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Talk given at
of the
School of Business Administration
University of Minnesota
Curtis Hotel

April 8, 1960


Frederick L. Deming, President
Federal Reserve Bank of Minneapolis

The title of this talk is supposed to convey two thoughts.


first is that I am going to use a lot of numbers throughout the talk because
I think it will be the quickest and easiest way to develop the points.


second is that numbers are tricky things to use and since there are so many
numbers available nowadays it has become almost a game to select those
favorable to the particular thesis one is trying to develop.

One thing I

hope to do today is to put some of the numbers that have been flying around
pretty casually into better and firmer perspective.
The first theme I want to talk about might be called 'big effects
from small numbers".

Here I want to talk about economic growth and economic

growth rates.
It is highly important, in talking about economic growth, to
understand that it occurs both because capacity increases and because demand

Either capacity or demand may limit growth at any particular

point in time.

Perhaps the most striking illustration of low capacity

limiting growth is in the underdeveloped countries.

Certainly the most

striking illustration of low demand limiting growth is the great depression
of the 1930*s.
Let us look at the long-term U. 3. growth record and at some
reasonable estimates of the capacity of our economy over the next several

So far this century we have been growing in real terms at an average

rate of about 3 per cent a year compounded.

That means that the total output

of the economy in physical terms has doubled about every twenty-five years.
We could have produced more than we did, i_f we had been willing to work longer
hours, invest in more capital and i_f we had had more demand.

A very recent study put out by the staff of the Joint Congressional

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Committee on the Economic Report has a chapter in it on potential rates of

It does not attempt to forecast what growth will be.

It merely

attempts to project what growth could be under varying and reasonable assumptions.
What this study shows is that over the next sixteen years this
economy of ours is likely to grow at the rate of at least 3.4 per cent per year
compounded, if we manage to do just about what we have been doing since World
War II has ended.

On the other hand, if we are able to smooth out our ups and

downs just a bit more and maintain unemployment at not higher than 4 per cent,
the potential growth rate would be 3.9 per cent per year compounded.

If we

could cut unemployment to 3 per cent, the growth rate would be 4.5 per cent
per year compounded.
Built into these growth rate figures are prospective population
increases and changes in number of hours worked.

Roughly speaking, the average

number of hours worked per year has declined about 0.9 per cent each year on a
long-term trend.

The projection allows for a future drop of about 0.5 per cent

per year.

This does not mean that the work week of 40 hours will necessarily


The average number of hours worked per year is affected by vacations,

number of holidays observed, and so on.
Now to come back to those little numbers I talked about that probably
don11 impress you very much.

Let me translate them first into terms of total

growth over the entire period, 1959 to 1975, and then into terms of billions
of dollars of gross national output.
With a 3 per cent growth rate, output in 1975 would be 61 per cent
ahead of today's output; a 3.4 per cent rate would make the increase 71 per cent;
a 3.9 per cent rate and the increase would be 84 per cent, a 4.5 per cent rate
and the increase would be 102 per cent.

If we could grow at the highest rate,

4.5 per cent, the GNP in 1975 would be close to one trillion ($979 billion)
dollars, and there is no price increase in that figure.

If we grow at a rate

of 3 per cent, it would be $200 billion less than that.

These figures become
Federal Reserve Bank of St. Louis

big to be very impressive, I think.

- 3 -

From such evidence as there is, it looks as though the Russian
economy is growing currently at about twice the rate of the United States
economy - perhaps 6 per cent - perhalf 7 per cent a year.

If ydu project

either of these trends to 1975, you get a Russian output increased by 2 1/2
times with a 6 per cent growth rate, or by three times with a 7 per cent
growth rate.
With due regard for the difficulties of comparison, the gross output
of Soviet Russia today is approximately one-third as large as that of the
United States.

That means we have approximately $300 billion more in output

in this country than the Soviets have.

If you take the 3 per cent United

States rate and the 7 per cent Russian rate, in 1975 this gap would be lessened
and cut back to perhaps $250 billion.

If we take a 4.5 per cent United States

rate and a 6 per cent Russian rate, the gap would be increased to more than
$500 billion.
Note now how tricky these numbers become.

We can grow at a rate

substantially smaller than the Russian rate and still widen, in absolute terms,
the gap between our total output and theirs over the next 16 years.
this be?

How can

It can be simply because we start from a much higher base and 4.5 per

cent Compounded of $480 billion is a bigger number than 6 per cent compounded
of $175 billion.

