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FEDER AL RESERVE BAtIK ST. L O U IW IOUISVILLE EIGI DIST • • MEMPHIS LITTLE ROCK e v Volume 50 i e \ A Number 9 Excessive Demand Slowing? L OTAT, demand for goods and services has con- tinued to expand at an excessive rate, causing price increases to accelerate. There is, however, some ex pectation of a slowing in the rate of growth in total demand this fall and winter. Any assessment of the short-term performance of the economy must always be influenced by the impact expected from recent monetary and fiscal measures. The recent rapid increases in the money stock, Federal Reserve credit, bank reserves, and the monetary base may be considered expansive influences on total spending for several months. On the other hand, those observers who expect total demand to moderate focus on interest rates, bank credit, and fiscal devel opments. Interest rates, although declining since May, have been at historically high levels, and growth in bank credit, although rising sharply in July and August, grew only moderately in the second quarter. The recent 10 per cent surtax and moderation of Federal expenditure growth are also expected by many to produce an immediate and significant slowing of total spending. Total Demand Remains Vigorous Total spending increased at a 10 per cent annual rate in the first half of 1968, while real product rose D e m a n d a n d P ro d u c t io n R a tio S c a le B illio n s o f D o lla r s Istqtr. 1$tqtr 1960 1961 R a tio S c a le Q uarterly Totals at A nnual Rates S e asonally Adjusted ^ 2ndqtr il___U—i_ 1962 1963 1964 1 965 1966 19 67 2ndqtr 1968 S o u rc e : U .S . D e p a rtm e n t o f Com m erce LL G N P in current dollars. 12 G N P in 1959 dollar*. Percentages are annual rates of change between periods indicated.They are presented to aid in comparing most recent developments with past "trends." Latest d ata plotted: 2nd quarter Page 2 at a 6 per cent rate. Most observers agree that such a rapid rate of increase in total demand is excessive and that such a high rate of growth in real product is unsustainable. From 1961 to 1967 total spending rose at a 7 per cent rate and real output grew at a 5 per cent rate. In the early years of this period, unemploy ment and idle capacity were reduced; in the later years inflationary pressures intensified as excessive claims were placed on available resources. Personal income increased at about a 10 per cent annual rate in the first seven months of 1968. Retail sales grew at a rapid rate of about 15 per cent during this period. Auto sales this year have been exceeding the sales of the last two years and have approached the high level of 1965. Reflecting the build-up o f stocks of steel and automobiles, the rate of accumulation of business inventories increased in the second quarter after having been reduced by unexpectedly high sales in the first quarter. The inventory-sales ratio was essentially the same at the end of the second quarter as at the end of the first. Industrial production has grown at a 5 per cent annual rate during 1968. Housing starts in May, June, and July were at a 1.4 million annual rate, compared with 1.3 million in 1967 and 1.2 million in 1966. Total civilian employment has risen at more than a 2 per cent annual rate since the beginning of the year, while payroll employment has grown at about a 3 per cent rate. By comparison, the population of working-force age has been rising at a rate o f about 2 per cent a year. Unemployment in the first seven months of 1968 averaged 3.6 per cent of the labor force. While unemployment increased slightly during the summer, it is still low by historical standards. From 1962 to 1967 the unemployment rate averaged 4.8 per cent. The rate this year has been the lowest since the inflationary period o f 1953. Price Increases Accelerate Prices have continued to reflect the rapid growth of total demand and the high rate of resource utilization. More than two-fifths of the increase in total expendi- P ric e s R a tio S c a le 1957-59=100 R a tio S c a le 1957-59=100 +4 3 120 ■ /? 121120 , +2.( 115 115 +3.1? 110 110 +2.9" f +1.27. ^ / 109.1 +3.8% Consumer 105 105 -2.J? Wholes ale r 100 L t ---- 100 Y +0 .1% AVG 1958 1 tor.'65 ♦?5 1960 1961 1962 19 63 1964 * 1965 Aug. '66 Apr.6 7 * * 1966 1967 July 68 * 1968 95 S o u r c e : U .S. D e p a rt m e n t o f l a b o ’ercentages are annual rates of change between periods indicated.They are presented to a id in comparing most receitdevelopments with p ast "trends." .atest data plotted: July preliminary tures in the first half of 1968 was manifested in higher prices. Consumer prices increased at a 4.8 per cent annual rate in the first seven months of 1968 compared with a 3 per cent average rate from 1965 to 1967, and a 1.3 per cent trend rate from 1961 to 1965. Wholesale prices increased at about a 3.7 per cent annual rate in the first seven months of 1968, compared with a 1.7 per cent rate from 1965 to 1967 and less than a 1 per cent rate from 1961 to 1965. Unanticipated inflation causes redistribution of wealth and income and alters the productive process. A rise in prices reduces the purchasing power of those who have a claim to a fixed future income or repay ment of debt. Inflation affects the country’s com petitive position in international trade. Because rising prices discourage the acquisition of certain financial assets and increase the relative desirability of real assets, nominal interest rates are driven up. The restraining effects of the fiscal package depend in part on the extent to which the fiscal measures are implemented. During the first 2 months of fiscal 1969, July 1 through August 31, tax and other receipts of the Government amounted to $29.3 billion, or $5.8 billion more than in the corresponding period a year earlier, according to the Daily Treasury Statement. Expenditures in the same period amounted to $36.2 billion, or $3.9 billion (12 per cent) above the like period last year. Spending by the Defense Depart ment went up $0.8 billion and all other outlays rose $3.1 billion. The resulting deficit was $7.0 billion compared with $8.8 billion in the corresponding period last year. The initial impact of the budget on the economy may be moderated by other developments. In the first half of 1968 savings amounted to 7.3 per cent of income after taxes, compared with a 6 per cent average rate from 1961 through 1967. If the relatively high saving rate in the first half were in anticipation of the tax hike, this aspect of the program would have already exerted much of its influence on the consumer. In addition, some of the effects of the fiscal actions may be felt only with a lag, and thus their influence on spending and prices may be spread over a longer period with less immediate impact. This impact may also be diminished to the extent that consumers and businesses expect the surtax to last only for the stipu lated period. The fiscal program will reduce Federal deficits and borrowing and may lower inflationary expectations, placing downward pressures on interest rates. Lower interest rates may, in turn, stimulate some offsetting consumer and business spending. Recent Monetary Developments Monetary expansion has been very rapid in the past year and a half, and it is possible that this growth, Impact of the New Fiscal Program The fiscal program enacted in late June — a 10 per cent income surtax and cuts in planned Government outlays — was motivated by a desire to relieve some of the inflationary pressures on the economy. The highemployment budget is expected to move from a $16 billion annual rate of deficit in the second quarter of 1968 to near balance by the fourth quarter, and fur ther to about a $13 billion surplus in the first half of next year. It is estimated that the high-employment budget would be in near balance in the third quarter of 1969 if the surtax were to expire on schedule. Dur ing the current fiscal year, however, the program is expected by many observers to have a dampening effect on total spending. Page 3 M o n e y Stock R a tio S c a le B illio n s o f D o ll a r s I9 6 0 1961 R a tio S c a le M onthly A ve ra ge s of D aily Figui y A d justed 2001------- ----- 1962 1963 T 1 9 64 Apr.'65 1965 B illio n s o f D o lla r s ----------poo A p r.'66 Jan.67 u_L 1966 1967 Aug.'68 1968 Percentagesareannual ra tes o f chan ge between periods indicated. They ore presented to a id in com paring most recentdevelopments with pa st "trends.” latest d ata plotted: A u gu st estimated because of lags, will continue to have effects later this year. The money stock has increased at about a 7 per cent annual rate since the beginning of 1967, three times the 2.4 per cent trend rate from 1957 to 1966. Whenever money holdings of the public exceed the amount of money people desire to hold, given in comes, wealth, interest rates and other strategic fac tors, spending for goods, services, and investments rises. The monetary base1 has shown a pattern similar to the money stock. Since January 1967 the base has risen at a rapid 6 per cent annual rate, compared with a 3.2 per cent rate from 1957 to 1966. Money supply plus time deposits in commercial banks and total commercial bank credit, two broad monetary measures, have recently shown patterns somewhat different from the