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I. Or*

For release on delivery
7 p*rru, Pacific Standard Time
K10 p., m<,, Eastern Standard Time)
Monday, December 19 1970

The Basis for Lasting Prosperity

Address by
Arthur F. Burns
Chairman, Board of Governors of the Federal Reserve System

in the
Pepperdine College
Great Issues Series

at the
Beverly Hilton Hotel
Los Angeles, California

December 7, 1970

The Basis for Lasting Prosperity

Nearly three years ago, in a talk here in Los Angeles, I
pointed out that once an economy becomes engulfed by inflation,
economic policy makers no longer have any good choices*


regain a lasting prosperity, a nation must have the good sense and
fortitude to come to grips with inflation.

There is, however, no

painless way of getting rid of the injustices, inefficiency, and
international complications that normally accompany an inflation.
Events of the past several years have lent poignancy to
these simple truths.

Recent experience has demonstrated once

again that the transition from an overheated economy to an economy
of stable markets is a difficult process.

Elimination of excess

demand was an essential first step to the restoration of stability,
but this step has brought with it a period of sluggish economic
activity, slow income growth, and rising unemployment,


while we have made some progress in moderating the rate of inflation,
our people are still seeing the real value of their wages and
savings eroded by rising prices.
The struggle to bring inflationary forces under control,
and to return our labor and capital resources to reasonably full
employment, is still going on.

I am convinced, however, that

- 2-

corrective adjustments in the private sector over the past twelve
to eighteen months are creating, in conjunction with governmental
stabilization policies, the foundation on which a prolonged and stable
prosperity can be constructed*
A cardinal fact about the current economic situation, and
one that promises well for our nation1 s future, is that the imprudent
policies and practices pursued by the business and financial
community during the latter half of the 1960fs are being replaced by
more sober and realistic economic judgments.

In my remarks to

you today, I want first to review some of the key developments that
lead me to this conclusion.

Then I shall turn to the tasks that must

still be faced in order to enhance the prospects for an early resumption
of growth in production and employment in an environment of reasonably
stable prices.
The current inflation got under way in 1964* Perhaps the
best single barometer of the extent to which it served to distort
economic decisions and undermine the stability of the economy is
found in the behavior of financial markets during the late 1960!s.
In 1968, well over 3 billion shares of stock exchanged hands on the
New York Stock Exchange--about two and one-half times the volume
of five years earlier.

The prices of many stocks shot upward with

« 3 -

little reference to actual or potential earnings.


the two years 1967 and 1968, the average price of a share
of stock listed on the New York Exchange rose 40 per cent,
while earnings of the listed companies rose only 12 per cent*
On the American Exchange the average share price rose
during the same two years more than 140 per cent on
an earnings base that increased just 7 per cent*
A major source of the speculative arcjor carne
from some parts of the mutual fund industry.


investment in stocks of companies with proven earnings
records became an outmoded concept for the new breed of
"go-go11 funds.

The "smart money11 was to go into issues

of technologically oriented firms—no matter how they
were meeting the test of profitability, or into the corporate
conglomerates--no matter how eccentric their character.
This mood of speculative exuberance strongly
reinforced the upsurge of corporate mergers which occurred
during the middle years of the 1960's.

No doubt many of these mergers

could be justified on grounds of efficiency.

But the financial history of


mergers--including some of the great conglomerates--suggests
that many businessmen became so preoccupied with acquiring new
companies and promoting the conglomerate image that they lost
sight of the primary business objective of seeking larger profits
through improved technology, marketing, and management*


talented corporate executives devote their finest hours to arranging
speculative maneuvers, the productivity of their businesses inevitably
suffers and so too does the nation's productivity.
These speculative excesses had to end, and it is fortunate
that they ended before bringing disaster to our nation.


values are now being appraised more realistically than a year or
two ago.

Investors are now more attentive to high quality stocks.

