19 MARCH 1977, Page 15

In the City

Over-reacting

Nicholas Davenport

I have never been able to understand how economics could ever be divorced from PsYchology. Economically an incomes policy can be related to an anti-inflation policy but When a few toolmakers stubbornly refuse to listen to their big union chief and insist on throwing many thousands of their mates out of work it is surely a case for a doctorPsYchologist. Whenever some crazy fanatic With a grievance takes hostages and threatens to blow them all up with himself a Psychiatrist is immediately called in to talk to him and establish a normal human contact. A pyschiatrist should obviously be Called in to talk to the toolmakers. They are Probably intelligent men who fanatically believe that you cannot run a great motor factory if the skilled men get little more than the floor-cleaners and that British Leyland would be better managed if split up into its component parts—Rover, Jaguar, the Mini, the trucks etc. But when they are conor Mr Varley they naturally become demented and more stubborn than a mindless mule or camel:The only course now open is to call ,1n our great charmer—the prime minister. If he can establish a human rapport at one session with the extraordinary new US President he could reach an understanding with the toolmakers over a cup of tea. But to come back to the City where Bank rate has been cut from 12 to 11 per cent and Where there is great excitement in the gilte,dged market and a bull market in equities. I have been wondering whether a psychiatrist should not have been called in years ago to study the behaviour of the Governor of the Bank of England. Certainly it was necessary the Montagu Norman days. In 1972 the Bank went a little mad—whether it was clue to the shock of a Tory government I do not know—and issued a green paper called c C.0 (Competition and Credit Control) proclaiming liberty to the banks to lend and to 4,.equire deposits as they pleased, provided they maintained certain reserve assets. Bank rate was thereupon abolished. In future the average rate of interest at which three_Month Treasury bills were allotted in the Wkly tender—rounding it up to the nearest Ziarter„ Point or so—was to be called the Li‘ (Minimum Lending Rate). The Thursday Delphic oracle of Bank rate was

to be closed down for ever. Shades of Montagu Norman !

But the Bank of England has now realised that it is not so easy to control money market forces. (Look what happened after the great Barber money inflation—fringe banks collapsing and property companies going bust !) So when a month or so ago money was pouring into Treasury bills and threatening to pull down the rate of interest faster than the Government wanted, the Bank said that it reserved the right to keep MLR as it pleased, that is, not to reduce it by as much as the CCC market formula would call for. But last week it had to confess defeat: it had to bow to discount market realities. The average bill allotment rate was only 10.30 per cent. So it brought the MLR down a full point to 11 per cent. The clearing banks immediately cut their base lending rate by I per cent to 104 per cent and their rate on deposits by 14 per cent to 64 per cent. A cut in building society mortgage rates is at last in sight. Hence the bullishness in the City.

Nevertheless the Bank has let the market know that it has no intention of altering its policy, which is to moderate the pace of the decline in interest rates. It might as well say that it intends to moderate the decline of the setting sun. It is no good having a monetary policy which is not feasible or sensible. When a business economy is caught up in a bad recession as well as a bad inflation it is inevitable that money rates should come down, not only to reduce the inflation—for high money rates, like high taxation rates, are inflationary—but to encourage the businessman to take more risks and expand. This must be the key question for the summit economic conference in May when President

Carter comes to London to lend a hand to us all in Europe. So when the Bank says that it wants to moderate the pace of the fall in money rates it is taking up as dangerous a stance as King Canute on the seashore.

In fact, it is being said in the City that not only has the Bank been wrong in trying to slow down the fall in interest rates, it has also been wrong in over-restricting the growth of the money supply; in other words, it has been endangering the chances of economic recovery this year. I have many times called attention to the over-issue of 'tap' stocks in the gilt-edged market (to the non-bank public), which has the effect of reducing the money supply as well as slowing down the fall in the rate of interest. It is calculated that in the first ten months of the financial year the sterling M3 money supply has risen by under 8 per cent against the Chancellor's expectation—repeated to the IMF—of around 11 per cent for the whole of the financial year. If this calculation is correct, as I believe it is, it means that the Treasury's monetary policy has been far too restrictive. It has no doubt accentuated the fall in output and the rise in unemployment which we have suffered in the past twelve months.

In the financial year ending April the Bank of England has made 'tap' stock issues to the non-bank public of no less than £9,250 million of which £2,750 million went towards the redemption of maturing debt. This leaves a net total of £6,500 million in one financial year, which is unprecedented. No wonder the money supply for commercial and industrial needs were restricted. The issues of such gigantic amounts of 'tap' stocks, culminating in the fantastic £1,250 million of Treasury 134 per cent 1993 on 14 January and bringing the interest bill charge on the Exchequer to over £1,000 million for around fifteen years, were surely the mark of hysterical anxiety. Confronted with a run on sterling, the drain-away of the reserves, and the approach of the inquisitors from the IMF, the Bank over-reacted to their crisis just as the toolmakers of Leyland are overreacting to theirs. If only we had an economic doctor-psychiatrist on the national health service!

Within a matter of three months everything has changed for the better as far as the Bank is concerned. Sterling support loans have poured in, the reserves have risen to a record 37,787 million, sterling is strong, a 'safety net' has been provided for the 'official' holders of the sterling balances and the February trade figures actually produced a surplus on current account. Now the Bank is over-reacting again, trying to slow down the rise in the sterling exchange and the fall in interest rates. What our exporters want is not a cheaper pound but better industrial relations, improved productivity and firmer delivery dates.

Next week I must deal with the markets. The gilt-edged market has temporarily reached a top, but the equity market has broken through the magic 420 point which was its 1976 index top.