In the City
Up and away
Tony Rudd
This is the first time since the war that people in the City have been making very considerable sums indeed while those in industry and commerce have either been losing it or at best hanging on by their eyebrows. The contrast is not a healthy one and, if it persists, could lead to a re-run of the Gordon riots or their modern equivalent (whatever that is). The issue which divide• economists today is whether the cir- cumstances which have led to the euphoric rise in gilt-edged prices in London and bond prices in America are the precursor of a widening spread of prosperity which will embrace industry and commerce or whether these market moves are merely the symp- tom of an economic collapse which is going to grow a great deal worse before it gets bet- ter.
Governments on both sides of the Atlan- tic would argue that the first proposition is the correct one, that falling interest rates will make it possible for industry to re- expand, for capital expenditure to start growing again and, by making savings less attractive, will lead the consumer to start consuming in great quantities once more. Businessmen who are out in the field would argue the contrary, that interest rates are only falling because nobody wants to bor- row, which in turn is due to the fact that few industrialists can see demand increas- ing. If they can't see the orders ahead they are not going to build new plant and take a risk. Thus they no longer knock on the doors of their banks trying to borrow more nor do they try to raise new money from the markets. This leaves the supply of savings looking for a diminishing number of outlets, a situation which in turn means that the existing stocks are bid up in price and the yields fall.
Most market operators in equities would be hard pushed to answer in which camp they really found themselves. They may not believe whole-heartedly in industrial recovery being the necessary corollary of falling interest rates; on the other hand, if there is just a chance of an amelioration of the situation they can't afford to be left out of the rally in stock prices. Fund managers earn their living not by being right but by avoiding being left in a minority which is clearly wrong. Their protection is derived from being in the majority. If everybody is wrong-footed they can't be blamed, but if an individual fund manager gets it wrong, against the trend, then he loses his job. This is why when an unexpected rally develops in a market, as it has done on several recent dramatic days on Wall Street, the herd rush in. No manager can afford to be rung up the next day by one of his non-executive trustees and have to say `no' if he is asked whether his fund is fully invested and par- ticipating in the recovery. The answer has to be 'yes'. And if, when he takes the call, he isn't fully invested, he will temporise, and ring back an hour later having got in. That's what a stampede is about. The situa- tion was well exemplified by Adam Smith (the modern one, that is) who in The Money Game had a character called `Poor Greville'. This unfortunate fund manager had missed getting in on a big rise and had to be helped by his friends to get into the market before it was too late; this, of course, meant buying a whole lot of rubbish
at unsustainable prices. Never mind; he was able to answer his trustees.
The point is that fund managers can't really afford to hang around answering what they think is a theoretical question as between the monetarist and Keynesian views of life. They need to be in the centre of the herd. This propensity increases everybody's short-term risks immensely. It means that only the very skilled or those willing to operate in the futures markets can afford to dabble in short-term positions. At present, for instance, it is really only safe to bet on the one aspect, namely that interest rates are definitely coming down and that bond prices are going up. The outlook for equities is really anybody's guess.
The problem is made worse by the fact that if the more hopeful view turns out to be correct and lower interest rates do even- tually stimulate industry, the equation bet- ween the supply and demand for loanable funds will be altered once more with de- mand rising. That is bound to put an end to the fall in interest rates. It might even put an end to the fall in inflation, at least tem- porarily. It is being argued, for instance by Dr Boekh of the Bank Credit Analyst, that the underlying tendency towards inflation will take years to get out of the system and that, as a result, there will be many false starts and many disappointments before we have finally got out of the economic system all the distortions brought about by three decades of inflation. In other words, it is far too early to be throwing one's hat in the air.
In the meantime by far the most hopeful event has been the 180 degree U-turn per- formed by President Reagan, who has replaced his tax-cutting programme with a tax-raising one. The sheer aplomb with which he announced this utter reversal in Reaganomics was breath-taking; it was as though John Wayne had been telling the US Cavalry to be nice to the Indians. Most peo- ple knew that the change had to come, but wondered if the President would be able to encompass it. The fact that he was able to do it so adroitly must have had a great deal to do with the subsequent change of heart on Wall Street. For at one stroke the nightmare of eternally rising budget deficits with their attendant financing problems was removed.
The President's act was probably the result of a compact with the Federal Reserve System. The Fed has been easing its policy for some weeks now. The authorities have been supplying more funds to the market and this in turn has cheered everybody up. But they would not have agreed to this extremely important switch from a hard line to an easy one without a vital quid pro quo. President Reagan's U-turn indicates that this was the Fed's price for their cooperation. The bargain was: we will ease money if you tighten up on the budget. It was as simple as that.
But going back to the argument whether all this portends better times for industry, the fact that the key element in the equation which has so cheered up the markets was a switch to a tighter budgetary policy in the US cannot be regarded as exactly encourag- ing. In Keynesian terms, at this point in the business cycle what is needed is an injection of demand, not a cut. And increased taxes in America must cut demand. After all, that is why people expect it to bring about fall- ing interest rates. So even if one was to believe the monetarist view that these are all preconditions for prosperity, they are still going to get worse before they get better.
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