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.

1941: Financial Review

Effects of War.

The field of finance was dominated in 1941, as it was in 1940, by the World War and events related thereto. New heights of business activity, virtual termination of the huge imports of gold of recent years, a sharp decline in excess bank reserves, continued low interest rates, huge Government borrowing, taxing, and spending program, and increasing bank loans and investments can be attributed in large part to war developments.

The outstanding financial development of the year was, of course, the continual enlargement of the defense program, with the concomitant requirement of raising by one means or another the untold billions of dollars called for by that program. This phase of finance is more fully discussed in Public Finance.

Stock Market.

So far as security prices are concerned, the most important development during 1941 was a fairly sharp decline in stocks. The Dow Jones average of 30 industrial stocks listed on the New York Stock Exchange closed 1941 at 110.96 as compared with 131.13 at the close of 1940, a decline of about 16 per cent. The corresponding averages of 20 railroad stocks were 25.42 and 28.13, a decline of 9 per cent, and 15 utility stocks were 14.02 and 19.85, a decline of 29 per cent. With the exception of the sharp decline in stock prices immediately following the direct participation of the United States in war, in December 1941, there were no outstanding trends in the stock market during the year. As measured by the Dow Jones index of industrial stocks, prices followed an irregularly declining trend from a high of 133.59 in January to a low of 115.30 in May. Prices then rose gradually to 130.06 at the end of July. By early December prices had fallen to 116.65, which was followed by a sharp break to the year's low of 106.34 following our entry into the war.

Lower prices, accompanied in some cases by increased dividends, raised stock yields to new high levels during the year. Measured by the stocks used in the Dow Jones averages, the yield on industrial stocks during the year rose from 5.46 per cent to 7.12 per cent, on railroad stocks from 6.08 per cent to 8.00 per cent, and on utilities from 6.68 per cent to 9.81 per cent. This sharp increase in stock yields during the year further intensified the abnormal discrepancy already existing between stock yields and bond yields. Immediately prior to our entry into the war, the prices of high-grade bonds, whether corporate, municipal, or Federal, were slightly higher than at the close of 1940, thus continuing to some extent the long-existent down-trend in bond yields. By the close of the year, however, war developments had brought bond prices to a level slightly under that at the close of 1940.

The volume of trading in stocks on the New York Stock Exchange during 1941 marked a continuation of the declining activity characteristic of each of the four preceding years. Total sales for the year, 170,600,000 shares, were 18 per cent less than the figure for 1940, 66 per cent less than that for 1936, 85 per cent less than that for 1929, and were at the lowest level since 1918. Total bond sales on the New York Exchange stood at $2,112,000,000, an increase of 26 per cent over the previous year. During 1941 a seat on the New York Stock Exchange sold at $19,000, a new low price for the present century. The high price for the year was $35,000 and the final price $25,000. These figures compare with a 1940 low of $32,000 and a 1929 high of $625,000, before a 25 per cent increase in the number of seats.

Capital Financing.

On the basis of figures published by the Commercial and Financial Chronicle, for the first 11 months of 1940, capital financing during that period (exclusive of the Federal Government and its agencies) amounted to $3,358,000,000, slightly less than the corresponding figure for the previous year. Further analysis, however, brings out some interesting variations in the make-up of the total, the most important of which was an increase in new capital corporate financing to $963,000,000 from $674,000,000 in the previous year. Plant modification and expansion necessitated by the defense program was presumably the cause of this increase, but in spite of this stimulus the amount of capital financing remained substantially below the average for more normal times. It is thus clear that much the greater part of the cost of plant expansion is being met by the Federal Government.

Continued low interest rates during the year were responsible for the refunding prior to maturity of $1,493,000,000 of corporate issues. A substantial proportion of issues of corporate securities was placed privately during the year rather than being publicly sold through investment bankers; estimates of the proportion run from one-third to one-half. Competitive bidding for public utility securities, which was ordered by the Securities and Exchange Commission in May 1941, was expected to lessen somewhat the private placing of securities, and certain other corporations sought competitive bids for their offerings, thus in many cases breaking down banker-company relationships of long standing. One of the more unusual events of the year was the purchase by the Reconstruction Finance Corporation of an issue of $136,000,000 of refunding highway bonds offered by the State of Arkansas.