Indeed, many of them have discovered or rediscovered that even bonds
and time deposits are a fit use of their funds*

Not a few of those

responsible for the frantic search for "performance stocks" have
shifted to other activities or joined the ranks of the unemployed;
so also have numbers of security analysts and stock brokers*
With speculation giving way to longer-term investment, the stock
market is now channeling risk capital to business firms more

- 5


A searching reappraisal of the economic philosophy of
mergers is also underway.
since mid-1969.

Merger activity has slowed materially

To some degree this is a response to the growing

concern in governmental circles over the dangers that may inhere
in large concentrations of economic power,

But it stems mainly

from the fact that businessmen are recognizing that time and
energy can usually be spent more productively in searching for
ways to increase the economic efficiency of their firm than in a
scramble for corporate acquisitions,
BusinessmeB are also reconsidering the wisdom of financial
practices that distorted their balance sheets during the late 1960's,
In the manufacturing sector, the ratio of debt to equity-^-which had
been approximately stable during the previous decade--began
rising in 1964 and was half again as large by 1970,

Liquid asset

holdings of corporate businesses were trimmed to the bone* On
the average, the ratio of prime liquid assets to current liabilities
fell by nearly half during those six years.

In permitting such a

drastic decline in liquidity, many of our corporations openly
courted trouble.
Perhaps the most ominous source of instability produced
by these financial practices was the huge expansion of the commercial
paper market*

The volume of commercial paper issued by

- 6-

nonfinancial businesses increased eightfold between the end of
1964 and mid-1970, as an increasing number of firms —some
of them with questionable credit standings--began to tap this market*
The hazards inherent in the spreading reliance on commercial paper
were taken much too lightly.

After all, the relations between the

buyer and seller of commercial paper are by their very nature
distant and impersonal—unlike the close working relationship that
normally develops between a bank and its business customers.


buyer--typically an industrial enterprise--rarely has the facilities
or the experience to carry out a full investigation of the risks
attaching to commercial paper*

Moreover, the buyer regards his

investment as temporary--to be withdrawn when cash is needed or
when questions arise about the quality of the paper.

The issuer,

therefore, faces considerable uncertainty as to the amount of
his maturing obligations that may be renewed on any given day.
The risks facing the individual issuer and buyer inevitably pose a
problem also for the nation's financial system, since the difficulties
experienced by any large issuer of commercial paper may quickly
spread to others.
These familiar truths were lost sight of in the inflationary
aura of the late 1960's.

It took the developments of last summer,

when the threat of financial crisis hung for a time over the commercial

^ 7-

paper market, to remind the business commujsity that timehonored principles of sound finance are still relevant.
As a result of that experience and the testing of financial
markets generally during the past two years, corporate financial
policies are now more constructive than in the recent past.


year, new stock issues have continued at a high level--even in
the face of unreceptive markets--as corporations have sought to
stem the rise in debt-equity ratios.

Of late, borrowing by corporations

has been concentrated in long-term debt issues, and their rate of
accumulation of liquid assets has risen.

Liquidity positions of

industrial and commercial firms are thus improving, though it will
take some time yet to rectify fully the mistakes of the past.
These efforts to restore sound business finances are not
without costs to the nation.

For example, long-term interest rates,

while below their peaks at the end of last year or last spring, are
still at unusually high levels because of this year's extraordinary
volume of new capital issues.

But there can be no doubt that

substantial adjustments in the financial practices of our nation's
businesses were essential if the basis for a lasting and stable
prosperity was to be re-established.

- 8 -

By and large, our major financial institutions conducted
themselves with prudence during the years when last practices were
spreading in financial markets.

There were, however, some

individual institutions that overextended loan commitments relative
to their resources, others that reduced liquidity positions to unduly low
levels, still others that permitted a gradual deterioration in the
quality of loan portfolios, and even a few that used funds of depositors
to speculate in long-term municipal securities.
institutions were distinctly in the minority.

