1939: Financial Review

The Year's Trend.

The year 1939 began with a mild business recession superposed upon conditions of fundamental financial strength. The security markets were inactive and prices drifted downward, while commercial bank reserves piled up and interest rates declined. In April, the crisis abroad attendant upon Germany's seizure of the remains of Czechoslovakia induced a temporary acceleration of the rate of decline in our markets while imports of gold strengthened bank reserves. In June, business began to recover and the financial markets improved also. The outbreak of war in the fall, far from impeding this recovery, caused a rapid expansion of business and even buoyancy in the security markets. Government bonds and the securities of public utility companies took the brunt of sales to realize cash. Throughout the fall, business conditions improved and commodity prices rose. However, doubts developed concerning the future of war profits. The financial markets, after the first spurt, only maintained their levels and new capital issues remained at the low levels of the earlier part of the year. Commercial bank loans expanded to some extent. Throughout the year the Federal Government continued its policy of deficit spending, thus helping to expand credit and stimulate recovery. The financial markets absorbed the new securities made necessary by this spending without raising interest rates. Only during the crisis in September did the market need support. The conservative element in Congress continued to show its strength sufficiently to encourage business. The settling of the dispute between the Tennessee Valley Authority and the Commonwealth and Southern tended to make public utility interests feel somewhat more secure but in the fall a new phase of the controversy appeared.

Securities Market.

The decline in security prices in the early months of the year were not drastic but did indicate a halt in the recovery which had been stimulated, chiefly by Federal spending, in the previous year. For common stocks the index of the Standard Statistics Company which stood at 95 in November was 90 in February. Not all classes of stocks joined in the decline; industrials dropped from 114 to 106, rails from 30 to 28 but public utilities rose from 78 to 84. In March, all classes rose a little. At the same time, corporate bond prices remained practically stationary. The volume of trading was exceedingly low. The average daily volume of stocks sold had been 1,100,000 in 1938 and 1,519,000 in 1937. In January 1939, it was 1,114,000 and in February, 708,000. Upon this general stagnation the crisis in Europe broke at the end of March. With it came declines in security prices but the volume of trading still remained low. For stocks, the index dropped from an average of 92 for March to 79 on April 12, industrials from 108 to 93, rails from 30 to 24, and utilities from 86 to 78. Corporate bond prices declined from 83 to 79. Government bond prices rose at the same time continuing a movement which had been apparent throughout the period. Treasury issues had risen from 104.0 in November to 104.8 in February and went to 106.6 in the early weeks of April.

The recovery from these conditions of crisis was slow. The index for common stocks rose to only 86 in June, a level which was maintained until war broke out in September. The recovery was general to industrial and public utility, stocks and bonds, but the prices of railroad securities remained at low levels. The bituminous coal strike which practically tied up the entire industry for six weeks during April and May cut heavily into railway traffic and the business recession added to their troubles. As a result railway earnings were again very low. Moreover, Congress did not pass any of the expected remedial legislation until summer and then only a portion of the program was completed.

Effect of the War on Securities and Foreign Exchange.

The crisis accompanying the outbreak of the war, far from bringing a break in security prices, led to a rapid speculative rise. The index for all common stocks which had been 82 on Aug. 23 rose to 84 on Aug. 30 as the tension tightened went to 92 on Sept. 6 and 96 on Sept. 13. The upward movement, it is true, was confined to stocks which might benefit by war profits but these issues bulk large in the business of the exchange. Industrials, on the average, jumped from 95 on Aug. 23 to 114 on Sept. 13 and rails from 23 to 31. Public utility companies could not be expected to gain substantially and the prices of their securities declined severely. The volume of trading which accompanied these price changes was heavy. The average daily volume for August had been 706,000 shares. In the week of Sept. 6 it had risen to 3,987,000 and for Sept. 13 was 3,204,000. The unexpected reaction of the security markets came from a variety of causes. In the first place, business was already expanding, whereas it had been contracting in the spring. Then, too, the outbreak of war had been anticipated for some time and the possibilities of inflation and war profits were well understood, as they had not been in 1914. But still more important were the effective controls which were introduced abroad. Immediately upon the declaration of war, Great Britain had required registration of all foreign securities held by residents, whether nationals or not, thus practically putting an end to all trading in them. The volume of these securities is enormous. Foreign holdings of American securities at the end of the year 1938 had been $3,250,000,000 (market value) and the amount had declined but little during the earlier part of the year. An attempt to withdraw so large an investment as happened in 1914 would have demoralized the exchanges particularly as trading had been so thin. As it was, distress selling was avoided and the market prices reflected the prospects for profit in American industries.

