1938: Business

The Year's Trend.

In 1938, every effort was expended to overcome the recession which had begun in 1937. In these efforts, the Government took an active part. Their success was in some degree spectacular. In many lines of activity, most of the lass of the previous year was regained. But in other lines of activity, notably the durable goods industries, the achievements at the end of the year were only moderate. The stimuli applied were, in the first instance, financial. Banking arrangements were reorganized to provide abundant funds. Gold poured into the country in unprecedented amounts. The money markets were easy and security prices rose rapidly, absorbing large amounts of new issues. The Government renewed its spending program. New construction was in relatively large volume. The continued decline in commodity prices and the lack of revival in the heavy industries remained disturbing factors. Although the Government introduced a few new reform measures, on the whole its attitude was more conciliatory. This change in attitude, together with the more conservative sentiment of the public as expressed in the November elections, led to a revival of business confidence at the end of the year.

The general course of business was marked by two periods; one of slow decline lasting until June and one of rapid rise extending throughout the rest of the year. The first period was a continuation of the recession which began in August 1937. At that time, the New York Times index (estimated normal 100) stood at 111. It declined without interruption until the first week of January 1938, when it reached 78. During the remainder of January, there was a little recovery, the index rising to 82. Then the decline began again and lasted until the first week of June, when the index was 75. The second period was one of unbroken recovery, with the exception of two weeks at the end of September when the tension in Europe accompanying the Czechoslovakian crisis was at its height. The index reached its peak for the year at 94 in the second week of December. It declined a point or two in the last weeks of the year. The recovery was exceedingly rapid. It was not as spectacular perhaps as the upward leap in the second quarter of 1933, but the net rise at the end of the year was 25 per cent. In that earlier period, it was two and a half years before a greater advance was maintained.

Durable Goods Industries.

The index of business traces the general pattern of business activity. It is, however, an average pattern, and in this year there have been some wide variations from it. Manufacturing production as a whole repeated the pattern with but little variation. The decline was a little greater, the recovery the same, and the high and low points coincided. But within the field of manufacturing, divergences appeared. A major division came between those industries which produced durable goods and those which produced consumers goods. The former declined very much more than the latter and reached their low point in June, while the low point for the latter group came in April. Thus the durable goods industries took the full force of the depression.

The steel industry shows the variations in the production of durable goods in perhaps an extreme form. The decline was drastic. The index for steel (1923-25 average = 100 adjusted for seasonal variation) dropped from 144 in August 1937 to 49 in March 1938. In October 1938, it was 93. Steel mills were operating at 25 per cent of capacity in December 1937, and at 40 per cent at the end of 1938. Two weeks earlier they had been at 60 per cent of capacity. Thus, although recovery has been rapid, the position of the industry is still low compared with its high point. Pig iron production was even more adversely affected, and the index for October was still only 63. Other types of metals were not so several, affected, but their recovery has been slow. Cement, a competing building material, declined much less and began to recover in February. At the end of the year it had reached nearly its former position. Production in certain building-material industries was nearly wiped out. The index for plate glass production, for instance, declined from 241 in April 1937 to 35 in February 1938, and rose again to 155 in October 1938. The automobile industry, so important because of its large number of employees, was affected only late in the recession. Its peak came in October, with an index of 142. Its low point came in July at 43, and recovery did not really appear until October 1938. At the end of the year, however, the extent of the recovery was substantial.

Non-durable Goods Industries.

In contrast to the amount of recession and revival in the durable goods industries was the record for non-durable goods industries, most of which make consumers goods. The production of wheat flour did not vary more than 12 per cent during the period, and its fluctuations were erratic. It was higher in June and July 1938 than it had been at any time during 1937. The production of meat products was lower in July 1937 than at any time in 1938. Cigarette production varied less than 10 per cent except for a sudden drop in October 1938. The highest point had been December 1937, but fluctuations did not follow a cyclical pattern. Other industries were affected by the cycle. The production of boots and shoes registered a drop from an index of 148 in May 1937 to 84 in November 1937. Thereafter, it recovered with occasional sudden drops, such as that of June 1938. In October, the index was 113. The textile industries followed more closely the course of durable goods. The general index declined from its high point of 129 in March 1937 to 74 in April 1938, and recovered to 100 in October 1938.