Fortunately, such

When the chips were

down, our major financial institutions proved to be strong and resilient.
And they are stronger today.

As monetary policy has eased,the

liquidity of commercial banks has been increasing.

Even so, loan

applications are being screened with greater care.

The emphasis

on investment quality has also increased at other financial institutions,
as is evidenced by the recent wid^ spread between the yields of high
and lower grade bonds.
These corrective adjustments in private financial practices
have materially improved the prospects for maintaining order and
stability in financial markets.

But no less important ta the establish-

ment of a solid base for a stable and lasting prosperity have been
the developments this year in the management of the industrial and
commercial aspects of business enterprise.

- 9-

During the latter half of the 1960's, business profit margins
came under severe pressure*

The ratio of profits after taxes to income

originating in corporations had experienced a prolonged rise during
the period of price stability in the early 1960's*

But this vital

ratio declined rather steadily from the last quarter of 1965 and
this year reached its lowest point of the entire postwar period.
Until the autumn of 1969 or thereabouts, the decline in profit
margins was widely ignored.

This is one of the great perils of

Underlying economic developments tend to be masked

by rising prices and the state of euphoria that comes to pervade
the business community.

Though profit margins were falling and

the cost of external funds was rising to astonishing levels, the
upward surge of investment in business fixed capital continued.
True, much of this investment was undertaken in the interest of
economizing on labor costs.

Simultaneously, however, serious

efforts to bring operating costs under control became more and
more rare, labor hoarding developed on a large scale, huge wage
increases were granted with little resistance, and some business
investments were undertaken in the expectation that inflationary
developments would one way or another validate almost any business

While the toll in economic efficiency taken by these loose

- 10 -

managerial practices cannot be measured with precision, some
notion of its significance can be gained by observing changes in
the growth rate of productivity*
From 1947 through 1966, the average rate of advance in
output per manhour in the private sector of the economy was about
% per cent per year.

In 1967, the rate of advance slowed to under

2 per cent, and gains in productivity ceased altogether from, about
the middle of 1968 through the first quarter of this year.

The loss

of output and the erosion of savings that resulted frojn this slowdown
in productivity growth are frightfully high.
The elimination of excess demand, which the government's
aB^i^inflajtian^ury policies brought abotet, ii now forcing business
firms to mend their ways.

Decisions with regard to production

and investment are no longer being made on the assumption that
price advances will rectify all but the most imprudent Business

In the present environment of intense competition in

product markets, business firms are weighing carefully the expected
rate of return on capital outlays and the co^ts of financing.


rate of investment in plant and equipment has therefore flattened out,
and advance indicators suggest that business fixed investment will
remain moderate in 1971*

- 11 ~

Business attitudes toward cost controls have of late also
changed dramatically.

A cost-cutting process that is more widespread

and more intense than at any time in the postwar period is now underway
in the business world*

Advertising expenditures are being curtailed,

unprofitable lines of production discontinued, less efficient offices
closed, and research and development expenditures critically

Layers of superfluous executive and supervisory

personnel that were built up over a long period of lax managerial
practices are being eliminated,,

Reductions in employment have

occurred among all classes of workers—blue collar, white collar,
and professional workers alike.

Indeed, employment of so-called

non-production workers in manufacturing has shown a decline
since March that is unparalleled in the postwar period*
Because of these vigorous efforts to cut costs, the growth
of productivity has resumed, after two years of stagnation.

In the

second quarter of this year, output per manhour in the private
nonfarm economy rose at a 4 per cent annual rate, and the rate
advanced to 5 per cent in the third quarter.

These productivity

gains have served as a sharp brake on the rise in unit labor
costs, despite continued rapid increases in wage rates.

- 12 -

In my judgment, these widespread changes in business
and financial practices are evidence that genuine progress is
being made in the long and arduous task of bringing inflationary
forces under control.

