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CONFIDENTIAL (FR)

CURRENT ECONOMIC
and
FINANCIAL CONDITIONS

Prepared for the
Federal Open Market Committee

By the Staff
BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM

February 24, 1966

CONFIDENTIAL (FR)

CURRENT ECONOMIC AND FINANCIAL CONDITIONS

By the Staff
Board of Governors
of the Federal Reserve System

February 24, 1966

I-

SUMMARY AND OUTLOOK

Outlook for GNP
GNP rose nearly $16 billion in the fourth quarter, and seems
likely to be increasing as much in the current quarter.

Some moderate

slowing is indicated for the second quarter, if the rate of increase
in government spending slackens as implied in the budget document.
The recent growth rate in real GNP--7 per cent annual rate-has been unusually rapid for this stage of cyclical expansion.

fact, it is close to rates achieved in the early stages of cyclical
recovery, as, for example, from early 1961 to early 1962 and in 1955.
However, it is still well below the 9.5 per cent rate achieved in the
first year of the Korean War, when Federal defense spending increased
by 140 per cent as compared with current increases of about 20 per cent
per year.
Sharp actual and prospective increases in defense spending
have been superimposed on an already booming civilian economy, and, in
the context of accelerated final sales and of prospects of supply
shortages, delivery delays and price increases, business inventory
demands have been stepped up sharply.

Over-all inventory accumulation

rose sharply further in the fourth quarter to the highest rate of the
whole expansion period and is expected to hold around this higher rate
in the first half of 1966 as steel accumulation resumes.

Despite the

sharp inventory rise in late 1965, stock-sales ratios generally remained

low.

I-

The rise in personal income was very small in January when the
social security tax boost became effective, and for this reason a smaller
In coming months,

rise in consumption expenditures was to be expected.

resumption of rapid gains in income--particularly if accompanied by
further escalation of the war in Vietnam--may be expected to heighten
consumer spending.

Prices and costs
Demands on manpower resources have intensified further as
employment in January continued to increase vigorously and the armed
forces added 50,000 more men to its expanding strength.

Continued rapid

expansion in production, as well as employment, resulted in further
increases in rates of industrial resource utilization.

For manu-

facturing industries, the current operating rate of about 92 per cent
was equaled briefly in late 1955 and exceeded only in the Korean War
period.
The strong expansion in aggregate demands and the general

tightening of labor supplies have resulted in wages in most industries
moving up a little more rapidly than earlier.

Even in manufacturing,

where wage increases have been moderate and a large portion of the
workers are covered by long-term contracts, an upward drift in wage
rate increases now appears to be getting underway.

Industrial prices

appear to be increasing at only a slightly more rapid pace than the 1.5

per cent annual rate that prevailed over most of 1965.

I - 3
An unusually large gain in manufacturing capacity is being
projected for this year, and should it be realized, the over-all rate
of utilization of manufacturing capacity is not likely to increase
significantly further.

Operating rates would remain very high, however,

and delays and bottlenecks would be a growing problem.

Unemployment

is expected to continue downward to well below 4 per cent, and with
aggregate demands expanding sharply further, consumer prices are likely
to continue to increase and demands for higher wages to intensify; the
outlook for the voluntary wage guideposts does not appear very favorable.
In these circumstances, and with general expectations for continued
expansion in activity very high, increases in industrial prices are
likely to be somewhat larger and more widespread than over the past year.

Bank credit demand and related bank adjustments
Expansion of bank credit is expected to be at a slower pace
during the spring than it was in December-January, although picking up
from the considerably reduced pace of late January and February to date.
Loan demand is expected to strengthen, following the comparative
moderation of recent weeks.

But Treasury financing, which contributed

significantly to the bank credit expansion of recent months, will be
of little if any importance.

In accommodating loan demand, city banks

may be expected to make further reductions in their holdings of U.S.
Government and other securities, the amounts depending in part on the

strength of demand and in part on their ability to obtain funds for
meeting this demand by loan sales or participations, issuance of CDs,
or purchase of Federal funds.

I-4
Recently, to obtain funds for lending city banks have increased
reliance on asset liquidations and placed less emphasis on time deposit
The volume of CDs outstandings at all weekly reporting

expansion.

banks has not yet reattained the earlier highs reached prior to the
December tax period.
Banks undoubtedly feel inhibited from competing aggressively
for CD money because marginal CD funds would be costly
return on loans, with the prime rate at 5 per cent.

relative to the

For example, 90 day and

longer CD money would cost banks 5-1/4 - 5-1/2 per cent, after including
costs for reserve requirements and FDIC insurance, although the cost of
shorter maturities would be lower.

Late last fall (before the discount

rate increase) CD costs for all maturities were about 1/4 percentage
point above the then prevailing prime rate.

In the weeks immediately

ahead, even with relatively high costs, banks may have to bid more
aggressively for CD funds to keep from losing ground because of heavy
run-offs during the March tax and dividend period and potential further
difficulties in April.

But in the process, the present yield structure

suggests that banks may be forced more into shorter-term maturities.
Structure of interest rates
During the past month, the yield curve has developed less of
a downward slope.

As will be recalled, the initial market response to

the discount rate action was chiefly in the short- and intermediate-term
area, and a yield curve with considerable downward slope emerged.
this

But

particular interest rate structure proved to be unsustainable partly

I-5
because investors and borrowers came increasingly to expect higher interest
rates and partly because long-term markets were under pressure from
rising borrowing demands to finance current business investment and from
bank portfolio adjustments.
Recent upward interest rate adjustments have been principally
in the long-term area.

Since mid-January, the 20-year U.S. Government

bond and high-grade corporate securities have risen about 20 to 25 basis
points, while the 3-month Treasury bill has risen only some 5 basis
points.
The stability of the present interest rate structure over
coming months is open to question.

A continued increase in our military

and economic commitment in Vietnam would certainly militate against
any change in market expectations that would lead to diminution of
pressures on long rates relative to short.

Financing demands of non-

financial businesses and others may continue to be enlarged by anticipatory
factors and long-term rates may rise further, although it is not clear
how general or widespread such rate increases are likely to be.
Corporate rates may be under relatively more upward pressure
than Government bond yields in view of the recent narrowing in the yield
advantage of corporates over long Government issues, the inability of the
Government to issue more securities in the long-term area because of the
4-1/4 per cent ceiling, and the expected build-up in the corporate new
issue calendar.

In the municipal market, upward yield adjustments have

developed only belatedly, and interest rates there may adjust further,

I-6
especially if bank participation in the market continues at a reduced
level.

In the mortgage market, the rather substantial turn-of-year

rise in yields may have largely discounted near-term developments,

although any further rise in corporate bond yields could put pressure
on the mortgage market as well.
If long-term market rates rise significantly further, there
may be a feedback effect putting increased upward pressure on bank
lending rates.

If banks, in turn, find they can lend (or invest) at

higher yields, they might then move closer toward the Regulation Q
ceiling in their bidding for CDs.

Thus, there is the possibility of

a ratchet-like movement of upward rate pressures down the maturity curve.

Balance of payments
The fragmentary information available on U.S. international
transactions early in 1966 provides no adequate basis for either confirming or questioning the view that it will be difficult to reduce
the deficit on the liquidity basis this year.

However, one piece of

information may be regarded as quite encouraging;

U.S. banks reduced

their foreign claims under VFCR much more than seasonally in January.
Merchandise exports and imports in January were both off a
little from the high December levels.

With corrections for statistical

carryover, the trade surplus was approximately the same as in December.
Data on new security issues, including issues scheduled for
March, indicate

an unusually large outflow of U.S. capital through this

channel, principally to Canada.

I-7
Reflecting these and all other transactions, U.S. reserves
and liquid liabilities have shown little net change through January
and part of February.

But seasonal influences are favorable in the

first quarter and the partial results suggest, therefore, a continued
deficit on the liquidity basis in early 1966.

No estimate can be given

yet of the balance on basis of official reserve transactions.

There

does appear to have been a substantial build-up of balances in the
United States by foreign commercial banks (including U.S. branches
abroad) which would tend to hold down official reserve accruals, but
this build-up was perhaps on no greater scale than in the early weeks
of 1965.
The various capital flows mentioned above are not inconsistent
with recent financial market developments here and abroad.

The rise in

U.S. money market rates since November has been paralleled by a rise
in Euro-dollar interest rates, illustrating how U.S. rates put a floor
under Euro-dollar rates.

An important mechanism through which this

relationship gets maintained is the continuing effort of U.S. bank
branches to draw on the Euro-dollar market for funds for the use of
their head offices.
In foreign markets for short-term and long-term funds other
than U.S. dollars, rates have risen less than U.S. rates, and in some
cases have declined.

On the basis of information presently available,

it is not possible to give a full explanation of the pullback of U.S.
bank credit that would take account of interest rate differences.

I -8
is reasonable to suppose, however, that the pressure of U.S. domestic
demand for bank credit relative to supply has been active as a causal
factor to reduce the banks' foreign lending.
Canadian long-term interest rates held a somewhat larger
than usual spread over U.S. long-term rates last autumn, a relationship that may have contributed to the large volume of Canadian bond
issues in the United States during the last few months.

Since early

December, Canadian long-term rates have moved up a good deal less
than U.S. rates; if this narrowing of spread should persist, we
might hope to see a slowing of Canadian borrowing in the United States.
Developments will depend, however, on Canadian monetary policy, and
this may be influenced in turn by the state of Canada's current
account balance of payments and its needs for financing by capital
flows.

February 23,

1966.

I -- T - 1
SELECTED DOMESTIC NONFINANCIAL DATA
(Seasonally adjusted)

Amount
Latest
Period Latest Preced'g
Period Period
Jan.'66
76.8
76.6
3.0
3.1
4.0
4.1

74.9
3.6
4.8

-16.3

Nonfarm employment, payroll (mil.)
Manufacturing
Other industrial
Nonindustrial

62.1
18.5
8.1
35.5

61.9
18.4
35.4

59.3
17.6
7.7
33.9

4.7
5.0
4.2
4.8

8.5
8.4
8.6
8.5

Industrial production (57-59=100)
Final products
Materials

149.9
149.5
150.1

148.5
148.8
148.3

138.6
138.4
138.8

8.2
8.0
8.1

17.2
16.0
18.5

Wholesale prices (57-59=100)1/
Industrial commodities
Sensitive materials
Farm products and foods

104.6
103.0
103.7
107.6

104.1
102.8
103.2
106.5

101.0
101.5
101.3
98. 1

3.6
1.5
2.4
9. 7

3.6
2.1

111.0
105.7
110.6
119.3

110.6
105.6
109.7
119.0

108.8
104.9
106.9
116.2

2.0
0.8
3.5
2.7

3.2
1.1
4.9
4.6

2.65
2.57
109.50 106.16

3.5
4.0

6.4
9.9

7.0

14.6

8.4

18.2
24.2
21.7

Civilian Labor force (mil.)
Unemployment (mil.)
Unemployment (per cent)

Consumer prices (57-59=100)1/
Commodities except food
Food
Services

Dec. '65

Hourly earnings,
Weekly earnings,

Jan.'66
2.66
"
110.40

mfg.
mfg.