money stock, climbing very rapidly in July and August after slowing sig nificantly in the second quarter. These measures usually indicate roughly the same degree of mone tary action as the money stock. The two broader measures have been affected by the ability of banks to attract interest-bearing deposits. In the late spring and early summer Regulation Q limits on maximum interest rates banks could offer on time deposits diverted flows of funds around banks. With the recent decline in interest rates, banks have again become more competitive in seeking funds and have resumed their intermediary role. Interest rates rose to historically high levels in the early months of this year. In May highest grade 'See “ The Monetary Base — Explanation and Analytical Use” in the August issue of this Review for a description of this series and a discussion of its usefulness. Page 4 corporate bonds were yielding about 6.25 per cent. By comparison, these yields averaged 4.35 per cent in the 1961-65 period. The high rates have reflected primarily the strong demand for credit, based in part on large Federal deficits and expectations of inflation. Since interest cost is a factor in spending decisions, especially for long-term investment, the high interest level may be a dampening factor on economic activity. Most interest rates have drifted down from their highs of late spring. The sharpest decline has been in the short-term maturity range. The yield on threemonth Treasury bills has declined from 5.65 per cent in May to 5.18 per cent in early September. The yield on highest grade corporate bonds has decreased from 6.27 per cent to 5.95 per cent over the same period. During the period from August 16 to August 30, all Federal Reserve Banks lowered their discount rate charged to member banks from 5Vz to 5Y4 per cent. Although most short-term interest rates have de clined, the rate on Federal funds, one day loans between commercial banks, has remained high (see chart). This rate increased from roughly 4 per cent a year ago to a 6 to 6V4 per cent range in May and remained near that level through August. The widen ing spread between the Federal funds rate and other short-term rates may reflect market expectations of further general interest rate declines in the very near future. With such expectations, banks may be willing to borrow on a short-term basis at rates higher than the return on paper of several months maturity. The decline of interest rates since late last spring may be, in part, a short-run result of the acceleration in the rate of growth of the money stock. Declines in and a deterioration in the nation’s balance of pay ments. The Government has now taken several actions designed to restrain the ebullient spending. Most observers anticipate a more moderate rise in spending this fall and winter, but views differ sharply on whether the slowing will be insufficient, appropriate, or excessive. A short-run forecast of the course of the economy is influenced by the weights assigned to the impact of recent monetary and fiscal actions. The recent fiscal actions as well as high interest rates have been cited as a basis for possible sluggishness in the near future. The recent rapid rate of monetary growth, on the other hand, is viewed by some as supplying fuel for continuing excessive growth in total demand. interest rates can also be explained in part by the anticipated reduced demand for funds due to the new fiscal program. To the extent that rates have been pushed down farther or more quickly than supply and demand forces in the economy would otherwise have called for, they tend to be expansive. That rates are still high by historical standards may be ascribed in part to the expectations of inflation. Conclusion Total spending by the Government, business and consumers has been excessive for many months, causing economic imbalances, inflation, inequities, B ulk MAILINGS of this bank’s The goal of stable economic growth will be diffi cult to achieve in the near future because of continuing inflationary pressures resulting from past excesses, lags in the effect of policy changes, and uncertainty concerning the ultimate impacts of policy actions. Federal budgetary influence on the economy is now essentially fixed until mid-1969, and the major public stabilization tool which is currently subject to short term control is monetary policy. If it is assumed that monetary developments have their major effect with a ldg of 4-to-6 months, then total demand for goods and services in the second half of 1968 is essentially determined by monetary and fiscal actions of the recent past. R e v ie w are available to the public without charge, including subscriptions to banks, business organizations, educational institutions, and others. For information write: Research Department, Federal Reserve Bank of St. Louis, P. O. Box 442, St. Louis, Missouri 63166. Page 5 Interest Rate Controls—Perspective, Purpose, and Problems T HBOUGHOUT MOST of this nation’s history, usury laws and other interest rate restrictions have had little impact on credit flows. In recent years, how ever, such restrictions have interfered increasingly with credit markets. The restrictiveness of legal limits is being felt over wide areas, as a result of a rapid rise in market rates of interest to levels that are above ceil ings set by usury laws and other government controls. These restrictions have been ameliorated, however, as maximum permissible rates payable by banks on deposits have been increased a number of times dur ing the past decade when market rates exceeded their ceilings.1 In 1957 the Federal Reserve Board, for the first time since being granted the authority in 1933, in creased the maximum permissible rates paid by mem ber banks on time and savings deposits. Since 1957, the Board has increased maximum permissible rates seven times as market rates have risen. Interest rate restrictions on funds flowing into finan cial agencies, which for many years were applied ex clusively to banks, have recently been extended to include maximum rates payable by some nonbank financial intermediaries. The 1966 Interest Rate Act directed the Federal Reserve Board, the Secretary of the Treasury, the Federal Home Loan Bank Board, and the Federal Deposit Insurance Corporation to take action to reduce interest rates to the extent feasible, given the prevailing money market and economic conditions. The Federal Reserve Board was given the power to set different ceiling rates for different classes of bank deposits. Exercising this broadened authority, the Board reduced the maximum rate on consumer-type certificates of deposit to 5 per cent. In 1966 the FDIC for the first time set maximum interest rates for mutual savings banks, and the Home Loan Bank Board applied dividend restrictions to the savings and loan associations. Despite this broadening of restrictions, a large per centage of funds has continued to flow through finan cial intermediaries in response to supply and demand f e d e r a l Reserve Bulletin, July 1968, p. A - l l. Since Feb ruary 1936, maximum rates that may be paid by insured nonmember banks have been the same as those for mem ber banks. Page 6 forces. Many financial agencies, such as the farm credit banks, sales finance companies, and nonfinancial corporation lenders, remain outside Federal controls on rates payable, though subject to state usury laws on rates charged. Lending rates of banks, savings and loan associa tions, and individuals are also subject to state usury laws, which impose limits which recently have been below market rates in many states. Although some areas of free market rates remain, controls are creating diversions in credit flows. The 6 per cent limit imposed on commercial bank loans in several states tends to reduce the flow of commercial bank credit to customers. Limits at the national level on rates paid by banks and savings and loan associations for funds slow the growth rate of these intermediaries. This article accepts the basic economic premise that free markets lead to an optimum allocation of re sources. It concludes that interferences with normal credit flows create inefficiencies in the financial markets that have an adverse impact on the distribution of capital and consumer goods. Such inefficiencies in resource use can be ex plained within the framework of a free market. The market determines the returns to savers and allocates loanable funds among borrowers. These returns and allocations are made on the basis of supply and de mand conditions. Supplies of loanable funds are de termined by savings and the increments of credit created by monetary action. Many savers have the alternative of lending to intermediary savings-type financial agencies such as banks and savings and loan firms, or investing directly through equities, loans, bonds, etc. Expected marginal return is the major factor determining the volume of savings flows into the various channels. If interest rates payable by financial agencies are restricted to levels below the yields of alternative assets, flows of funds through them tend to decline. On the other hand, if such rates are determined by market demand, the flows supplied will expand with the rising demand for credit. Demand for loan funds is a function of the mar ginal returns to capital