We may now look forward with some

confidence to a future when decisions in the business and
financial community will be made more rationally, when
managerial talents will be concentrated more intensively on
efficiency in processes of production, and when participants
in financial markets will avoid the speculative excesses of the
recent past*
Let me invite your attention next to the role that government policies have played this year in fostering these and r e lated adjustments in private policies and practices.
The fundamental objective of monetary and fiscal policies
this year has been to maintain a climate in which inflationary
pressures would continue to moderate, while providing sufficient stimulus to guard against cumulative weakness in economic

Inflationary expectations of businessmen and consumers

had to be dampened; the American people had to be convinced
that the government had no intention of letting inflation run

But it was equally important to follow policies that

- 13 would help to cushion declines in industrial production stemming
from cutbacks in defense and reduced output of business equipment, and to set the economy on a course that would release the
latent forces of expansion in our home-building industry and in
state and local government construction*

I believe we have

found this middle course for both fiscal and monetary policy.
A substantial reduction in the degree of fiscal restraint
has been accomplished this ye%r with the phasing out of the income tax surcharge and the increase in social security benefits.
These sources of stimulus provided support for consumer disposable incomes and spending at # time when manufacturing
employment was declining aiid the length of the work-Week was
being cut back.
I do not like, but I also am not deeply troubled,by the
deficit in the Federal budget during the current fiscal year.
If the deficit had originated in a new explosion of governmental spending, I would fear its inflationary consequences*
This, however, is not the present case.

The deficit in fiscal

1971--though it will prove appreciably larger than originally
anticipated—reflects in very large part the shortfall of revenues
that has accompanied the recent sluggishness of economic

- 14 activity.

The Federal budget is thus cushioning the slowdown

in the economy without releasing a new inflationary wave*


President's determination to keep spending under control is
heartening, particularly his plea last July for a rigid legislative ceiling on expenditures that would apply to both the
Executive and the Congress*

However, pressures for much

larger spending in fiscal 1972 are mounting and pose a threat
to present fiscal policy*
Monetary policy this year has also demonstrated, I
believe, that it could find a middle course between the policy
of extreme restraint followed in 1969 and the policies of
aggressive ease pursued in some earlier years.


rates have come down? and liquidity positions of banks, other
financial institutions, and nonfinancial businesses have been
rebuilt--though not by amounts that threaten a reemergence
of excess aggregate demand.

A more tranquil atmosphere

now prevails in financial markets.

Market participants have

come to realize that temporary stresses and strains in financial markets could be alleviated without resort to excessive
rates of monetary expansion*

Growth of the money supply

thus far this year—averaging about a 5-1/2 per cent annual

- 15 -

rate—has been rather high by historical standards.

This is

not, however, an excessive rate for a period in which precautionary demands for liquidity have at times been quite
The precautionary demands for liquidity that were in
evidence earlier in 1970 reflected to a large degree the business and financial uncertainties on which I have already commented.

It was the clear duty of the nation's central bank to

accommodate such demands.

Of particular importance were

the actions of the Federal Reserve in connection with the
commercial paper market last June.

This market, following

the announcement on Sunday, June 21, of the Penn Central's
petition for relief under the Bankruptcy Act, posed a serious
threat to financial stability.

The firm in question had large

amounts o£ maturing commercial paper that could not be renewed, and it could not obtain credit elsewhere.

The danger

existed that a wave of fear would pass through the financial
community, engulf other issuer** of commercial paper, and
cast doubt

on a wide range of other securities.

By Monday, June 22--the first business day following
announcement of the bankruptcy petition-**-the Federal Reserve

- 16 ~
had already taken the virtually unprecedented step of advising
the larger banks across the country that the discount window
would be available to help the banks meet unusual borrowing
requirements of firms that could not roll over their maturing
commercial paper.

In addition, the Board of Governors r e -

viewed its regulations governing ceiling rates of interest on
certificates of deposit, and on June 23 announced a suspension
of ceilings in the maturity range in which most large certificates of deposit are sold.

