Full text of Statements and Speeches of John J. Balles : Outlook for the Nation and Oregon : Oregon Bankers Association, 69th Annual Convention, Sunriver, Oregon

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OUTLOOK FOR THE NATION AND OREGON

Remarks by

John J. Balles
President
Federal Reserve Bank of San Francisco

Oregon Bankers Association
69th Annual Convention

Sunriver, Oregon

June 14, 1974

F E D E R A L R E S E R V E BANK O F SAN F R A N C IS C O

Outlook for the Nation and Oregon
I’m glad to have the opportunity to visit with so many old friends

and new acquaintances here in the beautiful and productive state of Oregon.

And as a speaker, I’ll try to keep in mind your unofficial state motto,

"Come visit us, but donft stay too long.”

apparently ignore that injunction, because I understand that 18,000 of

them cross the border to settle in Oregon every year.

However, quite a few Californians

A useful perspective on the nation’s problems and promises can be

obtained from overseas,

and I obtained just such a view recently when I

undertook a five-week tour of nine Pacific area countries.

purpose of the trip was to discuss the regulation of foreign banks, both

abroad and in the U.S.

with the central banks of the Pacific region, for the purpose of future

cooperation on problems of mutual interest, and also for the purpose of

making the Federal Reserve Bank of San Francisco a major nerve center in

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U.S. banking and financial relations with this rapidly growing region.

The immediate

In addition, I wished to establish on-going contacts

As I toured around the Pacific area, however, I could not help but

be impressed— indeed dismayed— with the problem of rampant inflation in

every country that I visited.

suffering from this problem of world-wide inflation, characterized by

double-digit interest rates and double-digit price increases.

found that in most of the Far East countries the rate of inflation over

the past year had been even more serious than in the United States.

Of course, we in this country are also

Yet I

This

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has led to some highly destabilizing effects.

major wage contracts negotiated this spring contained provisions for

25-percent annual wage increases, adding a strong cost-push factor to the

inflationary trend already experienced there.

example, the urgent need to combat inflation has led to an extremely tight

http://fraser.stlouisfed.org/
30 Reserve Bank of St. Louis
Federal

For example, in Japan the

In Australia, as another

F E D E R A L R E S E R V E BANK O F SAN F R A N C IS C O

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monetary policy, and short-term business borrowing costs were as high as

20-25 percent when I was there last month.

Desperate Problem of Inflation

All of the officials that I contacted overseas expressed sympathy

for the efforts we've been making in this country to overcome our many

economic problems.

that could be done in their area by continued price rises in the United

States, the cornerstone of the Pacific and world economies.

for our own sake we should be concerned about the severe

and protracted problem of inflation —

economic problems in the nation's history.

destroy all the hopes we have of regaining the prosperity levels of recent

years.

long continued, inflation at anything like the present rate would threaten

the very foundations of our society."

At the same time, they were worried about the damage

But,

one of the most difficult
This inflation threatens to

And in the words of Federal Reserve Chairman Arthur Burns, "If

You're already familiar with some of the unique factors that helped

cause our present inflation, so I'll review them only briefly.

1973, a business—cycle boom occurred simultaneously in this and every other

major industrial country, and because of this synchronized upsurge in

production, the prices of labor, materials and finished goods were bid up

everywhere.

forced a sharp run-up in food prices through most of 1973, while the price

and production policies of the oil-exporting countries brought about a

dramatic rise in energy prices last winter and fall.

price bulge has developed with the removal of wage and price controls.

During

In addition, disappointing crop harvests the previous year

More recently, a

Worse still, these special factors only magnified an underlying bias

toward inflation found in this and every other industrial nation.

want the good things of life and they want them now, generally turning to

People

F E D E R A L R E S E R V E B A N K OP 8AN F R A N C I S C O

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government when they cannot obtain those things through their own efforts.
The public nowadays expects the government to maintain a prosperous economy,

to ease the burden of job loss or illness or retirement, and to sustain

the incomes of farmers, homebuilders and other segments of the economy.

But in the rush to realize these goals— again Ifm quoting Chairman Burns—

’’governmental budgets have gotten out of control, wages and prices have

become less responsive to the discipline of market forces, and inflation

has emerged as the most dangerous economic ailment of our time.”
To show the pernicious effects of inflation, consider the havoc created

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in the worlds financial markets by the increase in price of a single major

commodity, petroleum.

the world!s monetary system than at any time since World War II.

U.S., Europe and Japan, the oil-import bill will be roughly $50 billion

higher than in 1973, contributing to a $100-billion investable surplus

for the oil-exporting countries by the end of the year.