Now obviously this kind of thing cannot go on forever;

eventually maintenance of these two rates will bring the bigger rate times its
base into equality with and then above the smaller rate times its base.


key questions then are how long can the Russians grow at 6 or 7 per cent and
can we really grow at 4.5 per cent.

Remember that 4.5 per cent is really a

capacity figure.
I cannot answer either of these questions categorically.

On the

basis of history I would say that the chances of maintaining a 6 or 7 per cent
growth rate for a long time are fairly Slim.

In our very rapid period of

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development in the middle 1800’ we grew at a rate of about 4.5 per cent.


the Russians do that well over a sustained period, they will do very well indeed.
We can hit the 4.5 per cent rate again if we can keep demand high
and reasonably consistent; if we suffer recessions, we will fall below it.
And, one way to avoid strong ups and downs is to avoid excesses in demand in
one period which lead to deficiencies in demand in the next.

This means that

we should try to produce sustainable growth and we should do so with a reasonably
stable price level so as to avoid the income distortions and the speculations
that accompany inflation and leave demand imbalances.
Finally, one thing we need to keep in mind is that we have to generate
real and effective demand to absorb the output.
private sector of the economy.

That will come mainly from the

We will have to and should increase certain

government expenditures - for schools, for roads, etc., and this will absorb
additional output.

But we must guard against trying to get government to

increase spending just to absorb output, and particularly we must guard against
this being done, at least in good times, via deficit spending.
As I have stated, there is not much point in growing unless you have
some demand for the additional output.

Let us now take a look at what we do

with our output and what we are likely to do with it 10 or 15 years from now.
In 1959 the gross output - the familiar Gross National Product - in
this country was $480 billion.

The major claimants on our output - the economic

sectors that use it - are consumers, business, government, and foreigners.
Instead of talking of use patterns by these claimants, tonight I want to talk
in terms of actual uses - defanse, investment, consumption of necessities and
discretionary consumption.
Let us begin with investment since this is the thing that produces
capacity for growth.

It usually is thought of as being construction, producer's

- 5 -

equipment, inventory change, and so on - the use of physical goods to produce
physical capital for bigger production tomorrow.

But we should think also of

another kind of investment - investment in human beings.

In this investment

process we plow money into education, into health, and into welfare.

Of the

$480 billion gross output of 1959, about $89 billion, or almost 19 per cent,
went into conventional investment, both public and private.

Another $52 billion,

or 11 per cent, however, went into education, health, and other governmental

Thus Americans used just a little less than 30 per cent of their

gross output to plow back into people and plant so as to provide a better base
for more output tomorrow.
In addition to this, a little less than 10 per cent, about $46 billion,
went for national defense.

So if you take defense and both types of investment

together, almost 40 per cent of gross output went into these two categories.
The balance of output was used up by consumers.

(Actually, under

conventional national income accounting, consumers used more than this, but I
have classed expenditures on education, health, etc., as really being investment.)
As I am defining it, consumers spent about $292 billion on consumption items in

Something more than half of this went for so-called necessities - food,

clothing and shelter.

A little less than half went for discretionary uses, on

automobiles and travel, on household goods and personal services, on charities
and recreation, and so on.
To sum up then, the pattern of use of output today is about 10 per cent
for defense, 30 per cent for investment, 60 per cent for consumption.
Now, let's look at what these patterns might be in 1970 and 1975.
For this purpose we will take the middle range of the projections I was talking
about earlier.

Let's assume that we can grow until 1975 at a rate of 3.9 per cent

per year compounded.
to achieve this.

Actually we need not do much better than we are doing now

Fortune Magazine thinks this rate is too conservative and

projects a growth rate of 4.2 per cent for the next decade.

Using 3.9 per cent,

however, means that the GNP in 1970 would be $730 billion, and in 1975 would be $885
The important points to keep in mind about the uses of output 10 to
15 years from now are that if we want to continue to grow, we are going to have
to continue to invest, both in material and in human resources, and we probably
are going to have to step up our investment rate soraewhal.

Since we are using

a little less than 30 per cent of our output today for this purpose, I am
assuming that we will use more than this proportion, perhaps about 31 per cent
in 1975, and that relatively more will go for investment in human beings.
Against today's $52 billion per year in human investment then, we should be
spending about $88 billion in 1970 and about $115 billion in 1975.


ment in physical capacity is taking $89 billion today and should be up to
about $130 billion in 1970 and about $160 billion in 1975.
Now let's be pessimistic and assume we will have to continue to
spend heavily on defense measures. If we assume - and I hope this is an
outside estimate - that roughly 10 per cent of our output should go for
defense and its associated purposes, then we would be spending about $73
billion for this purpose in 1970 and $90 billion in 1975.