The preceding discussion of details leads to the conclusion that the depression was considerably a depression of the durable goods industries, while the consumption goods industries were less affected. The recovery has been shared by both classes of industries; but the rate of recovery in some of the durable goods industries has been slow compared to that which might be expected. That there are peculiarities in this revival are emphasized by a consideration of other factors.

Employment and Payrolls.

Employment and payrolls have, of course, followed a pattern roughly similar to that of production, but the low point came at a later date, August. Payrolls suffered more than employment, with a drop of 35 per cent while employment declined by only 26 per cent. At the end of October, the index of production stood at 96; that for employment at 88; and payrolls at 84. At their high points, they had stood at 118, 109, and 110 respectively. The employees in the durable goods industries fared relatively badly. At the low point in July, the index for employment stood at 71 compared with 92 for the non-durable goods industries. Even at the end of the year, recovery had been slight; for the index was 78. It is, then, from this group that the relief problem arises.

Prices.

Another peculiarity of the revival from this depression was the behavior of prices. Normally, a rise in prices develops before recovery has advanced very far. In this revival, the price rise had not appeared, except for certain sensitive prices, even at the end of the year after six months of recovery. The wholesale price index (Bureau of Labor Statistics 1936 = 100) stood at 88 at its high point in April 1937. It was 77 at the end of November. There was much variation among the different groups of prices, but no major group showed a tendency to rise. Metals and metal products, hides and leather products, and building materials were relatively high; while farm products and textiles were relatively very low.

Retail prices, as is usual in recessions, declined less than wholesale prices. The index for foods (B.L.S. 1923-25 = 100) dropped from its high point in May 1937 of 87 to 78 at the end of October. For the general cost of living, the drop was even less; the index was 85 at its high point and 83 in the third quarter of 1938. Thus the lower level of money wages was not reflected in retail prices.

Construction Industry.

Part of the relatively low level of the durable goods industries is explainable because of the nature of the changes in the constructive industry. Construction this year will probably amount to $8,800,000,000, (estimate of the Department of Commerce). This is the largest amount in any year since 1930. It remains, however, 25 per cent below the average from 1920-29 and 32 per cent below the peak year of that decade. Although this volume of construction is large, its nature is peculiar, in that a comparatively large proportion is construction by the Government. In the decade from 1920-29. Government construction amounted to 22 per cent of the total; in 1937, it was 41 per cent; and in 1938, 47 per cent. These totals for construction are divided between new construction and maintenance, $5,185,000,000, belonging to the former category, and $2,530,000,000, to the latter. The total for new construction is a little less than in 1937, and the total for new private construction 12 per cent less. This decline in private construction was compensated by the rise in public construction. The drop in new private construction was much more in some varieties than in others. Construction by public utility companies was 20 per cent less than in 1937; nonresidential building declined by 16 per cent; and residential building by 7 per cent.

These changes in the character of the construction industry lead to a change in the type of goods demanded. Government activity was concentrated in the construction of highways and sewers. These projects require much less of steel products than do the types of private construction. Also, as many of them are planned to provide work relief, the proportion of labor to materials is higher. Among the various kinds of private construction, that of private residences also requires less of iron and steel products. Thus the type of new construction is such that it does not add as much to the demand for basic products as a similar increase in the volume of other types of construction.

Changes in the volume of construction also account to some extent for the variations in business from month to month. The total value of contracts awarded (F. W. Dodge Company for 37 Eastern States) rose during the early months of the year from $119,000,000 in February to $283,000,000 in May. It declined June and July and rose rapidly again to $358,000,000 in October (latest figure). In large measure these changes reflect changes in public construction. But the position of residential construction is of special interest, for it began to rise in February and continued to rise during the rest of the year. The amount of the rise is notable, from $30,000,000 to $113,000,000. Thus, by the end of the year, residential construction was far above the levels of last year. This feature is peculiar to this recovery in 1933, residential construction, far from leading, lagged behind. Since the lack of response of the residential building industry was one of the disappointing features of the other recovery, its rapid advance in 1938 has been most encouraging.

