Floating to reality
Nicholas Davenport
To whom credit is due for the brilliant stroke of floating the £ last Friday morning before we had woken up I do not know. Certainly not to the Bank of England whose Governor is said to have urged a wage freeze. Perhaps to St Anthony Barber who, have dropped a financial brick, may have thought that this was the best way to pick it up. But most probably to the Prime Minister whose capacity for taking bold decisions has now been proved for the third time.
I will deal first with the bricks. It was an enormous brick for a Chancellor to drop in his budget speech when he said it is neither necessary nor desirable to distort domestic economies to an unacceptable extent in order to maintain unrealistic exchange rates. Certainly in the modern world I do not believe that there is any need for this country or any other to be frustrated on this score in its determination to sustain economic growth and to reduce unemployment.
Of course he was dead right. I remember commenting — in commendation at the time — that this was the first time a Tory Chancellor had disassociated himself from the traditional policy of the moneyed ruling clique which had governed Britain since 1689, which was to give the £ sterling priority over employment at home. (This was the anti-socialist policy which Mr Wilson so idiotically pursued, destroying himself and his party in so doing). But although a truth is a truth is a truth it must not always be blurted out on awkward occasions. Coming in the budget speech every banker and business man abroad assumed that sooner or later the £ would be devalued again — sooner rather than later if the huge balance of payments surplus began to run off too quickly. The speed-up in the British wage-cost inflation, following on the costly miners' and the railwaymen's settlements, and the worsening of industrial relations between unions and Government, convinced the foreigner that the £ would soon be in danger.
Personally I was surprised at the speed of the panic. I returned home from a holiday to find everyone talking of crisis and devaluation, led, as is fitting, by 'the editorial columns of The Spectator, although it made me wince to read that devaluation, which immediately puts up the price of imports, was hailed as disinflationary! The reserves were still, precrisis, at the level of £2,700 millions.
The balance of payments in the first quarter was still in credit by £30 million on current trading account — thanks to the strong ' invisible ' account of £148 million, and there is little doubt that we kept a small trading surplus in the second quarter. What has changed, of course, is the inflow and outflow of capital. The inflow has run down and the outflow has run up.
Indeed £350 million went out for private investment overseas in the first quarter mainly due to portfolio investment in Europe financed by foreign currency borrowing. Towards the end of the second quarter the capital movements worsened and the more speculative hot money flowed out on a big scale. As we had recently subscribed to the EEC agreement to keep dealing margins within 21 per cent of parities, the European central banks had to support sterling and according to official reports from Brussels they spent the equivalent of $2,600 million in support of the £ in the past fortnight.
The other great brick which Mr Barber dropped was to agree to a $2.60 rate for sterling at the Smithsonian agreement last December when the new parities were fixed after the floating of the dollar. I said at the time that it was too high a rate for the comfort of our export trade. If it had been held when we entered the Common Market, the Germans, tht French and the Italians would have knocked our exports for six and pushed us out of the bulk of European trade. It is therefore absurd of the Chancellor to maintain that $2.60 is still a realistic rate. As a result of the rise in our prices and wages the competitive position of British export goods relative to those of other countries is probably back to where it was in 1967 before the devaluation.
The Chancellor declares that the floating of the £ is purely a temporary affair and that we shall return to a fixed parity as soon as market conditions permit. It is to be hoped that the floating will go on not only until January, when we officially join the Common Market, but for a sufficient period thereafter to determine how sterling will react to the extra costs we must incur on joining and to the worsening industrial relations we must expect if the unions persist in their jingoistic opposition to partnership with foreign labour. As I write the £ has dropped to around $2.50. Most people expect it to move towards '2.40 but a further labour crisis could drive it well below that figure.
The Government has wisely extended exchange control to the sterling area where funk money could quickly flow, as it did to Australia when Mr Wilson took office. But to look on the brighter side of this monetary crisis there is no reason why a period of ' clean ' floating for the £ should not help our export trade and our whole economy. There are signs that the economy is on an upward tack despite the harmful effects of the strikes. Unemployment is falling; unfilled vacancies are slowly beginning to enlarge; raw material imports are rising; industrial production is edging upwards, even in steel; private housing starts are still moving up and retail sales of consumer goods are broadening out, as the figures of paper and board consumption show.
All these encouraging signs do not stem from the 1972 budget, for its taxation reliefs only came into effect in May, but point to the fact that in spite of the non-cooperation of labour the massive spending of the • Heathian regime, which puts employment before exchange parities, is beginning to take effect. It will be speeded up if the TUC and the CBI agree upon some form of wage-price restraint and take the running away from the militant Marxist shopstewards.
The Stock Exchange responded gaily at first to the good floating news but fell flat on its face this week. The bull market is having a good shake-out--from 10 to 15 per cent — but provided Mr Heath continues to walk the tightrope of power it may recover its equilibrium before long. cent — but provided Mr Heath continues to walk the tightrope of power it may recover its equilibrium before long.
The gilt-edged market fell to yields of over 9i per cent in the ' longs ' and in the ' shorts ' you can secure running yields of nearly 7 per cent and gross redemption yields of over 8i per cent. This seems ridiculous seeing that a floating exchange removes or relieves the pressures which might drive interest rates upwards. Rumour has it that some form of control will be restored over bank lending. Not before it is time, for the outpouring of bank loans in the private sector has driven up the prices of houses and equity shares. The restoration of control would allow the bank lending rate, now 5 per cent, to come down and bank rate too, so don't sell the giltedged market.
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