The latter figure

is about twice as much as the present level.
Consumption of necessities should not take as high a percentage of
the total output in 1970 and 1975 as it does now.

On a per capita basis

such use should go up by about one-fourth, on a total basis it should be up
by about oO per cent in 1975.
The amount of

output that is available for discretionary purposes,

for what some observers have called "the good life", then should be a bigger


propostion of the total in 1970 and 1975 than it is now.
about $130 billion for these ends.

Today we are using

Ten years from now that figure should

be up by $90 billion, and five years from then by another $55 billion.
Actually in 1970 it should about equal what would be invested in both human
and natural resources, and even with a large population increase this will
permit a very substantial increase on a per capita basis.
Now I want you to understand that all of these things are attain­
able without us doing much more than we are doing at the present time - if
we are reasonable and sensible.

We shall have to avoid deep recessions, but

we have managed to do this pretty much since World War II.
keep about 9u per cent of the labor force employed.

We shall have to

We are not doing quite

chat well at the moment, but we have done about that well in the entire
postwar period.

We shall have to continue, and even to increase somewhat,

our investment program.

But this does not involve any cutback in consumption,

either of necessities or of fun goods.
I don't want to make this sound too simple, however, because there
are some things that will have to be done - not very difficult things, but
very important things.

These actions that need to be taken consist more of

using our heads than our muscles.

In very simple form, what is required for

the American economy to expand at this very satisfactory rate is for the
people to exercise the responsibilities of citizens in a democracy operating
under what is essentially a free market system.

This requires (a) an attempt

to understand the issues, (b) thoughtful appraisal of the future, that is,
some reference to tomorrow as well as to today, and (c) a sense of purpose to

E>ake this country and the world a better place to live in.

And it is im-


portant in this connection - of key importance, I would say, in the maintenance
of our type of economy - to have this kind of purpose come from the grass roots.
X referred earlier to the need to keep in mind that we have to
generate real and effective demand to absorb output.

What w e need to guard

against is a lot of proposals to increase public expenditures for purposes
that will not add to the real investment in human and physical resources,
but will merely be designed to create some demand for output.

That is not

the way for the economy to grow.
This leads roe to another point that is of high importance: the
need for savings and the role of interest rates.

Saving serves the very

crucial economic purpose of financing investment, which adds to productive
capacity, which permits and promotes economic growth.

A high level of saving

depends on a high level of income, but the amount of saving also is influenced
by the rate of return on savings.
the demand for saving.

This rate of interest also is a factor in

In a real sense, then, the interest rate serves to

equate demand for and supply of savings.

It also serves to channel savings

into more investment and into different types of Investment, or into more

I do not intend to use any numbers in discussing interest rates
for the points I want to make do not need such Illustration.

Rates are high

today; at year's beginning they were higher than at any tin® since the 1920*s.
But the last few years are really the only times since the 1920's that two
conditions have obtained:

(1) high prosperity and consequent high demand

for savings, and (2) reasonable balance in the money supply.

In the 1930's

we had depression and low demand for savings; thus rates were low.



£inaneed the war on a low rate structure that was pegged and continued the
pegs throughout the 1940's until 1951.

The results of this were a rapid

run up in the money supply and substantial price inflation.

We have had

two mild downturns in the 1950's, but by and large the economy has been
prosperous, demand for saving has been high and growth in the money supply
has been kept within reasonable bounds.
There has been a lot of comment in recent years to the effect that
low interest rates are good and high interest rates are bad.
difficult to judge interest rates in this fashion.

I find it

What we want, in fact

what we have to achieve, is an interest rate structure low enough to
stimulate investment, high enough to stimulate savings, and flexible enough
to serve the economic purpose of allocating funds, under varying economic
conditions, to uses which will best promote the welfare and strength of the

Thus there is no given level of rates that is either good or bad

in all instances; at times high rates are proper, at times low rates are
I might comment in passing on the relevance of the above analysis
to rates paid on Federal Government borrowing.

In an economy where savings

are voluntary, and where they have to balance investment over the long pull,
the Government has no choice but to pay what is required for savings when it

Normally rates on Government borrowing will be lower than rates paid

by competing borrowers because the Government is a preferred borrower.


the Government cannot dictate the rates it will pay in a free economy, except
in the short-run, and even then it may incur the costs of money supply infla­
tion with nothing but transitory relief.

