Reserve Bank of Australia Annual Report – 1975 Economic Developments Abroad

Conditions Overseas

Many of the economic problems faced by Australia during 1974/75 had parallels in other industrialised countries; in particular, most overseas countries had to grapple with the co-existence of rapid inflation and rising unemployment during the year. By the end of the year inflation rates were falling in most industrial countries, but, in some, price rises were continuing unabated.

3 Balance of Payments of Overseas Countries

Trade and payments

World trade in volume terms appears to have fallen slightly during 1974/75; this carries further the trend of the previous year when growth in the volume of world trade slackened to just below 5 per cent from an average annual increase of around 9 per cent over the late 'sixties and first few years of the 'seventies. Exports of the industrial countries, which had grown at an annual rate of about 11 per cent in the last half of 1973/74, fell by about 1 per cent (annual rate) in the first half of 1974/75 and declined at an annual rate of around 4.5 per cent in the six months to June 1975. Exports would have fallen further over the year just ended if it had not been for a rapid growth of shipments to the oil-producing countries, as that group converted some of their gains from oil price increases into goods. Trade between the industrial countries was depressed during the year as a result of subdued levels of activity. Sales to non-oil-producing less developed countries had grown strongly in the second half of 1973/74 but fell at a quickening rate over 1974/75; this partly reflected the difficulties faced by these countries as a consequence of the rise in oil prices during 1973/74.

The rate of growth of prices of traded goods eased during 1974/75. Oil prices rose by a comparatively moderate amount in the first half of 1974/75 and the oil-producing countries decided to maintain official prices at their January 1975 levels until September 1975; market prices declined slightly in the six months to June 1975. As a result of the falling levels of demand in the industrialised world, base metal and industrial raw material prices fell sharply during the year and the rate of growth in the prices of manufactures slowed. Due to a tight supply situation, food prices continued to rise strongly during the first half of 1974/75. Meat prices were an exception; with stocks high and demand lower, many countries introduced import restrictions and meat prices stabilised at levels below those prevailing in 1973/74. In the second half of 1974/75, food prices generally eased from their end-1974 peak as the supply position became somewhat easier; the need to rebuild stocks probably cushioned the fall in prices.

The industrialised countries were able to reduce their combined current account deficit during 1974/75 from the high level reached (mainly as a result of oil price rises) in the previous year. The increased rate of exporting to the oil-producing countries and a reduced volume of oil imports, due largely to cyclical developments, both contributed to this outcome. However, the main oil-exporting countries continued to run large current account surpluses with the rest of the world. Marked differences remained in the current account positions of individual industrial countries (see graph 3).

During the first half of 1974/75 capital flows were strongly influenced by movements of oil moneys. A sizeable proportion of these funds was invested directly in the major domestic financial markets. Funds were also channelled through the Euro-currency markets but at a slightly slower pace than in the second half of 1973/74. The Euro-currency market itself contracted sharply in the early part of 1974/75 but a moderate overall expansion subsequently occurred. Looking at particular countries, falling interest rates in West Germany prompted a capital outflow but private capital outflows from the United States were largely offset by the investment of petrodollars in that country. There was a substantial reduction in the outflow of long-term capital from Japan during the first half of the year. Most other industrial countries experienced a net capital inflow during the period. In the closing months of 1974 it appeared that the oil-exporting countries were opting to diversify their portfolios by placing more funds in the strong continental currencies and less in assets denominated in United States dollars; this trend appeared to continue in the early months of 1975.

4 Interest Rates Overseas

Overall, the major countries have coped with the balance of payments disequi-libria resulting from the oil price rises of 1973/74 with fewer difficulties than were expected; competitive devaluations have been avoided and resort to trade restrictions has been fairly limited. One factor that may have facilitated the adjustment process was the more flexible exchange rate arrangements in operation since March 1973. Since that date the currencies of the major countries have been floating; however, the majority of other countries (including Australia) have continued to peg their currencies in some fashion and the floating currencies have been subject to varying degrees of official intervention. Movements of selected currencies against the United States dollar are shown in the table on the opposite page. The United States dollar strengthened markedly in the first few weeks of July 1975.