This action gave banks the freedom

to bid for funds in the market and make loans available to
necessitous borrowers *
As a result of these prompt actions, a sigh of relief
passed through the financial and business communities.


actions, In themselves, did not provide automatic solutions
to the many problems that arose in the ensuing days and weeks.
But the financial community was reassured tliat the Federal
Reserve understood the seriousness of the situation, and that
it would stand ready to use its intellectual and financial resources, as well as its instruments of monetary policy, to
assist the financial markets through any period of stress.
Confidence was thus bolstered, with the country's large banks

* 17 *

playing their part by mobilizing available funds to meet the
needs of sound borrowers caught temporarily in a liquidity
The role that confidence plays as a cornerstone of the
foundation for prosperity cannot, I think, be overstressed.
Much has been dene over recent months by private businesses
and by the government to strengthen this foundation*

If we ask

what tasks still lie ahead, the answer I believe must be: full
restoration of confidence among consumers and businessmen
that inflationary pressures will continue to moderate, while
the awaited recovery in production and employment becomes
a reality.
The implications of this answer for the general course
of monetary and fiscal policies over the near term seem to me

The thrust of monetary and fiscal policies must be

sufficiently stimulative to assure a satisfactory recovery in
production and employment.

But we must be careful to avoid

excessive monetary expansion or unduly stimulative fiscal

Past experience indicates that efforts to regain

our full output potential overnight would almost surely be selfdefeating.

The improvements in productivity that we have

- 18 -"

struggled so hard to achieve would be lost if we found
ourselves engulfed once again in the inflationary excesses
that inevitably occur in an overheated economy*
As I look back on the latter years of the 196Q*s, and
consider the havoc wrought by the inflation of that period, I am
convinced that we as a people need to assign greater prominence
to the goal of price stability in the hierarchy of stabilization

I have recommended on earlier occasions that

the Employment Act of 1946 be amended to include explicit
reference to the objective of general price stability.

Such a

change in that law will not, of course, assure better economic

But it would call the nation1 s attention dramatically to

the vital role of reasonable price stability in the maintenance of
our national economic health.
At the present time, governmental efforts to achieve
price stability continue to be thwarted by the continuance of
wage increases substantially in excess cf productivity gains*
Unfortunately, the corrective adjustments in wage settlements
that are needed to bring inflationary forces under control
have yet to occur.

The inflation that we are still experiencing

is no longer due to excess demand.

It rests rather on the upward

push of costs—mainly, sharply rising wage rates*

- 19.-

Wage increases have not moderated.

The average

rate of increase of labor compensation per hour has been
about 7 per cent this year~-roughly the same as last year.
Moreover, wage costs under new collective bargaining contracts
have actually been accelerating despite the rise in unemployment*
In the third quarter of this year, major collective bargaining
agreements called for annual increases in wage rates averaging
10 per cent over the life of the contract*

Negotiated settlements

in the construction industry during the same three months
provided for wage increases averaging 16 per cent over the
life of the contract, and 22 per cent in the first year of the

Nqr is the end of this explosive round of wage increases

yet in sight*

Next year, contracts expire in such major

industries as steel, aluminum, copper, and cans.

If contracts

in those industries are patterned on recent agreements in
the construction industry--or, for that matter, in the trucking
and automobile industries--heavy upward pressures on prices
will continue*
I fully understand the frustration of workers who have
seen inflation erode the real value of past wage increases*

But it

is clearly in the interest of labor to recognize that economic

- 20 recovery as well as the battle against inflation will be impeded
by wage settlements that greatly exceed probable productivity
In a society such as ours* which rightly values full
employment, monetary and fiscal tools are inadequate for dealing
with sources of price inflation such as are plaguing us now--that
is, pressures on costs arising from excessive wage increases*
As the experience of our neighbors to the north indicates,
inflationary wage settlements may continue for extended periods
even in the face of rising unemployment.
has been moving up since early 1966,

In Canada, unemployment

New wage settlements in

major industries, however, averaged in the 7 to 8 per cent
range until the spring of 1969, then rose still further.


year, with unemployment moving above 6-1/2 per cent, negotiated
settlements have been in the 8 to 9 per cent range.
Many of our citizens, including some respected labor
leaders, are troubled by the failure of collective bargaining
settlements in the United States to respond to the anti-inflationary
measures adopted to date.

