THE ECONOMY
St Christopher upon the dashboard
JOCK BRUCE-GARDYNE
Mr Heath, we learn, reckons that 'the way to get sterling further .down is to go into the European Monetary System'. Now all sorts of remarkable fruits are, according to the devotees of the Euro-currency club, waiting for us to garner if only we would sign on for membership: both stable and cheaper interest rates, for example. But this is the first time we have been told that the way to depreciate the pound is to join a system of theoretically fixed exchange rates. However it has to be remembered that Mr Heath took us into the 'snake' (as it was then called) when he was running the shop — and took us out again when he found the rules meant what they said.
The worries of the money markets are almost precisely the reverse. How is a fellow to make an honest penny, they ask, when there is no knowing whether the Bank of England is going to resume its bargain sale of pounds, or interest rates are going to be cut, at 3 marks 10 pfennigs for the pound, or 3.15, or 3.20, or this year, next year, sometime, never? It is all very fine for the Chancellor to insist that when it comes to the exchange rate, 'actions speak louder than words': when you have to try to earn a crust in the foreign exchange markets, actions without words are liable to snatch it away from you. Now for some of us the one-way option offered to the money-changers nas been one of the less attractive aspects of playing Echo to the deutschmark. Still, it has to be conceded that the official line on last week's cut in interest rates did leave something to be desired. While 'arith- metical precision is impossible' in these matters, a three per cent rise in the value of the pound against the D-mark is worth half a point off interest rates. Is it, indeed? Tell that to the banks and the building societies. But is it not logical, if prosaic, to see that the decision to let the pound rise in the week before the Budget was no more than a tactical expedient to avoid having to change interest rates just before the Chan- cellor's appearance, after which we are back to normal. 'Normal' being the rough rule of thumb according to which if the pound is in demand abroad, then credit is cheapened at home.
So let us get back to basics. Now that we have had time to digest Mr Lawson's hospitality, the consensus seems to be that `balance budgeting' is the new guiding light.
We might be wise to take it with a pinch of salt. for quite apart from the fact that his actual target for the year ahead (allow- • ing for privatisation proceeds, admittedly) is a 'Public Sector Debt Repayment', it is surely worth recalling that it was only twelve months ago that he told us his aim for future years was to restrict the Budget deficit to one per cent of national output. Truth to tell — and not withstanding his authorship of the Medium Term Financial Strategy when all the world was young Nigel Lawson is not a target man at all.
What we are left with, therefore, is an inclination at any rate in the Treasury, to keep the exchange rate more or less steady, coupled with a disinclination to lose sleep over the credit boom. We must take such comfort as we may from last month's contraction in the rate of growth in borrowing from the banks. It is of limited reassurance, since the building societies seem to be taking up the running instead. Admittedly the Budget took a couple of swipes at credit advances for housing finance, with the withdrawal of mortgage interest relief from home im- provements, and the limitation of relief to one £30,000 per house. But the immediate effect of these restrictions is going to be perverse, because they do not take effect until August. Hence the purveyors of house improvement loans, and of loans to live-in boy and girlfriends (if not necessari- ly — at least to the same extent — the builders) are going to be working round the clock meantime. The next few months are thus unlikely to produce much evi- dence that the credit boom is cooling of its own accord.
Then there is another side effect of the Budget which should not be overlooked. According to the Inland Revenue's calcula- tions the net effect of the radical recasting of Capital Gains Tax on the Chancellor's receipts is no more than marginal (an extra £70 million, all from charging future capital gains at income tax rates. But the impact on the preferences of individual investors could logically be expected to be more substantial. For the first time for many years a guaranteed income, after tax at 40 per cent, from a high yielding gilt, is going to look rather alluring by comparison with a low-yielding equity investment on which true gains, after allowing for inflation (and after the first £5,000 per annum), will likewise be taxed at 40 per cent, always supposing that they materialise. In other words it would not be surprising if there were to be some sizeable switching into gilts — not least of equity holdings accumulated between 1965 and 1982, which have hitherto been 'locked in' by capital gains tax liability. When on top of that our good friend the government brok- er will only be in business to replace existing gilts as they mature, and maybe also to offset the effects of Bank of England exchange rate intervention if that is to be allowed, (and he is allowed to `sterilise' it) it looks as though the demand for gilts could comfortably exceed supply. And that in turn suggests that the down- ward pressure on interest rates may not only come from a desire to prevent the exchange rate going over the top. Finally there is that coy little message in the 'Red Book' about the Chancellor's favourite monetary speedometer, 'Little MO': 'MO growth . . . may move to the top of, or outside, its 1-5 per cent target in the early part of the financial year before coming back within it.' So far as I recall there has in fact been but one occasion to date when interest rates were ostensibly adjusted in response to Little MO's per- formance, and that was when the Chancel- lor caught the markets nicely on the hop last autumn. But the message now is clear: if 'Little MO' starts playing up, then, like her broader grown-up brothers in the days when they were supposed to count, she will be studiously ignored. Some years ago you could — or so I was told — buy a special St Christopher medal- lion in the States to stick upon your dashboard. When your road speed passed 70 mph it was programmed to bark out, `You're on your own now, brother'.
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