In the City
De-Thatchensed
Tony Rudd
The stock market ended last week in a L state of euphoria. Interest rates had been edging down in the money markets each day and the culmination was a cut in several of the clearing banks' prime lending rates from 141/2 per cent to 14 per cent. At last, it seems, the thaw is on its way. Or so it ta, ay seem until a late and unseasonable frost nips it in the bud. ta, ay seem until a late and unseasonable frost nips it in the bud. However what is clear is that the Govern- ment's Policy is well into the long-promised U-turn. -turn. The general expectation is of a mild budget with more being given away than had earlier been expected or than many observers will think is safe. In the meantime !t is now possible to see that the move
towards lower interest rates has been set in train by direct intervention, which must
have been as much politically as economic- ally inspired. It didn't come about of its °Ivo accord. Indeed it has now been reported that there was a meeting of the eance ministers of the leading countries in begin at which the decision was taken to rate a concerted policy of both interest 'ate and exchange rate intervention. It Would appear that Europe has finally tired e, f waiting upon the Americans and has taken the fateful decision to try to do what the Heath suggested last year, to unhitch ;he European economic bandwagon from American influences. They have given up I "log that Mr Voelker will sympathetical- Y Sacrifice American domestic economic /)°,_11cY to the needs of the rest of the world and have decided to go it alone. Consequently, interest rates were lowered ' most centres, not just London. And the accompanying support for leading Euro- rd° currencies by the European central ouanks was simultaneously very evident. On bbiLe, day for instance the German central ank was supporting the D-mark against pue. dollar in the morning and cutting the of- 101cIal 'Lombard' rate in the afternoon. The fact that London is very much part, if not the leader, of this move, underlines the new political commitment we are seeing from kuls, Government to the policy of reflation. elcome as this late conversion may be, the question remains: will the policy work?
As one former Governor of the Bank of England said, 'You can pull a piece of
sttr.log but you can't push it'. Industry cer- ,aally needs lower interest rates. The old forty which some of us learned thirty or el tiny Years ago when we did our elementary kc.ellomics, that high interest rates cause high unemployment, remains as true today brought ever. But having got them up and having , ttlught the economy to a state comparable 1° that of the Thirties it will need more than gbanks'lending rates to get industry re-
expanding again. In present circumstances it would probably need interest rates to be cut by at least half (if not more) to do the trick. The reason is that demand is so low. And without a good 'base load' of business, industry can only expand by doing so speculatively, by manufacturing not against firm orders but against hoped-for orders which are to come from economic recovery. But to do that managers need a very clear profit margin in their sights. So if the Government hopes to get it all moving once more by simply pushing interest rates down it should aim at a figure of about 5 per cent if this policy is to be effective. With the cur- rent borrowing requirement that's probably an unrealistic figure.
Of course the immediate impact of lower (even marginally lower) interest rates is not upon industry at all but upon capital markets, as we saw before and after the half-point cut in the banks' lending rate. The significance of the move to investors is that the direction of policy has been revers- ed. The actual level of rates may still be throttling industry, but for the capitalist, private or institutional, it is not that that matters but whether rates are moving up- wards or downwards. A half-point cut means that they are moving downwards. The second question is, however, whether even that fact can really be trusted.
What links interest rates with those in New York are not steel hoops, but rubber bands. The level of rates in the two interna- tional centres can move apart, but, with the rubber bands connecting them, they have a propensity to move back together if left to themselves. This means that they can only be kept apart by policy. The concerted move by central banks in Europe to get their interest rates down stretched the rub- ber band. But rates will go back together sooner or later. Either Mr Voelker will have to lower American interest rates or the Europeans will have to abandon their ex- periment. There is one other possibility and that is that exchange rates will take the strain. For if interest rates in Europe move substantially lower than those in New York, European currencies will have to fall sharp- ly against the dollar as investors move their money back into the dollar. The question then is how much will, for instance, the Thatcher Government mind about a falling pound. Some observers say that a lower rate for sterling will suit the Government because it will be much more palatable to industry and therefore helpful to a recovery of British economic activity. Others argue that a falling currency is bound to feed in- flation back into the system just when there was some hope of the inflation rate in the UK moving down towards 10 per cent.
So it all depends on America. And there the outlook for falling interest rates is not all that good. The prospect for a fiscal deficit which could reach over $100 billion this year and the consequent difficulty of holding the money supply down to targeted levels, is worrying Wall Street. Market men there feel that Mr Voelker and the Fed are bound to take a hawkish view. In any case the government's funding requirements will be so large that industry's very considerable needs will be crowded out and force interest rates up as a result of purely commercial forces. If this is how events are going to turn out in the US over the next few mon- ths, the prospect for the new European ex- periment cannot be regarded as bright. On- ly when a concerted effort to get the world going again includes in the concert those responsible for managing the US economy, will the prospect be really improved.
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