II
II
I
"
"

($)
($)

Personal income ($ bil.)-

550.9

515.4

24.9
9.4
5.8

25.1
8.5
5.7

22.9
9.6
5.2

1,537
41.4
23.6
3.4
93.32

1,763
41.4
23.3
3.5
91.73

1,442
41.2
21.3
3.1
86.12

Dec.'65

119.7

118.5

QIV'65
"

697.2
624.4

681.5
613.0

Selected leading indicators:
Housing starts, pvt. (thous.)
Factory workweek (hours)
New order, dur. goods ($ bil.)
New orders, nonel. mach. ($ bil.)
Common stock prices (1941-43=10)1/
Inventories, book val. ($ bil.)
Gross national product ($ bil.)
Real GNP ($ bil., 1958 prices)./
Based on unrounded data.

Ago

551.6

Retail sales, total ($ bil.)
Autos (million units)./
GAF ($ bil.)

8.1

Year

1/ Not seasonally adjusted.

Per cent change
Year
2 Yrs.
Ago*
Ago*

2.5

4.2
-25.8

5.8
7.9

-1.5
9.8

6.6

8.4

-13.5
3.2
19.5
20.9
22.1

110.5

8.3

13.8

641.1
584.7

8.8
6.8

15.5
11.5

0.5
10.9
9.8

2/ Annual rates.

February 23, 1966.

I -- T - 2
SELECTED DOMESTIC FINANCIAL DATA
Week ended Four-Week
Average
Feb. 18
Money Market 1/ (N.S.A.)
Federal funds rate (per cent)
U.S. Treas. bills, 3-ma,yield (percent)
Net free reserves 2/ (mil. $)
Member bank borrowings 2/ (mil. $)
Security Markets (N.S.A.)
Market yields 1/ (per cent)
5-year U.S. Treas. bonds
20-year U.S. Treas. bonds
Corporate new bond issues, Aaa
Corporate seasoned bonds, Aaa
Municipal seasoned bonds, Aaa
FHA home mortgages, 30-year 3/
Common stocks S&P composite index 4/
Prices, closing (1941-43=10)
Dividend yield (per cent)

Last six months
Low
High

4.58
4.66
-122
453

4.56
4.62
-95
432

4.63
4.70
98
627

1.00
3.77
-243
218

4.99
4.75
5.02
4.79
3.51
5.70

4.96
4.64
4.94
4.76
3.42
5.70

5.01
4.75
5.02
4.79
3.51
5.70

4.13
4.20
4.63
4.51
3.17
5.45

93.01
3.06

93.27
3.03

94.06
3.07

86.56
2.88

Annual rate of
change (%)
3 mos.
1 year

Change
in
Jan.
Banking (S.A., mil. $)
Total reserves
Bank loans and investments:
Total
Business loans
Other loans

U.S. Government securities
Other securities
Money and liquid assets:
Demand dep. & currency
Time and savings dep.
Nonbank liquid assets

Average
change
Last3mos.

123

137

7.4

5.2

3,000
1,500

2,700
1,200

11.2
21.4

10.2
12.2

1,700

1,100

11.3

12.2

-200
0

100
200

2.8
6.4

-4.2
12.9

1,100
1,000
1,900

1,000
1,500
1,200

7.0
12.3
5.5

5.3
14.9
6.2

N.S.A.--not seasonally adjusted. S.A.--seasonally adjusted.
1/ Average of daily figures. 2/ Averages for statement week ending February 16.
3/ Latest figure indicated is for month of January . 4/ Data are for weekly
closing prices.

I - T-3
U.S. BALANCE OF PAYMENTS
(In millions of dollars)

Nov.

Dec.

1965
QIII
QIV

Oct.

QII

Year

1964
Year

Seasonally adjusted
1,567

Current account balance

364
490
449 1,303 1,237 1,320
963
2,336 2,388 2,321 7,045 6,832 6,800 5,626
-1,9,72 -1,898 -1,872-5,742 -5,595 -5,480-4,663

Trade balance
Exports
Imports
Services,

etc.,

1,746 1,327

net

330
-1,975

Capital account balance (regular transactions)
Govt. grants & capital 3/
U.S. private direct investment
U.S. priv. long-term portfolio
U.S. priv. short-term
Foreign nonliquid

30e

-943
-515
-356
49
-210
-287

Errors and omissions

426

4.8
26.3
-21.5

364
-9.7

-1,528-2,070

-803
-974
-891 -1,159
100 -679
297
424
-186
274
-87

6.7
25.3
-18.6

-3.6
-2.4
-2.0
-2.1
0.4
-1.2

Balances, with and without seasonal adjustment (- = deficit)
Bal. on regular transactions, S.A.
Seasonal component
-93 - 137
Balance, N.S.A.
Liquidity bal., S.A.
Seasonal component
Balance, N.S.A. 4/

-8

Official settlements bal., S.A.
Seasonal component
Balance, N.S.A. 5/
-645

Memo items:
Monetary reserves
(decrease -)
Gold purchases or
sales (-)
1/
2/
3/
4/

-12

-401

-98

-91

-73

-58

131
-67
64

-726
467
-259

-2.0

-3.1

-320

-664
-695
50
-450
-614 -1,145

-2.0

-3.1

-531
-450
-981

267
-67
200

-647
467
-180

-1.3

-2.8

-320

-390
50
-340

-1.3

-2.8

-1,249
104
-99-1,145

218
-512
-294

230
-191
39

-581
599
18

-1.4

-1.2

-1.4

-1.2

-1.4

-82

-271

-41

-68

-842

-1.2

- .2

-119

-124

-590

-832

-1.7

- .1

Balance of payments basis which differs a little from Census basis.
Figures for October-December tentatively adjusted for changes in carry-over of
import documents. Third-quarter imports not adjusted by months.
Net of associated liabilities and of scheduled loan repayments.
Differs from balance on regular transactions by counting as receipts (+) debt
prepayments, advances on military exports, and net sales of non-convertible
Roosa bonds.
Differs from liquidity balance by counting as receipts (+) increase in liquid
liabilities to commercial banks, private nonbanks, and international institutions
(except IMF) and by not counting as receipts (+) increase in certain nonliquid
liabilities to foreign official institutions.

II - 1

THE ECONOMIC PICTURE IN DETAIL

The Nonfinancial Scene
Gross National Product.

The Department of Commerce has

revised its estimates of fourth quarter GNP to a level of $697.2 billion,
up $2.6 billion from the estimate available 4 weeks ago.

The upward

revision was due to higher estimates for inventory accumulation and
consumption expenditures, offset in part by lower net exports and "other"
Federal purchases.

The new level is $15.7 billion above the third quarter.

We are projecting a similar rise in the first quarter, to $713 billion,
and a rise almost as large in the second quarter.
The increases in GNP now estimated for the fourth quarter and
projected for the first quarter represent a pronounced step-up from the
$12 billion average gain in the second and third quarters of 1965.

large part this step-up has come from a sharp acceleration in Federal
defense spending in support of expanded operations in Vietnam -- for
equipment of all kinds and for the direct cost of the growing number in
the Armed Forces.

Defense purchases, which increased at an average

quarterly rate of only $0.5 billion in the second and third quarters,
rose an estimated $2.2 billion in the fourth quarter, and according to
Budget Bureau projections are expected to rise by $2.5 billion in the
current quarter.

In the second and ensuing quarters of 1966, however,

the Budget Bureau is projecting a marked slowdown in the rise in defense
spending; the gain shown for the second quarter is only $1.2 billion.

II - 2

This slowdown, incorporated in the staff projections shown in the attached
Table, contributes to the smaller rise now projected for GNP in the
second quarter.
The accelerating defense program, on top of high and rising

private final demands

has stimulated a faster rate of growth in industrial

output and employment since last autumn, and has fostered expectations

of supply shortages and larger price increases.

In this situation an

unexpectedly high rate of inventory investment occurred in the fourth
quarter, and business inventory demands are expected to remain strong
in the first half of this year.
The fourth quarter inventory rate represented a new high for

this expansion period, exceeding the previous high of $8.8 billion
reached in the first quarter 1965 when steel and auto stocks were
expanding at a rapid rate.

The fourth quarter rate was as high as the

temporary peak reached in early 1960 just before the 1960-61 recession
and it also just about equalled the average rate for the year 1951
during the Korean War '(although it was well below the quarterly

peaks of $15 billion reached in late 1950 and again in early 1951).
However, in those earlier periods, inventory accumulation represented
a much larger proportion of GNP.
Despite the large run-up in stocks in late 1965, the stocksales ratio for manufacturing and trade was at a new low for this
expansion period in December.

With steel liquidation ending, total

nonfarm inventory accumulation is projected to hold at the fourth quarter

II - 3

rate in the first half of 1966.

If, as appears likely, business sales

show less than the very sharp fourth quarter run-up, stock-sales ratios
might be expected to rise somewhat, but they would still remain low by
standards applicable to previous cyclical expansion periods.

Accumu-

lation of farm stocks, which speeded up so much in the last half of 1965,
is expected by the Department of Agriculture to start receding in the
current quarter, and, with the decline in the rate of accumulation of
farm stocks, over-all inventory investment is projected at a slightly
lower rate in the first half of this year.
With gains in personal income running larger in late 1965,
consumption expenditures speeded up somewhat.

It might be noted that

retail sales -- now available on a revised sample basis -- showed a very

sharp run-up in late 1965 (they

increased as much from September to

December as they had in the preceding nine months) but part of this
rise has been judged by Commerce to be an aberration due to the shift
in samples and has not been incorporated in their fourth quarter consumption estimates.
Following the sharp run-up in late 1965, retail sales have
changed little thus far in 1966 at a level moderately higher than the

fourth quarter average.

While some slowing of the rise in consumption

expenditures was expected in the current quarter as the social security

tax boost slows the rise in personal income, presently available retail
sales figures may be exaggerating the current slackening just as fourth
quarter figures apparently exaggerated the rise.

In January, social

II - 4

security tax increase -- from extension of the wage base as well as
from the upping of rates -- was debited against personal income and the
income rise was quite small.

In February, it is expected that large

increases in income will be resumed, and renewed expansion in retail
sales should also soon develop.

Whether consumer spending expands more

than now projected will depend partly on the course of war in Vietnam,
including the possibility that consumer anticipations of shortages of
certain consumer goods might develop.

There is little evidence as yet

of much, if any, scare-buying in the current situation.
Business fixed investment has been providing a strong underpinning to growth in GNP.

The large increases in this sector estimated

for the fourth quarter and projected for the first two quarters of this
year are based primarily on business plans for new plant and equipment
spending as reported in the Commerce-SEC survey conducted last November.
In confirmation of these plans, unfilled orders for machinery and equipment have expanded further since November as have pressures on capacity.
A capacity utilization rate of 92 per cent in December and January would
be expected to support, if not augment, manufacturers' earlier plans for
a large further expansion in plant and equipment outlays in the first
half of this year.

A new official reading on business fixed investment

plans -- this time for the entire year 1966 -- will be available shortly.

