ECONOMICS AND TIIE CITY
American deflation, British reflation
Nicholas Davenport
Money commentators are sometimes right and sometimes wrong — present company always excepted — but I cannot believe that Charles Stahl can be right when he said last week (Spectator July 6) that the Americans who ,bought gold abroad illegally will sell it and bring the money home in order to buy gold certificates, as soon as Congress had legalised them, or buy stocks on Wall Street, so that "the reflow of funds into the US will not only contribute to the lowering of the price of gold but will also fuel one of the greatest bull markets that Wall Street has ever seen."
I would have thought that these naughty Americans had already taken their 100 per cent profit in gold — it rose from $90 to $180 per ounce in five months and has now fallen to $138 — and I am sure they have not yet thought of becoming 'bulls' on Wall Street which is still reeling under the attack of Dr Burns, the head of the Federal Reserve, who is determined to kill inflation by dear and tight money.
The latest economic letter of the First National City Bank certainly gives no encouragement to those who take an immediately bullish view of Wall Street. The signals of upturn, it says, are too little and too weak to warrant optimism or even complacency about the American economy. Real output will have to grow much faster to prevent a widening of the GNP gap, the difference between what the economy is capable of producing and what it actually turns out. The gap has been widening since early 1973 and the Bank expects it to spread further during the remaining quarters of 1974 until it reaches a degree not seen since the 1960-61 recession. As the gap widens unemployment will probably rise to about 6 per cent by the year-end. The GNP gap measures the under-utilisation of both capital and labour. So the recession is real enough.
The American recession in economic terms will stop when the rate of income growth exceeds the rate of price inflation. In the first four months of 1974 the prices of nonfood commodities rose at an annual rate of 15 per cent — three times the Pace of the previous year — and the price of services at an annual rate of 8.8 per cent. The prices of food, fibres and some metals have recently declined but this deline made the business world disinclined to increase inventories and so added to the recession.
The rate of income growth in Dr Burns's view depends upon the rate of growth of the money supply which has lately been expanding at an annual rate of 5.7 per cent. "Continued resistance to a swift growth in money and credit," Dr Burns said, "is an essential to fight against inflation. The Federal Reserve is firmly committed to this task and isn't going to be a willing party to the accommodation of rapid inflation." So he has allowed the prime rates of the banks to rise to 12 per cent.
There are signs now that dear money is having its effect upon American business which is cutting back on stocks and using less bank inoney, so that interest rates should soon decline. This will allow Dr Burns to ease up on his tight money policy. He is on record as saying that "a restrictive money policy, if pursued too long, will damage the economy." The First National City Bank seems to suggest that Dr Burns will ease up before the end of 1974 to prevent unemployment rising into 1975. My guess is that he will ease up in September — in time for the November elections.
What happens to interest rates in the United States is, of course, of vital importance to the managers of our own economy at home. If American rates remain high we cannot bring ours down without putting sterling at risk. And if we cannot make interest rates cheaper here the Government will have to go on pumping money into the building societies to prevent their mortgage rates rising, which Mr Anthony Crosland has pledged himself to do for the rest of the year. At the same time Mr Healey cannot safely contemplate a reflationary mini-budget before the election, which may be in October, without frightening the foreign holders of sterling as well as the leaders of the CBI. Yet he is now contemplating reflation in some milder torm.
The Prime Minister struck the new note in his speech to the Socialist International conference which was held at Chequers last week. He said: "Inflation feeds on fear and the key to dealing with it is confidence. Confidence for the employee that his wage settlement Will not be swamped by rising prices [this is guaranteed by the threshold agreements — and by Mr Michael Foot who reminds him.. that there will be no wage freeze ever], but Confidence also of the employer that his business will be able to operate in the framework of a stable and orderly economy . . . Private industry must have the necessary confidence to maintain and increase investment and to do their duty by the people . • [Mr Jim Slater please note] . . and confidence demands that a clear frontier must be defined between what is public and what is private industry [Mr Wedgwood Benn please note]: This is Mr Wilson at his Establishment best, trying, like Mr Harold Lever, to bring some confidence back to the demoralised stock markets in Throgmorton Street.
Mr Healey is also toeing the confidence line. At the annual dinner of the CBI on May 14 he said: "We want a private sector which is vigorous, alert, imaginative and profitable ... No one now believes that profits is a dirty word, if profit is honestly earned and put to proper social use." It is not therefore surprising that the meeting of the National Economic Development Council last week was all money and harmony. The Government, the TUC and the CBI were agreed that it was vital to rebuild confidence. Without it investment would be impossible. Further deflation was to be avoided, as it was not considered to be the right solution for the economic malaise. Mr Healey claimed that he had already got the money supply and the public sector deficit under control. But he was obviously fishing for support for some form of reflation. He asked the CBI and the TUC to prepare reports on the outlook for demand and he indicated that he would like to have them by the end of this week.
The scenario for the election is thus becoming clear. The Prime Minister will stress that his is the only government which can pro-, duce a 'social compact' and hold the TUC to a policy of wage restraint, meaning no bigger rises in pay than are necessary to offset the rise in the cost of living, in other words, no rise in the real standard of living for 1974-75. At the same time to please the business world he will ease dividend restraint, restore the market in property (with limits on the rise in rents) and make capitalism work again in the private sector with more confidence: The sinister role of Mr Benn and the National Enterprise Board will be played down. And finally, I suspect, there will be some reductions in VAT to make sure that the threshold agreements do not get activated again and produce more inflation. All this could bring about a technical recovery on the Stock Exchange — until the real showdown comes with a fresh outbreak of militancy on the part of the revolutionary Marxist.
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