plus the demand by individ uals and government for current consumption in ex cess of current income. Each demand sector is willing to purchase funds as long as marginal returns exceed costs. Efficiency in the financial market is maxi mized when the marginal return on funds is equal for all sectors. The price of funds (interest rate) is thus the allocator of funds both among the various sectors — business, government, and consumer — and among the various demanding units in each sector. When this allocator is inhibited, an inefficient alloca tion of funds occurs. This article is a survey of interest rate restrictions in their historical setting, first outlining their ration alization as given by contemporaries of ancient, me dieval, and modem times, and concluding with a statement of current reasons for controls, control prob lems, and the impact of controls on various sectors of the economy. Historical Perspective Restrictions on interest charges were begun in an cient times. Interest payments were observed to in crease the wealth of the rich and were believed to deprive the poor. Controls consisted of both religious proscriptions and legislation which limited or forbade interest.2 Theories explaining why interest payments should be restricted were not well developed, al though such payments were criticized by most philosophers. Despite these legal and religious considerations and the strong antagonism of the philosophers, economic forces continuously fostered interest charges and pay ments. Economic relations had already become too complicated for gratuitous credit in much of the ancient world, and legal interest limits generally pre vailed in ancient Greece. In the 4th century B.C., the Romans condoned and later fully sanctioned in terest by the institution of legal rates.3 Following the collapse of the Roman Empire, a reaction occurred with respect to interest payments. The Christian Middle Ages treated the subject of interest charges on borrowed money more thoroughly, but with the same hostility as the earlier pagans. The exploitation of poor debtors by rich creditors appeared particularly hateful to the Christian, whose religion taught him to look upon gentleness and charity as among the greatest virtues and to think little of earthly goods. The Church, step by step, managed to introduce legislation prohibiting interest payments. Secular legislation finally fell almost en tirely under the Church’s influence, and severe inter est rate statutes emerged, thus abrogating the more liberal Roman law.4 Despite the charitable instincts of the Church, businessmen were generally able to prevent the en actment of laws which carried the interest limitation principle to its ultimate conclusion. Exceptions in cluded the privilege of public pawnbrokers, trans actions by other types of banks, the indulgence in usury practices by the Jews, and the payment of interest without its being written into the contract. Lending practices which involve hidden interest and which circumvent legal restrictions are thus not pe culiar to the present generation. By the early 14th century, economic activity had quickened and personal freedom was on the up swing. Although beliefs about interest had not changed, practical compromises were beginning to appear. Luther, Zwingli, and other reformers, while believing that interest was a parasitic gain, consented to its payment within limits. This practical com promise was justified by the argument that interest could not be conveniently eradicated because man was considered so imperfect.5 About the middle of the 16th century, students began to examine the theoretical foundations of severe interest restrictions. Calvin rejected the scriptural basis for interest prohibition on the ground that some passages of Scripture are interpreted differently, while others are invalid because of changed circum stances. He further pointed out the similarity of in terest payments to lenders and the use of money to purchase land on which a return is anticipated. Nevertheless, he believed in interest rate controls and adherence to terms established by law. Molinaeus, a French jurist, went further, refuting point by point both the pagan and scholastic doctrines of interest prohibition.6 He maintained that the use of money yields a service, that this service is the “fruit” of money, and that the lender is injured because of use foregone. In the 1700’s, theories related to interest developed rapidly. Turgot, a French economist, made perhaps the greatest contribution.7 He carried Calvin’s interest 4Bohm-Bawerk, p. 12. 5R. H. Tawney, Religion and the Rise of Capitalism, (N ew York: The New American Library of W orld Literature, Inc., 1950), p. 18. 2Eugen von Bohm-Bawerk, Capital and Interest, Volume I, 4th edition, 1921, translated (South Holland, Illinois: Libertarian Press, 1959), p. 10. 6Ibid., p. 20. 3Sidney Homer, A History of Interest Rates, (N ew Bruns wick, New Jersey: Rutgers University Press, 1963), p. 52. 7Joseph A. Schumpeter, History of Economic Analysis, (N ew York: Oxford University Press, 1954), p. 332. Page 7 analogy a step further, pointing out that money is the equivalent of a piece of land yielding a certain percentage of the capital sv$n. The owner will there fore not be inclined to invest his capital in other enterprises unless he can expect a net return as great as he would obtain through the purchase of land.8 Turgot also noted that an increase in the quantity of money which raises commodity prices might in crease the rate of interest.1' He thereby pointed to the possibility of a positive real return on money, and that price inflation might become imbedded in the nominal rate of interest. Following the breakdown of the hard tenets of scholastic doctrine as a result of economic analysis and the rising commercial demands for credit in the 1700’s, legal restrictions on the payment of interest were generally relaxed. Most nations, however, estab lished legal maximum usury rates. In 1545 England repealed the prohibition of interest and replaced it with a legal rate. The prohibition was later reimposed, but in 1571 it was again repealed and has never again been reinstated. The Netherlands yielded to repeal before 1600, and is an example of a sophisti cated economy that developed without the shackles on interest rates required by the scholastic doctrine. Germany, with a somewhat slower commercial de velopment, repealed the interest prohibition about the mid-1600’s. Repeal came later in Italy and France where canonistic influence was more persistent in both theory and practice. With the exception of England, laws imposing a maximum on chargeable interest rates have persisted in most European countries. In England these laws, along with other restrictions on commerce and trade, came under intense pressure in the 1800’s. Usury laws were suspended entirely in 1830 for bills under three months’ maturity and were repealed for all forms of credit in 1854.10 Early Practices in the United States Under the influence of the European powers, the American colonies adopted the traditions of their homeland with respect to usury. Reasons were ap parently unnecessary for the continuance of this ves tige of medieval and ancient views. For those who failed to recognize the limits possible under competi tive conditions, restrictions were a compromise be tween the necessities of commerce and industry and earlier custom and belief. Protection of the “poor” bor 8Bohm-Bawerk, p. 41. 9Schumpeter, p. 332. 10Homer, p. 187. Page 8 rower against exploitation by the “wealthy” lender re mained a central core of most usury legislation. Legal maximums were viewed as a means of restraining the natural appetite of the lender, and the interest received was considered a gratuity resulting from the magnanimous nature of the state. The services per formed by capital continued to go unrecognized by the public. Most of the early colonies followed the English custom of establishing a legal maximum of 6 per cent, a rate that still survives in a number of states. In most states, however, usury rates have been increased, and in a few states limits on commercial bank loans have been completely eliminated (Table 1). Four of the five states which currently have no maximum limits, namely Connecticut, Maine, Massachusetts, and New Hampshire, were settled early and estab lished the low 6 per cent maximum as colonies. Furthermore, none of the states which developed later west of the Mississippi River established maxi mum interest rates at the relatively low 6 per cent level. Later United States Restrictions In addition to the usury laws, which were a carry over from previous ages, many states in the 20th century set ceilings on the interest rates that banks could pay on deposits. These ceilings were usually imposed in connection with deposit insurance pro grams. Maximum interest rates permissible for state banks were, in some states, set at a lower level than TABLE 1: Num ber of States W ith Specified M axim um Rates of Interest on Commercial Annual Interest Rate SVi 6 7 8 yo 10 12 21 N o Maximum Rate Deposits Deposits1 Savings 3 'h 4 4'/, Bank 3 9 — — — — — and Loans Loans2 Time _ 8 3 1 — — — . — — ___ — 37 37 — _ — — — 11 5 12 1 n 4 1 5 JIn some states rates are set by the state banking authority w ithin prescribed