Why the pound is sliding
Jock Bruce-Gardyne
To one, at least, of the main actors in the last sterling debacle, there must be an awful feeling of deg, vu. More than eight years have passed since Mr Callaghan last shook the dust of economic management off his shoes in the aftermath of devaluation. And no sooner does he return to the front line than the pound once more disappears from view. It is not necessary to hold a personal brief for Mr Callaghan, whether as Prime Minister or formerly as Chancellor, to feel a twinge of sympathy for him in his predicament. The folly of the present Chancellor's last exercise in budget judgment has been exposed even more swiftly than usual for Mr Healey. Yet it is difficult to escape the conclusion that a substantial share of the blame should be laid at the door of official opinion at the Treasury and the Bank of England.
Both bodies have been very stern about the verdict of the exchange markets on Mr Healey's budget. The massive world-wide sale of sterling has been 'unjustified'. Have not the latest trade returns—allowing for all the exceptional factors—amply demonstrated that the balance of payments is coming dramatically right: that there are good times just around the corner?
If we were still living in the old unregenerate days before floating currencies had been identified as the key to eternal growth the answer to this question might well be yes. For in those days pressure on a currency fairly closely reflected the movement of the monthly trade returns. If the relationship between imports and exports appeared to be moving in the right direction, then the gentlemen of-Zurich were likely to come to the conclusion that the Government would have little difficulty in defending the exchange rate over the time-scale that mattered, and made their dispositions accordingly.
Now that the era of the floating currency has arrived, the rules of the game have changed. Exchange rates have become much more akin to a market in securities, with the dealers constantly trying to anticipate the probable course of relationships between different currencies in the knowledge that governments neither can nor will defend a particular rate with very much or for very long. So the decisive consideration is the relative rate of domestic inflation in different countries: a country which has a higher rate of domestic inflation than its competitors will certainly experience a swifter depreciation in its parity over time. Nor is an improving trade balance any comfort, for rising demand will stoke up inflation whether it comes from domestic consumption or from exports. It is this which makes the response of the international fraternity to Mr Healey's latest budget so much more logical than the Treasury is prepared to concede (or even, alas, privately to understand). For it marked a signal victory for the most obscurantist elements at the Treasury and the Bank of England: those who believe, in spite of all past disappointments, that the only way to curb inflation is by the administrative control of wages and prices.
It took the knights of Great George Street and Threadneedle Street a long struggle to bring Chancellor Healey round to their viewpoint. As Shadow Chancellor in 1973 he had given an impression of genuine outrage at the scale of deficit financing and 'monetary incontinence' then prevailing; and in his own first budget in March 1.974 all the emphasis was on the provision of what he called 'the framework of fiscal and monetary policy within which price controls and incomes policy can operate effectively'. Indeed he laid so much emphasis on the need to shrink the budget deficit that the Treasury's critic-in-waiting, Mr Wynne Godley, forecast a slump to make the hair curl.
Neither the Treasury nor the Bank believed a word of it. They reckoned it was a question of gritting the teeth until their new masters, like the previous ones, had swallowed pride and prejudice and instituted incomes control. In the event the budget deficit did not shrink—it grew enormously; but for largely fortuitous reasons the money supply lagged well behind the accelerating rate of inflation.
Then, just as the inflation rate had begun to turn at last, the Chancellor was brought, with the aid of a well-contrived run on the pound and a stern wigging from the Governor of the Bank, to see the error of his ways. Mr Jack Jones was trundled in with his £6 limit. Nine months later, Mr Healey's conversion is apparently complete. It is epitomised in two remarkable statements in the latest budget speech.
'It remains,' Mr Healey told us, 'my aim that the growth of the money supply should not be allowed to fuel inflation as it did under my predecessor. To this end I aim to see that the growth of the money supply is consistent with my plums jor the growth of demand e.vpressed at constant prices.' This was more or less word-for-word the formula used by Chancellor Barber in the 1972 budget statement, immediately preceding the hitherto unprecedented monetary explosion which occurred that year. And this was capped by the assurance that it was 'well worth while accepting some increase in the public sector borrowing requirement in order to achieve a lower rate of inflation.' As budget slogans go this was just about on a par with the present Prime Minister's 'steady as she goes' six months before the 1967 devaluation.