Gold prices rose steadily during the first half of 1974/75; the chance of stronger demand after 1 January 1975, when private ownership of gold in the United States became legal, contributed to this outcome. Of two million ounces of gold offered for sale in the United States by the U.S. Treasury in early 1975, tenders were accepted for only three-quarters of a million ounces. The average tender price was below market values. In general, gold prices fell back a little over the second half of 1974/75. A further half million ounces of gold was offered for auction by the U.S. Treasury on 30 June 1975; bids for over four million ounces were received and almost the entire offering was sold at close to market prices.

Finance

With monetary policies restrictive, financial conditions in major western economies were generally fairly tight in the closing months of 1973/74 and in the early months of 1974/75. Interest rates remained high and the rate of growth of money supplies declined. During this period, financing problems became acute for corporations in a number of countries, as falling profits reduced internal sources of funds, while inventories rose and outside funds were expensive and difficult to obtain. Financial institutions also faced problems during this period. Some institutions had earlier experienced a rapid increase in short-term deposits and had invested heavily in property; however, with tight financial conditions there was an ending of the property boom in some countries by the beginning of 1974/75, and an increased demand for liquid funds. At about this time the investment of large amounts of oil money for very short terms created extra problems for financial institutions. A number of international banks also experienced large losses because of speculative dealings (mostly unauthorised) in foreign exchange markets. These disturbances stimulated the introduction of closer supervision, in major countries, of the general operations of banks, and, particularly, of their foreign exchange dealings; subsequently monetary authorities undertook to intensify the exchange of information on banks operating in international financial markets.

By the end of 1974 most countries began to experience easier monetary conditions; in part, this reflected weaker demand for investment funds as economic activity declined. In some countries, such as the United States and West Germany, the authorities took the initiative to lower interest rates and encourage a further expansion of the money supply. Falling interest rates in the United States and West Germany enabled some other countries to lower their interest rates without provoking capital flows likely to lead to unwanted exchange rate movements. The move to greater monetary ease was reinforced as governments began to increase spending and the size of their budget deficits in order to reduce unemployment, which had been growing strongly. By the end of the March quarter interest rates had fallen considerably in most countries (see graph 4). The money supplies in a number of countries began to grow more rapidly early in 1975 but subsequently expanded only relatively slowly, partly because of a low level of demand for funds.

Activity

Aggregate demand and output declined in the industrial countries in 1974/75; the real gross product of the member countries of the Organisation for Economic Co-operation and Development (OECD) seems to have fallen by over 2 per cent compared with a rise of about 3 per cent in the previous year. The sharpest fall in output was recorded in the United States; there were also falls in Italy, Canada and West Germany. Growth was subdued in Japan, and a solid rate of growth in the United Kingdom in the first half of the year mainly reflected a recovery from the disruptions caused by industrial disputes in the second half of 1973/74. Business investment was particularly weak and private consumption was subdued in most countries.

With demand and output falling sharply industrial countries experienced continuing deterioration in the demand for labour during the year. There were declines in average weekly hours worked, increases in the number on short time and falling vacancies. In many countries employment declined. Unemployment, already on the increase in the closing months of 1973/74, rose rapidly throughout 1974/75. Graph 5 shows the upward trend in unemployment in a number of major countries; graph 16 on page 38 shows the steep increase in unemployment experienced in Australia.

As unemployment began to rise sharply and the extent of the decline in output became apparent, the emphasis of policy shifted in many industrial countries. By around the end of 1974, fiscal policy had become considerably more expansionary. As indicated in the previous section, monetary policy, which had remained fairly restrictive in the early part of 1974/75 in an attempt to slow the rapid inflation, was also eased at about end 1974.

During the first half of 1974/75, inflation in many countries mainly reflected rapid increases in labour costs per unit of output associated with sizeable wage increases and a cyclical fall in productivity; this experience contrasted with that during much of the previous year when the major impact on consumer prices came from the working through of increases in oil and commodity prices. Of course, the depressive effects on real incomes resulting from these earlier events may have been one of the factors behind the upsurge in wage demands; this would have been reinforced by a strengthening of expectations of further inflation. Because the wage increases coincided with a substantial easing in demand they added to unemployment, as firms found it unprofitable to keep labour on. However, by early 1975 some moderation in wage increases was apparent in the United States, West Germany and Japan. In some other countries such as the United Kingdom, wages continued to increase apace. In a number of countries the depressed state of demand and low level of use of capacity resulted in a fall in company profits; in some cases wages rose faster than prices, further reducing profits.

