In 1969, the expansion of other industries was sufficient to keep total employment growing in the face of the aerospace decline. But during the 1970-71 period, when the aerospace cutbacks grew more severe and the recession extended to other "export" industries as well, employment stagnated or even declined in the important secondary industries, such as trade, services, transportation, finance and construction. As a result, the state lost over 80,000 jobs and total employment dropped to 1,268,000 at the recession low, while the jobless rate jumped from 4.5 percent at the peak to almost 12 percent at the worst of the recession. Gradually, however, the recovery forces took hold, beginning with the agricultural industry. The state's farmers had had their troubles while the rest of the economy was booming in the late 1960's, largely because of reduced acreages and lower prices for wheat, as well as weather-caused cutbacks in deciduous-fruit production. But between 1969 and 1971, agricultural receipts rose almost 15 percent on the basis of substantial wheat harvests, and this was only a curtain-raiser to the spectacular 1972 performance. Washington's farmers received a record $1 billion in gross receipts last year, for a 20-percent gain for the year. Wheat, the state's number-one crop, registered a 61-percent increase and accounted for almost one-half of the gain in dollar receipts. During this period, sales to Russia and China not only raised export volume but also gave a strong push to grain prices. Cattle and calves were the second largest source of farm income, on the basis of a modest gain in production and a sharp upsurge in prices. The apple crop also contributed heavily to the rise in receipts, with prices rising as a result of short supplies in other producing areas of the nation. Washington's agricultural output this year has been adversely affected by unfavorable weather conditions in the eastern portion of the state, but higher prices could still conceivably push dollar receipts to a new record. The wheat harvest-affected first by a freeze and more recently by drought-is now expected to be only about 70 percent as large as last year's crop. But a worldwide scramble for u.s. supplies has pushed prices to nearly triple the year-ago figure. ! Drought losses in the Soviet Union and China led to their original placement of orders for U.S. wheat, but they may continue to import huge quantities, because of changing consumption patterns in those countries as well as their improved political relationship with the U.S. The Soviets plan to increase the animal-protein content of the Russian diet by 25 percent as part of their current five-year plan, but in order to boost their livestock herds, they will have to rely increasingly on the world market for grain. Washington's livestock producers have been confronted with rising costs and shortages of feed grains and hay, aggravated by the widespread drought. The total live weight of cattle slaughtered from January through July of this year was down 12 percent from the corresponding period of 1972. The nation's demand for beef has been extremely strong, however, due to the rise in incomes and the steady expansion of the hearty-eating young adult population, and prices received by Washington cattlemen, which rose sharply prior to the government-imposed freeze, are expected to continue upward now that price ceilings have been lifted. Rising farm productivity and an increasing variety of crop production have helped bring about a doubling of Washington farm receipts over the past decade. Washington of course is prominent as a producer of wheat, apples, potatoes and pears, but it also supplies national markets for such high-value, intensive crops as asparagus, grapes and berries. Irrigation has been a key factor in this development, but the proportion of total irrigated cropland (15 percent) is still well below that for the rest of the Pacific Northwest. Further expansion in these crops may depend on increasing the present total of 1.2 million irrigated acres. Recovery in forest products The forest-products industry was the second of the state's major "export" industries to recover from the earlier recession. Despite the sluggish nature of the nationwide economic recovery, residential construction rose sharply, with housing starts soaring by 62 percent over the 1970-72 period. Pacific Northwest lumber mills increased production by 16 percent over the twoyear period, but the pressure of demand kept prices rising steadily except during the 90-day freeze of 1971. Indeed, prod uction probably would have expanded further except for the distortions created by controls, since the profit-margin limitation provision of the Phase II program actually discouraged the large mills from producing atfull capacity. Over the same period, the pulpand-paper industry began to recover from its earlier problems of overcapacity and soft prices. During 1972, paper and paperboard consumption grew rapidly, so that the industry's operating rate approached full capacity by year-end. Supplies grew even tighter du ring the early part of 1973, resulting in a 13-percent boost in prices by August, at an annual rate. 25 During the last several months, the lumber industry has begun to retreat from the feverish pace of 1972. Housing starts have dropped because of tighter mortgage markets, the satisfaction of earlier pent-up demands, and the rise in vacancy rates in at least the apartment sector of the market. The almost uninterrupted price upsurge experienced during the prior 2Y2-year period undoubtedly also played a role in eventually curbing demand. During the first four months of the quasi-voluntary Phase III period alone (JanuaryMay), softwood lumber prices rose at an 85-percent annual rate, wh ile plywood prices shot upward at a 153-percent rate. Lumber and plywood prices have now declined in response to the weakening housing market, and they are likely to fall further in response to a projected drop in housing starts over the next year or so. The recent tight lumber market, however, suggests that the lack of availablity of timber could pose a constraint on homebuilding in the years to come. With current levels of forest management, demands and supplies of softwood sawtimber can be expected to balance in the _ 26 future only with rather substantial increases in prices of timber and forest products. The pressure will intensify if sizeable tracts of Federal and state forest lands are withdrawn from timber use for wilderness and scenic areas. The lumber supply problem lies principally in the area of timber availability; the industry generally has sufficient mill capacity to meet prospective demand, although efforts are being made to modernize facilities by installing equipment capable of conserving labor and raw materials. A somewhat different situation exists in pulp and