This development has placed more severe strains on
For the

It could be said that a decision by the OPEC countries to export oil

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at today’s high prices is equivalent to a decision to invest huge sums

of money abroad, especially in view of their very small domestic markets

for imported goods and services.

demonstrated a preference for investing in the Eurocurrency market, which

is a highly efficient mechanism for financial intermediation.

that market has certain obvious defects under present cirucmstances. Funds

placed in the Eurocurrency market tend to be on short-term deposit, while

the debts required to ease the payments strains of oil imports will need

to be relatively long-term.

well result from sudden and massive shifts of funds out of particular

money markets and across currency lines.

The oil exporters apparently have

Nevertheless,

Moreover, serious financial instability may

F E D E R A L R E S E R V E BANK O F I A N

FRANCISCO

Outlook for Prices and Production
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The GNP price index rose at an 11^-percent annual rate— an unprecedented peacetime
increase— during the first quarter of this year, and the rate was even higher after

adjustment for the soaring price of imports.

in the food and fuels categories.

somewhat below last summer’s peak increase— and energy prices jumped at a 67-percent rate—

several times any earlier increase.

and fuels suggest that these sectors will be less critical during the rest of the year.

In fact, the wholesale price index dropped to an 8.7 percent annual rate in April and the

consumer price index to a 7.4 percent rate.

be offset by the drive on the part of basic materials-producing industries to cover sharply

rising labor costs and to enlarge long-depressed profit margins.

The increase, of course, was concentrated

Consumer food prices rose at a 15-percent annual rate—

Recent improvements in the supply situation for food

Even so, any improvement in these areas may

Basic wage increases have not been as high as might have been expected for such an

inflationary era.

6.9-percent annual rate in major contract negotiations— not much higher than the 1973
average.

During the first quarter, wages and fringe benefits increased at a

But labor’s increasing emphasis on escalator provisions for both wages and pen

sions— and ’’uncapped" escalators at that— creates the danger of a vicious circle of rising

prices and wages.

productivity (such as we encountered last fall and winter) could send unit labor costs

soaring.

at an 11-percent annual rate over that period— twice as fast as in most of 1973— and that

type of inflationary pressure is continuing.

And even with the total wage bill kept under control, any decline in

Under the impact of bottlenecks and market distortions, unit costs increased

Wholesale prices of industrial commodities rose at a 29-percent annual rate

in the several months prior to the lifting of controls, and the increases since

then in steel, aluminum and other basic industries have been equally large.

We can hope that the initial "bulge of post-control increases will soon

disappear, and that the spiral of price increases will

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F E D E R A L R E S E R V E BAN K O F SAN F R A N C IS C O

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begin to contract rather than expand further.

curb speculative excesses wherever they appear.

But to do this , we must

According to a forecast prepared by my economics staff, prices are likely to

rise by 8h percent for the year.

significant deceleration in the price trend in contrast to the first

quarter s ll^-percent rate of increase.

may show no increase at all for 1974 as a whole.

a noticeable improvement in the second half, following the b-percent rate

of decline in the first quarter and the generally sideways movement of

the present period.

Bad as that is, it still represents a

As for production, real output
However, that suggests

The major areas of strength in the outlook are business spending for

new plant and equipment, as well as inventories.

should rise considerably

city halls.

several consumer-oriented sectors, especially autos and other durable

goods and (in' particular) new residential construction.

Government spending

in Washington, and also at the statehouses and

However, the expansion will be held in check by weakness in

Business spending for new capacity will be the driving force

behind the national economy this year and for several years to come.

New plant and equipment should increase at least 13 percent this year,

despite the continuation of shortages of certain parts and materials.

As evidence, new orders for capital goods have jumped 50 percent over

the past year —

a crucial need to build up capacity in petroleum, steel and other

basic materials-producing industries, which have been operating close

to the theoretical limits of capacity for over a year.

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the sharpest increase since World War II.

There is

The neglect of these basic industries dates back to the period
of excess capacity of the 1960’s, but investment continued to lag

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F E D E R A L R E S E R V E BANK O F SAN F R A N C IS C O

*"D

thereafter because of the inhospitable atmosphere created by a re

cession, price controls and environmentalist pressures.

new capacity then became obvious when the double devaluation of the

dollar limited the sales prospects for foreign goods in this country

while creating a vast demand for American goods overseas.

thus has been set for a massive business-investment boom, although

the financing for this boom will remain questionable until business

firms raise their profit margins above the low levels of the late

1960's and early 1970's.

The need for

The stage

The strong prospects for business spending are not likely to be

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matched anytime soon by the consumption sector.

Consumers were in a

recession during the final quarter of 1973 and the first quarter of

1974, with a 4-percent rate of decline in real spending, and the

recovery from that slump may be moderate and somewhat prolonged.

consumer has seen his rising take-home pay completely eaten away by

inflation over the past year; he has seen his real wealth decline

because of rising prices and a sliding stock market over the past

half-decade; and on top of that, he has been confronted with a huge

overhang of debt resulting from the spending spree of the past

several years.

quite a while, especially when considering purchases of big-ticket

items such as autos and household furnishings.

