Regional President Speech

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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF SAN FRANCISCO I Outlook for the Nation and Oregon I’m glad to have the opportunity to visit with so many old friends 3 and new acquaintances here in the beautiful and productive state of Oregon. 4 And as a speaker, I’ll try to keep in mind your unofficial state motto, 5 "Come visit us, but donft stay too long.” However, quite a few Californians 6 apparently ignore that injunction, because I understand that 18,000 of 7 them cross the border to settle in Oregon every year. 8 A useful perspective on the nation’s problems and promises can be 9 obtained from overseas, and I obtained just such a view recently when I 10 undertook a five-week tour of nine Pacific area countries. The immediate II purpose of the trip was to discuss the regulation of foreign banks, both 12 abroad and in the U.S. In addition, I wished to establish on-going contacts 13 with the central banks of the Pacific region, for the purpose of future 14 cooperation on problems of mutual interest, and also for the purpose of 1- making the Federal Reserve Bank of San Francisco a major nerve center in 16. U.S. banking and financial relations with this rapidly growing region. 17 As I toured around the Pacific area, however, I could not help but 18 be impressed— indeed dismayed— with the problem of rampant inflation in 19 every country that I visited. Of course, we in this country are also 20 suffering from this problem of world-wide inflation, characterized by 21 double-digit interest rates and double-digit price increases. Yet I 22 found that in most of the Far East countries the rate of inflation over 23 the past year had been even more serious than in the United States. This £4 has led to some highly destabilizing effects. For example, in Japan the 25 major wage contracts negotiated this spring contained provisions for 26 25-percent annual wage increases, adding a strong cost-push factor to the 27 inflationary trend already experienced there. In Australia, as another 28 example, the urgent need to combat inflation has led to an extremely tight 29 Digitized for FRASER http://fraser.stlouisfed.org/ 30 Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF SAN FRANCISCO -2 — 1 monetary policy, and short-term business borrowing costs were as high as 2 20-25 percent when I was there last month. j Desperate Problem of Inflation 4 All of the officials that I contacted overseas expressed sympathy 5 for the efforts we've been making in this country to overcome our many 6 economic problems. At the same time, they were worried about the damage 7 that could be done in their area by continued price rises in the United 8 States, the cornerstone of the Pacific and world economies. But, , 9 for our own sake we should be concerned about the severe 10 and protracted problem of inflation — one of the most difficult 11 economic problems in the nation's history. This inflation threatens to 12 destroy all the hopes we have of regaining the prosperity levels of recent 13 years. And in the words of Federal Reserve Chairman Arthur Burns, "If 14 long continued, inflation at anything like the present rate would threaten 1 the very foundations of our society." 16 You're already familiar with some of the unique factors that helped 17 cause our present inflation, so I'll review them only briefly. During 18 1973, a business—cycle boom occurred simultaneously in this and every other 19 major industrial country, and because of this synchronized upsurge in 20 production, the prices of labor, materials and finished goods were bid up 21 everywhere. In addition, disappointing crop harvests the previous year 22 forced a sharp run-up in food prices through most of 1973, while the price 23 and production policies of the oil-exporting countries brought about a 24 dramatic rise in energy prices last winter and fall. More recently, a 25 price bulge has developed with the removal of wage and price controls. 26 Worse still, these special factors only magnified an underlying bias 27 toward inflation found in this and every other industrial nation. People 28 want the good things of life and they want them now, generally turning to 29 Digitized for FRASER 30 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OP 8AN FRANCISCO — 3~ 1 government when they cannot obtain those things through their own efforts. The public nowadays expects the government to maintain a prosperous economy, 3 to ease the burden of job loss or illness or retirement, and to sustain 4 the incomes of farmers, homebuilders and other segments of the economy. 