The financial crisis
Nicholas Davenport
If rumour does not lie, the reason why MLR (Bank rate) was raised a Whole point from 11 to 12 per cent on black Friday, October 3, was as follows: the Governor of the Bank telephoned to Blackpool to tell the Chancellor that after he had been thrown off the National Executive Committee of the Labour Party some Arab oil producers — a conservative lot as you may imagine — had begun to withdraw deposits from London. Presumably the Governor advised that Bank rate should be raised immediately to make sterling — looking very sick at a few cents over $2 — a more attractive currency to hold. The Chancellor, enraged by the insult he had received at the hands of the left, told the Governor to do What he thought right and teach "those damned crypto-communists" a lesson.
Whether there is any truth in this story I do not know. Certainly dearer money is an unpleasant Medicine for the left to swallow, for it is bound to add to industrial costs, deter investment , and increase unemployment. You don't as a rule raise Bank rate at the height of a depression. Something explosive must have happened during that week to cause the Governor — the mild Mr Gordon Richardson — to advise such drastic action. On Friday morning the City had been confident that Bank rate would not be raised for there were signs that American interest rates were 'peaking'. In fact, the gilt-edged market had actually staged a recovery. The Bank rate rise to 12 per cent was, therefore, a nasty shock and involved the investment institutions, who had supported the £600
Million long-dated — Treasury 1234 per cent 1992 at 941/2 — nursing a nasty loss at the present price of 8914. I have never known the market so furious and disgusted With the monetary mismanagement of Whitehall.
While I incline to the view that some special threat to sterling blew LIP on this blackest of Fridays, there are other rumours flying around. There is talk of the government being forced to ask for an IMF loan. It could expect up to $3,200 million being made available in various tranches but there would, of course, be 'strings' attached, such as a higher Bank rate and more severe cuts in government expenditure to bring down the budget deficit. This, indeed, would teach the left a real lesson — that our foreign creditors are not prepared to hold sterling if British socialists cannot balance their internal accounts. As for the external account, although the deficit on the balance of payments has been sharply reduced this year, the 10 per cent rise in oil prices will add to it some hundreds of millions. The official reserves are still being used to support sterling and are now down to $5,860 million — about $2,000 million below their peak in 1974.
What upsets the foreign holders of sterling is to see the perpetual rise in government expenditure, which now seems to be out of control. Figures of the Supply and Consolidated Fund services for the first six months of the current financial year show a rise in expenditure of no less than 47 per cent on the same period of 1974/75 while revenue rose 31 per cent. The total expenditure for the half-year was £16,893 million — an increase of E5,375 million. This included £1,400 million more for the local authority rate support grant (up 77 per cent), £740 million more for the health service (up 46 per cent), £570 million more for subsidies to industry, £450 million more for social security and welfare, and £510 million more for defence. In addition there was a further hand-out of £470 million to the nationalised industries for 'price restraint'. It is a terrifying 'rake's progress'.
Mr Healey has not formally revised his borrowing requirement for the public sector, which he had hoped to reduce from £10,200 million to £9,000 million, but it looks as if it will now rise to around £12,000 million. In spite of Mr Crosland, our Minister of the Environment, telling the local authorities that "the party is over", it seems that their spending spree has not yet got into its full swing.
Clearly the Treasury must have underestimated the additional cost of pay and allowances in an inflationary period. It must also have failed to allow properly for the additional administrative cost of the new socialism — enlarging the public sector and feeding it with an expensive bureaucracy. There is something morally indecent in setting up two expensive ex-tycoons — the Lords Ryder and Kearton — to run two new public corporations, not to mention the monstrous regiment of local clerks to control development land and building, when we are having to borrow abroad to maintain a standard of living we are not paying for with our work.
If we cannot finance the increase in the borrowing requirement by our savings — that is, by subscriptions to government bonds from the non-banking public — we are in danger of running into a very dangerous monetary inflation. We began the financial year well by subscribing over £2,000 million to government bonds but I hear in the market that there has been little or no new money going into government bonds in the last two months.Hencetheincreasingweekly issues of Treasury bills which seep into the banking system, enlarge the money supply and create the wherewithal of monetary inflation. In March the clearing banks' holding of Treasury bills was only £418 million. By August it had risen to £1,583 million and in September to £1,965 million. One would have expected the Bank of England to have siphoned off these extra resources by calling for more special deposits. Fortunately the demand for bank loans is extremely slack and this monetary inflation has so far not been exploited.
How is this pernicious rise in public expenditure to be brought under control? I fear I cannot support the root and branch ideas of George (Gladstone) Gale (Spectator, October 1I). To hand financial control to the House of Commons would be fatal. Parliamentary control of expenditure has always been a non-starter. Members are always under pressure from their constituents to spend more of the taxpayer's money. The Bank of England cannot operate independently of the Treasury unless we were back on the gold standard and the Governor was the guardian of our gold reserves (supposing we had enough!). The Treasury must retain control and devise stricter measures of control. Mr Healey assured us that he had invented a new system of "cash limits for public wage bills" but we have not yet seen it enforced. He has also said that he is cutting public expenditure by £1,000 million in real terms in 1976/77, but that is not nearly enough. Make it £2,000 million and then cut income tax by £1,000 million next April. That would be reflation without inflation.
In the meantime cut Bank rate by 2 per cent — the present foolish rise merely adds to the inflation — and if it is necessary to tempt foreigners to hold sterling then give them a higher rate by starting the two tier system of interest rates. (Separate the domestic rate from a higher one offered to foreigners through the "authorised depositary" banks.) Though, if an Arab depositor is really scared of Britain becoming Communist, I can't see why he would want to leave his money in London for an extra 2 per cent. It is political confidence he wants — as we all do.
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