15 AUGUST 1958, Page 25



THE persistent rise on Wall Street seems to be causing some alarm, if not despondency—alarm, that is, at the idea of sober investors being bitten by the inflation bug —and the authorities have seen fit to increase the 'margin' re- quirement on buying stock from 50 per cent. to 70 per cent. The market has never really looked back since last November and the Dow Jones index of industrial shares, now 508, is close to its 520 high point of July, 1957. This astonishing climb of nearly 100 points has been made in the face of sharply declining com- pany earnings, and, in some cases, heavy trading Ipsses. The market, it is argued, could never have behaved in this madly optimistic fashion if the average investor had not been scared of inflation. That is held to be a dangerous sign and the wise- acres of Throgmorton Street are warning their Clients to keep out of dollar equities selling at twenty times or more their current earnings.

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The technical position of Wall Street may cer- tainly be vulnerable, but 1 cannot accept the conventional view of the market's outrageous behaviour. The American investor has been buy- ing equity shares because he has had no option to do otherwise. He was never able to make a good living, as the British investor has done, out of government stocks or deposits. Treasury bills have been offering him barely 1 per cent., five- Year bonds 2+ per cent., and long-dated 31 per Cent. And on July 18 the bond market gave him a good scare. The Middle East crisis caused some- thing like panic selling and the Federal Reserve hoard had to come to the. rescue by buying long- dated stocks—for the first time since 1952. In the following week the Treasury had to refund $16,000 million of maturing securities and the market demanded $2,800 million in cash! The market support operations of the Federal Reserve have added over $1,000 million of additional reserves to the banking system, which is certainly a nice dose of monetary inflation, but it is not true to say that the American investor has been rushing out of bonds into equities through fear of a gal- loping inflation. He has been selling bonds because they were too dear. Where exactly are the signs of inflation which could be said to be frightening him?

* When the Government asked Congress to raise the national debt ceiling by $8,000 million to $288,000 million it disclosed the fact that the budget deficit in the financial year ending next June would be about $12,000 million. Of this total deficit the extra spending on defence, farm sub- sidies, anti-recession and miscellaneous projects accounted for under $5,000 million. The balance Was simply due to a fall in revenues. Having regard to the huge fall in capital spending by private enterprise (estimated at $6,000 to $8,000 Million a year less), I cannot see anything infla- tionary in this modest counter-recession spending by the Government. It is only th'e hard-money- Minded bankers who can be shocked by reason- able government deficit-spending during a reces- sion.

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But wages, say the purists, have been rising in spite of the recession and the recent increase in steel wages and prices are surely evidence of infla- tion. Now steel wages have risen in accordance with a wage contract negotiated two years ago. As steel operations had fallen to below 50 per cent. of capacity at the worst of the slump the current increase in steel operations to 65 per cent. or more of capacity will enable the wage increase to be offset by increased productivity. Steel prices have, however, been modestly increased (as some companies were making a loss before the wage rise) and this will add about $10 to the cost of a $3,000 car, which is not very alarming. The cost of living has been rising this year mainly because of food prices, which may well fall in the next few months. Since April the rise in the retail index has been at an annual rate of no more than 1 per cent. Wages have certainlTrun ahead of prices— the present rise is probably 3 per cent. to 4 per cent. above the level of last year—but as the re- covery gets going and output rises there is a good chance that industrial productivity will rise fast enough to absorb this wage increase. I find it hard to take the threat of inflation seriously at the start of a recovery from one of the sharpest recessions America has suffered since the end of the war.

It has been an extraordinary recession in many ways with industrial output down over 10 per cent. and national income only 1 per cent. The start of it is generally attributed to consumer resistance to high-priced durable goods, in particular motor- cars whose clumsy models had become unpopular as well as expensive. It was certainly accelerated by a sharp, dramatic liquidation of business inven- tories or stocks—at an annual rate of $9,000 mil- lion in the first half of this year. But I do not think this is an adequate explanation. The prime cause was a slowing-down of government spending which began in the spring of 1957. Defence expenditures were sharply curtailed and were down to an annual rate of $8,500 million in the third quarter of 1957. It must be remembered that the American is a mature economy with an in- dustrial capacity tending to run ahead of its nor- mal population growth. To maintain full activity and employment it is necessary for the Govern- ment to spend heavily (and, if necessary, run budget deficits) except when external demand is exceptionally strong, as it was during the Mar- shall-planned reconstruction of Europe and the Korean War. When the Government reduces its expenditure, as it did in 1957, and there is no external demand to take up the slack, a recession is bound to develop. The present recovery is due simply to the fact that government expenditures began to increase at a faster rate than the decline in private capital spending. New orders for mili- tary equipment were at an annual rate of $20,000 million in the second quarter of 1958 compared with $8,500.million in the third quarter of 1957. The end of inventory liquidation will complete the recovery process and Wall Street is looking ahead to an upsurge of $50,000 million in the national product over the next eighteen months. It will probably be disappointed—it has yet to be seen whether the consumer will change his present buying habits—but it is entitled to some optimism after the recent wave of national depression.

The investor is also entitled to value his equity stocks in his own American way—not, as we do, on income yield, but on the growth prospect which any dynamic management can underwrite in an economy still set in creeping inflation.