5 But in the rush to realize these goals— again Ifm quoting Chairman Burns— 6 ’’governmental budgets have gotten out of control, wages and prices have 7 become less responsive to the discipline of market forces, and inflation 8 has emerged as the most dangerous economic ailment of our time.” 9 To show the pernicious effects of inflation, consider the havoc created 10 in the worlds financial markets by the increase in price of a single major commodity, petroleum. This development has placed more severe strains on 11 12 the world!s monetary system than at any time since World War II. For the 13 U.S., Europe and Japan, the oil-import bill will be roughly $50 billion 14 higher than in 1973, contributing to a $100-billion investable surplus 1 for the oil-exporting countries by the end of the year. 16 It could be said that a decision by the OPEC countries to export oil 17 at today’s high prices is equivalent to a decision to invest huge sums 18 of money abroad, especially in view of their very small domestic markets 19 for imported goods and services. The oil exporters apparently have 20 demonstrated a preference for investing in the Eurocurrency market, which is a highly efficient mechanism for financial intermediation. Nevertheless, 21 22 that market has certain obvious defects under present cirucmstances. Funds 23 placed in the Eurocurrency market tend to be on short-term deposit, while 24 the debts required to ease the payments strains of oil imports will need 25 to be relatively long-term. Moreover, serious financial instability may 26 well result from sudden and massive shifts of funds out of particular 27 money markets and across currency lines. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF IAN FRANCISCO Outlook for Prices and Production 1 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 3 adjustment for the soaring price of imports. The increase, of course, was concentrated 4 in the food and fuels categories. Consumer food prices rose at a 15-percent annual rate— 5 somewhat below last summer’s peak increase— and energy prices jumped at a 67-percent rate— 6 several times any earlier increase. Recent improvements in the supply situation for food 7 and fuels suggest that these sectors will be less critical during the rest of the year. 8 In fact, the wholesale price index dropped to an 8.7 percent annual rate in April and the 9 consumer price index to a 7.4 percent rate. Even so, any improvement in these areas may 10 be offset by the drive on the part of basic materials-producing industries to cover sharply 11 rising labor costs and to enlarge long-depressed profit margins. 12 Basic wage increases have not been as high as might have been expected for such an 13 inflationary era. During the first quarter, wages and fringe benefits increased at a 14 6.9-percent annual rate in major contract negotiations— not much higher than the 1973 average. But labor’s increasing emphasis on escalator provisions for both wages and pen­ 16 sions— and ’’uncapped" escalators at that— creates the danger of a vicious circle of rising 17 prices and wages. And even with the total wage bill kept under control, any decline in 18 productivity (such as we encountered last fall and winter) could send unit labor costs 19 soaring. Under the impact of bottlenecks and market distortions, unit costs increased 20 at an 11-percent annual rate over that period— twice as fast as in most of 1973— and that 21 type of inflationary pressure is continuing. 22 Wholesale prices of industrial commodities rose at a 29-percent annual rate 23 in the several months prior to the lifting of controls, and the increases since 24 then in steel, aluminum and other basic industries have been equally large. 25 We can hope that the initial "bulge of post-control increases will soon 26 disappear, and that the spiral of price increases will 27 L ^ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF SAN FRANCISCO —5 — 1 begin to contract rather than expand further. But to do this , we must 2 curb speculative excesses wherever they appear. 3 According to a forecast prepared by my economics staff, prices are likely to 4 rise by 8h percent for the year. Bad as that is, it still represents a 5 significant deceleration in the price trend in contrast to the first 6 quarter s ll^-percent rate of increase. As for production, real output 7 may show no increase at all for 1974 as a whole. However, that suggests 8 a noticeable improvement in the second half, following the b-percent rate 9 of decline in the first quarter and the generally sideways movement of 10 the present period. 11 The major areas of strength in the outlook are business spending for 12 new plant and equipment, as well as inventories. Government spending 13 should rise considerably in Washington, and also at the statehouses and 14 city halls. However, the expansion will be held in check by weakness in 1 several consumer-oriented sectors, especially autos and other durable 16 goods and (in' particular) new residential construction. 