All Commentary
Friday, March 1, 1974

Capital Conservation


Mr. Speer is Chairman of the United States Steel Corporation. This article is from his address at the National Meeting of the Society of Industrial Realtors, Washington, D. C., November 10, 1973.

A few weeks ago, when I informed my wife that I had to go to Washington for a very important meeting, her first comment was, “Oh, Ed, what have you done now?”

But then I told her that the group would be made up of some of the leading realtors of this country. So she made me promise that I would thank the members of your profession for the many services you have rendered the Speer family, during all of the moves that we’ve made through the years. and I do thank you —for past services and for this opportunity to join you at your national meeting here today. You don’t have to be in business very long to realize that a prime ingredient of industrial development is the knowledge and experience contributed by the industrial realtor.

It is sometimes said that every new business, and every expansion of an old business, begins with an idea and a prayer for success. But if that idea is to get off the ground and have a prayer of a chance for success, somebody has to find the right ground in the first place —the right site, in the right location for the right price. And, of course, this is where you people enter the picture.

So I have deep respect for the members of the Society of Industrial Realtors and the contributions you make to the on-going success of American industry. I’m sure that without those contributions, there would be a lot less capital generated within our capital system in this country.

A great deal of attention is being centered these days on real and possible shortages of the natural resources we’re going to need in the years ahead. You can pick up almost any issue of the news and trade magazines and read about the importance of conservation in our use of oil, gas and other resources, because of the widening gap between consumption and domestic supply. Even in real estate, there is a gap between demand and supply, creating a land fever across the country the likes of which we haven’t seen since the days of the Wild West. In fact, as you well know, the land boom is generating its own special brand of inflation with values and prices climbing quite a bit faster than the Consumer Price Index.

The problem, as I understand it, centers about the rapid consumption of what your profession calls “buildable land.” Of course, many of the eighty thousand units of government that we have in this country are contributing to the problem, rather than its solution, by a rush to find legal ways of restricting the use of the land that remains.

All of this comes on top of the turmoil being created in the name of a clean environment by many groups, most of them sincerely concerned, although not always fully informed. There are times when I suspect that the first of our natural resources to be exhausted may turn out to be the American taxpayer. He must foot the bill for the army of inspectors and enforcers who staff all of the agencies and bureaus that are one of the fastest growing elements in our American society.

Capital, a Vital Resource

There is one national resource, however, that we absolutely cannot do without. This national resource is essential to the development of land. It is more important than drilling rigs or mining technology in locating and extracting raw materials from the ground. It is the “magic” ingredient that converts all of the other ingredients of the business process into jobs and income, goods and services, and all the real and intangible progress that our nation gains from each successful business venture.

This vital national resource is capital. It is the money put together from a variety of sources and invested in what we always hope will be a “money-making” project — which means a project that will generate not only wages and salaries, but will also pay dividends and interest and increase the nation’s supply of investment capital.

It isn’t necessary, of course, to tell a group of industrial realtors about the role of capital in keeping the wheels of progress turning. I’m sure that you and the members of your Society spend a good portion of your time explaining these economic facts of life to those who come to you for service and guidance. I mention the subject because, like other resources, the supply of capital is not inexhaustible. We get a hint of this from time to time — as we have during much of 1973 — when money gets tight and the cost of borrowing capital gives every economics professor a chance to show his students what happens when demand outruns supply.

It’s also true that there’s a greater need for capital today than ever before — and we’re going to need more of it in the future. But unless we begin to practice some capital conservation — exercising the same degree of concern toward this vital national resource that many Americans have toward our natural resources — all of the rhetoric about how far and how fast our economy grows in the future will have become little more than an academic discussion.

How much capital are we using, and how much will we need in the future? Well, capital expenditures by American industry have been averaging around one hundred billion dollars a year. And I’ve seen estimates on future needs that place capital demand at well over a trillion dollars during the next twelve years — that is, between now and 1985. Now, I’ll confess that I’m not used to thinking in trillion-dollar terms, even in this era of the trillion-dollar economy. But it isn’t difficult to see how such a figure on capital needs could be correct, if you break out some of the individual requirements.

