1942: Financial Review

Financial Requirements of War Program.

In 1942, even more than in 1941, the field of Finance was dominated by the varied financial aspects of the war program. This domination will presumably be even more complete in 1943.

The role of national defense spending needs no elaboration or comment, other than to draw attention to the great increase of the actual defense expenditures, in each year since 1940, over the original budget estimates. The fact that in each of these years actual receipts of the Government were greatly in excess of the original estimates is the result of two important factors: (1) the passage of the new tax legislation; (2) a much higher level of business activity than had originally been anticipated. Estimated receipts for 1944 will probably be exceeded by a substantial amount for these reasons. Some perspective for the above figures may be gained from realization of the fact that our total expenditures for national defense for the years 1914-1920 amounted to only about $21,000,000,000, the largest single year's expenditure having been $10,965,000,000 in 1919. Monthly war expenditures jumped from $153,000,000 in June 1940 to well over $6,000,000,000 in November 1942, an increase of nearly forty-fold. The total amount of the authorized war program was about $240,000,000,000 at the close of 1942.

Financing War Expenditures.

The financing of these huge war expenditures places a tremendous burden upon the nation; the requirement for the fiscal year 1944 amounts to more than our entire national income in any year prior to 1942. Secretary of the Treasury Morgenthau, at the outset of the defense program, stated the desirability of meeting two-thirds of its cost from taxation and one-third from borrowing. This principle had to be abandoned as the requirements of the program grew by leaps and bounds. In the fiscal year 1941, about 60 per cent of the expenses of the Federal Government were met by taxation, in 1942 about 40 per cent, and for the current fiscal year ending in June 1943, the figure is expected to drop to about 30 per cent. On June 30, 1942, the national debt stood at $72,000,000,000 an increase of $23,000,000,000 over the figure a year earlier. By the end of the year it had reached $107,000,000,000. It is expected to reach $135,000,000,000 by June 1943, and $211,000,000,000 a year later. As a result of its monetary policies, including the continuing purchase of large amounts of bonds in the open market by the Federal Reserve System, the government is being enabled to finance its borrowing at an average interest rate less than half that at which it did its financing in the first World War.

Taxation.

The decrease in the proportion of Federal expenditures being met by taxation is occurring despite the passage in 1942 of the biggest tax bill in our history, estimated to raise about $7,500,000,000 net, or more than the total net tax receipts of the government in any fiscal year prior to 1942. Taxes on corporations were carried to such a level that despite the highest level of operations in their history, their earnings are for the most part showing a substantial decline as compared with 1941. Likewise, taxes on the higher income brackets have been carried to a level such that little additional revenue can be raised from this source.

In the 1942 act, exemptions were lowered from $750 to $500 for single persons, from $1,500 to $1,200 for married persons, and the credit for dependents was reduced from $400 to $350. Moreover, the normal tax rate was raised from 4 per cent to 6 per cent, and the surtax rate on the first dollar of taxable income starts at 13 per cent instead of the present 6 per cent. In addition, a Victory tax at the rate of 5 per cent on all income in excess of $12 a week with certain exceptions, became effective on Jan. 1, 1943. Some idea of the effect of higher tax rates and lower exemptions in recent years may be gained from the fact that whereas as recently as 1939 only 7,500,000 persons filed Federal Income Tax returns and 3,800,000 actually paid taxes, approximately 45,000,000 persons will be reached by the regular income tax, the Victory tax, or both, for the year 1942. The major part of the large amount of additional taxation that the government wishes to raise must be collected in one way or another from persons in the middle and lower income brackets. If major injustices are to be avoided it would seem that some method of taxation of individuals analogous to the so-called excess-profits tax of corporations might be the best solution. In other words, if the profit is to be taken out of war, proportionately much heavier taxes should be borne by those whose incomes have been directly increased as a result of it.

Relation to Inflation.

The method or methods by which the war expenditures are financed will have an immediate and important bearing upon the likelihood of a drastic inflationary development in this country. During the decade of the 1930's, when the deficits of the Federal government were averaging somewhat less than $3,000,000,000 a year, many monetary experts were seriously concerned about the ultimate impact of this situation upon our price structure. Now that the annual deficits are running from ten to twenty times this amount, drastic inflation looms as a serious national peril, second in importance only to military defeat. Opinions as to the imminence and degree of inflation vary widely. On two points, however, there is general agreement. First, the greater the proportion of the war costs that can be financed by taxes paid out of current incomes, the less dangerous becomes the threat of inflation. Second, to the extent that for political and other reasons it becomes necessary to finance the war by borrowing, the smaller the amounts of bonds that are bought by the banking system of the country, the less dangerous becomes the threat of inflation.