5 Unemployment Rates Overseas¹
SEASONALLY ADJUSTED

Consumer prices in the OECD countries rose at the rapid annual rate of about 14 per cent in the first half of 1974/75; however, late in 1974 and early in 1975 some slow-down in the rate of increase became apparent and this deceleration continued over the next few months. Factors contributing to the slow-down included the peaking of food prices in late 1974, falls in some industrial raw material prices, moderation of wage increases in some countries and attempts to liquidate stocks, which had reached high levels; fundamental to these developments was the sharp fall in demand and output in the industrialised world. Nevertheless, the rate of inflation was still fairly high in many countries at the end of the year, and with policies eased it was not certain that lower rates of inflation would be maintained. Graph 6 shows inflation rates in a number of major countries; comparable figures for Australia can be found in graph 18 on page 42.

International Monetary Reform

The Committee of Twenty, a committee of the Board of Governors of the International Monetary Fund, presented its final report on international monetary reform in June 1974. As a result of its recommendations the following institutional arrangements were introduced in the first half of 1974/75:

• An Interim Committee was set up to oversee the working of the international monetary system pending the formation of a proposed Council of Governors with decision making powers.
• A joint World Bank/Fund Development Committee was formed to study the transfer of real resources to developing countries.
• An Oil Facility was established within the Fund to assist members to meet the impact of the increase in oil prices.

6 Consumer Prices Overseas
PERCENTAGE CHANGE OVER SAME QUARTER OF PREVIOUS YEAR

Both the Interim Committee and the Development Committee held inaugural (mainly administrative) meetings in early 1974/75 and met for working sessions in January and June 1975. One issue engaging the attention of the Interim Committee has been the sixth general review of IMF quotas. General quota increases have the important purpose of increasing the Fund's financial resources. An individual member's quota determines its borrowing rights, its share of any allocation of SDR's and its voting power within the Fund. In January the Interim Committee agreed to an overall increase in quotas of almost 33 per cent. It also agreed to double the collective quota share of the group of major oil exporters and to maintain the quota share of the other developing countries in the enlarged Fund. These decisions implied a decrease in the quota share of the developed countries as a group. As yet full agreement has not been reached amongst the major industrial and other developed countries on individual quota increases.

The Committee continued to reaffirm the objective of making the Special Drawing Right the principal reserve asset in the international monetary system and of reducing the role of gold. It has been agreed that the official price of gold be abolished, along with obligatory payments in gold to the Fund. At its latest meeting in June, the Committee also agreed that there should be a partial return, at the present official price, of the Fund's gold to members and the sale of another portion, at market-related prices, for the benefit of developing member countries, particularly those with low incomes.

On exchange arrangements, the Interim Committee agreed that members should have a basic obligation to collaborate with the Fund and with other members in order to promote exchange stability, to maintain orderly exchange arrangements and to pursue exchange policies that contributed to the international adjustment process. Discussion continues of a wide range of exchange rate procedures over which the Fund exercises surveillance.

During the year the Development Committee initiated studies of the desirability of creating a special Trust Fund to provide resources on concessional terms to developing countries; it also urged the establishment of a “third window” for World Bank lending.

The Oil Facility was instituted in early 1974/75 when agreement was reached for seven member countries to lend the IMF a total of SDR 2.8 billion; shortly after this agreement the first transactions under the Oil Facility took place. Before the end of 1974 two more countries had contributed funds to the Oil Facility bringing the total resources made available to SDR 3 billion; purchases under the Facility for 1974 amounted to about SDR 2.6 billion by forty member countries. The January meeting of the Interim Committee agreed that the Facility should be continued into 1975 by seeking SDR 5 billion in loans to add to the unused funds from the 1974 Facility; by early June lenders had contributed SDR 2.9 billion. In addition, a Subsidy Account, financed by contributions from member countries, has been agreed in principle, to reduce the interest burden of drawings from the Oil Facility on those countries most seriously affected by the oil crisis.

Steps to assist industrial countries with serious balance of payments difficulties were also taken by the OECD during the year. In April 1975 an agreement establishing the OECD Financial Support Fund of SDR 20 billion was finalised; all OECD members, including Australia, have signed the agreement. The Fund will have the capacity to grant loans of up to seven years maturity during the period of two years from its entry into force. Loans are intended to assist members encountering serious external financial difficulties and are to be granted on condition that the borrowing country is following appropriate general economic and energy policies. Quotas in the Fund are the basis for determining borrowing rights and maximum financial liability to the Fund; Australia has received a quota of SDR 300 million.