It can, by intelligent debt manage­

ment, lessen the day to day impact of its borrowing and hence, perhaps, in
the long run lessen its borrowing costs.

This is a primary reason why statutory


ceilings on interest rates on Government securities are unwise; they force
debt management into unnecessarily confining programs.
The last point I want to discuss concerns our balance of payments
and our gold stock.

Here, I do want to use a few more figures, but first

let me define balance o£ payments.

The balance of payments is a technical

term that means the net difference between all flows of funds out of a
country and all flows of funds into a country from abroad.

It is a netting

out of the value of exports and imports of goods and services, the value of
investment going out and coming in, the income received and paid on such
investments, foreign aid payments, and military expenses abroad.

When the

difference is ''favorable" a country's holdings of gold or short-term foreign
assets rise, when "unfavorable", these holdings drop.

Over the long pull

balance has to be achieved or the country runs out of gold and foreign
exchange reserves.
We exported about $16.2 billion in goods and services last year
and imported about $15.3 billion.

But we spent about $3 billion in addition

on maintaining our military efforts abroad (I’ not talking about foreign
aid; this is our own) which, in effect, are imports since they represent
goods and services purchased abroad.

Our foreign investments totalled about

$2 billion and we got back a substantial net in income from all investments

Our foreign aid bill was more than $2 billion.

The net of all

this was that our balance of payments was "unfavorable" to the tune of about
$3.7 billion.

We settled this by foreigners increasing their holdings of

dollar assets and gold.

About $1 billion, or a quarter of this difference,

represented gold outflow, the remainder represented increased holdings of
dollar assets - bank balances, securities, etc.


Now just what do these developments mean?

They do not mean that the

United States is running out of gold and that the dollar is in danger of
being devalued.

One currently popular - and mistaken - line of reasoning

runs like this.

The United States has only $19 billion in gold.

dollar holdings total about $1& billion.

They could all be converted into

gold which would leave us only $3 billion.
back our currency.


By law, we need $12 billion to

Thus we have over-mortgaged our gold stock.

This argument is nonsense.
world (excluding Russia),

We hold half of ail the gold in the

Our ratios of gold to currenty and to foreign claims

on gold are higher than almost any other nation's.

If we are over-mortgaged,

everybody else is far more so.
Foreigners have to have bank balances in the United States just to
do business.

They invest in U. S. securities because they are profitable


The increase in their gold holdings represents a desirable

build-up of their gold reserves rather than a run on the dollar.

They are

not likely to turn their earning assets into gold, a non-earning asset, unless
they really do fear that the dollar will be devalued.

And finally, we hold

some earning assets abroad which are convertible into gold also.
But say the viewers-with-alarm:
on losing gold at this rate forever.
not mean much.

that may be true but we can't go

That is a true statement but it does

Our loss in 1959 was less than half that of 1958, and the

drain is smaller still so far in 1960.
focus what are real matters of concern:

But the statement does bring into
the competitive position of U. S.

goods and services in world markets, the importance of keeping our currency
sound, and again the question of interest rates.
On the former point, it should be noted that a solution cannot be
found through cutting imports.

We are more of a have-not nation than we used


to be and we need our imports.

Entirely aside from that crucial fact, cutting

imports is a game two can play, and at present we are more vulnerable than
are the nations to whom we export.

What we have to do is to get ©ore

competitive by keeping our costs down so that we can sell more abroad.
The importance of keeping our currency sound and the importance of
interest rates can be taken together.

If foreigners lose confidence in the

dollar, they can convert dollar assets into gold.
on a bank.

This is exactly like a run

There is no reason to believe that they will do this, _if we do

not cause them to lose confidence.

Also, if investments and rates of return

prove to be more attractive elsewhere, some of these balances will shift to
other nations.

The mechanics are:

(1) conversion of dollar assets fco gold,

(2) conversion of gold to other currency holdings.
outflow from the United States.

The net result is gold

So competitive interest rates are important

The real point, of course, is this.

We, like all other nations, are

now sub ect to the discipline of the balance of payments.

We have to seek

reasonable stability in our currency and we have to get competitive.
These, I think, are the important things to consider in the longer
run outlook for the United States.

We are going to have a good year in 19t0,

but how many good years will follow and how good will they be.

They all can

be pretty good if we settle down, tend to our knitting and stop smoking
economic opium that makes us believe that costs and prices are unimportant,
that inflation is a good way of life and that the rest of the world is of
little consequence to us.