Following is an excerpt of Gary H. Stern's March 10, 1993,
full testimony before the Senate Committee on Banking, Housing
and Urban Affairs. Stern, along with the other 11 Federal Reserve
bank presidents, was called to testify on the state of the district
economy and to share his views on monetary policy.
Mr. Chairman and members of the Committee, I appreciate this
opportunity to discuss with you economic conditions in the Ninth
Federal Reserve District and my views on monetary policy. Largely
by avoiding the swings of the national economy, the Ninth Federal
Reserve District's economy has grown steadily but unspectacularly
since 1985. In 1985 the nation was expanding, but the district
was still affected by problems in its natural resource-based industries.
Now, the district's economy is somewhat stronger than the nation's.
In recent years, while the nation's economy was sluggish, the
Ninth District's economyless affected by reductions in defense
spending and falling commercial real estate pricesgrew at
a faster rate.
Unspectacular but steady
Close to three-fourths of Ninth District business leaders responding
to a poll conducted by the Federal Reserve Bank of Minneapolis
last fall said their communities' economies were doing better
than the nation's. Personal income growth since the trough of
the 1990-91 recession supports their observations: Income in the
district's four complete states grew faster than in the nation.
And in 1992 the district's banks, buoyed by favorable interest
rate spreads and strong demand for residential loans, had their
best year in a decade.
This performance is in marked contrast to March 1985, when the
nation was in its ninth quarter of recovery, but the district's
states, except Minnesota, were expanding more slowly than the
nation. In fact, between the fourth quarter of 1982 and the first
quarter of 1985, South Dakota, North Dakota and Montana ranked
44th, 48th and 49th, respectively, in annual growth. During this
time the district's banks mirrored the real economy, especially
in rural areas, and in 1986 banks had their worst performance
The mid-1980s defense expenditure buildup and the commercial
real estate expansion largely bypassed the Ninth District; therefore,
when these industries suffered in the early 1990s, the region's
performance did not deteriorate as much as the nation's.
The Ninth District's relative improvement, however, is more
than the avoidance of the economic swings that have occurred nationally
(indeed, the district has experienced its own cycles, particularly
within its natural resource-based industries). My travels across
the Ninth District and visits with its leaders, along with articles
in the fedgazette, the Federal Reserve Bank of Minneapolis'
regional business and economics newspaper, reveal considerable
vitality and adaptability. Increased exports, growing output from
industries created by new technologies, expanding tourism and
Canadian cross-border shopping have enabled the region to advance,
despite persistent problems in its important natural resource-based
Many acres, many resources, few people
The Ninth District covers a big area but has a small population.
Montana, North Dakota, South Dakota, Minnesota, the Upper Peninsula
of Michigan and northwestern Wisconsin make up nearly 12 percent
of the total land area of the United States but contain only 3
percent of its population.
Natural resource-based industries are important in the district,
but are no longer the driving force they once were. Still, these
district industries produce about 16 percent of the nation's agricultural
output, 11 percent of mining and 9 percent of forest products.
Such industries are especially important in the district's three
western states, accounting for 26 percent of North Dakota's total
output, 22 percent of Montana's and 20 percent of South Dakota's.
These sectorsagriculture, mining and energy, and forestryhave
long been important in the Ninth District, but, in general, they
are no longer dynamic engines of growth. Instead, these sectors
struggle to earn modest profits, maintain employment levels and
replace obsolescent machinery. Agriculture, along with mining
and energy, went through a roughly parallel cycle of a 1970s surge
followed by a 1980s slowdown and a weak recovery into the 1990s.
The forest products sector has followed a different pattern, but
faces structural problems of its own.
The rural financial crisis was at its height in 1985. Concerns
for the agricultural and rural economies dominated board of directors
and advisory council sessions as well as many of my meetings across
the district throughout the late 1980s.
Agriculture experienced wrenching adjustments in the 1980s.
Good crop prices and low real interest rates led to the quadrupling
of land prices between 1970 and 1980. But these factors turned
negative in the 1980s and pushed agricultural profitability and
land values into a slump. From 1980 to 1987, Ninth District land
prices declined by 35 percent to 60 percent, and foreclosures
Now the spate of bankruptcies is over. Farm incomes have climbed
slowly from mid-1980s lows. Total agricultural debt dropped by
30 percent from 1984 to 1990 as lenders wrote off and farmers
paid down debt. Land prices stabilized and then rose; by 1992,
unadjusted for inflation, they roughly had regained their 1984
But farm profitability remains tenuous and highly influenced
by exchange rates and government support programs. At a recent
meeting of our advisory council, one member noted that farmers
are broken into two groups: well-capitalized and highly leveraged.
Well-capitalized farmers who did not become highly leveraged make
reasonable profits, continue to invest in new machinery and facilities,
and service debt without problems. But those farmers who were
highly leveraged in the early 1980s, even if they escaped liquidation,
still face high debt loads, earn only minimal profits at current
prices, and are unable to make substantial new investments.