17 Business spending for new capacity will be the driving force 18 behind the national economy this year and for several years to come. 19 New plant and equipment should increase at least 13 percent this year, 20 despite the continuation of shortages of certain parts and materials. 21 As evidence, new orders for capital goods have jumped 50 percent over 22 the past year — the sharpest increase since World War II. There is 23 a crucial need to build up capacity in petroleum, steel and other 24 basic materials-producing industries, which have been operating close 25 to the theoretical limits of capacity for over a year. 26 The neglect of these basic industries dates back to the period 27 of excess capacity of the 1960’s, but investment continued to lag 28 29 Digitized for FRASER 30 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF SAN FRANCISCO *"D L thereafter because of the inhospitable atmosphere created by a re­ y cession, price controls and environmentalist pressures. The need for 3 new capacity then became obvious when the double devaluation of the 4 dollar limited the sales prospects for foreign goods in this country while creating a vast demand for American goods overseas. The stage 5 thus has been set for a massive business-investment boom, although 6 the financing for this boom will remain questionable until business 7 firms raise their profit margins above the low levels of the late 8 9 1960's and early 1970's. The strong prospects for business spending are not likely to be 10 matched anytime soon by the consumption sector. Consumers were in a 11 recession during the final quarter of 1973 and the first quarter of 12 1974, with a 4-percent rate of decline in real spending, and the 13 recovery from that slump may be moderate and somewhat prolonged. The 14 consumer has seen his rising take-home pay completely eaten away by 15 inflation over the past year; he has seen his real wealth decline 16 because of rising prices and a sliding stock market over the past 17 half-decade; and on top of that, he has been confronted with a huge 18 overhang of debt resulting from the spending spree of the past 19 several years. He is thus likely to remain in a cautious mood for 20 quite a while, especially when considering purchases of big-ticket 21 22 items such as autos and household furnishings. 23 The other weak spot in the outlook is housing, an industry of 24 considerable interest to Oregonians. In dollar terms, spending in 25 this sector could decline 14 percent this year, compared with last 26 year's 7^—percent increase. But in real terms, the slump should be 27 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RE6ERVE BANK OF SAN FRANCISCO -7 - 1 somewhat steeper. Real spending declined at a 33-percent rate in late 1973 and early 1974, and the upturn originally projected for 3 the second half of the year has now been endangered by sharply rising 4 mortgage rates and the withdrawal of savings funds from mortgage- 5 financing institutions. Some help will come from the Administration's 6 plan to subsidize a potential 300,000 new and existing units, through below- 7 market interest rates. Even so, a sustained recovery in housing is not 8 likely until the inflation menace is somehow overcome. As things 9 stand, many builders fear that the soaring prices of land, labor and 10 materials could relegate the single-family home to the status of a 11 museum piece. 12 Outlook for Oregon 13 The outlook for Oregon is mixed, just as is the national outlook, 14 with weakness in those industries which supply consumer-oriented 1 sectors, and strength in those industries which support the nationwide 16 business-investment boom. The lumber industry is likely to suffer 17 a moderate decline in production and employment, reflecting the slump 18 in the housing industry and the partially offsetting boom in non- 19 residential construction. Also, residential permit activity in the 20 state has been running about one-third belox^ year-ago levels, although 21 basic demand appears strong, as evidenced by continued population 22 growth and a decline in Portland's vacancy rates. 23 In contrast, demand for pulp and paper has remained high, and 24 prices rose to 21 percent above year-ago levels after controls were 25 lifted from the industry this spring. The rising return on invested 26 capital, together with the prospect of continued shortages, is 27 28 29 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE DANK OF SAN FRANCISCO —8“ 1 spurring this and other basic industries— such as the machinery industry— to plan for substantial additions to capacity. With respect to energy 3 supplies, Oregon's abundant rainfall (if you'll pardon the reference) and 4 its large supplies of hydro-power place it in a more favorable position 5 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. 