II -

February 24, 1966

GROSS NATIONAL PRODUCT AND RELATED ITEMS
(Expenditure and income figures are billions of dollars,
seasonally adjusted annual rates)

1964

1965

1965
II
III

1966 -Proj.
II
I

Gross National Product

628.7

676.3

668.8

681.5 697.2 713.0 726,5

Personal consumption expenditures
Durable goods
Nondtrable goods
Services

398.9
58.7
177.5
162.6

428.7
65.0
189.0
174.7

424.5
63.5
187.9
173.1

432.5 441.0 448.3 456.5
68.0
65.4
66.4 67.0
190.5 195.0 199.0 202.5
176.7 179.6 182.3 186.0

Gross private domestic investment
Residential construction
Business fixed investment
Change in business inventories
Nonfarm

92.9
27.5
60.5
4,8
5.4

105.7
27.6
69.8
8.2
7.9

102.8
28.0
68.4
6.4
6.6

106.2 110.3 112.8 114.5
27.9 27.6
27.7 27.2
70.9 73.0 75.0 77.3
9.9 9.6
7.6 10.1
7.0
8.9
8.9 8.9

8.6

Net exports

8.0

7.4

6.9

7.5

8.0

Gov. purchases of goods and services
Federal
Defense
Other
State and local

128.4
65.3
49.9
15.4
63.1

134.8
66.6
49.9
16.7
68.2

133.5
65.7
49.2
16.5
67.8

135.4 139.0 144.4 147.5
66.5 69.2 72.5
74.0
49.8 52.0
54.5 55.7
18.3
16.7 17.2
18.0
68.9
69.8
71.9
73,5

Gross National Product in Constant
(1958) Dollars

577.6

609.6

603.5

613.0 624.4 635.0 642.7

Personal income
Wages and salaries

495.0
333.5

530.7
357.4

524.7
353.6

536.0 546.0 556.0565.3
359.0 368.1 376.5 383.8

12.4

13.2

13.0

435.8
26.3
6.0

465.3
24.9
5.4

458.5
22.4
4.9

77.0
2.7
74.2
70.4
3.9

78.4
2.7
75.6
72.2
3.5

78.2
2.7
75.5
71.9
3.6

5.2

&.6

4.7

Personal contributions for social
insurance (deduction)
Disposable personal income
Personal saving
Saving rate (per cent)
Total labor force (millions)
"
Armed forces
Civilian labor force "
Employed
Unemployed
Unemployment rate

"
"
(per cent)

5.2

4.7

13.3

13.6

471.2 480.3
26.8
27.1
5.7
5.6
78.5
2.7
75.8
72.4
3.4
4.4

4.~4

78.9
2.8
76.1
72.9
,3.2
4~?

16.6

16.8

488.4 497.7
27.6
28.3
5.7
5.7
79.6
2.9
76.7
73.8
2.9

80.1
3.0
77.1
74.3
2.8

1 _R
~R

3.6
3.6

II - 6

Industrial production. In January, industrial production rose
to 149.9 per cent of the 1957-59 average, a rise of 1.0 per cent over
December and of 8.2 per cent over a year earlier.
materials rose 1.2 per cent from December.

Output of industrial

Business and defense equip-

ment increased by nearly the same proportion as materials, but output of
consumer goods did not change.

Consequently, the increase in total

final products was only 0.5 per cent.
Auto assemblies declined slightly to an annual rate of 9.2
million as one manufacturer suspended production for part of January.
Output of television sets, household appliances and furniture continued
to expand, but apparel production was curtailed by the transit strike
in New York City.

Increases in production of machinery were widespread.

Iron and steel output rose more than 3 per cent in January,
continuing upward from the low point set in November.

However, it

remained about 13 per cent below the levels of last spring and summer.
At the end of December, inventories of steel mill products at manufacturing consumers were down nearly a fourth from their peak in August
and totaled 13.1 million tons -- equivalent to about 2-1/3 months'
supply at 1965 consumption rates.

In January, production of most other

materials also advanced.

Retail sales.

With a new reporting sample in effect, Census

figures on retail sales have been revised upward substantially beginning
last October,

The new figures show a rise of 4.3 per cent from September

to December, whereas the advance figures (available 4 weeks ago) had

II - 7

indicated an increase of only 2.2 per cent.

Both durable and nondurable

goods shared in this upward revision, as indicated in the table below.

PERCENTAGE INCREASE FROM SEPTEMBER TO DECEMBER 1965
Old.
series
Total retail sales

4.3

2.2

Durable goods

Revised
series

4
6

Automotive

Furniture and appliances

Other durables

Nondurable goods

2
3
2
3
-3
0
1

-1
5
2
7
1
1
5

Lumber and hardware

Apparel
Drugs
Eating & drinking places
Food
Gas
General merchandise
Other nondurables

Following the sharp run-up now indicated for late 1965,
retail sales were down slightly in January, according to advance figures,
but in early February, weekly figures indicate slight increases for both
durable and nondurable goods.

In January, total retail sales were

reported to be up 8 per cent from a year earlier, with sales of durable
goods up 6 per cent and of nondurable goods up 10 per cent.
The sample revision, which has resulted in substantially
higher levels of retail sales in recent months, was designed, according

II - 8

to the Census Bureau, "both to improve the reliability of the estimates
and to bring them more closely in line with the 1963 Census of Business
results."

The old figures were tied into the 1958 Census.

Unit auto sales and stocks.

Sales of new domestic automobiles

rose to an annual rate of 9.4 million units in January, a gain of 10
per cent over December, and were nearly as high as the record rate a
year earlier when sales were boosted by a backlog of demand from the
auto strike period.

Dealer deliveries in the first 20 days of February,

were down more than seasonally from their level in early January and
pointed toward a rate of less than 9.0 million for the month as a whole.
At the end of January, dealer inventories of new cars were down a little
from a month earlier and represented about 58 days' supply, a somewhat
higher ratio than is usual for this season.

Consumer credit.
ment debt in 1965.

Consumers added $8 billion to their instal-

This was by far the largest dollar increase on record,

but in percentage terms it ranked well behind such years as 1955 and
1959.
Auto credit, which dominated the movement in the total even
more than usual, rose $3.7 billion, more than 45 per cent of the total
increase.

While much of the expansion in auto credit was a direct

reflection of the rise in unit auto sales, some of it resulted
from the gradual upcreep in size and length of instalment contracts and
in the proportion of new cars sold on credit.
percentage point in 1965.

The proportion was up 1

Meanwhile, the average note for new cars was

II - 9

nearly $50 higher than in 1964.

As to maturities, perhaps the most

significant development in 1965 was the continued steady rise in the
proportion of new car contracts written for 36-months, the typical
maximum maturity.

By the end of the year, three-fourths of all contracts

fell in this category, an increase of about 2 percentage points from
a year earlier.
Other consumer goods credit rose about $2 billion in 1965, with
much of it coming from increased sales of television sets, appliances,
and other home goods.

Personal loans outstanding also rose $2 billion,

with the sharpest increases coming early in the year at tax time.
The pace of instalment debt growth was faster during the first
half of the year because of a rising volume of auto and personal loans,
and a little slower in the second half.

The December rise was at a

$7.8 billion annual rate and, based on an early report from the
commercial banks, the January increase was probably about the same.
There was a sharp rise in auto credit in December and a further sharp
rise would seem likely for January, given the usual relationship between
credit extensions and sales.

Orders for durable goods.

New orders for durable goods,

which had increased sharply in December, rose somewhat further in
January as large gains in aircraft and electrical machinery more than
offset moderate declines for steel, fabricated metals, and machinery and
equipment.

For the latter three industries, new order gains had been

large in late 1965.

- 10

Shipments of durable goods rose more than new orders in
January -- shipments of machinery and equipment showed an especially
The

large rise -- but unfilled orders expanded substantially further.
ratio of unfilled orders to shipments, at 2.8, was about unchanged
from other recent months but was slightly higher than a year ago.
Total durable new orders in January were up 11 per cent
from a year earlier.

Shipments were up by the same amount, while un-

filled orders were up 17 per cent,

Business inventories.

The pace of inventory accumulation in

manufacturing and trade accelerated during the fourth quarter, starting
with $685 million in October -- about the third quarter rate -- and
ending with nearly $1.2 billion in December.

The December rate about

equalled last March, the peak month of the first half steel and auto
stock build-up.
For the entire fourth quarter the book value increase totaled
$2.7 billion, moderately above the first quarter.

However, on a GNP

basis, after allowing for larger price increases in the fourth quarter
and a lower rate of accumulation in industries not covered by the
monthly book value figures total, nonfarm inventory accumulation in the
fourth quarter was at a seasonally adjusted annual rate of $8.9 billion,
slightly lower than the $9.2 billion rate in the first quarter.

Including

farm stocks, total inventory accumulation in the fourth quarter was $10.1
billion, a new high for this expansion period.

- 11

The fourth quarter inventory build-up -- at a rate much higher
than had been expected -- was widely dispersed throughout the manufacturing and trade sectors.

In marked contrast to the three earlier

quarters of the year, steel inventories were being liquidated at a
very fast pace from October on.

Nevertheless, inventory accumulation

by durable goods producers in the fourth quarter about equalled the
average rate for the first three quarters of the year.
A special feature of fourth quarter developments was a marked
upturn in accumulation by nondurable goods producers -- with much of it
concentrated in December.

However, this followed relatively low rates

of accumulation during the first three quarters and was accompanied by
a sharp rise in shipments; the stock-sales ratio in December was below
the average for the year.

A similar spurt in inventories and shipments

in the fourth quarter 1964 was followed by a slowdown in early 1965.
The fourth quarter increase in trade inventories was sharply
higher than the third quarter increase but it was well below the record
first quarter rise.

Accumulation of auto stocks -- which proceeded

throughout the year -- was at amuch less rapid rate than earlier in the
year but nevertheless accounted for nearly a third of the final quarter
increase.

A large rise in stocks at retail food stores accounted for

another third of the trade inventory increase in the fourth quarter;
earlier in the year food stocks had shown no change.

The spurt in

book value of retail food stocks accompanied a very sharp increase in
sales (7 per cent between September and December), and both reflected
in part a run-up in food prices.

CHANGE IN BOOK VALUE OF BUSINESS INVENTORIES
(Quarterly totals, seasonally adjusted, millions of dollars)
1964

1965

Fourth

First

Second

Third

Fourth

quarter

Manufacturing & trade, total

2,031

2,497

2,017

1,918

2,713

Manufacturing
Durable goods
Nondurable goods

1,925
1,375
550

764
560
204

917
979
- 62

1,642
1,349
293

1,624
877
747

Trade
Wholesale
Retail

106
239
- 133

1,733
603
1,130

1,100
346
754

276
245
31

1,089
182
907

Construction activity. New construction put in place rose 3 per
cent in January to a seasonally adjusted annual rate of $74.1 billion,
based on data incorporating revised series now being introduced by the
Census Bureau.

(See appendix note.)

Altogether, the total was 8 per

cent above a year earlier and moderately above the previous peak reached
last September.

Residential expenditures, benefiting from a recent

upturn in starts, rose appreciably further in January, to nearly the
March 1964 high.

Expenditures for private nonresidential construction

also advanced, while public construction changed little.
Seasonally adjusted housing starts, which spurted one-fourth
from October to December, lost about half of that advance in January.
A decline had been expected in view of the unusually high annual rate -1.76 million -- reached in December when weather conditions in the North
Central states were particularly favorable.

On a three-month moving

average basis, starts in the November-January period were at an annual rate
of 1.62 million, only 5 per cent below the recent peak reached in the first
quarter of 1965.