Moreover, small rural towns continue to lose businesses as retailing
moves toward larger regional centers. Similarly, the number of
farm implement dealers and agricultural input suppliers shrank
notably during the 1980s, putting further pressure on the economies
of smaller towns.
Pressure on prices and employment in mining and energy
As in agriculture, the metal mining and energy industries in the
Ninth District have experienced financial pressures since the
mid-'80s. Ninth District metal mines extract iron ore on the fringes
of Lake Superior, copper in the same area and in Montana, and
gold in South Dakota and Montana. Coal and oil production are
important in both North Dakota and Montana.
Iron ore is by far the district's most important mining sector
in terms of employment and value of output. Output grew through
the 1970s, declined in the early 1980s, recovered somewhat by
1990, and is again in a slump. Iron mining employment in Minnesota
has dropped by about 20 percent since 1985. Our remaining ores
are low-grade and require expensive processing, making it hard
for existing iron mines to compete with more recently developed
high-grade sources in Latin America. The industry has cut costs,
reduced staffing, improved technical efficiencies and undergone
Copper and gold are also important mining products in the Ninth
District. These mines have important local employment and spending
impacts in northern Wisconsin, the Upper Peninsula, western South
Dakota and Montana. Output and employment have been essentially
stable over the past eight years in spite of fluctuating prices
and limited profitability.
At present, both copper and gold prices are low; copper and
gold mine layoffs have occurred recently in Michigan and South
Dakota. Few new mines, which are capital-intensive and involve
long lead times, are being developed due to current depressed
prices. Some officials are concerned that employment and output
may thus shrink as ore deposits in existing mines are exhausted.
In the 1970s, coal and oil development apparently faced a bright
future in North Dakota and Montana. But these hopes slumped with
falling oil prices in the 1980s. While coal production has remained
relatively stable, oil output has declined, and both oil exploration
and new coal mine development are at a virtual standstill.
Excess capacity plagues paper industry
Since the mid-'80s, the forest products industries have faced
problems somewhat different than those of agriculture, and mining
and energy. The paper industry in Minnesota, Wisconsin and Michigan
is an important source of employment and value-added. In the late
1980s, we heard reports of substantial new construction or renovation
of paper mills. But now the industry is in the middle of a long
slump marked by excess capacity nationwide, stagnant prices and
limited profitability. Industry officials do not expect prices
to recover for another three years, it was reported at our most
recent advisory council meeting. Several mills have laid off workers
and are running at less than capacity.
Forestry faces shrinking resources and technological change
In Montana and western South Dakota, the forest products industry
consists of traditional lumber production, with most timber cut
from national forests. As in the Pacific Northwest, available
timber supplies are shrinking due to depletion of stocks of mature
trees and somewhat tighter environmental regulations. Prices bid
for cutting rights are rising dramatically and profits are squeezed
tightly, even at current high lumber prices, according to directors'
reports. This situation is apparently a long-term one; output
and employment can be expected to continue to shrink. While this
particular sector is not large relative to the entire Ninth District
economy, effects on employment and spending may be painful to
But at the eastern end of the district a whole new sector is
emerging. The late 1980s saw substantial construction of plants
that use new technology to produce plywood substitutes from what
were considered low- value trees. Several such plants, built in
Minnesota, Wisconsin and Michigan over the past decade, are presently
running at capacity.
District avoids decline in manufacturing
While many natural resource-based industries were struggling,
other district industries escaped the vagaries of national economic
swings. This is especially true of defense spending and its effect
on the district's manufacturing employment. Although several Ninth
District communities were, and still are, vulnerable to base closings,
defense spending cutbacks were expected to hit the Pacific, New
England and South Atlantic census regions the hardest. Likewise,
Ninth District manufacturing employment was essentially unchanged
over the last two years, while nationally it dropped by about
While defense orders have been shrinking, manufacturing exports
have been increasing for the nation, and district manufacturers
have been as successful as their national counterparts when it
comes to exporting. Between 1987 and 1991 growth in manufactured
exports totalled at least 55 percent in the district and nation.
Avoiding defense cutbacks' full brunt and participating in the
export surge have not kept the Ninth District from plant closings
and layoffs, but the region has been able to offset many of them.
Over the years, Minneapolis/St. Paul has blossomed into a major
computer manufacturing center. However, the bloom is now off;
these firms have been laying off workers. Nevertheless, the Twin
Cities still generates high-tech manufacturing jobs; during the
last two years, the increase in instrument manufacturing jobs,
primarily medical devices, offset the decrease in computer manufacturing
Outside Minneapolis/St. Paul, manufacturing is resilient as
well. I periodically travel to Ninth District communities as part
of my District Dialogue program, and in Aberdeen, S.D., and Eau
Claire, Wis., business leaders report that they have been able
to attract firms to help compensate for major plant closings.