Transportation Industry.

Changes in production and in construction reflect themselves in changes in the transportation industry. The volume of freight car loadings declined and rose again. At its high point in April 1937, the Reserve Board index (1923-25 = 100) had stood at 84. In April 1938, it was 57, and it had increased only to 68 in October 1938. The number of passengers on the railroads declined similarly. In October 1937, 815,980 passengers were carried; and in September 1938, only 720,753. The result of the decline in both passenger and freight business was to cut the revenues of the railroads seriously. In October 1937, the net operating income of the Class I railroads was $60,000,000; in April 1938 it shrank to $9,000,000; but in October, it was $69,000,000.

These changes did not come entirely from changes in traffic. In November 1937, a new schedule of wage rates went into effect. The new schedule was 15 per cent above the old one. Almost at the same moment, revenues declined, with the result that net income dropped drastically. The railroads were in a serious financial condition when 1938 began. A third of them were in bankruptcy, and another 10 per cent near it. The roads, therefore, asked a 15 per cent increase in freight rates to compensate themselves in part for the increase in wages. This increase the Interstate Commerce Commission granted only partially. In April, rates were raised by an average of some 7 per cent. By that time, however, traffic had declined still more.

During the first 8 months of 1938, 49 of the 137 Class I railroads failed to earn expenses and taxes. They, therefore, tried to recoup themselves by reducing wages. The negotiations dragged throughout the rest of the year. In the fall, on the recommendation of a fact-finding Commission appointed by President Roosevelt, they agreed not to cut wages. In the meantime, as mentioned above, their net operating income had improved. The result of the financial difficulties of the railroads was that the price of railroad securities declined drastically. With the low price of securities, it was impossible for these companies to raise capital for new construction. Hence arose in part the decline in new construction for public utilities.

Income Payments.

Total income payments to persons in the United States followed the course of general business. In January, they amounted to $5,482,000,000; in May, their low point, to $5,020,000,000; and in October to $5,054,000,000. These changes in income payments are closely related to changes in retail trade. The degree of fluctuation in both cases is less than that for production. Both reflect changes in Government expenditures for relief.

Store Sales.

The index of department store sales of the Department of Commerce (1023-25 = 100, adjusted for seasonal variation) declined from 89 in December 1937 to 78 in May 1938, and revived to 84 in October. Stocks of goods had declined to such a level that the volume of new orders to manufacturers was again normal for the volume of sales. Chain store sales in October were within 3 per cent of their value in December 1937. Sales of rural merchandise, which usually reflect the level of farm incomes, were 9 per cent below last year's level. Sales of automobiles amounted to only 2,101,202 cars in the first 11 months of 1938, compared with 4,482,740 cars during the same period of 1937. At the end of the year, their sales were in greater volume than they were in 1937.

Foreign Trade.

Foreign trade continued to show the peculiarity which developed last year: imports were low compared to exports. For the first 10 months of 1938, exports were $2,543,000,000, compared with $2,608,000,000 for the same period in 1937; and imports were $1,014,000,000 compared with $2,507,000,000. The excess of exports amounted to nearly $100,000,000 a month. In earlier years, there had been an import surplus. However, the excess of exports will probably not continue; for exports declined continuously throughout the year, while imports increased beginning in May.

The revival of industry and trade which appeared so dramatic was induced in part by changes in financial conditions in the country, and these again partly by changes in Government policies and partly by conditions abroad. The net effect was to provide abundance of credit with low interest rates and rapidly rising security prices.

Changes in Government Policies.