limits. This table excludes the state o f Louisiana, which requires that banks paying 5 per cent or m ore must classify funds as borrow ed. 2Maximum rate that m ay be set by contract. These rates are subject to legal exceptions in m ost states, such as rates on installment loans, inves tigation fees, etc. Since August 1967 some states have raised their limits. Source: National Association o f Supervisors o f State Banks, “ A Profile o f State-Chartered B anking,” (W ashington, D. C., A ugust 1967). those paid by national' banks. To remedy this situa tion, the Federal Reserve Act was amended in 1927, limiting the rates paid by national banks on time, savings, and other deposits to the maximum permitted state banks in the same state.11 Following the ensuing depression of the early 1930’s, the Banking Act of 1933, with little discussion, prohibited member bank payment of interest on demand deposits and gave the Federal Reserve Board authority to set max imum rates on time and savings deposits for all member banks. These limitations were extended to nonmember insured banks by the Banking Act of 1935. Reasons for interest rate restrictions given during the hearings related to the Banking Acts of 1933 and 1935 fell into three general categories. First, a reduc tion of interest rates payable by banks would tend to reduce the rates charged to bank customers. Second, interest restrictions, especially the prohibition of in terest on demand deposits, would prevent the move ment of funds from smaller to larger communities, and more funds would remain in the small rural communities to meet local demands. Third, restrictions on rates payable would prevent the excessive bidding up of rates which in turn leads to high-return, highrisk assets and bank failures. Dr. Oliver M. W. Sprague, Professor of Banking and Finance, Harvard University, presented the first view. Concerning the “need” for lower interest rates, he said: " . . . I should look for it to be brought about, more, through the moderate rate of interest that banks may pay on deposits . . .”12 Marriner Eccles, Chair man of the Federal Reserve Board, testified: “Fixing the maximum rate of interest on deposits tends to bring down the rate on loans. That is the effect.”13 Similar views were expressed by Senator Smith W. Brookhart of Iowa, a member of the Committee on Banking and Currency, and Harry J. Haas, President of the American Bankers Association.14 The second view, that the prohibition of interest on demand deposits prevents the movement of funds to financial centers, was presented by Senator Carter Glass of Virginia, Chairman of the Subcommittee ^Amendment to the Federal Reserve Act, section 24, dated February 25, 1927 (44 Stat. 1224, ch. 191). 12Hearings Before a Subcommittee of the Committee on Banking and, Currency, United States Senate, Seventyfourth Congress, First Session on S-1715, Part I, April 19 to May 13, 1935, p. 217. 13Hearings Before the Committee on Banking and Currency, House of Representatives, Seventy-fourth Congress, First Session on H. R. 5357, February 21 to April 8, 1935, p. 330. ,AH carings Before the Committee on Banking and Currency, Seventy-second Congress, First Session on S-4115, Part I, March 23-25, 1932. on Monetary Policy, Banking, and Deposit Insurance. Speaking on the floor of the Senate in 1933, Senator Glass said: . . this payment of interest, particularly on demand deposits, has resulted in drawing the funds from country banks to the money centers for spec ulative purposes.”1” Similar views were expressed by Congressman Patman of the Committee on Banking and Currency,16 and by Ronald Ransom, Vice Chair man, Board of Governors of the Federal Reserve System.17 A third thread extending throughout the hearings prior to the Banking Acts of 1933 and 1935 was that interest rate restrictions were essential to prevent the excessive bidding up of rates. Benjamin M. Andersen, Jr., economist with the Chase National Bank, said: “The only place where a definite abuse existed that needed public regulation was time deposits.” Senator McAdoo stated: “The bidding by banks against each other for the deposits of customers who had large deposits . . . led to unwholesome competition between banks and an unwholesome condition so far as de mand deposits were concerned.” 18 Leo T. Crowley, Chairman of the Federal Deposit Insurance Corpora tion, said: “. . . in years gone by, banks paid as high as 4, 5, and 6 per cent for what we would term ‘time deposits’. They offered all kinds of premiums, like blankets and clocks . . ., and the banks which per haps should not have paid those high interest rates were the ones that were the most apt to offer the depositor an interest rate that was not sound.”19 In 1966 a fourth reason for the control of rates payable on time and savings deposits was developed — the elimination of unsound competition between banks and other financial intermediaries. In hearings on the Interest Rate Act of 1966, excessive competi tion was the principal subject of discussion. Norman Strunk, Executive Vice President of the United States Savings and Loan League, reported: “The adverse effect on the flow of savings into savings and loan associations and savings banks has been severe and the situation is worsening monthly. Those commer 15Quoted in Hearings Before the Committee on Banking and Currency, House of Representatives, Seventy-eighth Con gress, Second Session on H. R. 3956, December 10, 1943 to February 9, 1944, p. 2. ioIbid., p. 679. 17Ibid., p. 16. 18Hearings Before a Subcommittee of the Committee on Banking and Currency, United States Senate, Seventyfourth Congress, First Session on S-1715, Part II, May 1422, 1935, pp. 490-91. 10Hearings Before the Committee on Banking and Cur rency, House of Representatives, Seventy-fourth Congress, First Session on H. R. 5357, February 21 to April 8, 1935, p. 86. Page 9 cial banks unable or unwilling to compete at the new rates are equally affected. “The commercial banks, as short-term lenders with their funds invested in short-term business loans and high-interest-rate consumer loans, are able to charge more in periods of high interest rates, and commercial bank loans can be adjusted to higher interest rates more readily. Bank earnings, thus, can increase very rapidly in periods of rising short-term interest rates, and banks can pay higher rates on savings.”20 Similar views were expressed by John E. Home, Chairman of the Federal Home Loan Bank Board.21 In addition to the need for restraining competition between banks and other financial agencies, Larry Blackmon, President of the National Association of Home Builders, emphasized the merit of giving first preference for savings to homeowners.22 The need for at least temporary restraint on competition for funds was expressed by the Council of Economic Advisers.23 The Interest Rate Regulation Act of 1966, which was passed following these hearings, directed the supervisory authorities to take action to bring about a reduction of interest rates to the maximum extent feasible in the light of current money market and economic conditions. It authorized the Board of Gov ernors of the Federal Reserve System and the Fed eral Deposit Insurance Corporation to prescribe dif ferent rate limitations for different classes of bank deposits, and also provided for regulating rates paid by mutual savings banks and dividends on savings and loan association shares. The Effects of Usury Laws An analysis of reasons for interest restrictions by ancient, medieval, and modem societies reveals the heavy influence of ethical and moral considerations. These considerations were heavily weighed in favor of low interest rates which were generally believed obtainable through legislation. The actual impact of usury legislation, however, probably has been con trary to the intended impact. Instead of providing lower cost credit, such laws have often retarded credit flows. The result has been a scarcity of credit available for many vital activities. 20Hearings Before the Committee on Banking and Cur rency, Eighty-ninth Congress, Second Session on H. R. 14026, May 9 to June 23, 1966, pp. 7-8. 2iIbid., p. 72. 22Ibid., p. 263. 23Ibid., p. 429. Page 10 Usury Restrictions Retard Home Construction Attempts by states to restrict interest payments have been frustrated by the interconnection of credit markets. Low ceiling rates, instead of fostering credit to the poor and for local economic development, have fostered the export of capital to other areas, despite the great demand for credit locally. Harry L. Johnson, in an article on conditions in Tennessee where low limits are placed on both usury rates and rates pay able by banks, reports: “Among the more immediate and discernible economic ills which have occurred in the past and which will be aggravated by unreal istic limitations on interest rates are: (1) a decline in residential building, (2) an increase in the level of unemployment in construction, (3) a decline in the sales of building supplies, (4) an outflow of sav ings, (5) an increase in the rate of interest and yields on bonds issued by the State of Tennessee and its political subdivisions, and (6) increased competi tion for Tennessee’s financial resources by out-of-state individuals and businesses.”24 The maintenance of low legal maximum rates on commercial loans might be expected to foster industrial development and economic growth. Most of the 11 states with the lowest legal limit (6 per cent), however, are not noted for wealth and vigor, or for the ease of credit conditions for the poor. About half of them are lo cated in the Appalachian Area.25 Credit for home mortgages is affected adversely in states with low usury ceilings. In a speech before the Pennsylvania Bankers Association, Andrew F. Brimmer, Member of the Board of Governors of the Federal Reserve System, pointed out the adverse ef fects of low ceiling rates on credit flows into the home mortgage market. He stated that the reduction in the supply of funds tends to reduce activity in home building and the transfer of existing dwellings.26 The total volume of funds for lending is curtailed in states with low usury rate ceilings. Loanable funds search for areas of highest returns. Funds in low rate ceiling states tend to move to other states and to 24See Harry L. Johnson, “ An Island Unto Itself,” Tennessee Survey of Business, the University of Tennessee, Volume III, No. 7, March 1968. 