Possible revisions of the Federal Securities Act of 1933, which regulates the sale of new issues of securities, have been under discussion for more than a year between representatives of the investment bankers, the Securities and Exchange Commission, and the House Committee on Interstate and Foreign Commerce, but no legislation has as yet been forthcoming. It has truthfully been said that money and credit is one major war requisite with which this country seems plentifully supplied. The exact mechanism, however, by which this huge supply will be drawn into the war effort has not yet been clarified.

New Taxes and Industry.

Compilations by the National City Bank of New York show the heavy impact of increased taxes upon rising corporate profits. Profits of 350 leading industrial corporations in the first 9 months of 1941 amounted to $1,111,000,000, an increase of 26 per cent over the corresponding figure for 1940. An analysis of the reports of 140 of these corporations, which give tax details, shows that their earnings before taxes were $1,632,000,000, an increase of 91 per cent; income and excess profits taxes were $895,000,000, an increase of 255 per cent; and net profits were $737,000,000, an increase of 22 per cent.

A group of 25 large public utility companies reached a new high in operating revenues in the 12 months ended Sept. 30, 1941, showing an increase of 6 per cent over the preceding 12 months. Because of increased taxes and other expenses, however, their net income showed a decrease of 5 per cent. Despite sharply increased revenue from both freight and passenger business, the railroads of the country are still earning less than 4 per cent on their property investment. Recently granted wage increases, as well as increases in other operating costs, may reduce this return substantially unless recent requests for increased rates are allowed.

United States Monetary Status.

The heavy gold movements into the United States during the preceding several years seem to have come to a halt during 1941. In contrast to a net increase in our gold stock of $4,351,000,000 in 1940, the net increase in 1941 was only $741,000,000, and the year-end total of $22,736,000,000 was actually lower by $25,000,000 than the total reached in September. Gold held at Federal Reserve Banks under earmark for foreign account at the end of November amounted to $2,116,000,000, an increase of $308,000,000 since the end of 1940. Although the huge additions of recent years to our net domestic gold stock seem to have come to an end, there is still a substantial potential addition represented by an annual production now running at the rate of more than $1,000,000,000, as well as by the more than $2,000,000,000 of gold held here for foreign account. Problems presented by our ownership of a large majority of the world's gold supply are among the more important questions confronting those responsible for the monetary policies of the nation.

The sharp decline in gold imports, a large increase in currency in circulation, the increase in bank loans and investments resulting from increased business, and finally an increase in the reserve requirements, combined to bring about a reduction from the $6,896,000,000 excess reserves of Federal Reserve member banks on Jan. 15, 1941, to $3,090,000,000 at the close of the year. The significance of this to the monetary picture of the nation is perhaps more clearly indicated by the statement that excess reserves at the close of 1940 were $6,620,000,000, or 89 per cent of the required reserves of $7,406,000,000, whereas at the close of 1941 excess reserves of $3,090,000,000 were only 33 per cent of the required reserve of $9,360,000,000. The threat to the monetary stability of the country by huge excess reserves has thus been greatly lessened during the year.

Money in circulation increased sharply from $8,733,000,000 at the close of 1940, to $11,161,000,000 at the close of 1941. Part of this increase is believed to be attributable to hoarding, but probably the greater part is the result of increased employment and payrolls. Short-term commercial money rates remained practically unchanged during 1941, at the low levels which have prevailed for several years. There have been no changes since 1939 in the various Federal Reserve Bank discount rates. Effective Nov. 1, 1941, the member bank reserve requirements were increased by about one-seventh, bringing them up to the maximum permitted by law as it now stands. During the week when the new rates became effective, excess reserves dropped from $4,602,000,000 to $3,409,000,000.

Banking.

Increased business activity during 1941 was accompanied by increased banking activity. Federal Reserve Reporting Member Banks in 101 cities showed on Dec. 31, 1941, total loans and investments of $30,085,000,000, an increase of $4,558,000,000 over the figure a year earlier. Of this increase, $1,980,000,000 was represented by loans, consisting of $1,710,000,000 to commerce, industry and agriculture, $122,000,000 of open market paper, and other loans of $240,000,000. Loans relating to the securities business declined by $92,000,000. The net increase of $2,578,000,000 in investments was represented entirely by purchase of direct or guaranteed obligations of the Federal Government, other investments having decreased by $9,000,000. Bank clearings of member banks in the first 11 months of 1941 totalled $335,799,000,000, an increase of 19.6 per cent over the corresponding figure for the previous year.

New Developments.