In other words, receipt by individuals of the greatest aggregate incomes in the history of the country, at a time when the war program has resulted in a sharp decline in the output of consumers goods, exerts a strong upward pressure on prices which has only partially been held in check by the price fixing policies of the Office of Price Administration. Unless a much larger proportion of the incomes is siphoned off by some method such as taxation or forced saving, this pressure may well become too strong to hold in check. The purchase of bonds by the banking system of the country simply adds to the aggregate purchasing power by the creation of new credit. Their purchase out of current income by non-banking sources absorbs already existing purchasing power and reduces the inflationary pressure. Any discussion of the long-run future pressure toward a substantial degree of inflation as a result of a huge national debt is beyond the scope of a review of 1942.

Bonds.

So far as its methods of borrowing money are concerned, the Treasury raised more than $9,000,000,000 during the year by the sale of Savings Bonds, and it raised more than $12,000,000,000 in December by a special Victory Bond drive. Main reliance, however, has been placed upon the weekly offerings of bills, which were gradually stepped up from an average of $150,000,000 a week in the early months of the year to a figure of $600,000,000 in the week of Dec. 21.

Currency in Circulation.

During 1942, the amount of currency in circulation continued at an accelerated rate the increase which has continued without interruption for several years. Per capita currency circulation at the close of 1942 was in excess of $110, as compared with $84 in 1941, $66 in 1940, $53 in 1939, and about $40 during the peak of prosperity in 1929. The total amount at the close of 1942 was $15,407,000,000, an increase of $4,247,000,000 in one year. The increase in recent months has been at the most rapid rate in the history of the Reserve System for any similar length of time, running at the rate of over $500,000,000 a month since August of this year, as compared with about $200,000,000 a month during the corresponding period of 1941. This increase, which is distinctly inflationary in its implications, is attributed largely to the high level of business activity, involving large payments to people who don't make use of banking facilities.

Gold.

The heavy gold movements into the United States, which had reached a climax in 1940 with a net inflow of $4,351,000,000 and tapered off to a mere $742,000,000 in 1941, were reversed for the first time in ten years, and there was a slight decline in our net holdings of gold at the end of the year. Although we still have about 75 per cent of the world's monetary gold supply, the immediate problems raised by the huge annual inflow of former years no longer confront us. However, the inflationary expansion that can be based upon our present gold supply, as well as the question of its ultimate disposition, are serious problems confronting those responsible for the monetary policies of the nation.

Banking.

The cessation of heavy net imports of gold, the large increase of currency in circulation, and heavy purchases of United States Government bonds combined to bring about a sharp decline in member bank excess reserves during 1942. At the close of the year the figure stood at $1,660,000,000, as compared with $3,090,000,000 a year earlier, and $6,620,000,000 two years ago. This decline occurred in spite of the lowering of the reserve requirement against net demand deposits from 26 per cent to 20 per cent in the New York and Chicago districts during the year. Excess reserves are now only 15 per cent of the required reserves as compared with 33 per cent and 89 per cent one year ago and two years ago, respectively. On the face of it, this sharp decline in excess reserves might seem to serve as a brake on further large purchases of Government obligations by member banks. However, to forestall any such eventuality, the Federal Reserve System has reduced from 1 per cent to ½ per cent its rate for advances to member banks secured by Government securities maturing in less than one year. Moreover, in April the Reserve banks began a policy of open-market buying of Government securities on a large scale; by the end of the year they had purchased $3,735,000,000 of such securities, thus supporting the easy money policy of the treasury. This raised their total holdings of such paper to nearly $6,000,000,000.

Except for the changes in the New York and Chicago rates, already referred to, reserve requirements remained unchanged during 1942. Similarly, rediscount and lending rates remained unchanged, except for the reduction to ½ per cent, already referred to, on advances secured by certain Government securities. Call money rates remained unchanged during the year at 1 per cent, 60 day time money at 1¼ per cent, and prime commercial paper rates ranged from ½ per cent to ¾ per cent.

The weekly reporting member banks in 101 cities showed a record breaking increase in loans and investments during the year, the figure rising by more than $10,000,000,000 to a total of $40,457,000,000 on Dec. 23, 1942. Actually the increase in holdings of United States Government securities more than accounted for the entire increase, since business loans actually declined during the year by more than $600,000,000, in spite of the high level of business activity. This contraction in loans was in sharp contrast to the increase of $1,710,000,000 in business loans in 1941.