The

He is thus likely to remain in a cautious mood for

The other weak spot in the outlook is housing, an industry of

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considerable interest to Oregonians.

this sector could decline 14 percent this year, compared with last

year's 7^—percent increase.

In dollar terms, spending in

But in real terms, the slump should be

F E D E R A L R E 6 E R V E BANK O F SAN F R A N C IS C O

somewhat steeper.

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Real spending declined at a 33-percent rate in

late 1973 and early 1974, and the upturn originally projected for
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the second half of the year has now been endangered by sharply rising

mortgage rates and the withdrawal of savings funds from mortgage-

financing institutions.

plan to subsidize a potential 300,000 new and existing units,

market interest rates.

likely until the inflation menace is somehow overcome.

stand, many builders fear that the soaring prices of land, labor and

materials could relegate the single-family home to the status of a

museum piece.

Outlook for Oregon

Some help will come from the Administration's
through below-

Even so, a sustained recovery in housing is not
As things

The outlook for Oregon is mixed, just as is the national outlook,

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with weakness in those industries which supply consumer-oriented

sectors, and strength in those industries which support the nationwide

business-investment boom.

a moderate decline in production and employment, reflecting the slump

in the housing industry and the partially offsetting boom in non-

residential construction.

state has been running about one-third belox^ year-ago levels, although

basic demand appears strong, as evidenced by continued population

growth and a decline in Portland's vacancy rates.

The lumber industry is likely to suffer

Also, residential permit activity in the

In contrast, demand for pulp and paper has remained high, and

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prices rose to 21 percent above year-ago levels after controls were

lifted from the industry this spring.

capital, together with the prospect of continued shortages, is

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The rising return on invested

F E D E R A L R E S E R V E DANK O F SAN F R A N C I S C O

—8 “

spurring this and other basic industries— such as the machinery industry—
to plan for substantial additions to capacity.

With respect to energy

supplies, Oregon's abundant rainfall (if you'll pardon the reference) and

its large supplies of hydro-power place it in a more favorable position

than its neighbor to the south, which is heavily dependent upon external

sources of natural gas and fuel oil to meet industry's energy demands.
Agriculture should have a reasonably good year, although nothing

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approaching the halcyon days of 1973.

Gross cash receipts of Oregon's

farmers and ranchers should increase about 7 percent— far below last

year's record— while net farm income may even decline slightly because

of soaring production costs.

a recent decline in wheat prices, because of a sharp increase in the

harvest of that major crop.

because of a softening of prices and a one-third decline in the number of

cattle placed on feed.

Policy Problems

Gross crop receipts should be up, despite

A gain in livestock receipts is less certain,

The outlook for the state and the nation is dominated by the need to

expand basic industrial capacity, so as to reduce the severe inflationary

pressures which now confront us.

depends upon how well they support the necessary expansion of supply,

and how well they curb excessive demand.

and price controls clearly fail, because of the distortions and bottle

necks they have created over the past several years.

noble experiment, but like that other noble experiment of a generation ago,

they will be remembered only for the terrible hangover they generated.

On the fiscal side, we must keep the Federal budget under control

The choice of policy weapons thus

By this standard, direct wage

Controls were a

so that it doesn't aggravate our serious inflation problem.

Congress

should strongly resist pressures for a tax cut, which would stimulate demand
at a time when the correct policy prescription calls for a strong expansion

F E D E R A L R E S E R V E BANK O F «AN F R A N C IS C O

in supply.

—9 ~

Restraint is doubly necessary because a substantial amount of

fiscal stimulus is already included in the fiscal 1975 budget, with a
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projected deficit of at least $11^ billion.

deficit in the fiscal year now ending— a period of unprecedented peace

time inflation.

at the record of fiscal policy of the last fifteen years in terms of its

contribution to economic stabilization.

a surplus appears in only one year (1969).

This follows a $3^-billion

More broadly speaking, it is very discouraging to look

In the entire period 1961-1975,
All other years show deficits.

Monetary policy has a difficult role to play because of the distortions

created by inflationary pressures in the real economy and in the credit

markets.

supplies of money and credit to finance an orderly economic expansion, but

it does not intend to accommodate accelerating inflation.

the growth of the money supply has decelerated in the last several months,

The Federal Reserve intends to encourage sufficient growth in

To this end,

after a bulge late last fall and again in February and March.
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Over the

past twelve months, the money supply has increased about 6^ percent altogether.

Yet monetary policy has had to contend with a fantastic rise in business

demand for short-term credit.

more than a 25-percent annual rate in the first four months of this year,

and the pressure was eased only slightly by a slowdown in mortgage and con

sumer loans.

for new plant, equipment and inventories, and also in recent months by a

shift away from the commercial-paper market and into the banks.

increases incurred because of capacity-expansion requirements were to be

welcomed.

in an inflationary atmosphere were understandable, although not welcome*— but

those loans made because of speculative inventory purchasing and other purposes

should have been rejected.