Specific Needs

For example, the domestic oil industry believes that their capital needs alone could be a minimum of two hundred billion dollars over the next twelve years. The power generating utilities are talking of a need for seventy billion dollars just in the next five years. In communications, one company — American Telephone and Telegraph —has projected its capital requirements at forty to fifty billion dollars during the next decade. In transportation, the railroads believe that capital spending in the neighborhood of thirty-six billion dollars will be necessary over the next decade to keep pace with expected demands on their transport facilities. And in the steel industry, estimates of capital spending range upwards of thirty billion dollars between now and 1980 if we are to keep steel supply in balance with steel demand, and install the nonproductive equipment required by ever-changing pollution control standards.

That’s a lot of billions to be invested over a relatively short period of time — yet it is only a partial listing. Additional capital in equally large amounts will be needed for private housing and other land development activities… to increase the stock of goods and services that American families have come to expect and want… to build recreation centers and the facilities to house a growing national interest in the arts. So there’s an unprecedented need for capital to maintain as well as to improve our standards of living and to move forward in our efforts to upgrade American standards of life.

You know, when naturalists talk about conservation of the land, they mean preserving the capacity of the land to renew itself. It is in this same sense that I speak of capital conservation, for the whole theory of our system is one of using, renewing and increasing the supply of capital. We invest dollars in productive efforts… that create profits… which are reinvested or paid out in dividends so that more dollars will flow into the mainstream of capital investment. And under ordinary circumstances, this system could be counted on to supply all of our capital needs.

But today’s circumstances are not as “ordinary” as they once may have been. For one thing, we haven’t been investing as much of our Gross National Product in new assets as we once did. Back in 1950, almost eleven and a half per cent of our GNP was being returned to the economy to increase our stock of fixed assets in this country. As recently as 1970, however, this percentage had dwindled to 6.2 per cent — about half what it was twenty years earlier. During those same twenty years, we dropped to last place in the rate of net domestic investment among the ten leading industrial nations of the Free World. And what about profits from the investments we have made? Well, I don’t know how you people are making out in the real estate business, but I can tell you that in steel and many other areas of industry, they’re nothing to write home about.

Paper Profits

Oh, I’ve been reading those articles in the papers about the big increases that are occurring in business profits. I saw one not long ago that said the after-tax earnings of U.S. corporations in the second quarter of 1973 climbed to an annual rate over seventy-two billion dollars — a 36 per cent jump over the same period of 1972. And from numbers like that, I’m sure many of the American people believe that business is rolling in profit dollars these days. But the truth is that an inflated dollar is still an inflated dollar, whether it goes into a pay envelope or is added to the profit column of a business ledger.

Morgan Guaranty Trust Company pointed out several months ago that more than half of the increased profits reported by nonfinancial corporations during the past year have been so-called “inventory profits.” These are the gains made on the goods that a company sells out of inventory —or put another way, the difference in the value of those goods between the time they were bought or produced and the time they were used or sold. And this value reflects the rate of inflation that occurs during that period.

So a business gains no lasting benefit from these inventory profits. In fact, considering the Federal tax bite on the profits resulting from the increased value of inventories, and the higher cost of rebuilding those inventories, there actually could be a loss. On this basis, then, the on-going level of corporate profits didn’t increase during the first two quarters of 1973. It went down — to a point where, as a share of Gross National Product, they were some forty per cent below the average level of the 1960′s.

Would You Believe?

In fact, during the past three years, the average return on sales for all manufacturing companies was only 4.8 per cent — not the 28 per cent that the general public believes companies make in profits — and below the average of six per cent earned in the 1950′s and the 5.7 per cent earned in the decade of the sixties.

We are particularly concerned about our own profit situation in the steel industry. As we look down the road, we can see the demand for steel growing right along with the rest of the economy. After all, steel is not only a very versatile material — but it is also an inexpensive material. Your average pound of steel costs in the neighborhood of ten cents, and there isn’t much you can buy these days for ten cents a pound. It’s even less expensive than those proverbial peanuts.