25States with the 6 per cent limit as of August 1967 were: Delaware, Kentucky, Maryland, New Jersey, New York, North Carolina, Pennsylvania, Tennessee, Vermont, Vir ginia, and West Virginia. Since then some of the above states have raised their limits. 26Andrew F. Brimmer, “ Statutory Interest Rate Ceilings and the Availability of Mortgage Funds,” Federal Reserve Bank o f Philadelphia, Supplement to Business Review, June 1968. non-credit demands. Financial intermediaries in such states cannot effectively compete for savings, as the limited returns on loans do not transmit the free market signals to savers. The limited volume of funds flowing into such agencies results in a reduced level of loans. look at the credit market indicates that the richcreditor, poor-debtor implications carried over from the Middle Ages may not hold in modem economies. Credit to Low Income Groups Reduced Instead of the rich leaving funds in the banks’ custody to loan out to poor borrowers, the reverse may be closer to the facts. In 1957 more than half of all member bank business credit was extended to firms with net worths of $50,000 and over.27 Credit is more difficult for low income groups to ob tain in states with low usury ceilings. Loanable funds, when restricted to low interest rates, do not seek out poor borrowers whose security is less adequate and whose repayment capacity is limited. Such credit flows more readily to borrowers with adequate assets for pledging. These borrowers can demand larger low-risk loans with handling costs at a minimum. Consequently, instead of protecting high-risk bor rowers from high rates, usury laws actually prevent those borrowers from acquiring funds, or force them to seek illegal or less efficient sources. Venture Credit Impeded Venture or development credit, which is also risky, is retarded in states with severe usury laws. Such credit can only be extended at a higher rate of interest to offset the higher risk. In states with low maximum rates, no means to offset high risks are available. Usury laws are relatively harmless when market rates are low relative to the legal maximums, i.e., when the usury rates are not effective. They are harmful to all concerned when doing the job for which they were designed — limiting the rates chargeable. The volume of credit flowing to low-risk individuals and well-established businesses may be almost as great under severe usury restrictions as under free market conditions. Low usury ceilings prevent other individuals and firms from effectively bidding for funds. With the higher risk users in effect excluded from the market, most funds will probably flow to lowrisk individuals and firms. Limits on Rates Payable to Savers Restrict Credit Flows Like usury laws, many restrictions on rates payable have their roots imbedded in ancient and medieval thought. For example, the belief that a reduction in interest rates payable by banks on deposits tends to reduce rates charged bank customers (and that this is a worthy objective) implies that low charges to debtors are preferable to high returns to savers. A The Rich-Creditor, Poor-Debtor Fallacy Investment of savings through banks and savings and loan associations has not led to the accumulation of great wealth during the period of national controls on rates payable. For example, an investment of $10,000 in 1934 in savings deposits at ceiling rates, with 75 per cent of earnings reinvested annually, would have been worth $20,239 in 1967. Similar in vestments in Standard and Poor’s composite list of common stocks and farm land would have been worth $232,530 and $271,476, respectively. At constant prices based on the Gross National Product price deflator, the savings deposit yield was negative, whereas the investments in common stocks and farm land rose 8 and 9 fold, respectively. These data indicate that great wealth has not been accumulated from savingstype investments in recent years. On the other hand, a large proportion of such depositors was in the mid dle and lower economic classes and had few alterna tive opportunities for investment. Low Rates to Savers May Cause Higher Rates to Borrowers In addition to the rich-poor fallacy, the causation assumed in the “low rates paid to savers lowers rates to borrowers” argument is questionable. Legal maxi mum rates, which are effective in holding rates below levels that banks and other financial agencies can af ford to pay under competitive conditions, tend to re duce the flow of funds through normal channels and to divert savings into non-credit uses such as bonds, equities, real estate, etc. The smaller supply of funds moving into the credit market will meet an equal amount demanded at higher rates. Borrowers must pay the higher rates to obtain funds. Attempts to lower the rates to borrowers by limiting their oppor tunity to compete for funds is comparable to efforts to lower food prices by limiting the amount that farmers can spend on production. Total costs could 27“ Member Bank Lending to Small Business,” Federal Re serve Bulletin, April 1958, p. 396. Page 11 be lowered, but output and consumption would de cline, and prices of farm products and food would be increased. A reduction in the flow of funds through efficient financial agencies and the consequent higher prices retard economic growth. Credit’s contribution to growth is maximized when scarce credit resources flow most efficiently to areas where returns are great est. Rates offered savers then transmit consumer and business demands for credit. When market rates ex ceed the legal maximum permitted, the appropriate signal is not transmitted to savers, and flows of funds are diverted from normal channels. Flows through the credit market decline and a greater portion of savings moves into equities, real estate, bonds, and direct loans. Credit-using activities which comprise a major part of economic growth are thus retarded. This diversion of credit flows and the consequent growth retardation are especially severe in the case of state restrictions, since funds are not only diverted to non-credit uses, but to credit uses in surrounding states. Market Rates Distribute Credit to All Areas The second reason for restricting interest rates pay able — that uncontrolled rates paid tend to dry up loanable funds in rural areas and cause excessive concentrations of funds in the largest cities — is like wise questionable. It was contended that the specula tors who borrowed funds in the largest cities could outbid borrowers in the smaller communities. Farmers, rural merchants, and other citizens would thus be without available credit, whereas bountiful supplies could be found in the large cities available to the speculators. This conception of the financial market is not consistent with the facts. The large financial agencies which gather funds are often lo cated in the large centers, but they gather savings from both rural and urban areas, and under free market conditions distribute funds to areas where marginal returns are greatest. Rural areas have dem onstrated their ability to compete for funds in na tional markets when provided with access to such markets. The farm credit banks are good examples of the ability of rural communities to compete for funds in the money market centers. Commercial banks likewise gather funds from savers in all areas and distribute them to areas of greatest marginal returns insofar as the banking structure permits. In some instances these distributions are in the form of direct loans, while in other cases funds are distributed to ultimate users through other financial agencies such as the farm credit banks. Page 12 Danger of Institutions Failing Overstated The third argument for restricting rates payable — that high rates paid on savings force financial insti tutions into high-risk investments and ultimate failure — dates back to the early thirties. Its proponents see nothing that will serve to break the rise in rates paid on deposits when banks begin to bid against one another for funds. It is argued that the banks are com pelled to take one imprudent investment step after another until asset risks reach intolerable levels and depositors’ funds are ultimately