6 7 Agriculture should have a reasonably good year, although nothing approaching the halcyon days of 1973. Gross cash receipts of Oregon's 8 farmers and ranchers should increase about 7 percent— far below last 9 year's record— while net farm income may even decline slightly because 10 of soaring production costs. Gross crop receipts should be up, despite 11 a recent decline in wheat prices, because of a sharp increase in the 12 harvest of that major crop. A gain in livestock receipts is less certain, 13 because of a softening of prices and a one-third decline in the number of 14 cattle placed on feed. 1- 16 Policy Problems The outlook for the state and the nation is dominated by the need to 17 expand basic industrial capacity, so as to reduce the severe inflationary 18 pressures which now confront us. The choice of policy weapons thus 19 20 depends upon how well they support the necessary expansion of supply, 21 and how well they curb excessive demand. By this standard, direct wage 22 and price controls clearly fail, because of the distortions and bottle­ necks they have created over the past several years. Controls were a 23 noble experiment, but like that other noble experiment of a generation ago, 24 they will be remembered only for the terrible hangover they generated. 25 On the fiscal side, we must keep the Federal budget under control 26 so that it doesn't aggravate our serious inflation problem. Congress 27 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 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF «AN FRANCISCO —9~ 1 in supply. Restraint is doubly necessary because a substantial amount of fiscal stimulus is already included in the fiscal 1975 budget, with a 3 projected deficit of at least $11^ billion. This follows a $3^-billion 4 deficit in the fiscal year now ending— a period of unprecedented peace­ 5 time inflation. More broadly speaking, it is very discouraging to look 6 at the record of fiscal policy of the last fifteen years in terms of its 7 contribution to economic stabilization. In the entire period 1961-1975, 8 a surplus appears in only one year (1969). All other years show deficits. 9 Monetary policy has a difficult role to play because of the distortions 10 created by inflationary pressures in the real economy and in the credit 11 markets. The Federal Reserve intends to encourage sufficient growth in 12 supplies of money and credit to finance an orderly economic expansion, but 13 it does not intend to accommodate accelerating inflation. To this end, 14 the growth of the money supply has decelerated in the last several months, after a bulge late last fall and again in February and March. Over the 16 past twelve months, the money supply has increased about 6^ percent altogether. 17 Yet monetary policy has had to contend with a fantastic rise in business 18 demand for short-term credit. Commercial-bank business loans increased at 19 more than a 25-percent annual rate in the first four months of this year, 20 and the pressure was eased only slightly by a slowdown in mortgage and con­ 21 sumer loans. Business-loan demand was stimulated by increased financing 22 for new plant, equipment and inventories, and also in recent months by a 23 shift away from the commercial-paper market and into the banks. Loan 24 increases incurred because of capacity-expansion requirements were to be 25 welcomed. Increases incurred because of the higher costs of doing business 26 in an inflationary atmosphere were understandable, although not welcome*—but 27 those loans made because of speculative inventory purchasing and other purposes 26 should have been rejected. At any rate, thanks to rising prices and soaring 29 Digitized for FRASER 30 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF SAN FRANCISCO —10— 1 loan demand— along with the market's expectation of a sharp monetary- 0 policy response— we have witnessed a sharp and surprising upsurge in 3 interest rates. Within three months' time, the prime business-loan rate 4 rose almost three percentage points to an unparalleled 11% percent, before easing off last week. 5 The capital markets have also been under heavy pressure, even though 6 many corporate and government treasurers have scaled down or postponed 7 scheduled bond issues. The situation has not been helped by the very large financing needs of the housing agencies, and in particular, by 8 9 the concern aroused by the Con Ed and Franklin National episodes. Thrift institutions meanwhile have suffered substantial outflows of funds, 10 reflecting the rise in rates of various market instruments— witness the 11 12 sharp increase in noncompetitive tenders at Treasury bill auctions and 13 at the May refunding of longer issues. 14 Many market participants have feared a further upsurge in interest rates as a consequence of the recent reduction in money-supply growth. 