II - 13

Seasonally adjusted building permits also dropped in January,
particularly for multifamily structures which had accounted for all of
the rise in permits in the previous two months.

Except in the West,

where activity has been unusually low, all regions shared in the January
decline in both permits and starts.
PRIVATE HOUSING STARTS AND PERMITS
January 1/
(thousands
of units)

Per cent
change from
Month ago I Year ago

1,537

-13

+ 7

1,214
716
498

8
- 3
-16

- 5
- 3
- 9

North East

241

- 4

+ 1

North Central
South

341
387

-20
-13

- 2
- 7

West

245

+20

-12

Starts

(total)

Permits
(total)
family
1
2-or-more family

1/ Seasonally adjusted annual rate; preliminary.
Personal income.

Personal income rose $700 million in January

to a seasonally adjusted annual rate of $551.6 billion.

The rise was

checked by a $2.8 billion increase in personal social insurance contributions.

The increase in social insurance taxes was from 3.625 per

cent to 4.2 per cent of taxable wages for both employees and employers
and the taxable earnings base rose from $4,800 to $6,600; both of these
changes were effective at the beginning of the year.

Personal income

would have risen $3.5 billion (annual rate) in January if social
security taxes had remained unchanged.
monthly increase last year.

This about equals the average

- 14

Labor market. Demands for labor continued very strong in
January.

Employment again rose sharply with gains widespread.

is made for the New York transit strike, increases in non-

allowance

farm employment in January were close to the extremely high rates of
November and December.

Over the past three months more than 1.1 million

jobs have been added to nonfarm activities, an annual rate of increase
of 7 per cent.
Almost all industries showed advances in January.

In durable

goods manufacturing, employment gains were as large as in the two
previous months and the workweek rose to a new postwar record of 42.4
hours -- .2 above December.

(During the Korean War average hours in

durable goods were never above 42.0 hours.)

Most nondurable goods

industries showed further gains but they were largely offset by a
decline of 16,000 in the apparel industry because of the New York
strike.

The workweek was also sharply curtailed in the apparel industry

causing the nondurable group total to decline somewhat.

Thus, except

for the strike, average hours of work in manufacturing would have been
at a new high, instead remaining at the November and December level.
Employment continued to advance at a fast pace in trade and
Government.

Federal civilian employment which has been rising steadily

since early summer increased by 17,000 in January.

At 2.4 million,

Federal employment was 70,000 above a year earlier; in contrast,
Federal employment had shown no change in the two previous years.

After

rising sharply at the end of last year, construction employment leveled
off in January at close to the high December level.

II - 15
The total employment rise in January was again larger than the
increase in the labor force and the unemployment rate declined to the
4.0 per cent interim target.

Significantly, the proportion of short-

term job seekers, (those seeking work less than 4 weeks) accounted for
over one-half the total unemployed, the first time the proportion has
been this high since early 1957.

UNEMPLOYMENT RATES
(Seasonally adjusted)
January
1965

1966

1953

1956

2.9

4.0

4.8

4.0

Males
14-19 years
20-24 years
25 years & over

6.2
4.1
2.5

9,3
6.5
3.1

16.0
7.1
3.1

11.4
4.2
2.5

Females
14-19 years
20-24 years
25 years & over

7.2
3.9
2.5

10,7
5.9
3.6

17.0
7.5
4.0

12.8
7.1
3.3

Total, all ages

Substantial inroads have been made over the past year in
unemployment rates for all groups.

Relatively, the sharpest declines

have been among men 20-24 years of age, reflecting the impact of expanding
draft calls on unemployment.

Not only have draft calls been met mainly

from this age group, but they have also apparently induced larger college
enrollments than had been anticipated.

The teenage unemployment rate

has been declining noticeably in recent months and, although still high,
it is significantly below a year ago.

- 16

Current unemployment is much more heavily concentrated
among young inexperienced workers than in earlier periods of low
unemployment.

This reflects the change in population structure in recent

years, with much of the increase in working age population now in the
early age groups.

Among adult men, whose population has been relatively

stable in recent years, unemployment rates are now well below those in
In fact, for all male groups, except the teen-

the 1956-1957 expansion.

agers, unemployment rates have been reduced to close to those during the
Korean conflict when the over-all rate fell below 3 per cent.

Wages. As the available supplies of labor have diminished
wages have moved up more rapidly and increases spread more widely.
Most industries show higher rates of increase from the fourth quarter of
1964 to the fourth quarter of 1965 than they did on average for the year
1965 as a whole.
AVERAGE HOURLY EARNINGS
Annual per cent increases
1951-52
1955-56
1964-65

QIV 1964QIV 1965

Manufacturing

5.8

4.8

3.2

3.5 1/

Construction

5.4

4.9

3.7

4.2

Retail trade

4.4

4.5

4.0

4.9

Telephone

6.7

2.2

3.1

3.3

Telegraph

9.2

5.3

3.6

4.7

Banking

n.a.

3.9

4.0

Laundries

n.a.

4.9

5.0

1/ Quarterly average is November, December and January.

- 17

Even in manufacturing, where employment pressures were slow
to develop, an upward drift in wages now appears to be getting underway
with the rate of increase in the past three months somewhat higher than
the average for 1965.

Apparently, higher overtime pay, upgrading of

some jobs and wage scales to limit turnover of skilled workers, and
more rapid increases in wages in the nonunion sector have pushed up
hourly earnings somewhat, despite the relatively few new union contracts
signed in the period.

Wholesale prices. The industrial commodity price index rose .2
per cent from mid-December to mid-January, and is estimated to have
increased .1 per cent further into late February.

The index, estimated

for late February at 103.1 per cent of the 1957-59 average, was up .4
per cent from 3 months ago and .8 per cent from 6 months ago, and thus
is rising at an annual rate of slightly over 1.5 per cent.

Average

prices of foodstuffs rose an additional 2 per cent in January and
February, largely as a result of short market supplies of livestock and
weather damage to vegetable and fruit crops.

The estimated total wholesale

price index has increased nearly 1 per cent further since December, and
is almost 4 per cent above a year ago.
From mid-December to mid-January, 58 per cent of the industrial
commodity subgroups exhibited price increases (compared with 48 per cent
in each of the two months previous), 27 per cent were unchanged, and 15
per cent declined.

Prices of hides and leather in January rose sharply

further to a level more than 10 per cent above a year ago.

Leather

II - 18

footwear also rose further, following the rise in material costs, and
was 5 per cent above the previous year.

Lumber rose nearly 1 per cent,

in part because of favorable weather for construction in many parts of
the country, and paper products also increased.

Machinery prices

rose further, led by metal working machinery which was up .4 per cent,
Metals increased again, mainly as a result of the continuing upward
drift in steel scrap, copper scrap, and copper tubing.

Man-made fiber

textile products again declined and some declines also occurred among
organic chemicals,
A continuing series of strikes in Chile has accentuated the
worldwide copper shortage.

While the domestic producer price is 36

cents a pound and the foreign producer price is 42 cents, the price in
the London "free" market has risen to 84 cents, and the domestic scrap
price to nearly 50 cents.

Most domestic copper users are paying

varying weighted averages of the several prices -- probably in the range
from 38 to 45 cents a pound.

II - 19

WHOLESALE PRICE INDEXES
1957-59 = 100

Commodity Group

Per cent increase to January 1966
from
Dec. 1965
Jan. 1965
Jan. 1960
(72 months)

(12 months)

Index
January
1966

(1 month)

4.1

3.6

0.5

104.6

1.4
0.7
1.9
1.2
3.4

1.5
1.7
1.1
1.0
1.1

0.2
0.2
0.1
0.1
0.1

103.0
102.3
103.6
102.4
106.0

Foodstuffs
Livestock and products
Crops and products

12.8
17.0
8.1

9.9
18.5
1.5

1.2
0.9
1.6

109.1
111.6
106.3

Addendum:
Industrial commodities:
Less metals & machinery
Metals and machinery
Nonferrous metals

0.3
2.9
10.8

1.4
1.5
6.0

0.2
0.3
0.9

101.1
105.7
118.2

Total index
Industrial commodities
Industrial materials
Industrial products
Consumer nonfood
Producer goods

II-c.1
ECONOMIC DEVELOPMENTS - UNITED STATES

2/23/66

SEASONALLY ADJUSTED

INDU STRILA L P R OD U CTION -I
"""i""

1957-59.100
RATIO SCALE

"."

160
JAN 1501
JAN
149 9

TOTAL
MATERIALS

1960

1962

1964

1i i1i" 4Jsllu
i--

1966

PRICES

CONSUMER

1957-59-400

"
"""llll.

""'

RATIO SCALE
NOT S A

112

DEC 1110
ALL ITEMS

107

102
WHOLESALE

INDUSTRIAL COMMODITIES

JAN 1037

105

IJAN 1030

100

II--C-2

2/23/66

ECONOMIC DEVELOPMENTS - UNITED STATES
SEASONALLY ADJUSTED

BUSINESS INVESTMENT
I I

BILLIONS OF DOLLARS, ANNUAL RATES
RATIO SCALE-

60
589
589

NEW PLANT AND
EQUIPMENT
1
EXPENDITURES
(COM

I II

SEC)

30
PER CENT

-12
GNP FIXED INVESTMENT
AS SHARE OF GNP

oQ.
5
os

t l1 11l 1 III
l
111
l
1960

1962

1964

1966

RETAIL SALES
T7T ITTTTTI

1960 61 110RATIO SCALE

JAN
1610

NEW

ALL DURABLE GOODS

m,_1

J
U.S. AUTOS I\1
UNITS
I

MACHINERY AND
EQUIPMENT
I

1,5
6

l A 44

11111111111
1
II lIItII11

1964

1962

1960

1966

BUSINESS INVENTORIES,
ll

ADTEDIV

ALI

NONFARM

I II I

f
I tI '

ANUA
ANNUAL RAl
RATES

BILLIONS OF DOLLAR

5.0

BILLIONS OF DOLLARS

8 9

10.

GNP BASIS
-----

5 .C

0I
5.0
INVENTORIES/SHIPMENTS
NET CHANGE

I--

1960

IN OUTSTANDINGQo

. I ml lilill1
I,
I

1962

1964

RATIO

1 46

1.5
MANUFACTURING
AND TRADE

I I 1

I I I

1966

1.3

1960

1962

1964

1966

III - 1

DOMESTIC FINANCIAL SITUATION

Bank credit.

Total loans and investments at city banks

declined substantially in late January and early February, as these banks
remained under pressure.

Although loan expansion moderated in recent

weeks, city banks continued to make substantial reductions in holdings
of U.S. Government securities and their holdings of other securities
rose much less than usual.

At banks outside leading cities, funds

continued to be readily available in January; they added nearly $1
billion to their holdings of Governments and also made additions to

their holdings of municipal and agency issues.

In the first half of

February, however, credit at these banks showed a small contraseasonal

decline.
In the four weeks ending February 16, total loans at city
banks rose much less than usual, mainly reflecting a large drop in
security loans.

Broker loans declined sharply, presumably in large part

in response to firmer lending policies--the rate charged on these loans
was raised to 5-1/4 per cent in late January--and increased participations
with correspondent banks.