lost. However, little evidence to confirm this view has been forthcoming. George Benston found no relationship between in terest rates paid on deposits and gross rate of return on investments.28 He also found no relationship be tween average rates paid by banks and average risks of their portfolios, as measured by ultimate write-offs of investments. Contrary to the expectations of the high-rate, high-risk thesis, he found that interest rates paid were substituted at the margin for other operat ing expenses such as salaries, facilities, automated machinery, advertising, etc. Profit maximization by banks, as in other firms, pro vides a more rational explanation of bank behavior. Banks are likely to use the same criterion in deciding what rate of interest to offer as they use in making other decisions relative to expense. In making deci sions on hiring additional workers, they base their decisions on the expected value of services performed. They are likely to continue to hire additional help as long as the gain in value of services exceeds all costs associated with the additional labor. Marginal costs and returns, with due allowance for risks, also determine the level of interest rates that a bank de cides to pay. Otherwise, the bank is not maximizing. Haywood and Linke conclude in a recent publica tion that “when stripped of the folklore that has grown up around it, the relevant rationale of deposit interest regulation in 1933 was price fixing, which was somewhat in vogue at the time as an anti-depression measure.”29 A Costly Method of Protecting Financial Intermediaries A more recent argument given for controlling in terest rates payable on deposits at financial inter 28George J. Benston, “ Interest Payments on Demand Depos its and Bank Investment Behavior,” Journal of Political Economy, October 1964, pp. 431-449. 29Charles F. Haywood and Charles M. Linke, The Regula tion of Deposit Interest Rates, a study prepared for the Trustees of the Banking Research Fund, Association of Reserve City Bankers, (Chicago, Illinois: June 15, 1968), p. 3. mediaries is that sizable increases in rates paid may cause substantial hardship to savings and loan associations. In addition to destructive internal com petition, destructive external competition has become a reason for restricting rates payable. It is contended that hardships would be especially severe on savings and loan associations because of the long-term nature of their assets and the short-run contracts on funds purchased. The average interest rate paid on all de posits rises immediately as rates offered increase, whereas returns increase only on new mortgage ad ditions to the portfolio. Average earnings thus rise much more slowly than expenses. The need for rate controls for this purpose may be questioned. The book value of aggregate reserves and undivided profits of savings and loan institutions is currently nearly twice the size of their yearly dividend payments. They also have cash and govern ment security holdings from which payments could be made totaling over double their yearly dividend payments. These ratios prevailed even at the end of 1966, after the associations had endured their most adverse year. This means that the average association could remain solvent in an accounting sense and pay its dividends for nearly two years, even though it had no net profits.30 Investing on a long-term basis with short-term funds apparently calls for a substantial amount of liquidity. Such liquidity can be either in the form of short-term loans or other short-term assets, such as government bonds, etc. If changes in savings and loan restrictions are necessary to provide greater liquidity, such changes are preferable to rate rigidities which deprive the community of the benefits of rate competition. Furthermore, other opportunities, such as maximum assistance from the Federal home loan banks during periods of stress, have apparently not been fully exploited. With 12 to 15 per cent of the portfolios of savings and loan associations turning over each year, assistance from the Home Loan Bank, coupled with a permissible reduction in reserves, should take care of most periods of interest rate rises for the major portion of savings and loan associations. These associations have considerable ability to with stand these periods when terms of trade are adverse. Furthermore, on the downside of interest rates, rapid accumulations of reserves can be made, offsetting losses on the upside of rate movements, and the Home Loan Bank can be repaid and reserves recouped. 3°See “ Does Slower Monetary Expansion Discriminate Against Housing” by Norman N. Bowsher and Lionel Kalish in the June 1968 issue of this Review. Rate controls may have been the most important factor contributing to the slowdown in the housing industry during the recent periods of sharply rising general interest rates. Rising rates make yields on saving accounts at controlled levels less attractive than rates paid in the free market. There have been several setbacks in the rate of increase of savings capital of these institutions during periods of rela tively high or rising interest rates. In only one quarter, however, (third quarter, 1966, during which rate controls were put into effect) was there a moderate net decline. To the extent that rate controls reduced credit flows into the savings and loan industry, they affected housing adversely. Appropriate monetary and fiscal policies are also important factors in maintaining the stability of sav ings and loan associations. Sharp increases in interest rates during recent years have been associated with rising prices. The real rate of return on loans and investments has been relatively stable. The rising prices can be .associated with expansive fiscal and monetary actions. Thus, an important factor in main taining relatively stable interest rates is the mainte nance of fiscal and monetary policies that are condu cive to stable prices. If, as a final resort, other means are necessary to pre vent widespread failures in savings and loan associa tions, direct Government loans through the Federal Home Loan Bank System are preferable to interest rate controls. Such assistance could be given only to the weak associations which had not adequately pre pared for adverse economic conditions. In contrast to helping only the weak, rate controls widen the spread for all associations, and prevent rate competi tion within the banking community, and between savings and loan associations and banks. Thus, the public loses the benefit of rate competition and at the same time loses the benefit of the potential growth of both associations and banks during periods of sharply rising rates. A major effect of rate controls is the limitation of the size of controlled firms, which in turn causes a more rapid growth in flows of funds which are not controlled. Rate restrictions thus may not be profitable to the agencies restricted. With the slower growth rate, bank earnings are likely to be less over the longer run, and savings and loan associations will perform a declining function in the economy. The rapid growth of farm credit at the farm credit banks relative to commercial banks in the past two years may illustrate this situation. Farm credit outstanding at production credit associations and Federal land Page 13 banks rose at almost double the rate of farm credit expansion at commercial banks from 1965 to 1967. Summary Restrictions on interest rates charged and paid by competitive financial institutions are vestiges of me dieval and ancient thought, and are inapplicable to modem commercial economies. They are based on false premises, operate perversely, and are economi cally inefficient. The ancients banned interest for ethical reasons, the medievals for religious and moral considerations; modem restrictions are a carry-over of such ideas plus a lack of confidence in market forces. Supply and demand for loan funds rather than rate controls historically have kept interest rates at moderate levels in the United States. Ancient and medieval desires to improve the posi tion of poor debtors relative to rich creditors may have had some basis. There is no evidence today, however, that borrowers from financial institutions are less wealthy than their saving depositors. A floor un der rates paid might be more helpful to the poor than a ceiling. Usury ceilings eliminate the poor higherrisk borrowers from the credit market and thereby channel a higher percentage of loanable funds to lower-risk customers. Consequently, any alteration of rich-poor relationships made by low usury ceilings is likely to be in favor of the wealthy. All ceilings which alter normal flows of funds re tard economic growth. Low usury ceilings prohibit the higher rates necessary to offset the higher risks of business and individual innovators. Credit tends to be channeled into well-established, low-risk func tions. Low ceilings on rates payable by financial agencies tend to restrict the flow of funds through usual credit channels. Loan fund supplies are thereby reduced, affecting borrowers adversely. Such restric tions are especially harmful to long-term credit users, such as the housing industry, where credit is the major source of purchase money and interest an im portant part of the total costs. The thesis that