in the City
The Duke of York's men
Tony Rudd
The most depressed part of the City these days is the gilt-edged market. The outlook for government stocks seems so much less hopeful than it did only a few months ago. The trouble stems directly from the Government's decision, underlined in Mr Nigel Lawson's recent speech, to soldier on this year with a much higher borrowing requirement than previously planned for in the medium term financial strategy. The struggle to keep it down and to cut government expenditure in real terms has been virtually abandoned. Clearly the view is that the recession is too deep to make a draconian policy acceptable. Although the burden of personal taxation will be increased in the Budget this March, the PSBR is still likely to stay above £10 billion for 1981-2 (compared with a target of £7.5 billion). From a Keynesian point of view and indeed in terms of the long-term damage which might be inflicted by further deflation, the policy makes sense. But the burden it is going to put on the market for government stocks is very considerable and that cost has yet to be calculated. Presumably the calculation in the Treasury is that as inflation is likely to fall during 1981 to single figures, at least by the end of the year, investors will find the existing Yields on government debt of around 141/4 per cent acceptable, if not attractive. That indeed should be true. And it is the reason why up until now the Government has managed to fund its borrowing requirement relatively successfully, considering the vast size of the operation which this has entailed. On the other hand it must be recognised that it is impossible to keep an army fed on hoPe alone; the soldiers must be provided With real victories. And for the past two Years there haven't really been any. It has from time to time looked as though victory Was around the corner. The troops in ccmsequence have been aroused to enthusiasm and indeed to feats of both bravery and endurance, but after each admirable tejfort they have been given, not victory, but ne promise of yet a new campaign. As it is, the process has gone on for a ,..a.nraculously longtime. We are now coming ;JP fo the second anniversary of the great soatPtie of Watling Street when the hordes of _aeculators were so large that the combined PaCity of the stairs and the lifts of the 211k of England New Issues Department cameinsufficient to carry all the eager paigners up to the third floor and to the al;aling counters. Recrimination was rife trou,_new and better arrangements were "•1/4'.c for the accommodation of future pn,c)rclies. The • e point is that those eager °••-atiernert of two years ago were under the impression that they were on to a good thing, in that the government stock being offered at the time would yield a good profit. So it did. But that was only because the buyers expected, in turn, to hold a profitable long-term investment. And their judgment, very correct in the sense that the market is still above the level of two years ago, was less correct in that the amounts of stock still being offered and likely MI be offered over the next six months are as vast as ever. This is where the law of supply and demand comes in. Never mind about the prospects for inflation. If the appetite for government stock is assuaged as regularly as it has been over the past two years, the eagerness of the buyer is bound to get blunted; the troops lose their enthusiasm. This is particularly so if the rate of increase of institutional cash flow is lower this year, as seems likely. Furthermore, they begin to detect that they are being used as cannon fodder. The colourful simile for the operation of the gilt market in these circumstances is that of the grand old Duke of York leading his troops up the hill then down again. What this means in practice is that before an intended funding by the Government the market in existing stocks is allowed to go soft, then when it has reached a point at which. with a little encouragement, buyers might enter, a new stock is offered at a bargain price. The troops have been led up the hill; at the top they're given their stock; then they're led down again triumphant. It is remarkable • how often this kind of pantomime can be repeated. It seems the troops have very short memories. Perhaps they've been programmed in a Pavlovian manner. But good things like this must come to an end eventually. And it is to be doubted how many more times the trick can be repeated.
Paradoxically there will be a retreat one day. Eventually the Government's borrowing requirement will abate. When the country comes out of its current recession the revenue will become more buoyant and many of the demands upon it will also fall as, for instance, unemployment falls. All the while, oil revenues are rising and the contribution from these will make an increasing impact on the borrowing fequirement. Finally, as inflation falls to single figures the attraction of government stock at the present yields is bound to overcome their current disappointments. It is like a campaign that has gone on too long. The troops, weary of promises and sceptical of victory, are wavering in their regard for their leaders. They are all too ready to leave the field at just the moment when the real victory is within their reach. That is why the risk which the Government is running during 1981 because of its relatively high borrowing requirement has such serious implications. In the very short term, over the next few months and particularly leading up to Sir Geoffrey Howe's next budget, the Government could run into a buyers' strike in the gilt market. Mr Nigel Lawson in his speech last week referred to the possibility of new methods of funding. He didn't enlarge on this. But such an initiative may well be timely. This year should see a substantial decline in inflation, which after all is the prize for which we have all been working and suffering. It would be unfortunate if the time when this is finally delivered should also produce chaotic conditions in the gilt-edged market. If this is to be avoided the authorities must have recourse to better technical arrangements than the deployment of the thoroughly demoralised body of men led by the grand old Duke of York.
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