Stock Market.

The volume of trading in stocks on the New York Stock Exchange during 1942 marked a continuation of the declining activity characteristic of each of the five preceding years. Total sales for the year of 125,700,000 shares were about 25 per cent less than the figure for 1941, 75 per cent less than in 1936, and 89 per cent less than in 1929. With the exception of 1913 and 1914, since which time listings on the exchange have increased about 9 times, sales in 1942 were the lowest for the present century. Total bond sales on the exchange in 1942 amounted to $2,183,000,000, an increase of about 3 per cent over the previous year. During 1942 a seat on the New York Stock Exchange sold at $18,000, a new low price for the present century. The price had risen to $28,000 by the end of December.

So far as security prices are concerned, the early months of the year were marked by a declining trend of prices, and the later months by a recovery. The Dow-Jones average of 30 industrial stocks, which had closed 1941 at 110.96, reached a low of 92.92 on Apr. 28, 1942, and closed the year at 119.40, showing a net gain for the year of nearly 8 per cent. The average of 20 railroad stocks also showed a net gain for the year of 8 per cent, closing at 27.39 after reaching a low on June 2 of 23.31. The high point of 119.71 for the industrial stocks was reached in the final week of the year, whereas that of 29.01 for the rails was reached in February. The average of 15 utility stocks attained a new low since its compilation, reaching a figure of 10.58 on Apr. 8, 1942, as compared with the previous low point of 14.02 at the close of 1941. The average closed the year at 14.54, to show a gain for the year of just under 4 per cent. The average of 40 bonds closed the year at 90.55, to show a gain of nearly 3 per cent over the figure a year earlier.

Capital Financing.

Figures published by the Commercial and Financial Chronicle for the first eleven months of 1942 show capital financing (exclusive of the Federal Government and its agencies) of only $1,472,000,000, representing a sharp decline from the $3,377,000,000 in the corresponding period of 1941. The most important part of the decrease took place in refunding issues which declined from $1,498,000,000 to $354,000,000 for corporate issues and from $416,000,000 to $172,000,000 in the case of state and municipal issues. New capital corporate financing dropped from $982,000,000 to $621,000,000. Flotations of corporate securities in November were at the lowest monthly figure since January 1935. The pressure being put upon the sale of Federal securities, the completion of the major part of adapting plants to the war program, and the possibility of private corporations directly or indirectly securing Federal funds, will probably combine to keep new corporate financing at a low ebb for some time to come.

Legislation.

No legislative modifications in the various securities acts took place during the year. The activities of the Securities and Exchange Commission seem to have been largely confined to the administration of the Public Utility Holding Company Act of 1935, particularly the so-called death sentence provisions relating to the dissolution or simplification of holding companies. For the most part the holding companies have been fighting the orders of the SEC with every means at their disposal. Near the close of the year, the United Gas Improvement Company, one of the largest and oldest companies in the field, surrendered unconditionally. Whether this will mark the beginning of a widespread acceptance of the orders of the SEC remains to be seen.

Insurance.

The outstanding event in the field of insurance during 1942 was the writing, mostly in the month of July, of nearly $100,000,000,000 face amount of war damage insurance by the Federal government. The amount of life insurance in force rose to a new high of $130,000,000,000 in 1942, and the assets of life insurance companies reached a new high total of $34,750,000,000, an increase of $2,000,000,000 over the previous year. Holdings of United States Government securities by life insurance companies rose during the year by $2,300,000,000 to a new high of $9,300,000,000. The net increase in the holdings of such securities during the year thus exceeded the increase in total assets. Among the factors tending to restrict life insurance sales at the present time are higher taxes, increased living costs, personnel difficulties of insurance companies, increased military personnel buying Federal government insurance, and less favorable treatment of insurance under Federal Estate Tax provisions.

Installment Financing.

As a result of wartime curbs on production of durable goods and on installment financing, the amount of such financing declined by about 60 per cent in 1942 to about $2,800,000,000. This poses serious problems to the companies engaged in this business. Many of the smaller ones are expected to go out of business, while some of the larger units are embarking upon new lines in an endeavor to compensate, in some part at least, for the loss of a major part of their regular business.

Conclusion.

As a general conclusion it may be stated that all financial interests in the country are being made secondary to meeting the tremendous production and financing requirements of the Federal government. For so long as such requirements continue we may expect to see the normal financial channels of the country either dried up entirely or diverted in new directions.