We’ve worked hard to keep the cost of steel down. Over the past dozen years, the steel industry has invested more than nineteen billion dollars to acquire the modern efficient facilities we need to produce better steels — and to maintain and improve both the jobs and the earning potential of steel employees. Millions of additional dollars were spent to research and develop not only new steels that give the buyer more for his dollar, but new ways of using steel that reduce the costs of such things as housing and commercial buildings. I’m happy to say that even in this era of intense competition among materials, these efforts have paid off with a continuing high demand for steel in this country. Just about every order book in the industry has been full during 1973, and some of them are beginning to fill up for the early months of 1974.

This kind of business won’t last forever, of course, but we do expect the demand for steel to grow at a pace that will require perhaps twenty to thirty million tons of additional raw steel production by 1980. And this is where that thirty billion dollars comes in that I mentioned a few moments ago. It’s going to require that amount of capital to add this new capacity —to replace our existing facilities as they wear out — and to meet the demands being placed upon the industry to help clean up the environment.

Generating Additional Capital

Now, the thirty-billion-dollar question is this: Where is all that capital to come from? I can assure you that we don’t have it squirreled away in an old ingot mold. During the five years prior to 1973, the industry’s average return on sales was a lowly 3.7 per cent. Even during the first half of 1973, when sales were at an all-time high, the average profit on sales in the industry was a mere 4.5 per cent. Four and a half cents on the sales dollar isn’t the kind of return that generates the large sums of capital required by an industry like steel — where a single facility in a single plant can cost many millions of dollars, and where several hundred million dollars are spent every year in pollution control equipment alone.

It isn’t the kind of return, either, that can cause the lending institutions to welcome steel companies with open arms — although I’m not sure many steel companies would be interested in acquiring much more indebtedness. The industry as a whole is already carrying more than five billion dollars of long-term debt — most of it acquired while we were upgrading our facilities… to become more efficient… to meet the foreign steel imports that during most of the 1960′s the government told us weren’t really a problem.

More recently, of course, the government has told our industry that our profit problem is not as important as the one it has with the over-all fight against inflation. And while inflation has to be of major concern to every business and every American, I wonder how long we can continue to rob profits to pay the price of containing inflation. I don’t claim to be an expert in economics, but I do know that among the causes of inflation is the inability of production facilities to supply growing demand. This was reflected just last summer in the spiraling prices of food and other commodities. The same theory is at work in real estate as the demand outruns the supply of buildable land.

So I fail to see any great economic wisdom in containing the forces of inflation by restricting the profits that are the basis for expanding production. It may be politically expedient over a short period of time — but in the long run, it is economic folly. In fact, with the need for capital already great and growing in almost every sector of the national economy, the “long run” may be shorter than we think.

Look to the Market

Now, what’s the answer? Well, at the risk of bringing down the wrath of the economic gods here in Washington, I think it’s time they restored their faith in the American free market system. After all, we didn’t become the most productive nation in the world as a result of bureaucratic tinkering with the economy. Economic controls aren’t some new device, created by modern economists. In ancient China, Egypt, Greece, Rome — in fact, for more than four thousand years —the idea has persisted that governments can hold down prices simply by making it illegal to raise them. Yet in all this time, under all manner of circumstances, the results have usually been shortages and economic chaos, generating greater problems for the same people that the controls were supposed to protect.

The results are much the same here in the Twentieth Century. Almost daily, shortages and dislocations caused by the current economic controls are becoming more evident. And while the government says it is trying to find a way out of controls, there are hints that it may recommend some type of permanent agency which could, as Business Week phrased it, “keep the federal government in the controls business forever.”

Frankly, I believe it’s time to put more freedom back into our free economy. It’s not that I distrust the planners here in Washington. It’s just that I have a lot more faith in the private judgments of the American public, whether they’re acting as consumers or producers — whether they consider themselves part of labor or management — whether they are packaging, selling, or buying real estate. In other words, I’d rather see the cost of living controlled by the millions of private decisions that are made every day in the supermarkets of this nation than by some super-authority located in our nation’s Capital. The only true test of whether a product is worth its price, or a company worth its profit, is that ultimate decision that’s made at the point of sale.

So it seems to me that a very necessary first step toward practicing capital conservation in this country should be to “phase out” the economic controls hampering the price structure and the rates of profit that are essential to increasing the flow of capital in our type of economy. It would be a big help also if, somehow, we could get as many Americans interested in the conservation of this vital national resource as seem to be concerned about the proper conservation of our other resources.

