In the City

The markets rule

Jock Bruce-Gardyne

So the markets rule, OK! For months L./now, the markets have been signalling that US interest rates had to rise, and that the dollar was dirt cheap. For months, the American authorities have been answering that there was no call for interest rates to rise; and for the past ten days the central banks of Germany, France and Japan, sup- ported modestly by the Federal Reserve, have been selling dollars as if they were in- fected. No matter: the dollar soars to new peaks, and US prime rates bow to the inevitable.

Truth to tell, the half-point rise in the prime rate was a little like a marriage of cohabitants: it changed appearances more than the reality. Prime rates had diverged too far from market rates for the banks to bear them. Nevertheless appearances do matter, and having forced the major US banks to move against the influence of the Fed, the bond markets are looking to a repetition before too long. The appetite grows with feeding. And similarly the failure of the central banks to turn the dollar exchange rate can only enhance en- thusiasm for the US currency.

All this has caused widespread vexation, some of which is not altogether easy to understand. Three years ago, when the pound was nudging $2.40 and over 100 on the trade-weighted index, our Govern- ment's critics accused it of abandoning our markets to the foreign competition and ex- porting employment on a massive scale. Now, when it is the US dollar which is at the apex of the roller-coaster, one might logically expect these same people to rejoice at the glittering opportunities offered by the US authorities to us and other overseas sup- pliers of the customers of American in- dustry at home and abroad. Not only that, but with the US economy growing at an an- nual rate of almost 9 per cent, and retail sales rising by a phenomenal 15 per cent, the Federal Reserve Board has continued to view the repeated weekly splurges in the money aggregates way above the latest and more generous official targets with magisterial unconcern. Lord Keynes, one feels, were he around in Washington today, would be on the telephone to Paul Volcker advising him to cool it.

The nerves of his latter-day disciples, of course, are made of sterner stuff. 'Growth' is their priority, and inflation for them is not a monetary phenomenon so much as a symptom of unreconstructed union bargaining. So the US authorities are doing everything to please them: not just 'leading the world out of recession', but charging away over the horizon; generally resisting the fierce pressures for domestic protection (and incidentally the European Commis-

sion really has a nerve to attack the Americans for dumping butter on the Egyp- tians); letting US credit rip and tolerating a huge and rapidly increasing trade deficit. True, it could be said that overseas sup- pliers of the US market are lending it the cash to buy their goods by depositing their capital in New York bonds. But then that is the sort of 'constructive recycling' of which the neo-Keynesians generally approve.

Yet, far from being grateful, they monotonously accuse the American authorities of gross irresponsibility. Their crime, it seems, is that they have not put their backs into the campaign to cut the value of the dollar. Since the markets failed to get the message, this is treated as proof not that currency intervention is pretty inef- fective, and sometimes perverse, against the weight of market fashion, but that it was wholly inadequate in scale. We have the word of Lord Lever, Harold Wilson's inter- national credit-raiser in the Sixties for that.

It is a curious charge to come from this quarter. It is rather as if Lord Lever had been dispatched in 1968 to Bonn to ask the Germans to devalue the D-mark for fear that the British economy would otherwise be over-heated by the clamour of demand from German customers. But it is an in- grained instinct among the neo-Keynesians to find out what the markets are up to, and then to try and stop them.

To be fair, the incongruities are not all one-sided. One could not help wondering how Lord Richardson, from the comfort of retirement, viewed the ostentatious abstemiousness of the Bank of England in last week's central bank exchange market operations. For there was no more commit-

was the only way I could gel anyone to dig the garden.'

ted British advocate of exchange rate stabilisation than the former Governor. So are we now seeing the influence of a dif- ferent style of management in Threadneedle Street? Perhaps, but I am inclined to doubt it. I suspect that the absence of Bank of England participation was determined by the Treasury. In part it may well have reflected a healthy scepticism about the ef- fectiveness of exchange rate intervention. But perhaps our doctrinaire monetarist Chancellor was also less keen to curb the competitive edge of UK firms in dollar markets than his neo-Keynesian critics.

Admittedly he can afford to take a more relaxed view of the soaring dollar than his continental and Japanese colleagues. Thanks to North Sea oil, a falling dollar is to us a mixed blessing, and a rising dollar at worst a mixed curse. Dearer dollars add to the bill for imports and thus eventually to inflation expectations. But they also add to public revenues, since North Sea oil, and the petroleum revenue tax which flows from it, are dollar-valued. The continentals and the Japanese suffer the impact on domestic ex pectations of inflation, without anY countervailing gains in public revenues to offset them.

So there was no obvious reason for the Bank of England to join the concerted in- tervention in the currency markets. The British authorities can afford to concen- trate on what is going on at home, Tuesday's provisional money figures for the month of July were certainly a big improve- ment on what had gone before; but they did not really wipe out earlier worries. There is nothing to eliminate the impression that this year's government borrowing is heading for an over-shoot running into billions (although dollar-boosted oil revenues should help). And given the evidence of the vigour of the personal de- mand for credit and of the housing market, it is not easy to take the apparently flat figures of bank lending at face value. So the government broker still looks as if he will be working overtime this winter if the Chancellor wants to bring the money figures back towards his target. Which, in turn, suggests the need for some rise in UK interest rates before we are much older.

It is not a need that will be readilY responded to, however. The CBI would howl with rage if it were. Number 10 would view the prospect of another rise in mort- gage rates with dismay, to put it mildlY. Above all, the official Treasury would be most reluctant to run the risk of facing once again the charge that it had provoked an uncompetitive exchange rate for British industry.

Practical men, as Keynes told us, are often the slaves of some defunct economist (usually, these days, himself): civil servants

are more likely to be chained up to a bygone pillory. Individually they escape respon-

sibility for their past decisions, arguably to a dangerous extent. But collectively they can bear burdens of guilt for crimes of which the conventional wisdom has con- victed them without obvious justification. The Treasury is currently held responsible for sacrificing a whole generation of British industry on the killing-ground of an ex- cessive exchange rate in 1979 and 1980. I suspect that history will conclude that it was almost wholly innocent. No matter: it is not minded to be placed in the dock again. So whatever the apparent signals from the monetary aggregates and such other in- dicators as the price of real assets, Great George Street is going to take a lot of per- suading that higher interest rates are called for. Unless, that is, sterling takes a real nose-dive first.

Even so, the Chancellor must be hoping that White House confidence that US interest rates will soon be heading down again is well-founded. There is no reason to doubt the sincerity of the American authorities' desire for cheaper money, with White House thoughts already turning to the 1984 elections, and they feel terrified of the repurcussions of dearer money on the Latin American sovereign debtors to the US banks. Unfortunately, as Paul Volcker pointed out to the massed bankers of Arkansas on Tuesday, with downtown America booming, the appetite for commer- cial credit looks set to enter into competi- tion with the need to fund the massive federal deficit: but perhaps the overseas en- thusiasm for US bonds will yet come to Mr Volcker's rescue. Perhaps the markets know best after all.