THE LONG—TERM RATE FOR CAPITAL
By NICHOLAS DAVENPORT
WHY is the long-term rate of interest so high? Is it doing any harm? If so, why cannot it be reduced? I have constantly asked these questions and the Chancellor of the Ex- chequer has constantly avoided answering them. It is therefore good to have Professor Victor Morgan of Swansea joining in this controversy in a provocative paper he has written for the June issue of the Three Banks Review. His theme is that high rates may have been justified during most of the post-war period by the world shortage of capital but that there are now signs that this shortage is abating—at least in western industrial countries. On the one hand, there is the remarkable growth of personal savings (largely through group pensions); on the other, there is the com- pletion of the war-time back-log of invest- ment. The present industrial over-capacity is still a hangover from the last recession. If economic resources are to be fully used in the 1960s, says the Professor, we may need considerably lower rates of interest in the 1950s.
The yield on most irredeemable and long- term stocks has been over 5 per cent for over two years. Indeed, interest rates have never been so high for so long for forty years. In the past the swings between cheap and dear money have produced variations in the long- term rate equal to about a third of the change in bill rates. On this basis the fall in Bank rate and Treasury bill rates since the be- ginning of 1958 should have produced a fall of about I per cent. in the long-term rate whereas the actual fall has been little more than per cent. It has already cost the Treasury an extra £60 million a year in the interest charge on the national debt for the conversion of six issues with low coupons. In the next five years there are £2,000 million more to convert and nearly £5,000 million in the next ten. At present rates these con- versions would add between £100 and £150 million to the interest bill, which would be equivalent to about 6d. on the income tax.
Now the Professor admits that if the rate of interest is to be used as a regulator it must respond to market forces; it must not be manipulated just to ease the Budget. But rates which are high and inflexible are just as dangerous, he rightly argues, as rates which are low and inflexible. Surely it is clear to everyone outside Great George Street that the Treasury has got itself saddled with a dangerously high and rigid structure of long-term rates, which is making social investment (in housing, etc.) much too expensive and is tending to restrict new and essential investment in private industry. I am sure that Mr. Amory would agree with the Professor that a lower gilt-edged rate would be a great help to our present recovery when the stimulus of the hire- purchase de-control wears off, as he says it is bound to do perhaps before the end of the year.
Why then, has a lower rate not come? The Government's funding policy, carried to an excess last year, has been the main technical reason. The Departments, having recently had to buy the bulk of the short- to-medium dated stocks which the banks had perforce to sell when they increased their advances, are now busy disposing of these stocks by 'the tap' in the market. This is a bore and we must hope that the tender issue of Treasury bills will now increase rapidly enough to enable the banks them- selves to re-absorb these 'tap' sales. But, technical considerations apart, Professor Morgan attributes the high and rigid level of interest rates to a more deep-seated cause—the change in the relationship of public debt to private property caused by two world wars and the nationalisation programme of the Labour Government. In 1914 the market value of the public debt was only £500 million of which the Depart- ments held £200 million. Thus government securities in private hands were only 2i per cent. of the total value of private property— then estimated at about £12,000 million. In the 1920s the proportion had risen to about 25 per cent.: in 1955 it was about 45 per cent. The public debt was then nearly £28,000 million, the departmental holdings about £7,000 million and the total value of private property between £45,000 and £50,000 million.
Because world war and nationalisation caused the value of the public debt to rise by much more than the value of property as a whole, the ordinary operation of the law of supply and demand caused, accord- ing to the Professor, the yield on govern- ment securities to rise in relation to that on other types of asset. Here I cannot follow him. Certainly, when the volume of government debt is swollen rapidly the government credit rate in the market will fall unless the demand for its bonds is also swollen in like manner. But this did in fact happen—until the demand for equities began to reduce the demand for bonds. There was an increasing demand for the different types of government securities issued. For example, the banks and sterling depositors from overseas wanted more Treasury bills and 'shorts', the insurance companies wanted more medium-dated stocks and the small savers wanted more defence bonds, savings certificates and savings bank deposits—all because their money claims had increased. My point is that a rise in the rate of interest could have been avoided if the increase in the supply of government debt had been balanced by the general increase in the supply of bank money (deposits and cash) which the government in the long run can control. But under Labour the money supply was over-extended, so that the rate of interest was cut too low, while under the Tories since 1955 the money supply has been over- reduced, so that the rate of interest has been kept too high. Can we not have a better ordered financial system? If Mr. Amory believes in the 'equilibrium' rate of interest, why not try to get it by increasing the money supply today? Then I firmly believe we could bring the long-term rate down from over 5 per cent. to 4i per cent.
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