Other financial developments of interest during the year were the Federal regulation of instalment financing, the freezing of certain foreign-owned bank deposits in this country, and various restrictions relating to dealing in foreign exchange. As is true of all other phases of our economic life, the outlook for finance in 1942 is completely dominated by the war program and the actions of the Federal Government in administering it. See also BANKS AND BANKING; BUSINESS; PUBLIC FINANCE.

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.

1938: Financial Review, United States

The Year's Trend.

After three unsatisfactory months, the year 1938 brought so substantial a recovery of the security markets that even the war scare was able to shake it but briefly. Security prices rose rapidly during the summer, and a large volume of new issues appeared. Money rates and bond yields were low. Part of the stimulus to the market was artificial. The Government changed its policies with regard to gold and to member-bank reserves, the spending program was renewed, and gold poured into the country from abroad. Loanable funds were in abundance. A more conservative attitude in Congress modified the tax laws somewhat, and the Republican victories in the November elections doubtless encouraged business. The New York Stock Exchange itself suffered a shock in the spring when the defalcations of Richard Whitney were discovered. A reorganization of the government of the Exchange followed.

Securities Market.

During the first three months of the year the stock market continued the decline of the previous year. The New York Times stock-market average was 142 at its high point in March 1937 and 86 at the end of December 1937. At the end of March 1938, it was 71. The decline was not similar for different groups of stocks. Thus, industrials dropped 12 per cent during the first quarter; railroads, by 33 per cent utility stocks by 18 per cent. Bond yields declined similarly, corporated issues dropping from 81 in January to 74 in April. Again the amount of the decline was widened by the heavy decline of railroad bonds.

The recession in the prices of industrial stocks was to be expected in view of the low level of business activity and the consequent low level of profits. Railroad and public utility securities suffered from special causes. A third of the railroad mileage was in bankruptcy, and another 10 per cent near it. The situation of the roads was so apparent that the President asked for new legislation in their aid. However, the Interstate Commerce Commission granted only a part of the increase in freight rates asked by the railroads, while Congress failed to pass any legislation. A general railroad strike threatened during most of the year. Thus, not only was the financial condition of the roads bad, but it was being discussed publicly. Prices of public utility securities were affected by the uncertainty of the relation of private companies to the Government. The dismissal of Arthur Morgan from the Tennessee Valley Authority on March 22 and the validating of the Public Utility Holding Company Act by the Supreme Court a week later helped to increase the uncertainty. The discussions of the acquisition of properties of the Commonwealth and Southern Corporation by the Authority served to shake further the confidence of the public in the future of utilities. Throughout the year these causes served to keep the prices of these two groups of securities relatively low compared with the rest of the market.

The revival of general security prices was rapid. The market average moved up to 85 in May and 104 at its high point in August. Then followed the drop accompanying the war scare abroad. In September, a low point of 89 was reached. This reaction was very short-lived: in October, the average reached 109; in November, 110; and at the end of the year was again 109.

During this period of rising prices, the volume of trading was heavy. In the early months of the year, there was an average daily turnover of some 700,000 shares. In June, contrary to the seasonal tendency, it jumped to 1,932,302 shares and in July to 1,701,718 shares. In August and September, there were declines but, in the late fall, trading was nearly as active as during 1937. Accompanying the heavy trading went a large volume of capital issues. The average monthly offerings last year for new capital and refunding had been $323,000,000, while during the first 10 months of 1938 the average was $353,000,000. But the early months had been very low, about $175,000,000. In June, the total was $511,000,000 and in October $763,000,000. September was, of course, a low month. Of these issues, government offerings — Federal, state, and municipal — bulked large, and refunding issues amounted to nearly half. However, in the three months June, July and August, new corporate financing amounted to $456,000,000. This sum compares favorably with the amount of new capital raised by industrial corporations in the period before the depression. The almost complete absence of railroad and public utility financing which once was so important an element makes the totals seem insignificant.

Government Policies.

The buoyancy of the market was induced in part by artificial stimuli. The Federal Government embarked upon a variety of policies tending to make credit easy and funds abundant. In February, it modified its gold sterilization policy and in April abandoned it altogether. This restored to the monetary system $1,400,000,000 in gold and increased the reserves of the Federal Reserve System. It also provided the Government with funds for current expenses and for the next three months made borrowing unnecessary. The withdrawing of Government demand from the market allowed investment funds to flow freely into other channels.