paper, where supplies could remain tight over the next several years because profits have not been sufficient to encourage significant investment in new capacity. In this industry, the huge capital outlays required to meet air- and waterpollution abatement standards are being met in part with funds that otherwise would have been spent on expansion of capacity. But the burden of meeting these standards is so high that the companies are turning to municipal-revenue bonds to reduce the cost of borrowing; about $200 million has been earmarked for this type of financing by the region's paper and metal manufacturing industries. Recovery in aerospace Following the upturn in Washington's farming and forest-products industries, the aerospace industry began to pull out of its prolonged tailspin. Employment in the industry gained 4 percent last year, and the slow but steady expansion has continued in 1973, although employment todayroughly 58,000-is only about half of the record high of five years ago. The commercial-aircraft sector, the major cause of the severe downturn, similarly has provided most of the thrust for the upswing. In 1972, the nation's airlines recorded an impressive 12percent gain in passenger traffic and a marked improvement in their profits. In particular, the year's growth brought travel demand closer into balance with capacity, leading to a doubling of Boeing's commercial-aircraft orders. China's $125 million purchase of ten 707s meanwhile provided an historic breakthrough in the foreign market. j \ ~ J I ~ I _------------_ J.'J .., Government orders also supported the upturn, as military prime contract awards rose 45 percent (although from a relatively low base) during the year. The list of projects was relatively long, and involved avionics work on the advanced B-1 bomber, continued work on the Minuteman missile, development of an Air Force short-takeoff-andlanding aircraft, and development of the Mariner spacecraft system. The aerospace industry's order backlog, although well above the year-ago level, has begun to taper off in recent months, however, so that the likelihood of a major expansion in employment looks somewhat doubtful. The growth in domestic airline passenger traffic this year has been lower than expected, and most forecasts are being cut in half, to at best a 5- to 7-percent increase in traffic for all of 1973. The longrun future for the aerospace industry looks fairly strong, however, because of the 11-percent annual gain in domestic airline traffic anticipated over the next decade. Converting airline-traffic projections to requirements for new aircraft, the Boeing Company forecasts a total world market of $51 billion by 1980, which could mean $22 billion in sales for the firm if it maintains its present 43percent share of the world total. Orders for the jumbo 747 have been improving, and Boeing may well meet its sales goal of 600 planes by 1980, especially in view of the work now underway to enhance the plane's flexibility. (The recently unveiled 747 SP is the seventh version of the basic 747 model.) The company also has a new plane on the drawing board, the 7X7, to replace the highly successful 727 when it is phased out later in the decade. However, forward planning is affected by the fact that preproduction costs of an entirely new commercial aircraft can approach $600 million. Recovery in aluminum The aluminum industry, finally, recorded a turnaround in its supply-demand situation during 1972. Producers were able to reopen most of the potlines closed earlier because of serious overproduction problems, and the industry's operating rate rose gradually over the course of the year. The deterioration in market prices halted during 1972, and the market then began to strengthen considerably. ByApril of this year, supplies had become so tight that the selling price for ingot finally reached the published level of 25 cents per pound, ending more than three years of heavy discounting. Demand conditions in the national industry have been extremely strong this year, and shipments could be up as much as 20 percent from 1972's level. Purchases from the government stockpile have helped to meet demand, but supplies have been very tight nonetheless. The price of ingot, which remained frozen at the 25-cent level until August 13, could reach as much as 28 cents by year-end. The present national shortages are due in part to the regional industry's recent difficulties. Major facilities were shut down in mid-April because of hydropower shortages, and the problem has grown increasingly severe since then, resulting in the closure of 352,000 tons of annual capacity by mid-July. The problem arose when the Bonneville Power Administration was forced to cut back 50 percent of its interruptible power to industrial customers, as a consequence of the lowest stream flow into the Columbia River Basin in the last 30 years. j I I ! I '[ II I II II 27 I , Even when this problem is overcome, the national supply of aluminum could remain tight for several years to come, since no new smelter capacity is scheduled to come on stream until 1976. This situation is attributable in part to the sharp expansion in capacity of the 1960s, which has now left its scars in the form of a huge long-term debt, increased still further by necessary spending for environmental purposes. But in addition, the industry's return on capital in recent years simply has not been sufficient to justify the bUilding of new facilities. is engaged in a hydro-thermal power program designed to triple the Northwest's energy resources over the next two decades. But Bonneville's projections indicate that, even under the most favorable conditions, total power supplies will be inadequate to meet guaranteed load requirements during the next several years, while interruptible power supplies will be in deficit throughout the decade. Meanwhile, the expanding role of nuclear power in the region could raise power costs perhaps 25 percent over the next several years. When new aluminum facilities are built, they will probably not be located in Washington, because of the likelihood of continued power problems in this region. The Bonneville Power Administration, in cooperation with private and public utilities, The unusual severity of Washington's 1969-71 recession reflected a bunching of individual recessions in several key industries, but it also reflected the overoptimism implicit in the expansion plans formulated during the previous boom. In the present recovery, producers apparently are not making the same mistakes, but rather are gearing capacity more closely to demand. This cautious and more balanced expansion in capacity should prevent a recurrence of the sharp cutbacks in employment and output characteristic of the 196971 period, in the event that national economic activity should weaken in 1974. Yvonne levy
@FedFRASER