16 But their fears may be largely unfounded. Many borrowers this spring 17 saw the earlier rise in the money supply as presaging both increased 18 inflationary pressures and a tightened policy response, so they borrowed 19 as much as they could, creating excess demand for funds and pushing rates 20 even farther upward. These exceptional factors could just as well 21 change in the other direction, causing short-term rates to fall because 22 of the belief that inflation was coming under control. In addition, 23 any slowdown in inflation should reduce the massive increase in the 24 replacement cost of inventories, and thereby reduce the need for bor­ 25 rowing to carry larger stocks. 26 At present, we have a difficult role to play, but so do you. There's 27 a new word to describe your task— "de-marketing", which means cutting back the demand for your product during a period of shortages. You must 29 Digit3iz0ed for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF »AN FRANCISCO -1 1 - 1 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 3 productive capacity. This approach may make funds both scarce and expen­ 4 sive for many of your good customers, but at this juncture, it seems 5 essential that you rein in the demand for loans. 6 The greatest need in financial markets today is discipline, and you 7 are the people who must instill that sadly lacking quality into current 8 business activity. Admittedly, part of the problem has been caused by 9 corporations turning to banks for the money they would ordinarily raise 10 through the sale of stocks, bonds and commercial paper. And as I've 11 already said, some of these demands must be met, to help meet the nation's 12 future needs. But those who come to you with other proposals, no matter 13 how attractive, must be forced to lower their sights or even to withdraw 14 completely from the market. If you follow the business press at all, you'll realize that I am 16 not alone in making this plea for sanity. One publication recently 17 editorialized, The nation s commercial banks are heading down a dangerous 18 road. In their eagerness to accommodate old customers and build new 19 business, they are pushing out loans at an unsustainable rate and trying 20 desperately to attract deposits to cover them." Here is another 21 comment, "In the push to expand, "banks have taken more and more 22 risks and devise more and more ways to stretch the regulations" — followed by 23 the ominous note, "No lmnk officer under k-5 years old today 24 can even remember 1933*" And here is a welcome 25 note of caution from Arthur Snyder, President of the Bank of the Common­ 26 wealth of Detroit, 'As a matter of public policy, the banker is expected 27 to be different from the ordinary business man. They are affected with the public interest; they are the guardians of the liquid assets of 29 Digitized for FRASER 30 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF BAN FRANCISCO -1 2 - 1 millions of families and businesses. The essence of being a banker is o to stand apart from the excitement and to serve business and the community without joining in business activity.11 3 Concluding Remarks 4 To conclude, there’s no blinking the fact that the nation is going 5 through a very difficult period. Economic activity seems to be slowly 6 improving, but at a somewhat fitful pace because of serious supply 7 constraints. The price trend seems to be decelerating, helped along by 8 the prospect of bumper crops as well as new productive capacity in industry, 9 but again, the improvement occurs at a maddeningly slow pace. Productivity 10 continues to stagnate because of the problem of bottlenecks, and profits 11 gains thus remain limited, at least after adjustment for inflation. 12 13 Nonetheless, we are moving in the right direction, especially since 14 new capacity is being built that will permit the economy to return to its historical growth trend. Monetary policy has been formulated to assist 16 that movement back to trend, and meanwhile to squeeze out the inflationary 17 excesses developed in recent years. At the same time, in its role as 18 lender of last resort, the Federal Reserve has shown that it will not 19 permit disorderly conditions to develop in the credit markets. Over time, 20 with the cooperation of the banking and business communities, the return 21 to a period of healthy growth should be assured. 22 23 24 25 26 27 29 Digitized for FRASER 30 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

John J. Balles (1974, June 13). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19740614_john_j_balles

@misc{wtfs_regional_speeche_19740614_john_j_balles,
  author = {John J. Balles},
  title = {Regional President Speech},
  year = {1974},
  month = {Jun},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19740614_john_j_balles},
  note = {Retrieved via When the Fed Speaks corpus}
}