The changes in Government policies came in the spring. Early in February, when the degree of recession became evident, the Government changed its gold policy. Instead of sterilizing all gold which came into the country, as it had been doing for some time, it limited its purchases to the excess above $100,000,000, a quarter. At this time the level of imports was low, so that the new gold flowed into the banks. As the recession deepened further, changes were made. The gold sterilization program was abandoned altogether. Besides, the Government restored to the monetary system all the gold it had purchased since the initiation of the sterilization program. This amounted to $1,400,000,000. The initial effect of the restoration was to increase the reserves of the Federal Reserve Banks. Later, the member banks were affected. The Government used the funds so provided to meet its current expenses, and thus the accounts were quickly transferred to the reserve balances of the banks. Since the banks already had excess reserves, they now had higher excess reserves. Another effect of the change was to remove Government borrowing from the markets. During the early summer, the gold fund financed an increased spending program, while the Government debt actually declined. This fact had a decided effect on the security markets. (See below.)

In April, also, the Government announced a change in reserve requirements for member banks. In 1936 and 1937, the Board of Governors of the Federal Reserve System had increased reserves in order to prevent an unhealthy increase in speculative activity. They now proceeded to reduce them. The result was a further large increase in excess reserves of member banks. On Sept. 1, 1937, the low point for the previous year, excess reserves were $750,000,000; in March 1938, $1,560,000,000; and in April, after the change in requirements, $2,071,000,000.

Another aspect of the Government policy was the renewal of the spending program. During 1937, while recovery was in progress, the rate of Government spending had declined. Since relief demands lag behind business activity in recession, spending for relief was at a low level for post-depression years at the end of 1937. In the early months of 1938, it was at the rate of $160,000,000 a month; and in March it was $153,000,000. The new program raised the level to $202,000,000 in April and to $314,000,000 in June. For the rest of the year, it averaged some $240,000,000 a month. The category of 'all other' expenditures of the Government also increased from a level of $175,000,000 to one of $230,000,000 a month. This change in the rate of spending had several results. First, it increased the reserves of member banks and added to the easiness of the money markets. Second, it added to the volume of new construction and led to a demand for certain kinds of construction goods. Third, it added to the total of income payments, and thus served to increase the demand for consumption goods. In the usual revival, the demand for consumption goods arises out of the increase in production of durable goods. In this case, it came in large measure from relief. Thus, the character of the revival was unusual.

Another feature in the financial situation was the large volume of gold imports which poured into this country during most of the year. In January and February, such imports were very low. In March, they began to increase, and $52,000,000 came into this country in that month. Part of it came from Japan, part from London. The rate of March was maintained until August. Then, with the increasing fear of immediate war, the amount jumped to $166,000,000 and, in September, when war was really imminent, became $521,000,000. Thereafter, the flow declined; but throughout the rest of the year it amounted to some $180,000,000 a month.

The result of all these changes was that the banks were abundantly able to supply credit in greatly increased amounts. The total reserves of the Federal Reserve Banks increased from $9,500,000,000 in December 1937 to $12,100,000,000, at the end of 1938. Member bank excess reserves rose from $1,200,000,000, to $3,300,000,000. However, the expansion of credit did not take place. Deposits at member banks increased, but no more than can be explained by the increase in Federal spending and by the gold imports. Most of the increase came in New York City banks; while deposits in country banks decreased. Loans declined during most of the year at all the banks. Reserve banks decreased their portfolios of bills and direct advances. Member bank loans declined for all categories except those on real estate, which changed but little. The banks did, however, increase their holdings of securities, particularly of Government bonds. Reporting member banks alone held a billion dollars more of securities at the end of the year than they had had at the beginning.

The great abundance of funds showed itself primarily in low interest rates and rising security prices. Customers rates at banks declined throughout the year until, at its end, they were 2.33 per cent in New York City. Open market rates on prime commercial paper were at 7/16 per cent; and stock exchange call loans remained at 1 per cent, and time loans at 1.25 per cent throughout the year. New issues of Treasury bills yielded 10 per cent at the beginning of the year and rose to .02 per cent by the end of the year.

Security Prices.