high rates paid cause institutions to invest in high-risk assets has little validity. Instead of contributing to imprudent banking practices, high rates may indicate flexibility and competitiveness in meeting the sound credit demands of the community. Bank failures result from numerous factors, both in ternal and external. External factors such as monetary and fiscal policies and regional economic conditions may result in deposit drains and loan losses. These factors were probably the major cause of the failures Page 14 in the 1930’s which led to rate ceilings. In any event, evidence indicates that when low legal limits are set on rates payable, banks substitute other expenses at the margin, such as advertising, attractive buildings, and gifts, where such substitutions are profitable. The more recent reason for controls — that rate competition creates excessive hardships for savings and loan associations — is likewise difficult to uphold. It implies that a wider profit margin for banks is necessary to keep funds flowing through the savings and loan associations into the home building industry. This wider margin for banks was established despite the fact that bank failures were almost at the zero level. This type of assistance protects both the strong and the weak, inhibits price competition between the two types of firms and among firms within each group, and diverts funds to less desirable uses. Greater liquidity in the form of more short-term assets is apparently necessary for a number of sav ings and loan associations. Some increase in such assets will permit the associations to weather most sharp increases in rates without excessive strain. If some assistance is necessary for savings and loan associations, a reduction in price competition appears to be an extremely expensive type of aid. Greater assistance to the weaker associations through the Fed eral Home Loan Bank System would appear more appropriate. Monetary and fiscal policies which contribute to greater price stability should alleviate most requests for assistance by savings and loan associations. Such policies will reduce the rate of inflation, which in turn is incorporated into interest rates, thus moder ating rate increases. Finally, controls on rates payable by financial agencies ignore the welfare of savers who invest through these agencies. Such savers perform a vital function in the economy. Rate controls deny many low income savers the right to a competitive loanable funds market. High income savers can bypass the controlled market by investing in equities, etc., but if rate controls cause them to divert funds or to lose interest income, their contribution to economic prod uct is reduced. C l if t o n B. L uttrell This article is available as reprint series No. 32. Farm Income Rises ABM INCOME resumed its upward trend in the first half of 1968 after declining from $16.2 billion in 1966 to $14.2 billion in 1967, according to the United States Department of Agriculture. Realized net in come of farmers from farming, at the seasonally ad justed annual rate of $14.6 billion, was up 3 per cent from the rate in the first half of 1967. Cash receipts from farm commodity sales were 2 per cent higher, reflecting slightly higher prices and a small increase in the quantity of products marketed. Nonmoney income combined with Government payments were up 6 per cent. Production expenses were also higher, offsetting about half the income gain. Based on preliminary estimates, the number of farms in the nation declined about 3 per cent from 1967 to 1968, the same rate as during the past dec ade. Net income per farm, estimated at an annual rate of $4,781 for 1968, is 5 per cent higher than a year earlier, reflecting fewer farms and increased total farm income. Total net farm income has risen 36 per cent from its post-World War II low of $10.7 billion in 1957 TABLE I: Realized Net Farm Income 48 States1 Total Income (M illio n s of dollars) 1 945 1 95 0 1 955 1957 1959 1961 1963 1 96 5 1 96 6 1967 1968 12,751 12,861 11,249 10,7 0 7 11,362 12,646 12,583 13,993 16,193 14,241 14 ,6 0 0 2 N um ber of Farms Income Per Farm (Dollars) 5 ,9 6 6 ,7 5 0 5 ,6 4 7 ,8 0 0 4 ,6 5 3 ,8 0 0 4 ,3 7 1 ,7 0 0 4 ,0 9 7 ,3 0 0 3 ,8 1 4 ,8 0 0 3 ,5 5 5 ,6 0 0 3 ,3 3 4 ,5 0 0 3 ,2 3 3 ,4 0 0 3 ,1 4 1 ,3 0 0 3 ,0 5 3 ,6 0 0 $ 2 ,1 3 7 2,2 7 7 2,4 1 7 2,4 4 9 2,773 3,3 1 5 3,5 3 9 4 ,1 9 6 5,008 4,533 4,781 in clu d e s returns fo r op era tor’s and unpaid fam ily labor and op era tor’s investment. 2First h alf o f year at seasonally adjusted annual rate. Source: U SD A . (Table I ). Gross income has risen 47 per cent, from $30 billion to $44 billion, and production expense has risen 57 per cent, from $23 billion to $36 billion. With the number of farms decreasing since 1957, average net income per farm has risen from $2,449 to $4,781, an average gain of 6.3 per cent per year. These figures are not to be confused with estimates of income per farm family since they do not include income received by farm families from nonfarm sources.1 TABLE II: Output of Livestock Products Eggs, mil. M ilk, mil. lbs. Beef, mil. lbs. Pork, mil. lbs. Poultry, mil. lbs. Jan.<June Jan.-June Per Cent 1967 1968 C hange 3 5 ,3 3 4 6 2 ,8 6 6 10,066 6,093 3,441 3 5 ,5 5 9 6 1 ,8 2 4 10,131 6,319 3 ,4 0 7 0.6 -1 .7 0.6 3.7 - 1.0 Source: U SD A. The gain in receipts from farm commodities from the first half of 1967 to the first half of 1968 was the result of an increase in livestock receipts, with little change in returns from crops. Livestock receipts, which accounted for two-thirds of all farm receipts, were up about 4 per cent during this period. The increase in receipts from livestock reflected small increases in both production and prices. Pork output was up almost 4 per cent from a year earlier, while beef and egg production showed modest in creases. Production of milk and poultry, however, declined slightly (Table II). Output of all livestock products increased about one per cent. Production per consumer was about the same as a year earlier, as the nation’s population also increased about one per cent. Prices of livestock products in the first half ] For estimates of trends in income of the farm population from all sources, see the Farm Income Situation, July, 1968. Page 15 more than offset the impact on prices of a moderate increase in production. TABLE III: M ajor Agricultural Commodity Prices Jan.-June Jan.-June 1967 1968 Beef cattle, cwt. Hogs, cwt. M ilk, cwt. Eggs, doz. Broilers, lb. All livestock products1 Cotton, lb. Soybeans, bu. Corn, bu. W heat, bu. Rice, cwt. Oats, bu. A ll crops1 $2 2 .0 2 19.23 4.91 .32 .14 27 6 .20 2.72 1.27 1.55 5.15 .69 22 4 $23 .13 18.52 5.08 .30 .14 281 .21 2.56 1.06 1.37 5.31 .69 231 A ll farm products1 252 258 Per Cent C h a n ge 2 5.0 -3 .7 3.5 -6 .9 2.9 1.8 1.8 -5 .9 -1 6 .5 -1 1 .6 3.1 -0 .2 3.1 2.4 'A v era ges o f price indexes (1910-14= 100). P e rc e n ta g e changes calculated p rior to rounding o f prices. Source: U SD A. of the year averaged 1.8 per cent higher than a year earlier, indicating a slight increase in demand (Table II I). Prices of beef cattle, broilers, and milk averaged well above year-earlier levels, while hog prices were lower as a result of the major gain in output. The sharp decline in egg prices reflects both the continued long-run decline in demand and a small increase in production. Crop receipts were about unchanged from the first half of 1967 to the first half of 1968. Prices aver aged 3 per cent higher this year than a year earlier, while the quantity marketed was down. Higher prices were received for fruit and vegetables, which were in relatively short supply. These crops constitute a large share of total crop sales in the first half of the year and have a major impact on average prices dur ing this period. Prices of the major crops — com, soybeans, and wheat —which are marketed primarily in the last half of the year, were lower. Favorable Outlook for Last Half of 1968 Supply and price prospects point to favorable farm incomes through the remaining months of 1968. The United States Department of Agriculture has esti mated that cash farm receipts for all of 1968 will exceed year-earlier levels by $1.5 to $2 billion and that Government payments will be up about $300 million. Production expenses, however, are expected to offset about half the gain. This would result in a rise in net income for the year of about 5 per cent. These farm income estimates are based on expec tations of slightly higher prices than a year earlier and a small increase in production. The rising de mand for farm products, coupled with the Govern ment price supports for most crops, is expected to Page 16 Total production of livestock products in the last half of this year will probably remain about un changed from year-earlier levels. Larger beef and broiler production may offset some reduction in pork, veal, lamb, mutton, and turkeys. A small increase in population may result in slightly lower per capita output of meat. In the first half of the year milk pro duction was well below year-earlier levels; however, at midyear output was increasing, and the second half may exceed that of a year earlier. The lower replacement pullet hatch during the ten months end ing in April indicates a sharp reduction in egg pro duction in the remaining