MONEY & THE CITY
The Bank's dubious manoeuvre
Nicholas Davenport
The Bank of England now seems to be acting independently of the Government on City matters. Its timing seems to bear no relationship to the timetable of the Cabinet. For example, it recently relaxed the rules on outside bank participations in merchant banks as from January 1, the date of our entry into the EEC, regardless of the fact that our new populist Minister of Trade and Industry, Mr Peter Walker, is about to promulgate new rules regarding monopolies and mergers and the behaviour of merchant banks. (This was commented on in my last paragraph last week which was unfortunately omitted). Now the Bank has done it again. Last Friday it announced a £600 million new tap issue bearing the unprecedented coupon of 9/ per cent at 97/ to yield 9.77 per cent to gross redemption in 1999 — regardless of the fact that the Prime Minister was about to give the details of his Phase 2 proposals this week and answer questions perhaps as to why moneylenders are not subject to the squeeze.
I know that the Chancellor has made vague remarks about dearer money being necessary to control the money supply but every economist outside the Treasury and the Bank of England is well aware that there are other and better ways of controlling the money supply, such as calling for special deposits from the clearing banks, which has at last been done, and restricting the volume of the hire purchase debt. And most economists will agree with me and Sir Roy Harrod who said in his fine contribution in Bretton Woods Revisited that "high interest rates are inflationary."
What makes the Bank's issue of a new and expensive 'long tap' so obtuse and unnecessary is that the gilt-edged market was just beginning to recover its confidence in Mr Heath and start moving up. It had been impressed by the fact that the freeze had worked reasonably well and had not provoked the unions to disobey the law. It was therefore expecting Mr Heath to carry through statutory controls for Phase 2 and bring the inflation down to a more tolerable level. This return of confidence would have enabled the Treasury to sell up to, say, £500 million of stock to the non-banking public and so reduce the money supply. Of course, the rise would have lowered the rate of interest by, perhaps, 2 per cent but that would have been all to the good for industrial borrowers who have to pay the highest rates.
As it is, the new tap has upset the market and knocked the ' longs' down by about Ili per cent, so that the Treasury 7i per cent 2012/15 is now yielding close on 9.9 per cent to gross redemption. This, in cidentally, has caused the disgruntled professionals, who despair of a rational gilt-edged, policy, to switch into the medium-dated Treasury 7i per cent 1985/88 at 861 to yield 9.4 per cent to gross redemption. Myself, I prefer, while this lunacy about dearer money lasts, to remain " short " with Transport 4 per cent 1972/77 at just under 84 to yield 8 per cent to gross redemption in five years' time. It .; a gift for pri vate family fu ;.
It was a • madness to undermine d confidence of investors in government bonds at a time when they are trying not to be too upset over the bad trade returns for December. In this month there was a deficit on visible trade of £93 million and as the surplus on ' invisibles ' remained at £55 million the monthly current account on the balance of payments was in debit — £38. million—for the first time since 1968. For 1972 as a whole we have seen a £1,000 million trading surplus virtually disappear. The year ended with a deficit of around £40 million against a surplus of £1,040 million in 1971.
Various alarmist estimates have been made of the coming deficit in 1973 — £220 million by the OECD, £300 million by the National Institute of Economic and Social Research and finally £1,000 million by Messrs Godley and Cripps of the Cambridge Department of Applied Economics. The reason why the last estimate is so high is that the authors believe that a sustained 5 per cent growth rate will suck in an alarming amount of imports. Last year the value of imports was 16 per cent higher than in 1971 while the value.of exports was only 4 per cent higher. For 1973 the Cambridge economists estimate a rise in the value of imports of at least 15 per cent and for this reason they think that the Government should begin to restrain credit by hire purchase restrictions in order to cut the demand for durable goods — motor cars etc — which are a major element in the imports of manufactures.
I think the Cambridge alarm is overdone. They seem to assume that either labour or plant capacity at home will be insufficient to meet the demand. Clearly with 3.2 per cent of the labour force unemployed — some 728,000 at the end of December — there is no labour shortage. It will be 1975 before labour bottlenecks return assuming a still growing economy. And there can hardly be a plant shortage in sight if industrialists are still reluctant to invest in new plant and equipment because of their present surplus capacity. If the trade figures are analysed over the months it will be found that there were 'exceptional' imports to be taken into account in both 1971 and 1972. The biggest rise came from the EEC and there are surely grounds for expecting that with our entry into the Common Market on January 1 our trade with the Continent will be better balanced. Finally the Cambridge pessimists ignore the capital side of the balance of payments. A deficit on trading account can be offset by a surplus on capital investment account. And at the moment we have a floating exchange to keep the balance.
This brings me to the most serious part of the Bank's independent and damaging action in offering the new 'long tap.' It is raising the rate of interest in order to attract more foreign money to London which is already offering the highest money rates of any financial centre in the world. Industrial borrowers now have to paY over 11 per cent for loans which they can raise on the Continent at 71 per cent in the Eurobond Market. Presumably the Bank wants dearer money to prop UP the floating £ and accede to M. Pompidou's request for an early fixation of the sterling rate. But why should it try to please M. Pompidou if it is in the national interest to allow sterling to fall to a low enough rate to curb the flow of imports and speed the flow of exports?
It might be thought that Mr Heath connived at the Bank's action in order to stop any further rise in the prices of imported food and raW materials through a falling C. But I do not believe that Mr Heath would stoop to any such form of deceit. He is approaching the most critical stage of his administration. He has got to win over a majority of the trade unions to his Phase 2 statutorY control of prices and incomes and he can only do so on the basis of absolute honesty and reality.
To allow prices to rise to meet the increased cost of imported food and raw materials after he has secured an agreement with labour would be to destroy his credibility. He has to disclose to Mr Vic Feather his exchange and monetary policy here and now and the Bank must not intervene.
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