Government Bond Markets.

The Government bond market took the brunt of the need for liquidity. Prices sagged badly. The average price of Treasury issues which had been 107.7 on Aug. 23 dropped to 100.8 on Sept. 20. Short term securities were similarly affected, the yield on Treasury notes rising from .53 per cent to 1.18 per cent at the highest point (Sept. 9). The Federal Reserve System stepped in to support the market. During the summer, holdings of short term Government securities had been allowed to decline. For some time, these securities had been selling at purely nominal prices. Since there was no profit to the Reserve Banks and the market was short of investments, the banks withdrew. Now, at the crisis, in the two weeks ending Sept. 13, $400,000,000 of securities were acquired. In addition the Reserve Banks issued a statement on Sept. 1 that they were prepared to make advances to member and non-member banks on Government bonds at par at the rates prevailing for member banks. At the same time, several of the Reserve Banks (but not New York) reduced their rate for such advances from 1½ per cent to 1 per cent. Although no use was made of this offer, its effect was to steady the market. As a result, the transition to war was accomplished without any severe dislocations except in the foreign exchange market itself.

After the immediate impact of the crisis passed the pressure on the market for Government bonds ceased. Bond prices rose slowly. On Nov. 15 (latest available figures) they were 104. The stock market, while not maintaining quite the levels of September still was relatively high. On Nov. 15 the index for all stocks was 94, that for rails 31, for industrials 110 and for public utilities 87. The volume of trading remained above the average for 1938. That the market did not continue to advance was somewhat surprising. Prospects for war profits remained good. Wholesale commodity prices continued to rise, industrial activity increased and shortages of permanent capital particularly for the railroads became apparent. The course of the war, however, was unexpected and the market remained cautious.

Throughout the year the volume of new capital issues was low. Although the total for the year will be larger than in 1938 this figure results mainly from the financing of state and Federal Government agencies, and even much of this is refunding. Total new issues for the first eight months of 1939 amounted to $4,038,000,000 of which $2,764,000,000 represented refunding issues. One Federal refunding issue alone amounted to $1,021,000,000. Corporate refunding amounted to $1,275,000,000 and new capital issues for corporations to only $301,000,000. The immediate effect of the outbreak of the war was to curtail new issues drastically. The total for September was only $174,000,000 of which $133,000,000 were refunding issues. Even as late as November, although new capital needs for expanding war business were apparent, new issues did not expand. Business men remained hesitant and abundant short term credits made long term commitments unnecessary.

Short term credit was available at almost nominal rates throughout the year. Fed by gold imports and by a Treasury policy which allowed the general fund balance to decline throughout most of the year, excess reserves of member banks mounted to levels even above those of last year. At the end of October (latest figure) they amounted to $5,490,000,000. Interest rates to customers at banks in principal cities which had averaged 2.65 per cent rose to 2.96 per cent in the March quarter but were 2.68 per cent in September 1939. Open market rates for commercial paper remained unchanged throughout the year at a minimum.

Government Policy.

Treasury financing continued to be the dominant factor in the capital markets. The spending program initiated in April 1938 continued unabated and the public debt mounted. For the fiscal year ending June 30, 1939, the excess of expenditures over receipts was $3,542,000,000 compared to $1,384,000,000 in the year ending June 1938, and for the September quarter it was $967,000,000 compared with $687,000,000 the year before. The gross debt increased even more, for last year the inactive gold was utilized for current expenses. At the end of October, the total debt had reached $41,036,000,000.

The attitude of Congress continued to be conservative. A new spending program planned by the administration was introduced into Congress in July when business recovery was not yet apparent. It called for revolving funds of various types to be used over a period of years. It would not have involved borrowing directly by the Government but by the independent agencies, thus allowing further deficits without technically reaching the debt limit. The bill was defeated in Congress. Appropriation bills which allowed spending at an accelerated rate were passed, however.

Public Utilities.

In the field of public utilities the Tennessee Valley Authority finally acquired properties in Tennessee of the Commonwealth and Southern, the negotiations for which were begun last year. At the time, this settlement was hailed by both sides as an end of the direct competition between public and private utility interest, at least for the present. It was hoped that new private utility financing would result from the removal of fear from private enterprise. Such investment did not occur. In September, the Tennessee Valley Authority launched a new attack upon the Commonwealth and Southern, this time in connection with power lines for the rural electrification program. See also BANKS AND BANKING; BUDGET OF THE UNITED STATES; BUSINESS; NATIONAL DEBT; TAXATION.