months of 1968 compared with year-earlier levels. Crop production in 1968 will be 3 per cent greater than the record harvest of last year, based on USDA estimates of August 1. Crops expected in larger quan tities this year include food grains, oil seeds, cotton, sugar, noncitrus fruits, and summer vegetables. Total feed grain tonnage is expected to be only slightly below the record of 1967. Forage crops and tobacco will be down somewhat from 1967. Cotton production is expected to rise 47 per cent from the small 1967 crop of 7.5 million bales, as a result of both increased acreage and larger yields. Both rice and soybean output are expected to con tinue the uptrend of recent years. Rice production is estimated at 24 per cent higher than a year ago, while soybean production will probably rise about 9 per cent to 1,064 million bushels. Wheat production is forecast at 5 per cent above last year, while com output is expected to be down 4 per cent from a year ago, but 18 per cent above the 1962-66 average. Supplies of most crops, reflecting increased produc tion and carry-over from past production, will be somewhat greater in the 1968-69 marketing year than a year earlier (Table IV ). Total feed grain supplies will be up about 5 per cent. Oats and barley TABLE IV: Estimated Supply of M ajor Crops ( 1 9 6 8 - 6 9 M arketing Year) Production Feed G rains, mil. tons 174 1,064 Soybeans, mil. bu. W heat, mil. bu. 1,606 Rice, mil. cwt. 112 Cotton, mil. bales 11 Tobacco, mil. lbs. 1,828 C arry-O ve r Total Supply Per Cent C hange From 1 9 6 7 -6 8 49 160 537 8 6 4 ,0 8 7 223 1,224 2,143 120 17 5 ,9 1 5 5 15 10 22 -1 2 — 3 Source: U SD A, A ugust 1 crop estimate. will be more than 10 per cent greater, and somewhat larger supplies of sorghum grain are in prospect. A larger wheat crop, coupled with an increase in carry over, indicates total supplies are about 10 per cent larger than a year earlier. Soybean supplies are esti mated at about 15 per cent above a year earlier, as a result of a sharp increase in carry-over and the 9 per cent increase in production. The rice crop and carry-over supplies may exceed year-earlier levels by 22 per cent. The crop is expected to total 24 per cent more than a year earlier, and carry-over stocks are about unchanged. Cotton supplies will be down again in 1968-69 despite a prospective 50 per cent increase in the crop compared with a year earlier. Production of 7.5 million bales last year was the lowest in this century. With use estimated at about 13.4 million bales, carry-over stocks into the 1968-69 season will decline to about 6 million bales, the smallest carry over in more than a decade. This carry-over added to the current production estimate of 11 million bales provides supplies of 17 million bales, a level adequate to meet demands at current price levels, but not excessive in light of usual foreign aid commitments. Tobacco supplies, reflecting an expected 7 per cent decline in the crop and little change in carry-over stocks, may be down about 3 per cent from the 1967-68 level. The generally plentiful supply of crops in 1968-69 would indicate somewhat lower prices in the months ahead compared to year-earlier levels. However, Government price supports, coupled with rising de mand, will tend to hold most crop prices near current levels. On the other hand, the reduced per capita supplies point to somewhat higher average prices for livestock products. This combination of lower crop prices and higher livestock prices indicates little change in average prices for all farm products in the second half of 1968 compared with year-earlier levels. With little change in average prices and some in crease in production and Government payments, farm incomes are likely to continue above a year earlier during the remaining months of 1968. Prospects for Carry-Over at End of 1968-69 Year-end stocks of most crops in the 1968-69 mar keting year will probably be well below the average for the past decade, despite generally larger supplies. Domestic demand for crops continues to rise with the increase in population, and exports for cash and foreign aid have also trended upward. TABLE V: Rate of C h ange in Total Farm Commodity Use (both domestic consumption and exports) Soybeans, mil. bu. W heat, mil. bu. Rice, mil. cwt. Cotton, mil. bales Tobacco, mil. lbs. Corn, mil. bu. O ats, mil. bu. Barley, mil. bu. Sorghum G rain, mil. bu. 1 9 6 2 -6 3 1 9 6 7 -6 8 A nnual Rate of C hange 702 1,224 63.5 11.8 2,030 3,8 9 5 1,019 410 516 903 1,405 89.6 13.4 2,013 4 ,3 9 6 786 375 740 5.2 2.8 7.1 2.6 -0 .2 2.4 -5 .1 -1 .8 7.5 Source; U S D A . Feed grain stocks at the close of 1968-69 are ex pected to be only slightly above the 1967-68 level of 47 million tons, but well below the 69.1 million ton average for 1961-65. Total supplies of feed grains in 1968-69 will rise 4 per cent, while use is expected to repeat the 2.5 per cent gain of recent years. Stocks of soybeans and wheat may show sizable increases at the end of 1968-69. Soybean supplies in 1968-69, up 15 per cent compared with a 5 per cent increase in rate of use (Table V ), point to an in crease in carry-over stocks of about 100 million bush els. Carry-over stocks of soybeans have heretofore been relatively insignificant, averaging less than 10 per cent of the crop during the past decade. They rose to 90 million bushels on September 1, 1967, and are estimated at 160 million bushels this year. Wheat carry-over may increase 175 million bushels to about 600 million unless unexpected markets develop. This carry-over would still be only about half the average of the past decade. Rice carry-over may also be up somewhat a year hence from the nominal levels of recent years (about 10 per cent of the quantity used in 1967-68). Such carry-over, however, is not likely to be great relative to past carry-over stocks of other major crops. Carry-over stocks of both cotton and tobacco at the end of the 1968-69 marketing year are likely to be well below a year earlier. Cotton inventories are already down to relatively moderate levels, and when added to another relatively small crop, they provide a total supply of only 17.7 million bales, or about 3.4 million more than was used domestically and ex ported in 1967. Carry-over stocks at the end of 196869 may be 50 per cent less than a year earlier. Esti mated tobacco production is about 200 million pounds below estimated use in the current marketing year, pointing to a 5 per cent reduction in carry-over stocks at the end of 1968-69. This will approach the mini mum level of tobacco inventories necessary for proper aging. Page 17 TABLE VI: M A J O R CROP P R O D U C T IO N (Per Cent Change from 1 9 6 7 ) Corn O ats Barley Sorghum G rain W heat Rice Cotton Tobacco 1.0 13.2 “ 2.1 21.6 7.0 -1 6 .8 -1 5 .9 — 4.0 -2 1 .6 -1 0 .7 24.4 — 14.4 19.6 — 116.3 — 52.8 205.1 155.2 5.1 — 3.8 10.7 Soyb eans 2.4 -2 1 .7 -2 0 .0 - 8.0 -3 0 .2 15.4 - 9.2 - 8.2 6.8 -1 7 .0 23.3 84.3 6.3 3.2 3.6 2.7 14.8 68.1 24.8 10.0 -2 0 .1 - 6.8 - 7.7 4.9 8.1 8.0 15.7 8.5 -2 8 .0 -1 7 .0 -2 0 .7 — — 23.3 — — 84.3 — 0.6 6.1 3.5 20.0 14.8 0.8 9.4 5.4 24.4 47.2 -1 6 .1 -1 8 .8 -1 2 .1 13.0 -1 4 .1 - 0.2 - United States - 15.9 10.5 - 3.6 28.0 0 - _ -3 4 .4 -1 3 .2 — 0 - 6.7 A rkan sas Kentucky M ississipp i M issouri Tennessee Central M ississippi Valley (5 states) Illinois Indiana Seven States - 7.3 Source: U SD A, 1968 estim ate as o f A ugust 1. The Central Mississippi Valley Reflecting smaller-than-average crop production in 1967, cash receipts in the first half of this year trailed year-earlier levels in much of the Central Mis sissippi Valley. By contrast, cash receipts nationally were somewhat higher than a year earlier. Part of the cash receipts decline in the Valley states was offset by larger Government payments. Nevertheless, with ris ing farm expenses, net income to area farmers was probably lower than a year earlier. Prospects for Central Mississippi Valley fanners Page 18 are better in the second half of this year. Cash re ceipts from livestock product sales are likely to con tinue above those of last year in view of the favorable price prospects. In addition, crops over most of the area are very good (Table V I). Due to Government price supports, larger crop production will probably more than offset any price declines, resulting in higher receipts. With higher receipts in prospect from crop and livestock sales and larger Government payments, net income to Central Mississippi Valley farmers for the year should be higher than year-earlier levels, despite higher operating costs. J I o f JJu& Sank Qrududa: Weekly U. S. FINANCIAL DATA Monthly REVIEW MONETARY TRENDS NATIONAL ECONOMIC TRENDS SELECTED ECONOMIC INDICATORS - CENTRAL MISSISSIPPI VALLEY Quarterly FEDERAL RUDGET TRENDS U. S. RALANCE OF PAYMENTS TRENDS TRIANGLES OF U. S. ECONOMIC DATA GROSS NATIONAL PRODUCT Annually TRIANGLES OF U. S. ECONOMIC DATA RATES OF CHANGE IN ECONOMIC DATA FOR TEN INDUSTRIAL COUNTRIES (QUARTERLY SUPPLEMENT) Copies of these publications are available to the public without charge, including bulk mailings to banks, business organizations, educational institutions, and others. For information write: Research Department, Federal Reserve Bank of St. Louis, P. O. Box 442, St. Louis, Missouri 63166.
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