Loans to Government securities dealers also

declined as dealers reduced trading positions in response to increased
financing costs and expectations of further advances in market yields.
Business loan demand moderated in recent weeks from the accelerated pace in December and early January.

Nevertheless, the rate of

growth has continued fairly rapid, after allowance for usual seasonal

III - 2

changes, possibly at about the November level.

The industries accounting

for the growth in business loans are fairly widely distributed.

But

with the exception of public utilities, they are not industries in which
estimated plant and equipment expenditures, seasonally adjusted, show
a large rise from the fourth quarter of 1965 to the first half of 1966.
Thus, the increased borrowing presumably is associated with inventory
accumulation and other expanded working capital requirements, although
it could also reflect some anticipatory borrowing as well as delayed
financing of some fourth quarter investment outlays.
The recent slackening in business loan expansion is believed
to be temporary.

With liquidity of corporations already thin,

their

needs for bank loans are expected to rise substantially in March and
further in April.

Assuming that the proposed legislation for acceleration

of corporate tax payments is enacted,

those payments in the second

quarter are estimated to total $11.3 billion, or $3 billion more than
in the same period last year.

Bank deposits and the money supply.

The money supply declined

substantially over most of January after reaching a peak in the week of
January 5, but it edged up somewhat in the first half of February.
Assuming only seasonal movements over the remainder of the month, the
increase for February would be nominal and mainly in currency.

This

reaction to the December-early January surge in money growth was similar
to those that occurred after growth spurts in the past.

Moreover, with

increasingly attractive yields available on other financial assets,

III - 3

particularly marketable securities, there could have been some transfers
of funds from demand deposits into other financial assets.
Growth in time deposits at commercial banks slackened further
in late January and early February to an annual growth rate of about
6 per cent, less than half the fourth quarter rate.

The slowdown

was concentrated at city banks, where a substantial part of the time
deposit inflow in recent years has been from depositors, particularly
large corporations, that have relatively uneven funds flows, are highly
interest-sensitive, and have a variety of alternative outlets for their
funds.

At country banks, where savings inflows are mainly of local

origin, personal, and less interest-sensitive, time deposit growth
recently has accelerated.

These inflows help explain the large January

rise in holdings of investments at these banks.
Notwithstanding further advances in offering rates, city
banks continue to encounter difficulty in attracting and holding CD
funds.

Following past quarterly tax period run-offs, these banks

generally had reattained the pre-tax period peak of outstandings in
about a month.

After the December 1965 run-off, outstandings did not

approach the earlier peak until late January at New York City banks and
early February in Chicago, and in the week of February 16, reflecting
in part recent shortening of maturities, New York City banks experienced
run-offs three-fifths as large as those during the December tax and
dividend period.

At banks outside these cities, outstandings have

recovered less than three-fourths of the December decline.

III - 4

The outflow of savings deposits at city banks, which had
been substantial in early January, slackened late in the month and
appears to have been reversed in early February.

This turnaround pre-

sumably reflects completion of adjustments in savings stocks in response
to changes in interest rates and in savings instruments which became
effective at many institutions at the turn of the year.

In some

areas, however, the 4 per cent ceiling on savings deposits may have
become an impediment to effective competition with other savings
institutions, and savings deposits are continuing to decline.
While city banks have been attracting sizable amounts of funds on
savings certificates and other nonpassbook instruments, their
total inflows of time and savings deposits in recent weeks have
been less than one-third as large as those in the comparable
weeks last year.

III - 5

U.S. Government securities market.

Yields on U.S. Government

securities have continued to move higher in recent weeks and are currently
above their peaks of late 1959--early 1960 in the longest maturities.
The 3-month bill rate advanced to a new record high of 4.70 per cent
in mid-February and has fluctuated just below that level recently.

YIELDS ON U.S. GOVERNMENT SECURITIES
(Per Cent)
Date
3-month
Date
3h
(closing bids)
bills

6-month
th
bills

3 years

5 years

4.68
2.08

5.15
2.33

5.17
3.08

5.11
3.30

4.90
3.63

4.51
3.70

Highs
Lows

4.70
3.76

4.89
3.81

5.08
4.00

5.01
4.08

4.95
4.17

4.76
4.17

1965-1966
Dec. 3
31

4.12
4.49

4.26
4.67

4.54
5.00

4.52
4.88

4.52
4.65

4.44
4.52

4.64
4.70
4.69

4.77
4.89
4.89

4.98
5.08
5.08

4.97
5.00
4.98

4.72
4.90
4.95

4.65
4.75
4.76

1959-1961
Highs
Lows

10 years

20 years

1965-1966

Feb.

8
16
23

The continuing rise in yields on Treasury notes and bonds has
occurred against a background of continuing talk of inflationary developments in the domestic economy, discussions of possible tightening of
monetary policy, and heavy current and prospective demands on the credit
markets.

Bond market participants apparently have decided that interest

rates are likely to work higher before a new trading level is reached.
In the circumstances, dealers have been reluctant to take on bonds, and

III - 6

while investment demand has not been stimulated by rising yields on
intermediate- and long-term Treasury bonds, investment selling has also
remained relatively light.

Market sentiment was further weakened

recently by the poor reception accorded the $700 million Export-Import
Bank issue of participation certificates for which subscriptions totaled
only $360 million.

In addition, a $410 million offering of 1-15 year

participations certificates by FNMA scheduled for mid-March was expected
to place further pressure on the Treasury bond market.
There has been some investment demand for shorter-term coupon
issues, including the new 5's of November 1970 which are currently
trading at a small premium.

Dealer positions in the new 5's had

reached minimal levels on the February 15 payment date, owing in part
to Treasury investment account purchases of the new issue.

The System

bought about $44 million of short-term coupon issues on February 17,
its first purchases outside the bill area since early September 1965.
Treasury bill rates have risen in recent weeks, especially
rates on the longer maturities which have encountered considerable
competition from rising new issue rates on CD's and on Federal agency
issues.

Demand for bills has been seasonally strong but has tended to

favor shorter maturities where reinvestment demand from the proceeds of
recent capital issues has been concentrated.

Dealer positions in bills

remain at relatively low levels.
The recent advance in yields on selected short-term debt

instruments is indicated in the table:

III

- 7

SELECTED SHORT-TERM INTEREST RATES 1/
1965-66

Dec. 3

Jan. 28

Feb. 23

Commercial paper 4-6 months

4.375

4.875

Finance company paper 30-89 days

4.375

4.875

Bankers' Acceptances 1-90 days

4.25

4.75

4.875

4.50
4.50

4.90
5.00

5.00
5.125

Secondary market:
3-months
6-months

4.49
4.57

5.00
5.13

5.07
5.20

Municipal Note 1-year

2.70

2.85

3.05

Federal Agencies

4.49

4.90

5.03

Certificates of deposit (prime NYC)
Most often quoted new issues
3-months
6-months

6-month

1/ Rates are quoted on offered side of market; rates on commercial
paper, finance company paper, and bankers' acceptances are quoted on
a bank discount basis while rates on the other instruments are on an
investment yield basis.

Treasury finance.

With the completion of its combination

refunding and pre-refunding operation in mid-February, the Treasury has
substantially accomplished its financing program for the current fiscal

year apart from a possible cash financing of perhaps $1/2 billion in
late March or early April and a routine refunding in May.

The Treasury

is also expected to continue its $100 million additions to the weekly
3-month bill auctions until the end of the current quarter.
The Treasury will experience a large seasonal drain in its
cash operating balances during the first half of April
and these balances will probably be drawn

III -

down to very low levels even with a projected $1/2 billion cash borrowing
in the market.

Thereafter, strong seasonal receipts will serve to

rebuild the Treasury's cash balances until the next period of sustained
cash drains in July.

Corporate and municipal bond markets.

The further general

advance of interest rates since the latter part of January has amounted
to nearly 20 basis points in the market for new corporate bonds and to
12 basis points in the market for highest quality seasoned municipal
securities.

These increases have extended the more general yield

advance which began in these markets about a year ago, to 70 basis
points for new corporate issues and to nearly 60 basis points for
municipal issues,

Much of the recent further stimulus to yields has

come from the heavy immediate volume of new security issues.

But the

sharpness of the advance has also reflected market expectations that
future demands for long-term funds will substantially exceed the supplies
available from usual institutional sources.
BOND YIELDS
(Per cent per annum)
Corporate
Aaa
Seasoned
New

State and local Government
Bond buyer
Moody's
(mixed qualities )
Aaa

Previous
Postwar High

5.13(9/18/59)

4.61(1/29/60)

3.65(9/24/59)

3.81(9/17/59)

1965 Low

4.33(1/29)

4.41(3/12)

2.94(2/11)

3.04(2/11)

4.56
4.79
4.84
5.02

4.48
4.60
4.74
4.79

3.16
3,37
3.39
3.51

3.25
3.50
3.51
3.70

Weeks ending:
July 23
Dec. 3
Jan, 21
Feb. 18

III

Public offerings of corporate bonds have continued in record
volume during February and are expected to remain so in March when
a $250 million AT&T issue is scheduled for offering late in the month.
With corporate private placements reportedly also continuing at an
unusually high level and offerings of State and local government,bonds
expected to average more than $1 billion a month--thanks in part to
the $400-600 million New Jersey Turnpike issue scheduled for March-the gross volume of first quarter bond offerings in both markets may
total nearly $7 billion.

This would be the largest combined supply

of bonds ever offered in these markets in any quarter, exceeding the
next largest total for the usually light first quarter by nearly $2
billion.

Add to this the recent and prospective sales of Federal agency

participation certificates and the magnitude of immediate- and near-term
market pressures on interest rates becomes clear.
To some extent the unprecedented first quarter volume of
corporate financing in capital markets appears to reflect shifts in the
timing of offerings prompted by interest rate considerations.

Near the

end of 1965, planned financings by domestic corporations--estimated
to total more than $500 million (including private placements as well
as public offerings)--were reportedly deferred in the hope of obtaining
more favorable terms after the turn of the year.

In early 1966, however,

indications that interest rates would rise further, caused many of the
postponed corporate issues to come back in, and other business borrowers
moved to anticipate their 1966 financing requirements.

It is difficult

to judge how much of the 1966 business need for funds is being met by

III - 10

But given the projected further rise in business

anticipatory borrowing.

outlays relative to internal sources of funds, and given the usual
second quarter build-up of new issues in both corporate and municipal
security markets, new bond offerings are generally expected to exert
continuing pressures on yields as the spring progresses.
BOND OFFERINGS 1/

(In millions of dollars)
Corporate
Public
Offerings

1965-66
1965
Yearly
Average

1964-65

Private
Placements

1965-66e/ 1964-65

State & local Govt.

1965-66e/ 1964-65

474

300

707

604

938

904

October
November
December

287
613
326

181
30
320

574
529
1,161

642
645
1,342

867
1,018
768

852
578
1,078

January
February
March

430 2/
575
650

161
187
557

700
600
700

565
450
658

1,170
1,000
1,200

849
966
904

1966

1/ Includes refundings--data are gross proceeds for corporate offerings
and principal amounts for State and local Government issues.
2/ Excludes $600 million of U.S. Steel Corporation bonds, converted
from preferred stock on a "rights" basis early in January. While some
holders of the preferred stock "rights" may have sold them to other
investors through the market, the volume of such transfers is not known.