So with monetary policy safely consigned once more to the pigeon-hole where Treasury and Bank believe it should be kept, and hicomes policy once more enthroned, the path was clear for the announcement of the objective of a 3 per cent ceiling on wage increases. It is all rather ironic. For the past six years—ever since we last escaped from the supervision of our international creditors—the Treasury has furiously resisted all requests for the publication of specific annual targets for money supply growth Arid domestic credit expansion, partly because It does not believe in such things anyway.
What happens now ? There is still no reason to doubt that the rate of domestic inflation will continue to decline for several more months as a result of the way in which monetary growth lagged behind inflation in 1974 and 1975. Whether the Chancellor's objective of single-figure inflation by the end of the year will be met is another matter —judging by his own latest pronouncements Mr Healey himself shares the scepticism. But if—as most indicators suggest— the economy is now beginning to expand again, the money supply will soon start shooting ahead as personal and corporate savings no longer mop up the huge budget deficit. And if that happens the Chancellor tells us he would be ready to use 'the appropriate mix of policies—not necessarily mone: tary policy alone—to redress the situation.
If we had any doubts about the meaning of that particular delphic utterance we had only to turn to the Jimmy Young Show. This was the appropriate environment chosen by the Chancellor to spell it out. 'I warned people in November 1074', he reminded Mr Young, 'that if the Social Contract was broken I would increase taxes 10 the next budget and that is what I have to do'. In reality he has already committed himself in advance to cuts in tax rates. In return for pledges from the unions which will not be forthcoming and would not he honoured if they were, but let that pass. The important point is that if the growth of the money supply starts once more to 'fuel inflation' there is only one way to bring !t back on course in the short term, and that Is by allowing interest rates to rise to the point at which people will be prepared once more to buy the Government's paper. Dem' Healey has made it clear that this is the one thing he is determined to avoid: that while a temporary increase in the minimum lending, rate may be forced upon him by externa! pressures (as it has been), an unexpected acceleration in the money supply is to he met by higher taxation and/or cuts in public spending which, however essential they are as a medium-term strategy, can only 1111,, pinge on the course of the money suPP" with a considerable timelag. So the future is all too painfully predict: able and familiar. As it becomes apParer"
that the stage is being set for an advance into hyper-inflation in 1977-8 the foreign exchange markets are giving the appropriate response, thereby accelerating the denouement. This will leave the Government with two possible courses of action. The first would be the retreat to the siege economy, complete with quantitative restrictions on all the goods which British Leyland and other gems in Lord Ryder's crown would be producing if they were not on strike. Left to their own devices that is the course which Mr Healey and his successorelect, Mr Crosland, could be relied upon to Choose.
Fortunately, though, they will not be left to their own devices. Those who clamour for import controls argue that we are now too insignificant as trading partners to provoke retaliation. The reverse is true. Ten Years ago the British economy was still sufficiently important to be worth preserving. Now, if we are determined to commit economic suicide (and that is how a reversion to the siege economy would be correctly interpreted overseas) our trading partners would shrug their shoulders and let us go. But they would be determined to make sure that nobody else was tempted to follow our example. And so they would respond in kind with the utmost rigour against our exports.
So in the end the path of virtue is likely to impose itself. The IMF will once more come to our rescue. No doubt it will have to take the knights of Great George Street (and Threadneedle Street as well, one hopes) off for a refresher course to explain that money really does matter after all, just as it did in 1968. Once more Treasury and Bank will be Obliged to set public targets for domestic credit expansion and money supply growth, With the IMF to monitor their achievement once a quarter. Public expenditure will have to be brought under control at last, and there will have to be a rapid return to balanced budgeting. It will not be comfortable: indeed for many in Whitehall and the Mini-Whitehalls up and down the country 'twill be very uncomfortable indeed. But it Will work.
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