27 JULY 1974, Page 25

ECONOMICS AND THE CITY

The hidden banking crisis

Nicholas Davenport

One of these days, while ignorant politicians at Westminster are devising new schemes for nationalising the most efficient private enterprise, like oil, and putting workers on company boards to make it impossible to arrive at sound profitable decisions, the Whole financial system of the industrial West will blow up in their faces. It worked fairly well when it was under some form of monetary discipline and control; it has been working very unsteadily since the formal convertibility of the dollar into gold was abandoned in August 1971 and much more so since all currencies began to float against the devalued dollar in March 1973.

It will have been observed that several large banks have recently Made heavy losses in foreign exchange dealings under these new Conditions — for example, the Franklin National Bank of New York, Westdeutsche Landesbank and the Unioh Bank of Switzerland — and now the Herstatt Bank of Germany has gone crashing down for about £80 million or more. The crash unfortunately involved Hill Samuel in a loss of £91/2 million because it could not collect the dollars against the German marks it had delivered before the doors were closed by the liquidator. Speculation in gold is said to have added to Herstatt losses, for eleven tons of it had to be sold in a hurry. Corning after the loss of £131 — on bad credits — by the Hessische Landesbank this new collapse caused the greatest gloom among German and Swiss bankers. Several private banks on the Continent have since had to be helped by the authorities because of sudden withdrawals by depositors. We are all aware of the large number of 'fringe' or phoney banks which have had to be Propped up in London by the clearing banks and the Bank of England. Their failures caused a crisis in the affairs of two large building companies — Bovis and Northern Development — and one of them, Bovis, had to be taken over by P. & 0. Bad money from the 'fringe' bank sector is said to have run into £1,000 million or more.

Nervousness about the banking System grew after the collapse of the property boom in the last half of 1973. It has not been relieved by the terrifying.mountain of money still Riling up in the uncontrolled Eurodollar market. This market has

grown from $9,000 million in 1963 to $170,000 million by the end of 1973. The eminent M. Jacques Rueff pleaded for the international control of this market in a cogent arti

cle in the Times of July 8. In his

Opinion it is the root cause of the present wave of inflation in the western world and embodies all the worst aspects of the defunct gold exchange standard. The primary cause of inflation is, of course, the aggressive spending of nation states through budget deficits and the payment of incomes (wages and salaries) in excess of the value of the national product, but M. Rueff is correct in saying that the Eurodollar market facilitates this inflation when its deposits can be so easily and quickly tapped to finance spending schemes in any country of the western world. These dollar deposits were built up when the US was running huge deficits on its balance of payments, that is, when foreigners were being paid for their goods and services in dollars in overseas American banks. These immense funds are now the source of monetary creation as bountiful as the old golddollar exchange standard. "The faculty of monetary creation attached to them," says M. Rueff, "is rarely understood" (how right he is!) . . . "In almost all western countries the restoration of monetary order requires the drying up of the inexhaustible source of money made available by the development of Euro-currencies. Let it be dried up and budgetary equilibrium will be granted in full measure." M. Rueff is surely too optimistic about the latter. He may be right in France, where the new President (a money expert) is imposing a deflationary policy, but not in the UK where a socialist-mad government is intent on adding to its huge budget deficit by widespread nationalisation schemes, including North Sea oil.

M. Rueff did not advocate — somewhat surprisingly — a return to the discipline of a gold standard but urged that an expert committee be set up to draft an international agreement for the control of the Euro-dollar market, the basis of which should be that the opening of lines of credit in foreign currency to non-residents be submitted to the same costs and regulations and the same fiscal burdens as credits in the national currency. What he might have mentioned was that the

problem of control has been immensely complicated by the monetary confusion caused by the Arab countries and Iran who have quadrupled the price of their oil. The increase in the bills falling on the oil importers between 1973 and 1974 will be around $65,000 million. The Arab states can use up only a tiny fraction of this amount by increasing their imports — Iran can do more because the Shah is bent on industrialising his country and making it militarily the superpower of the Middle East — so that we shall see immense paper transactions in the monetary world, billions of dollars credited to the oil exporters and billions of dollars debited to the oil importers in the books of the central banks.

It was hoped that the opulent Arabs would start investing in the debtor countries. Abu Dhabi has, in fact, made a start by paying E36 million in cash for a 44 per cent stake in the Commercial Union Assurance head office building in the City of London. This is the first big investment by an Arab state in the British property market. The Kuwait Investment Board, an old established institution, has always invested to a modest extent in the equity shares of leading British industrial companies. It is thought that it may be renewing this investment policy now that many leading British equities can be bought on a. price-earnings ratio as low as 8 and even below. It is a pity that the Shah does not follow the Kuwait lead and set up an investment board in Britain. Alas! he has done it in Germany. He has bought over 25 per cent of the steel-making subsidiary of the

Krupp group. The Iranians and Krupp are to set up a joint invest ment company in Zurich, the Ger mans supplying the technical know-how and the Shah the cash.

Mr Barber, who rushed over to see the Shah in January in company with Herr Helmut Schmidt, appears to have been snubbed. Or could Britain not deliver the goods?

Arab investment in the oil importing countries with such a tiny beginning will not solve the major monetary imbalance created by the quadrupling of the price of oil. The bulk of the Arab billions will be placed on deposit in the world's financial centres — London has already seen a big influx — and the rest will spill over into the Eurodollar market. This will add to the inflation-potential of this market and drive poor M. Rueff into fresh alarm, if not despondency. Strangely enough, this will not help to solve the hidden banking crisis. The Arab finance ministers will play for safety and place their major deposits in the surplus countries US and Germany — who will be forced by their fear of inflation to take extra deflationary measures to the detriment of the British export trade. The managers of the Eurodollar funds will in the end be taking bigger credit risks and if only one credit line collapses the failure of a Euro-dollar house would have immense repercussions in the world's financial markets.

My impression is that the imba lance set up by the Arab billions is getting worse because the Western governments are pursuing different and conflicting financial policies. It is a mad financial world becoming madder.