Commercial-bank business loans increased at

Business-loan demand was stimulated by increased financing

Loan

Increases incurred because of the higher costs of doing business

At any rate, thanks to rising prices and soaring

F E D E R A L R E S E R V E BANK O F SAN F R A N C IS C O

—1 0 —

loan demand— along with the market's expectation of a sharp monetary-

policy response— we have witnessed a sharp and surprising upsurge in

interest rates.

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rose almost three percentage points to an unparalleled 11% percent, before
easing off last week.
The capital markets have also been under heavy pressure, even though

many corporate and government treasurers have scaled down or postponed

scheduled bond issues.

large financing needs of the housing agencies, and in particular, by

the concern aroused by the Con Ed and Franklin National episodes.

institutions meanwhile have suffered substantial outflows of funds,

reflecting the rise in rates of various market instruments— witness the

sharp increase in noncompetitive tenders at Treasury bill auctions and

at the May refunding of longer issues.

Within three months' time, the prime business-loan rate

The situation has not been helped by the very

Thrift

Many market participants have feared a further upsurge in interest

rates as a consequence of the recent reduction in money-supply growth.
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But their fears may be largely unfounded.

Many borrowers this spring

saw the earlier rise in the money supply as presaging both increased

inflationary pressures and a tightened policy response, so they borrowed

as much as they could, creating excess demand for funds and pushing rates

even farther upward.

change in the other direction, causing short-term rates to fall because

of the belief that inflation was coming under control.

any slowdown in inflation should reduce the massive increase in the

replacement cost of inventories, and thereby reduce the need for bor

rowing to carry larger stocks.

These exceptional factors could just as well

In addition,

At present, we have a difficult role to play, but so do you.

a new word to describe your task— "de-marketing", which means cutting
back the demand for your product during a period of shortages.

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Digitized
30 for FRASER

There's

You must

F E D E R A L R E S E R V E BANK O F »AN F R A N C IS C O

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make sure that your stock in trade is used only for the most essential
purposes, concentrating on those sectors that will expand the nation’s

productive capacity.

This approach may make funds both scarce and expen

sive for many of your good customers, but at this juncture, it seems

essential that you rein in the demand for loans.
The greatest need in financial markets today is discipline, and you

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are the people who must instill that sadly lacking quality into current

business activity.

corporations turning to banks for the money they would ordinarily raise

through the sale of stocks, bonds and commercial paper.

already said, some of these demands must be met, to help meet the nation's

future needs.

how attractive, must be forced to lower their sights or even to withdraw

completely from the market.

Admittedly, part of the problem has been caused by

And as I've

But those who come to you with other proposals, no matter

If you follow the business press at all, you'll realize that I am
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not alone in making this plea for sanity.

One publication recently

editorialized, The nation s commercial banks are heading down a dangerous

road.

business, they are pushing out loans at an unsustainable rate and trying

desperately to attract deposits to cover them."

comment, "In the push to expand, "banks have taken more and more

risks and devise more and more ways to stretch the regulations" —

the ominous note,

can even

note of caution from Arthur Snyder, President of the Bank of the Common

wealth of Detroit,

to be different from the ordinary business man.

In their eagerness to accommodate old customers and build new

Here is another

followed by

"No lmnk officer under k-5 years old today

remember 1933*"

And here is a welcome

'As a matter of public policy, the banker is expected
They are affected with

the public interest; they are the guardians of the liquid assets of
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F E D E R A L R E S E R V E BANK O F BAN F R A N C I S C O

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millions of families and businesses.

The essence of being a banker is

to stand apart from the excitement and to serve business and the community

without joining in business activity.11

Concluding Remarks
To conclude, there’s no blinking the fact that the nation is going

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through a very difficult period.

improving, but at a somewhat fitful pace because of serious supply

constraints.

the prospect of bumper crops as well as new productive capacity in industry,

but again, the improvement occurs at a maddeningly slow pace.

continues to stagnate because of the problem of bottlenecks, and profits

gains thus remain limited, at least after adjustment for inflation.

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Economic activity seems to be slowly

The price trend seems to be decelerating, helped along by

Productivity

Nonetheless, we are moving in the right direction, especially since
new capacity is being built that will permit the economy to return to its
historical growth trend.

Monetary policy has been formulated to assist

that movement back to trend, and meanwhile to squeeze out the inflationary

excesses developed in recent years.

lender of last resort, the Federal Reserve has shown that it will not

permit disorderly conditions to develop in the credit markets.

with the cooperation of the banking and business communities, the return

to a period of healthy growth should be assured.

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At the same time, in its role as

Over time,