Besides restoring the gold, the Federal Government added to bank reserves by changing the reserve requirements of the Federal Reserve System. The decrease amounted to some 13 per cent, and excess reserves were accordingly increased. Since the banks for the most part had had ample reserve margins before this change occurred, the effects of the policy were not obvious immediately.

Another aspect of the Government policy was the increase in spending. Expenditures for relief, public works and national defense were all increased substantially. As a result, the volume of orders for various types of business was increased, and profits rose to form the basis for higher security prices. Of course, by fall the $1,400,000,000 in gold had been used, and the Government debt began to rise again until, by the end of the year, it amounted to some $30,000,000,000. In the fall, the financing of the debt brought the new issues of Government securities mentioned above.

Abundance of Funds.

Another cause of additional funds coming into the market was the political tension abroad and even the war scare. This tension had very little direct effect in disturbing our markets. The stock market declined for a few weeks in September, and new issues of securities were cut off for a month. On the other hand, gold poured into this country for months in unprecedented amounts. The gold flows began early in the year. In the first two months, they had been negligible: but in March they reached $52,000,000 and remained at that level till August. Much of this came from Japan and from London. In August, the amount jumped to $100,000,000 and in September to $521,000,000. Although this marked the high point for the year, the movement of funds to this country continued throughout the rest of the year. The result was a further increase in the deposit accounts at the member banks. With these new funds, the banks might have increased their volume of loans. Such does not seem to have been the case. Even brokers loans remained at a low level. The banks did increase their holdings of securities. At the end of November, reporting Member Banks had $2,000,000,000 of securities more than at the end of November 1937. Most of this increase was in Government bonds. This increased demand on the part of the banks was a considerable factor in the bond market.

With the excess reserves and the general abundance of funds, money rates were naturally low. Prime bills dropped to per cent and bankers acceptances to 7/16 per cent. Treasury bills, which had averaged .45 per cent in 1937, stood at .02 per cent at the end of November; yet, the volume of loans did not expand.

Modifications of the Tax Laws.

One element in the financial situation was at least in part psychological. The attitude of Congress became much more favorable to business and financial interests. In spite of administration protests, the revenue bill in the spring carried modifications of the tax law. These modifications were not drastic, but they did give tangible evidence of goodwill toward business. The tax modifications were of two kinds: first, the taxes on undistributed profits were reduced. Under the preceding law they had been progressive with the amount of net earnings retained in a corporation rather than paid out to the stockholders. They could amount at a maximum to 27 per cent of net income. Under the new law, the maximum could not exceed 2 per cent and all businesses with net incomes below $25,000 were exempt. Since corporations had felt the old law a hardship, the new law made investment prospects better. The second tax modification conserved capital gains from the sale of securities. Here the old law had provided taxes on a scale adjusted according to the period for which these securities had been held. The new law lowered the rates and lengthened the periods. Again the investor was left freer in his operations.

In addition to modifying the tax law, Congress showed greater independence with regard to reform legislation than it had in many years. This independence did not lead to a cut in any of the appropriation bills. However, there were indications that Congress was beginning to share the doubts of business men with regard to the spending program.

Fraud Cases and More Stringent Laws.

The financial world was shocked by the discovery of two conspicuous cases of fraud during the year. The first was that of Richard Whitney. Long a leader in financial circles and a former president of the New York Stock Exchange, he had had great influence on the affairs of the Exchange. In recent years, while the Exchange had been undergoing a process of reorganization, partly in accordance with the provisions of the Securities and Exchange Commission Act and partly on its own initiative to prevent further public regulation, Richard Whitney had been the leader of the conservatives. He had effectually blocked many reform measures. In March, his firm failed because of the illegal practices of Whitney himself. Although the failure of this firm caused no flurry in security prices, it did shake confidence in the practices of members of the Stock Exchange. An organization which allowed such flagrant abuses to go undiscovered for so long a period obviously needed reform and this was made. The Exchange adopted a new form of government and changed many of its rulings. On June 30, a new president, William M. Martin, Jr., was elected. For the first time, the presidency became a full-time paid position.

The other case of fraud was discovered in December. It concerned the president of the wholesale drug firm of McKesson & Robbins, who called himself, Donald Coster. His defalcations, though large, were not important in the general financial world. The importance of the case lay in the fact that it exhibited dramatically the possibilities for deceit and fraud in business. Coster had had a long criminal career, yet leading bankers financed him. He defrauded his corporation of millions of dollars, yet the certified public accountants did not discover it. Obviously, our security laws are not yet stringent enough to protect the public.