District construction employment rises as nation's declines
Ninth District construction, like manufacturing, is also resilient.
Although Minneapolis/St. Paul's office vacancy rate rivals the
nation's, commercial construction is expanding in Grand Forks,
N.D., Rochester, Minn., and Sioux Falls, S.D. Moreover, some communities
are experiencing a surge in residential construction. Western
Montana, for example, is benefiting from an in-migration of West
Coast residents. Thus over the last two years Ninth District overall
construction employment has risen about 1.5 percent, in contrast
to its decline at the national level.
In services, as in manufacturing and construction, the Ninth
District's performance recently surpassed the nation's. During
that last two years, employment in services has increased about
4 percent in the region, well above the increase in the nation
as a whole.
Telecommunications brings jobs to the region
Service industries from outside the district are using advances
in telecommunications to access the region's labor force. In the
last 12 years, bank credit card processors, notably Citibank,
have become a major South Dakota industry. They now account for
around 5,000 jobs in Sioux Falls, 6 percent of the city's employment.
These jobs are not limited only to the region's cities and towns;
a Salt Lake City firm has hired farmers and rural residents in
northeast Montana to work out of their homes.
More people travel to district
The Ninth District also has benefited from rising tourism. Part
of this increase comes from the region's exposure in movies"Dances
With Wolves" and "A River Runs Through It," for
example. New attractions, like the Twin Cities' Mall of America
and casino gambling, are also pulling people into the region.
Moreover, the dollar's decline has made U.S. travel attractive
Closer ties to Canada helping border communities
The Ninth District's proximity to Canada has also benefited the
region. Although the impact of the U.S.-Canada Free Trade Agreement
cannot be easily sorted out from exchange rates and other factors,
a 1991 fedgazette poll revealed that Canadian business,
particularly in border communities, had increased since the agreement's
implementation. Furthermore, in my Dialogue trips to Grand Forks
and Minot, N.D., and Great Falls, Mont., residents reported how
Canadian shoppers are buoying these communities.
Last year, however, the Canadian dollar fell relative to the
U.S. dollar, and at recent advisory council meetings a slowing
of cross-border traffic into North Dakota and Montana was reported.
Moreover, the Canadian government has recently taken measures,
such as tougher duty-free limits, to discourage cross-border shopping.
The region avoided the full effect of the economic slowdown of
the early 1990s, but the region's businesses have also taken advantage
of the opportunities offered by changes in the economy. Consequently,
the Ninth District has scored well on one important test for a
regional economykeeping its unemployment low. The United
States essentially has the same unemployment rate today as it
did in 1985, but unemployment rates have declined in Ninth District
While district unemployment rates have been declining, prices
and wages have not been increasing as fast as they did nationally.
Between 1985 and 1992, the Minneapolis/St. Paul consumer price
index rose at a 3.3 percent annual rate, in comparison with about
a 4 percent rate nationally. During the same period, hourly manufacturing
wages increased more slowly in the district than they did nationally.
Banking industry improves with economy
As the district's economy improved, so did the banking industry.
For example, the return on average assets (ROAA) of Ninth District
banks more than doubled between 1986 and 1992. By 1986, the lagging
effects of the 1981-82 recession, the mid-1980s agricultural slump
and problems with loans to less-developed countries had combined
to weaken all types of banks, but agricultural banks were particularly
stressed. However, by 1992, district banks reported their highest
average ROAA in a decade.
In addition to the increased average ROAA for all district banks
between 1986 and 1992, another measure of the solid improvement
is a reduction in the number of banks reporting losses. Only 17
banks reported losses for the first three quarters of 1992, about
2 percent of the district total, compared to 279 for 1986, or
20 percent of all banks.
Residential mortgages drive current lending growth
As discussed earlier, 1986 was a year of retrenching for many
banks, so it is not surprising that loan volumes were low. Loan
growth then improved through 1988, but in 1990 and 1991 credit
quality problems surfaced with commercial loans, in particular
commercial real estate and highly leveraged transactions.
By 1992 loan growth had improved again, but the composition
of loans changed and was more heavily weighted toward residential
mortgages. Favorable long-term interest rates spurred a substantial
volume of mortgage refinancings as well as new loans for purchases
of new and existing residential real estate. Moderate growth occurred
in multifamily residential lending and agricultural lending. Loans
to businesses, financial institutions and non-residential loans
to individuals all declined in 1992. It is also interesting to
note that banks participating in our seasonal borrowing program
were more aggressive in making agricultural and small business
loans than were those that did not participate.
Also, despite recent concerns about banks investing in securities
instead of making loans, district banks' proportion of securities,
as a percent of total assets, was unchanged in 1992 from 1986.