Security prices had moved downward in the early months of the year. The New York Times market average for fifty stocks was 86 in January and 70 at its low point in March. The response to the new Government policies was rapid. By the end of the summer, the average was 103. After a brief decline resulting from the crisis abroad, it continued to rise until it was 109 at the end of December. However, the recovery was really more marked than this average indicates. For, as mentioned above, special factors caused a severe decline in the price of railroad securities. The Times average weights these prices heavily. For industrials alone, the average was 150 at the end of 1937 and 191 at the end of 1938, while for railroads the figures were 22 and 26 respectively. Bond prices followed a similar course. Corporate issues averaged 81 in January and 82 at the end of November. Treasury issues stood at 105 in January and 103 in November.

Not only were security prices rising after April, but a large volume of new issues appeared. At first, these new issues were mostly government issues, Federal, State, and Municipal. In the summer months, corporate issues were important. Total corporate issues for new capital were $11,000,000 at their low point in April, but rose to $191,000,000 in June, and remained high for July and August. In September and October, they were $62,000,000. These figures compare favorably with new industrial issues of former years; but railroad and public utility issues, once very important, were now lacking. Refunding issues were important in the fall, and Government issues throughout the latter part of the year. Not only did the total Government debt rise to the new heights of $39,000,000,000 but also there was a shift from short-term to long-term financing.

Causes of Psychological Recovery.

The record of business for the year was one of substantial recovery, but the recovery in business sentiment was even greater. This psychological change came in part from a change in the attitude of the Government. The Administration itself introduced fewer reform measures and pushed recovery measures energetically. Moreover, it showed a growing tendency to share the opinion of many business men that spending, though temporarily a stimulant, leads in the end to a charge on business. This change in opinion resulted in long delays in passing appropriation bills, but not in the reduction of the appropriations themselves. However, in November the composition of Congress changed, so that the number of those who are conservative in their financial ideas is greater.

Laws Affecting Business.

Several laws important to business were enacted during the year, besides those calculated to produce recovery through spending. The Fair Labor Standards Act was first among these. This law was designed to provide a 'ceiling for hours and a floor for wages.' For industries operating in interstate commerce, now interpreted very widely by the courts, maximum hours and minimum wages are set. For the first year (the Act went into operation in October) the minimum wage is 25 cents an hour and the maximum working week 44 hours. Maximum is here defined to mean the point at which overtime pay shall begin, not a real limitation on hours. The Act provides for a gradual increase in minimum wages and a gradual reduction of maximum hours until the minimum wage is 40 cents an hour, and maximum hours are 40 a week. The actual introduction of the Act apparently caused little difficulty to industry for, by November, industrial conditions had improved. The Administration reported that only some 200,000 employees were affected by the wage provisions. Of these, some 50,000 were discharged.

A second change in law which affected business directly was the modification of the tax laws contained in the Revenue Act of 1938. Business interests had long complained of the serious hindrance to good business produced by the Surplus Profits Tax. This tax, upon the amount of profits retained in a business instead of distributed to stockholders, was graduated according to the proportion of profits retained. At its maximum, it amounted to 27 per cent on net income. The new tax reduced the rates, so that at a maximum they amounted to 2 per cent of net income. Corporations with net incomes of less than $25,000 were made entirely exempt. This change allows corporations to increase their capital from carnings without suffering a heavy penalty. A second modification of the revenue law was in connection with the Capital Gains Tax. This tax was on the profits realized from the sale of securities, and varied with the length of time the securities had been held. The new act reduced the rates and the periods involved.

Federal Investigating of Business Practices.

In addition to these changes in laws, the Government launched upon an investigation which may have far reaching importance for business. In the spring, the Senate appointed the Temporary Economic Committee under the chairmanship of Senator King to investigate monopoly and other related practices. The investigation interpreted its field widely and has considered many phases of business organization in relation to the national economy. During the summer, a corps of experts prepared materials on the general aspects of the problem. In December, this material was presented to the Committee in open sessions. The Committee then proceeded to a consideration of corporate policies with regard to patents.