They have come to the conclusion, as

I have, that it would be desirable to supplement our monetary
and fiscal policies with an incomes policy, in the hope of thus

- 21 -

shortening the period between suppression of excess demand and
the restoration of reasonable relations of wages, productivity,
and prices.
To make significant progress in slowing the rise in
wages and prices, we should consider the scope of an incomes
policy quite broadly.

Tha essence of incomes policies is that

they are market-oriented; iii other words, their aim is to
change the structure and functioning of commodity and labor
markets in ways that reduce upward pressures on costs and
The additional anti-inflationary measures announced by
the President last Friday will make a constructive contribution
to that end*

The actions to increase the supply of oil will

dampen the mounting cost of fuels, and the recommendations
made by the President to improve the structure of collective
bargaining in the construction industry strike at the heart of
a serious source of our current inflationary problem,
I would hope that every citizen will support the President's
stern warning to business and labor to exercise restraint in
pricing and wage demands*

A full measure of success in

- 22 -

the effort to restore our nation's economic health is, I believe,
within our grasp, once we as a people demonstrate a greater
concern for the public interest in our private decisions.
If further steps should prove necessary to reduce upward
pressures on costs and prices, numerous other measures might
be taken to improve the functioning of our markets.

For example,

liberalization of import quotas on oil and other commodities would
serve this purpose.

So also would a more vigorous enforcement

of the anti-trust laws, orlan expansion of Federal training
programs to incre^sejthe_sugply of skilled workers where wages
are rising with exceptional rapidity,! or the creation on a
nation-wide scale of local productivity councils to seek ways
of increasing efficiency, or a more aggressive pace in
establishing computerized job banks, or the liberalization pf
depreciation allowances to stimulate plant modernization, or
suspension of the Davis-Bacon Act to help restore order in
the construction trades, or modification of the minimum wage
laws in the interest of improving job opportunities for teenagers,
or the establishment of national building codes to break down
barriers to the adoption of modern production techniques in
the construction industry, or compulsory arbitration of labor

disputes in industries that vitally involve the public interest>
and so on.

We might bring under an iricotnes policy, also> the

establishment of a high-level Price and Wage Review Bokrd
which, while lacking enforcement power, would have broad
authority to investigate, advise, and recommend on price
and wage changes*
Such additional measures as may be required can, of
course, be determined best by the President and the Congress.
What I see clearly is the need for our nation to recognize
that we are dealing, practically speaking, with a new problem-namely, persistent inflation in the face of substantial
unemployment--and that the classical remedies may not
work well enough or fast enough in this case.

Monetary and

fiscal policies can readily cope with inflation alone or with
recession alone; but, within the limits of our national patience,
they cannot by themselves now be counted on to restore full
employment, without at the same time releasing a new wave
of inflation.

We therefore need to explore with an open mind

what steps beyond monetary and fiscal policies may need to be
taken by government to strengthen confidence of consumers and
businessmen in the nation's future.

- 24 -

In the past two years we have come a long way, I
believe, towards the creation of a foundation for a lasting and
stable prosperity.

Confidence has been restored in financial

Businesses have turned away from the imprudent

practices of the past.

Productivity gains have resumed.

Our balance of trade has improved.

The stage has been set for a

recovery in production and employment--a recovery in which
pwe tieeds for housing and public construction can be more
fully met.
To make this foundation firm, however, we must find
ways to bring an end to the pressures of costs on prices.


are no easy choices open to us to accomplish this objective.
But that, as I indicated at the outset, is the tough legacy of


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