In the latest calendar week, however, the corporate bond market
exhibited a somewhat better tone.

A 5.05 per cent reoffering yield on

a triple-A rated corporate utility bond attracted a quick sell-out
and other offerings were quite well received.

With underwriters unsold

balances of new issues at a low level and with the volume of new public

III -

offerings scheduled for the current and immediately subsequent weeks
below the 1965 weekly average, it is possible that corporate bond yields,
following their sharp recent rise, are approaching at least a temporary
equilibrium.

On the other hand, spreads between yields on U.S. Treasury

bonds and those on both new and seasoned corporate bonds have recently
narrowed.

Hence yields in the corporate bond market are particularly

vulnerable to renewed market pressures.
In the municipal bond market, last week's 12 basis point yield
adjustment was the largest for any week since August 1958.

The size of

this advance represented a belated response by the municipal bond market
to developments already underway for several weeks in other bond markets.
As yields had risen in other bond markets, the advertised inventories
of municipal dealers had also grown, and when the slow receptions accorded
last week's two largest new offerings threatened a further inventory
build-up, dealers began to reduce prices in order to cut-back their
holdings of older issues.

Home mortgage markets.

Upward pressures on mortgage rates

are continuing this year, although apparently at a slower pace than at
the end of last year.

In early February, following two successive

downward revisions in FNMA secondary market prices designed to stem
the tide of offerings from private investors, the Federal Housing
Administration raised the permissive contract rate on new FHA-insured
home mortgages from 5-1/4 per cent to 5-1/2 per cent.

Such a move had long

been anticipated, although, according to the trade, the extent of the rise

III -

was still insufficient to meet competitive requirements, particularly
in the West where discounts tend to be large.
In January, yields on 5-1/4 per cent FHA-insured home mortgages
sold in the secondary market had already moved 8 basis points higher to
an average of 5.70 per cent.

This was 26 basis points above the average

just six months earlier and the highest since November 1961.
Contract interest rates on conventional mortgages for newhome purchase held at their advanced December level in January--6.00
per cent, 20 basis points more than a year earlier and the highest in
nearly five years.

Comparable rates on mortgages for existing home-

purchase were also unchanged in January, at 6,05 per cent.

These

averages, as reported by the Federal Housing Administration, are rounded
to the nearest five basis points.

Corporate profits.

After-tax profits of manufacturing

corporations, based on data now available for about 600 large companies,
appear to have been 18 per cent larger in the fourth quarter of last
year than in the same quarter of 1964.

This compares with year-to-year

increases in the first three quarters of 21, 18 and 16 per cent
respectively.

Part of the year-to-year gain in the fourth quarter

reflects the fact that profits in the fourth quarter of 1964 were
held down by strikes in the auto industry.
An increase of 18 per cent in reported profits after taxes
would mean an increase of 17-18 per cent in manufacturing profits
(before taxes) and inventory valuation adjustment, as presented in

III - 13

the Department of Commerce national income accounts.

Department of

Commerce estimates for the fourth quarter are not yet available; fullyear estimates imply a fourth quarter level (annual rate, seasonally
adjusted) of $38.3 billion for the manufacturing sector, 18 per cent
above the fourth quarter of 1964.

The implied fourth quarter estimate

for nonmanufacturing industries is $37.1 billion--a year-to-year
increase of 14 per cent, which seems reasonable.
A recent survey conducted by McGraw-Hill indicated that more
than 8 out of 10 corporations expect their profits before taxes to be
larger in 1966 than in 1965 and 5 out of 6 expect profit margins to
stay the same or increase.

In the light of these expectations, and

considering both the recent level of profits and anticipated further
expansion in economic activity this year, the expected rise in total
profits before taxes shown by the survey--only 6 per cent--seems small.
It would mean an average for this year only 2-1/2 per cent above the
implied fourth quarter 1965 level.
Stock market.

Stock prices have fluctuated rather widely

on very active trading so far this year, as stock traders have exhibited
a high degree of sensitivity to the numerous cross-currents that have
recently clouded the outlook for corporate earnings and stock prices.
After advancing 2.7 per cent from early December to a new high in midJanuary, Standard and Poor's composite index of 500 stocks dropped about
2 per cent in the latter half of January, only to rise to another new
high on February 9.

Since then, the index has dropped off again, by

III

- 14

more than 2 per cent, nearly to the level that prevailed in early
December.

Trading volume in the most recent decline has averaged 8.8

million shares a day, almost as high as in the preceding advance.
While forecasters are generally assuming a further growth
of 6 to 10 per cent in corporate profits during 1966--which at prevailing price earnings ratios (17.5 in the Standard and Poor's composite
index) would seem to justify some further general rise in stock prices-stock traders have apparently become sensitive to developments which
might change this outlook.

Each new rumor of peace possibilities

in Vietnam is reflected in stock price declines.

But at the same

time, the inflationary implications of possible further escalation
in the war also create worries--about higher business taxes, higher
costs, and official restraints on prices--and these also contribute
to price weakness.

Finally, on top of these war uncertainties, the

sharp further widening of spreads between stock and bond yields, the
mark-up in costs of call money, and rumors that an increase in margin
requirements may be imminent have created further hesitancy among
stock traders.
Customer credit in the stock market rose only $21 million in
January despite the continued heavy volume of trading, falling well
behind the monthly credit increases of $190 million and $400 million
which occurred in November and December.

A moderate increase in customers'

net debit balances with brokers more than accounted for the January
growth, as bank purpose loans declined slightly.

Adding the January

increase in customer net debit balances to the earlier increases

III - 15

experienced since stock market credit turned-up in August, the total
expansion for the full period amounts to nearly $700 million.

This

has carried total CNDB's to within $35 million of the $5,6 billion
record reached in November 1963.
The sharp drop in the rate of stock market credit growth from
December to January was partly attributable to the impact of transactions undertaken to defer the realization of capital gains taxes
into the new calendar year.

Thus, investors with large potential

profits in glamour stocks, wishing to realize these gains in the strong
year-end market without having to pay the gains tax until 1966, could
achieve both ends by borrowing additional stocks of the same company
and selling them short.

In this way the investor established a hedged

position, protected against further price variation; but he could
avoid the capital gains tax liability until the new tax year when the
short position would be covered with the stock already held.
Due in large measure to this practice, short-sales of stock
on the New York Stock Exchange rose to a record 11.7 million shares
in December, and then declined to 10.1 million shares in January, as
short positions were covered.

Since short-sales require a 70 per cent

margin under Federal Reserve regulations, this December-January buildup and decline was sharply reflected in the volume of outstanding margin
debt; that is, the December increase was inflated and the January increase deflated.

Averaging the two months together, total stock market

credit rose $210 million per month, slightly more than in November.

III-C-1
FINANCIAL DEVELOPMENTS - UNITED STATES

MARKET YIELDS-BONDS & MORTGAGES
PER CENT I

I-

111ll

NEW HOME FIRST MOCRTGAGES:

25
-

IVENTIONAL

D
FHA INSUR ED-4

30-YEAR
,
1

BONDS:
v'

NEW

JAN

6006
57

JAN 484

CORPORATE Aaa

/
S

-JAN

4524

S20-YEAR U.S. GOVT.
JAN 3 40~
i

I-I

I
r
I
-L--I
STATE AND LOCAL GOVT. Aaa

1960

1962

1964

2/23/66

IV - I

INTERNATIONAL DEVELOPMENTS

U.S. balance of payments.

Preliminary indicators show a deficit

in January of $100 million on the liquidity basis, without seasonal adjustment, and small weekly surpluses in part of February. After some allowance
for seasonal influences -- which are strongly favorable in the first quarter
taken as a whole, and are probably favorable in this part of it -- the
The

balance for this month and a half appears to be a moderate deficit.

balance was adversely affected by payments in January of $146 million for
new Canadian security issues postponed from 1965 and by the conversion in
January and early February of $53 million of nonconvertible Roosa bonds
into liquid liabilities.

On the other hand the balance was favorably

affected by official Canadian purchases in January of $40 million of Canadian
securities from U.S. holders.
Balances owed by American banks to their foreign branches rose
by nearly $500 million in the seven weeks to February 16, following a
drop of nearly $400 million in the two weeks to December 29.

In large

part this swing reflected the return of funds of European commercial banks
to the Euro-dollar market after the year-end.

Italian banks, for example,

had borrowed dollar funds and drawn down dollar deposits by a total of
about $330 million in December, and are believed to have returned a somewhat smaller amount to the Euro-dollar market in January.

Without season-

al adjustment, the U.S. payments balance on basis of official reserve
transactions was in surplus by about $300 million in January, according
to preliminary data. This surplus,resulting as it does from movements of
commercial bank funds, must be regarded as mainly or entirely seasonal.

IV - 2

The recent movements of American bank branch balances at their head
offices have been of roughly the same magnitude as in corresponding weeks
at the end of 1964 and beginning of 1965.
U.S. banks' foreign assets under the VFCR declined by $210
million in January, substantially more than the normal seasonal drop for
that month.
New issues of foreign securities --

almost entirely Canadian --

are expected to amount to nearly $500 million in the first quarter, include
ing about $180 million of Canadian issues postponed from 1965.
the postponed issues the total would be about $300 million.

Without

Canadian

issues during all of 1965, plus the postponed issues, were about $900 million.
U.S. EXPORTS1/
(in billions of dollars)
1965/.
1963

1964

1965

III

16.7

19.3

20.2

20.9

21.6

Canada

3.6

4.3

5.0

5.1

5.6

Western Europe

5.6

6.3

6.4

6,7

7.0

Latin America

2.8

3.3

3.4

3.6

All others

4.6

5.4

5.5

5.6

5.4

5.6

6.3

6.2

6.7

6.8

Under Govt. programs

1.6

1.8

1.4

n.a.

Other

4.0

4.5

4.8

n.a.

Nonagricultural:

Agricultural:

1/ Including special category exports,destinations of which are not
available except for the four broad areas shown. Military grant-aid exports
are excluded.
2/ Seasonally adjusted annual rates; area distribution of nonagricultural
exports in December based on December area totals minus agricultural exports
distributed proportionately to October-November data.

IV - 3

Nonagricultural exports to Canada rose sharply in the fourth
quarter, and shipments to Europe also advanced strongly.
Australia and South Africa fell off.

Exports to

Total agricultural exports edged

up further from the advanced level reached in the third quarter.

For

the year 1965 as a whole, a drop in agricultural exports under Government programs was largely offset by an increase in commercial sales.

U.S. IMPORTS
(amount in billions of dollars)
Fourth quarter 19 6 5iAnnual rate
Increase
seasonally
from Q-III
(per cent)
adjusted
Industrial supplies:
Petroleum
Steel

Year 1965
Increase
Total
for 1964
(per cent)

11.54
2.10
1.21

0
-14

11.11
2.10
1.27

10
53

Nonferrous metals

1.76

1.58

Other materials

6,47

6.16

Capital equipment

1.81

1,59

Consumer goods:
Autos and parts
Other

4.52
1.12
3.39

23
4

4,11
.90
3.21

20
22

Foods and beverages

4.18

3.83

.82

.73

22.87

21.37

All other
Total

1965 Q-IV and Q-III data are after preliminary correction for
1/
statistical carryover; percentage changes in column two are subject to
possible errors of 1 to 3 per cent.
The further rise in U.S. imports from the third quarter to the
fourth occurred in all major categories except petroleum and steel, as
the second column of the table shows.

