A PAUSE FOR EQUITIES
By NICHOLAS DAVENPORT Tuts .week I venture to take the short view—always the most difficult for a financial commen- tator—and suggest a pause in the long-term upward trend in equity share values. It is my hope and belief that this will coincide with a more lasting recovery in the gilt-edged market. Who should come to my aid in this respect but that gallant and courageous
knight of economics—Sir Roy Harrod. Writing in the June issue of the District Bank Review he boldly argues for a much stronger policy of expansion reinforced by a lower long- term rate of interest. In his view our total national product should grow in line with our potential capacity for production, not only because we have- to meet the economic challenge of the Soviet bloc, but because if we diverge too sharply, whether upwards or downwards, from our natural and sustainable line of growth, a lack of economic balance will be created and the problem of stable prices and employment will become intractable. Here is his argument in more detail.
From 1948 to 1955 our industrial production measured per head of those employed in the indus- tries covered by the index rose by 3.1 per cent. per annum. From 1955 to 1958 it rose by only 0.5 per cent. per annum (this is not to be confused with the higher rate of increase in the total national income) in spite of the fact that this was a period during which new equipment was being delivered to industry at an unprecedented rate. If this equipment had been fully utilised, output would have risen by much more than 3 per cent., but it went down because there was not enough demand to keep the plants busy. To reach full activity gradually and cautiously over the next three years it will be necessary, Sir Roy thinks, to increase demand by £750 million a year. The Chancellor had apparently much the same figure in view for 1959-60 when he removed the hire- purchase controls, framed his Budget of tax reliefs and stepped up the investment of the public sector. But when he seeks to encourage private investment by veiled subsidies (the investment allowances) while discouraging it by dear money he is pursuing a contradictory policy.
What arc the inhibitions, asks Sir Roy, which are preventing a return on the part of the Treasury to the time-honoured reflationary policy of easier money? Obviously an obsession with the past alarms over inflation, flights from sterling and losses of gold. The inflation crisis of 1957, he says, was a bogus one. Demand was actually falling and our external balance was improving. But we allowed idle gossip among financiers, British as well as foreign, to spread the idea that British wages were advancing more rapidly than wages in competitor countries and that we were prepared to see the German mark revalued upwards. Hence the violent speculation against the £. The 7 per cent. Bank rate and other deflationary measures stopped the upward growth of the economy and it was twelve months or more before we could officially resume expansion. And a tight monetary policy has persisted ever since, as Sir Roy shows by the use of an ingenious statistic—the number of weeks' total domestic product which the outstand- ing volume of bank deposits would purchase at market prices. This was 20.3 in 1938 when old Consols yielded 3.38 per cent. It was 27.8 in 1947 —the Daltonian period of ultra-ease in monetary policy when old Consols returned 2+ per cent.— but was back to 19.4 in 1953. In 1957 and 1958 it was down to 15.5 and old Consols were yielding nearly 5 per cent. This monetary tightness is still restraining private investment and growth.
What we need is obviously a lower long-term rate of interest without necessarily having to have a low short-term rate which might interfere with the defence of sterling in the exchange markets. The long-term and short-term markets are not rigidly linked together and Sir Roy thinks that we could go a considerable way towards increasing the quantity of hank money—which would bring down the yield on Consols—without bringing about a substantial fall in short-term rates. Let the Bank of England increase the cash base of the banks and at the same time let the Treasury in- crease the supply of Treasury bills to the market. By adjusting the supply-demand position in the bill market the short-term rate can be held. In my own view this is precisely what is going to happen this month as the tax reliefs begin to operate and the extra post-war credits are released. The coming increase in the tender issue of Treasury bills will ease the money situation, remove the need for the banks to sell any more investments and allow the gilt-edged market to rise.
Now I can return to the point at which I began this argument. Many institutional investors will stop adding to their equity portfolios at the present
high prices if they think the' gilt-edged market is going to stage a recovery. They will buy War Loan instead—on a yield basis of 5+ per cent. They will not, of course, sell their equities. The year of recovery from an industrial recession following on high investment is the best year for company profits. Productivity will leap ahead as the factory plants work harder with less labour at the machines. But a cessation of institutional buying will bring about the long-expected reaction in the market. Equity shares have more than recovered the fall which the 'bogus' crisis of 1957 inflicted upon them. A rise of sixteen months, broken only by a temporary setback in the first two months of this year, is a long enough run and on past experience 1 would expect a temporary fall of around 124 per cent. But the gilt-edged market could enjoy a rise of much the same extent, bring- ing the long-term rate down to 4+ per cent. Sir Roy Harrod apparently will not be satisfied until old Consols yield 3 per cent.
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