Conservation Conscious

We are rapidly developing and in some respects already have a conservation culture here in America. Individually and in groups, large numbers of our people are actively engaged in a wide variety of conservation efforts. Conservation of energy… conservation of our natural resources… conservation of land… conservation of historical landmarks… the list of things to be conserved and preserved is almost endless.

I say “almost endless,” because the one that has been missing is the conservation of capital. Certainly, it is this national resource that we need to conserve, if we are to accomplish the other objectives. Yet the current trend seems to be one of putting most of the others first, often at the cost of increasing the amounts of capital that will be needed to maintain the American way of life.

As I’ve already mentioned, some of the largest amounts of capital investment to be made in the years ahead will be those by the energy-producing industries. Supplying the growing energy needs of this country is going to be a costly job, and the longer we wait to get on with the job, the higher those costs will rise. But delay, rather than progress, seems to be the order of the day in our approach to our energy problems. Whether it is bringing oil from Alaska or generating electricity, months and even years go by while environmental matters are given precedence — and the costs of each project climb.

Don’t misunderstand me. Protecting the environment is a highly desirable goal. American industry in general is working hard to do its part, spending billions of scarce capital dollars every year to meet various environmental needs. Yet there is still no scientific basis for many of the pollution control standards that industry is being asked to meet. For example, at U. S. Steel’s Fairless Works, north of Philadelphia, we are already controlling better than 99 per cent of the dust emitted from the open hearth furnaces of that plant. The equipment was expensive — but it is effective. Now, we are being asked to remove all visible dust from this steel making facility. And if we are forced to go this final mile, the additional investment cost — in terms of the capital spent per pound of dust collected — will be two hundred times greater than the original investment we made to reach 99 per cent effectiveness.

At the moment, however, no one knows whether this and similar expenditures at other plants are justified, for there is no scientific data to show that any harm is done by this relatively insignificant amount of dust. And I think you’ll agree that an industry already facing a “capital crunch” can’t afford, and shouldn’t be asked, to spend excessive amounts of capital for nonproductive equipment that may, in the end, be proved unnecessary.

In many areas, you can find other efforts that — however well intentioned — threaten to push the costs of growth beyond the range of capital available to bring about such growth. This is certainly evident in the rush to find legislative ways to cool off the land fever that’s sweeping the country. As you know, a bill to establish a national land-use policy has been passed by the Senate. I understand that hundreds of other measures are before the Congress and state and local governments, dealing with everything from urban growth to “no-growth.”

In fact, much of this legislation seems designed to discourage the use of land, despite the fact that land itself is a very vital resource. Aside from its surface value, the land of this country has beneath its surface other resources — oil and gas, coal and other minerals —that we’re going to need in ever larger quantities.

The development of land, including its use for the production of energy and minerals, is already a very costly business. And if common sense isn’t applied in large quantities today, we may find at some point in the future that both the land and its mineral wealth have been legislated into a position where no one will be able to justify the capital outlays required to make it useful to the American people.

Seward’s Folly

You know, ladies and gentlemen, out of the more than two billion acres that comprise these United States of America, there is one plot of better than three hundred seventy-five million acres that now makes up our forty-ninth state, Alaska. At the time we acquired this land from Russia over a century ago, the purchase price was seven million dollars. That was a lot of money in those days, and the whole deal was known as “Seward’s Folly,” because no one could see the value of those acres so far to the North.

Today, of course, Alaska’s mineral wealth alone has a value many, many times the original price, even if you were to measure it in one-hundred-year-old dollars. And the term, Seward’s Folly, has been relegated to a brief mention in the history books.

Let us hope that our efforts to generate growth in this second half of the Twentieth Century will turn out as well as did the purchase of Alaska in the second half of the last century. But let us also do more than hope.

Let’s be sure that our economic policies and goals in this country are set by us, and not for us. Let’s be sure that in your industry and mine, we make every effort to convince those in government that our goals are also very much in the national interest. And let’s be sure we use every opportunity to tell the American public that the conserving of capital is the one conservation effort that cannot be ignored — because capital and the profits that create and attract capital are essential to whatever objectives we set for ourselves and for our nation.