Steel imports fell off further

in December; in the third quarter they had been 70 per cent above the
1964 average, and by December they were down to about 130 per cent of

IV - 4

the 1964 average.

The unusually steep jump in imports of autos and

parts in the fourth quarter resulted in part from the elimination of
Accelerated

tariffs under the U.S.-Canadian automobile agreement.

advances in imports of industrial materials other than steel reflected
heavy U.S. demands for use and for inventory.

Imports of capital equip-

ment rose further, at an annual rate of nearly 30 per cent.
Interest rates in the Euro dollar market.

The seasonal tendency

toward rise and fall of rates over the year-end -- due in large part to
temporary withdrawals of funds from the market by commercial banks in
various European countries -- was superimposed this year on a rise closely
in line with U.S. money market rates.

The seasonal peak in 30-day rates

and in those for longer terms was reached early in December, after a
quick upsurge in the first half of the month.

But the subsequent dip

was followed by a rise in January for most rates, a highly unusual development at that time of.year.

A slight easing, thus far unexplained, occurred

in mid-February.
From mid-November to February 24, bid rates for Euro-dollar
deposits of various maturities rose by a little under 1/2 of 1 percentage
point for the longer terms, and by 3/4 of a point for call and 7-day money.
The latter rates then stood at 5 and 5-1/8 per cent, respectively.

The

90-day bid rate was 5-3/8 per cent.
Yields on new issues of dollar bonds in Europe by U.S. corporation
subsidiaries in January and February were 40 to 50 basis points higher
than on comparable issues in October and December.
European national financial markets.

Rates in interbank loan

markets on the Continent eased seasonally in January.

The underlying

IV - 5

tendency in short-term rates was perhaps still upward in Germany and
Switzerland, but much less so than it was in the Euro-dollar market.
A turn has occurred in the German bond market, where the banks made
heavy support purchases at the end of December, while new issues have
been limited.

Italian bond yields have come down again in recent months.

In Britain both short and long interest rates have risen somewhat further
in February.

The German public authorities have been following a program
to ration their bond market borrowings; for its part, the Federal government has planned a lower budget deficit in 1966.

New public authority

bond issues in January were less than one-half the amount floated a year
earlier.

The turn in the market began in late December when German banks

bought heavily in order to drive prices up and cut their bond valuation
losses for the year.

In early February, public authority bond yields

were down about 50 basis points from the record 8 per cent set in midDecember.
Upward adjustments were made in the rates on some money-market
instruments in January.

On January 7 the Bundesbank raised the rates

at which it stands ready to buy and sell Treasury bills and non-interestbearing Treasury bonds of various maturities up to 2 years.

The 2-year

selling rate was raised by 1/2 of 1 per cent, to 5-1/4; the 90-day rate
was moved up by 1/8, to the level of the Bundesbank's discount rate, 4 per
cent.

This action followed the introduction by the Dresdner Bank

several days earlier of its own notes bearing higher yields for similar
maturities, and later in January the Dresdner Bank raised its rates.

IV - 6

In the Swiss short-term money market, developments have
resembled those in Germany, with a seasonal easing after the year-end
but upward adjustments in certain rates including those on bankers'
acceptances and on one of the categories of savings deposits.
In Italy, bond yields were reduced in the fourth quarter;
from September to December, the monthly average composite yield on all
bonds except Treasury bonds declined 17 basis points.

The Italian com-

mercial banks continued to increase their bond portfolios rapidly as
the external surplus supplied reserves while domestic loan demand was
still rising only slowly.

The heavy additions to banks' bond holdings

helped to bring yields down by 40 basis points in the 12 months ending
in December.

The volume of new bond issues reportedly increased in

1965 (only annual data are published).
In France, the money market eased seasonally after the first
of the year.

However, the Treasury's outstanding borrowings from the

Bank of France remain significantly below earlier levels, tending to
hold down the supply of reserve funds to the banking system.

Conse-

quently, when the monetary authorities raised the banks' liquid assets
reserve requirement in January for seasonal reasons, they kept the
increase in the requirement ratio smaller than it would have been
otherwise.
In Britain, the U.S. discount rate increase ended any hope
of an early decline in money market rates.

In the following two weeks

the U.K. Treasury bill rate advanced 12 basis points, and the yield on
War Loan rose by the same amount.

In February there have been further

IV - 7

increases.

The rise from December 3 to February 18 amounted to 18

basis points for Treasury bills and again the same for War Loan.
The recent rise in short-term rates reflects in part the
seasonal squeeze on liquidity of the banks and discount houses, related
to tax collections, and in part official determination to bring the
balance of payments into equilibrium.

Weakness in the bond market may

be due in part to growing realization that the authorities will have
to take further action to achieve balance by the end of 1966.

Recovery

of confidence in sterling was partly self-reinforcing last autumn, but
psychological momentum now seems to have been lost.
Continued strength of aggregate demand for goods and services
in Britain, despite earlier credit measures, led to adoption of new
restrictive monetary measures in early February.
regulations were tightened:

Installment credit

the minimum downpayment was raised from

15 to 25 per cent (except on automobiles, on which it was already 25
per cent), and the maximum repayment period was shortened from 30 to 27
months.
In addition, the Bank of England announced a new and more
restrictive ceiling on bank credit supply.

The new request to the banks

asks that, for an indefinite period, bank credit to the private sector
(except for seasonal purposes) not rise above 105 per cent of the
amount outstanding in March 1965.

From March 1965 to January 1966,

bank loans rose at a seasonally-adjusted annual rate of only 3 per cent;
this rise compares with 12 per cent in the year-earlier period, and was
in fact slower than the 5 per cent expansion limit allowed for the 12
months ending March 1966.

From June to November 1965, installment credit

increased less than 1 per cent, at an annual rate, compared to a 7 per
cent annual rate rise during the same period in 1964.

IV - 8

However, the private sector made increasing use of other
credit sources during the closing months of 1965.

In September-December,

net new security issues by U.K. companies ran at a monthly average double
that of the previous eight months, and mortgage lending by the building
societies advanced sharply in the fourth quarter.
Japanese financial markets.

While the Bank of Japan's discount

rate has been unchanged since its reduction last June, and the principal
rate for call loans has not changed since October 1, average rates on
commercial bank loans and discounts have continued to decline gradually.
In December the average was 7.61 per cent, compared with 7.99 per cent
a year earlier.

The large city banks were charging their best customers

5.66 per cent in December.
With the rise in U.S. short-term interest rates, Japanese
domestic sources of import financing have become more competitive with
U.S. sources.

The cost of foreign borrowing was increased on December 9

when Japanese foreign exchange banks raised the principal rate of U.S.
dollar import acceptance bills from 7.00 to 7.25 per cent.

Concerned

that an extensive shift from external to domestic import financing
would affect the payments balance adversely, the Japanese authorities

in January temporarily suspended the preferential arrangements for import
financing known as the "import bill system."

(Under this arrangement,

yen-based credit for imports had been available to Japanese foreign
exchange banks from the Bank of Japan at a rate of 5.84 per cent with
a maximum two-month maturity.)
Precise comparisons of the interest rate differential on
Japanese import financing between Japan and the United States are difficult

IV - 9

because the rates vary, depending on such factors as the size or
credit standing of the borrower and the cost of cover in the forward
exchange market.

According to recent information from the Bank of

Japan, financing by Japanese companies of the highest credit standing
is about 0.4 percentage points cheaper in Japan, for the next category
of importer the cost is about the same in the two markets, and for the
smaller companies it remains cheaper to finance in the U.S. market.
Foreign bond flotations have also become increasingly unattractive to private Japanese business firms.

Currently Japanese

sources estimate that Japanese securities exempt from the I.E.T. would
have to be floated in the United States at a minimum yield of 6.3 per
cent to subscribers.

In Germany the rate would have to be 7.2 per cent.

Comparable domestic securities in Japan would carry a nominal rate of
7.3 per cent, and a 8.5 per cent cost to the issuer.

Although this

appears to make foreign borrowing still relatively attractive, other
considerations -- including possibly the lower cost of short-term funds
in Japan -- have reportedly discouraged private Japanese companies from
any further borrowing abroad for the present.
Canadian financial markets.

The Canadian Treasury bill yield

has moved up nearly 1/2 per cent since early December.

The rate for

90-day finance company paper, which had risen sharply in October-November,
has advanced only 1/8 of 1 per cent further.

Canadian bond yields rose

in the first two weeks after the discount rate increases here and in
Canada.

Since then, rates on longer issues have moved sharply higher

in early February.

The yield on a representative 17-year issue was

IV -

higher by 24 basis points on February 16 than at the beginning of
December.

With U.S. long-term rates up more than this, there has

been some reduction in the spread between Canadian and U.S. bond
yields, which had been unusually large last autumn.

2/23/66

I--C-1

U.S. AND INTERNATIONAL ECONOMIC DEVELOPMENTS
SEASONALLY ADJUSTED

U.S. BALANCE OF PAYMENTS

90-DAY RATES
PER CENT
NOT S A

,11111111
7

FEB 16

EURO-DOLLARS

FEB

U.S.

1963

C-D'S

1964

1965

1966

U.S. IMPORTS BY END USE

I'II

BILLIONS OF DOLLARS
ANNUAL RATES

II I

____11 3

INDUSTRIAL SUPPLIES
1

___

N-q
-

I
I

110

I R /ni

FOOD A

D BEVERAGES

"'~,

CONSUMER GOODS-.-mC--.-

CA FITAL EQUIP MENT
1960

1962

il_1I I I I 'o

1964

1966

AS
'RIV. CAP. OUTFLOWS - BANK REPT. CLAI h
f II

MILLIONS OF DOLLARS|

SHORT-TERM

600

A
400

LATIN

AMERICA

2 00
+

ALL OTHER

~
I

1962

1963

1964

I -L

I L __2 00
1965

VIr

154

A-

APPENDIX A:

REVISION IN CONSTRUCTION ACTIVITY SERIES*

New data just released by the Census Bureau show that the
increase in value of new construction put in place last year was substantially larger in total and for private nonresidential and public
construction than had been estimated earlier on the basis of procedures
now being superseded. For earlier years, however, except for offsetting
changes between 1963 and 1964 for business construction, annual levels
were not materially altered from those previously reported. The residential expenditures series were not involved in this revision.

REVISED NEW CONSTRUCTION PUT IN PLACE
1965 p
$ Billions

1962

Per cent increase
1964
1963

1965 p

Total
New series
Old series

71.3
68.1

8
7

6
5

5
5

8
3

Private
New series
Old series

49.6
47.9

9
9

4
5

5
5

8
4

(Residential 1/

26.6

Nonresidential
New series
Old series

23.0
21.2

5
5

2
3

9
8

New series

16.6 2/

Old series

15.6

8
6

5
5

7
2

18
10

Business

Public
New series
Old series

21.7
20.2

(4) 1/
(4)

20 2/

1/ Not involved in recent revision.

2/ Estimate based on first ten months only.

* Prepared by Bernard Freedman, Economist, Capital Markets Section,
Division of Research and Statistics.

A - 2

Altogether, as shown by the new series in the table, the sluggishness in residential construction expenditures in 1965 was considerably
more than offset by further increases in public expenditures and
particularly in expenditures for private nonresidential construction -mainly business -- as these are now being measured. As a result, the
year-to-year advance in total construction last year approximated 8
per cent -- except for 1962, the highest in recent years.
In 1957-59 dollars, the year-to-year advance in 1965 was 4
per cent. This compared with no change shown by the old series, and
with increases of about 3 per cent in each of the previous two years
for the new series.
Nearly all of the increase in level between the new and old
series for 1965 reflected a much sharper upsurge than had been previously
estimated in late 1964 and the early months of 1965 in the seasonally
adjusted monthly data. Measured in current dollars, business construction
put in place expanded 18 per cent in that period, while all other
private nonresidential and public construction rose 8 per cent respectively. After March, the level of total construction activity had
remained relatively stable during 1965, as some uptrend by business
construction was offset elsewhere.
Introduction of the new series with the January data marks the
first major procedural change since responsibility for monthly construction statistics was taken over by the Census Bureau in mid-1959. The
new series are based on direct measurement through regular sample
surveys of work actually put in place in lieu of the mechanical application of monthly progress patterns to reported value figures on
construction awards, permits and related data. For private nonresidential construction as defined by the Census Bureau, data based on the
new procedures carry back to mid-1962; for State and local construction,
the related revisions go back to January 1963.
The new series have been adjusted to the level of the old
series in some cases but because of the changed compilation procedures,
the monthly data are not strictly comparable with those for the earlier
periods. Also, because of reporting lags and sampling problems, current
estimates for some components will be available only with a longer than
accustomed time lag. In the case of certain components of private nonresidential construction, for example, the lag may be as much as three
months or more; in the case of public construction, where direct use
of quarterly reporting on State and local expenditures is now involved,
firm estimates for a recent month may not be available over a period as
long as five or six months from the current month.

A-

Introduction of the new series was delayed until release of
the January 1966 preliminary estimates. However, the effect of the
revisions is already reflected in the Office of Business Economics
estimates for private nonresidential structures and also State and
local expenditures in the GNP accounts currently available for all
quarters in 1965.

B- 1

APPENDIX B:

1967 BUDGET FOR AGRICULTURE*

The Federal Budget provides for a small net increase in the

scope of Department of Agriculture activities in fiscal 1967, mostly
in the direction of providing more assistance to rural people as a
whole. Expansion in these activities is to be offset in part by paring expenditures on a few selected activities. Budgets of most of the
old-line agencies of the Department will permit levels of activity not
greatly different from those of recent years. Although outlays of the
Department are expected to be somewhat larger than in fiscal 1966, net
budget expenditures are expected to be substantially lower.
Larger scale activities are projected for programs to expand
and to coordinate efforts to develop the economies of rural areas; to
distribute food to the needy by means of the Food Stamp Program and
child feeding; to expand insurance by the Farmers Home Administration
(FHA) of loans of private lenders to individuals and communities in
rural areas for housing, water and sewer facilities; to provide special
watershed and conservation projects in problem areas; to promote farm
exports and related activities; and to get underway the recently authorized
Cropland Adjustment program.
Expenditures are to be pared by shelving some low priority
research projects, and by reducing subsidy payments to the States for
cooperative research projects, for the special school milk programs,
and for the school lunch program. A substantial portion of the permanent appropriation for surplus removal buying is to be redirected to
the Food Stamp program. Reductions in expenditures of the Commodity
Credit Corporation for income stabilization and foreign assistance are
to be achieved without reducing the scale of activity of these programs.
The International Wheat Agreement (IWA), eliminated in the 1967 budget,
will have to be reinstated because the U.S, has recently announced
approval of a 1-year extension through June 1967.
Despite somewhat larger operations programmed for the
Department of Agriculture in the 1967 Budget, the projected expenditure is scaled down to $5.8 billion from an actual expenditure of
$7.3 billion in 1965 and an estimated expenditure of $6.9 billion
in the current year. To finance operations in 1967 on a 15 per cent
smaller budget, the Department is to rely chiefly on the substitution
of private for Treasury financing. Net expenditures will be reduced
*--Prepared by Wilellyn Morelle, Economist, Business Conditions Section,
Division of Research and Statistics.

B - 2
in four principal ways: (1) sale to the public of participation
certificates in the amounts of $600 million and $400 million, respectively, by the FHA and the CCC; (2) a change in budget procedures of
the REA to permit relending of collections ($200 million in 1967)
from loans previously made which would lower the net expenditure shown
in the Budget by this amount; (3) requiring packers and processors to
pay for meat and poultry inspection services, an annual saving of $60
million; and (4) reduction of about $225 million in expenditures of
the CCC on the foreign assistance programs because of lower prices
paid for wheat and cotton, higher repayments of Title IV loans by
foreign governments, and the elimination of the IWA expenditures.
Realization of the proposed reductions in expenditures outlined above depends on many unknowns. Three reductions, amounting to
$860 million, are contingent on enactment of new legislation providing
for: (1) a change in FHA authority to permit sales of certificates of
participation in a pool of direct loans to the public, beginning in
1967; (2) a shift by the REA to a revolving loan account so that
collections may be used to finance new loans beginning in 1966; and
(3) a shift of meat and poultry inspection services to a users' fee
basis. The proposed reductions in State funds for research, school
milk and lunch programs will undoubtedly be resisted in Congress.
The ability of the CCC to sell certificates of interest will depend
on the liquidity of banks.
Because of the new provisions of the Food and Agriculture Act
of 1965, the most significant unknown may be the proposed reduction in
the expenditures of the CCC for price support and income stabilization.
These expenditures are projected at $2,172 million after a deduction
is made for an increase (a receipt) of $400 million in price support
loans to be financed by banks. Reductions in expenditures in 1967
are projected for feed grains and cotton. Feed grain expenditures,
which amounted to $1.5 billion in 1966, present the biggest question,
a question that is being answered now in the Corn Belt during the feed
grain acreage diversion program sign-up period which ends in April.
The $200 million reduction in feed grain expenditures in the
1967 budget is based on the expectation that production will be reduced,
an expectation that may not be realized. The 1966 feed grain diversion
sign-up is going slowly according to early indications, partly because
of changes in the program and partly because of bullish expectations
of producers concerning U.S. efforts to meet world food needs. Corn
prices are now far enough above the loan rate for the CCC to be able
to sell some corn for domestic use at its minimum resale levels.
Still "free supplies" of corn, estimated at 3.1 billion bushels on
January 1, are larger than expected disappearance for domestic use
and export of 2.9 billion bushels in the January-September period.
Any readjustment in feed grain expectations will have direct implications for the 1967 budget of the CCC.

B - 3
The 1967 budget of the Commodity Credit Corporation will be
the first to fully reflect a change in method of stabilization in which
payments to farmers are the principal means of income stabilization and
the price support mechanism is designed to let prices of our major export
crops settle to world price levels. The Act of 1965 extended to cotton,
beginning with the 1966 crop, this policy which had already been applied
to feed grains and wheat. Expenditures on cotton stabilization in 1967
are projected at about $650 million, down $200 million from 1966.
Acreage diversion and price support payments to farmers will be larger
than the equalization payments made to the mills in 1966, but farmers
are required to cut their acreage by an eighth in order to qualify for
the payments. Wheat expenditures will be larger in 1967 because supplementary payments to farmers formerly financed entirely by the tax on
users of wheat were increased by the Act of 1965 with the increment to
be paid out of Treasury funds.

C-1
APPENDIX C:

VETERANS' READJUSTMENT BENEFITS ACT OF 1966*

The new "G.I." Act, signed.into law by the President this week,
could have a considerable impact in the coming year on college enrollments,
available manpower resources and residential construction. Its major
features include educational allowances, similar to those in effect during
the Korean War, and housing loans either through guarantees to private
lenders or direct loans by the Veterans' Administration when private
financing is not available. Education allowances will be payable beginning June 1, 1966. The other provisions became effective when the act
was signed.
In contrast to the previous "G.I." Acts which applied only to
veterans who had been in service during a major conflict, the current Act
is retroactive to January 31, 1955 (the expiration date of service eligibility under the Korean "G,I." bill). Thus, all veterans with a minimum
of 180 days service discharged since then as well as those now in service
will be eligible. In all, there is a backlog of about 4 million eligible
veterans. Discharges are currently estimated at 500,000 a year and will
go somewhat higher in the near future as a result of the current expansion
in the armed forces.
A veteran will be eligible for one month of education allowance
for each month of active service up to a maximum of 36 months (equivalent
of 4 years of schooling). For full-time training the allowance is $100 a
month for a single veteran, $125 if he has one dependent and $150 if
he has more than one dependent. Proportionate rates are paid for
less than full-time training. The allowance can be used for tuition,
equipment and subsistence. Educational training must be completed within
8 years of date of discharge or by June 1, 1974 for veterans already discharged. The dollar amounts provided are $10 less in each category than
for Korean veterans. This Act is thus a somewhat less generous program
in both dollar amounts and in "real" terms since it takes no account of
the increase in educational costs and subsistence since 1955.

The housing loan program provides for a guarantee up to $7,500
for loans made by private lenders. Where private financing is not available, direct loans of up to $17,500 (previously $15,000) are authorized.
The maximum interest rate established by the Administrator can not be in
excess of the rate of the home loan insurance program of the National
Housing Act.

* Prepared by Jane Moore, National Income Section, Division of Research
and Statistics.

C-2
Cost estimate. Estimates of cost are extremely difficult to
make because there is no way of knowing the number of veterans who have
been out of service since early 1955 who will take advantage of the new
opportunities. About 55 per cent of the veterans of World War II and 45
per cent of those in the Korean conflict entered training and two out of
three who took training had dependents.
In preparing the bill it was estimated that the cost for education for the first full year would be $327 million, and a medical care
provision would cost an additional $20 million. (This is about $200 million more than was included in the Administration's 1967 Budget, since the
new Act provides larger benefits than were originally proposed by the
This cost estimate is based on the assumption that an
Administration.)
average of 240,000 veterans will receive education benefits during the
first full year. Moreover, it is also assumed that there will be no increase in enrollments. One-half of the estimated total is expected to be
veterans already enrolled full-time in college. Of the remaining number,
there would be those resuming training upon discharge.
The estimate apparently makes no allowance for any increase in
full-time enrollments of veterans who otherwise would not have gone to
school. Under the earlier bills large number of veterans, especially
those in the lower income groups who could not afford college training,
did take advantage of the benefits of the G.I. training provision. It
seems likely that some of the large pool of veterans eligible under the
new Act, even though the allowances provided are smaller, would avail
themselves of the new opportunity for further education. The cost estimate thus appears to be low. If an increase in enrollments does take
place, as seems likely, the supply of available manpower in these age

groups will be further reduced.

Other provisions of the Act include medical care for eligible
veterans with non-service-connected disabilities if the veteran would
otherwise be unable to pay for the cost of needed care; this is the same
basis provided for veterans of other wars. Job counseling and job placement assistance is also provided as under the Korean bill and so is

preference in Federal employment. Unlike the Korean bill, no allowances
are payable for on-the-job training.

Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, March 1, 1966 : Greenbook

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