The Government and gilt-edged
Nicholas Davenport
The Treasury, we all know, is not supposed to issue instructions to the Bank of England on purely monetary matters but in view of what happened last week I suggest that Mr Heath should send for the Governor of the Bank and ask him to explain himself. The Bank raised its minimum lending rate, which it used to call Bank rate, by per cent to 8 per cent. This followed on its forcing several discount houses to borrow at the previous penal minimum rate of 7i per cent. This was naturally interpreted in the market as an attempt to force the joint stock banks to raise their base lending rates to 73 per cent. And so it . was. The National Westminster Bank, as usual, has been the first to do so. But what is the point of making businessmen pay 93 per cent or 10 per cent for overdrafts when the Prime Minister is complaining that industrial investment is still lagging behind the growth of the economy? Does it not occur to him that they are lacking confidence in the Government's management of the economy?
The DTI figures reveal that the capital spending of manufacturing industry in the first nine months of the year fell by 11 per cent to £1,020 million, which was only partially offset by a rise in the capital spending of the distributive and service and shipping industries. There are signs from the latest survey of business opinion by the Financial Times that a rise in capital spending is at last on the way but this will be killed stone dead if the business work believes that the Government intends to put up the cost of borrowing still more. Mr Michael Clapham, the President of the CBI, has already expressed his misgivings about the Government's 5 per ,cent growth rate. He would like to see 19 per cent of the GNP devoted to investment but with the Bank's thi'eat of dearer and, dearer money this is a pipe-dream.
The Governor of the Bank may reply to
Mr Heath that he was merely following up the Prime Ministerial statement in the House of Commons at the end of November that interest rates must be used as a means of controlling the money supply. Both Treasury and Bank appear to have fallen for this academic nonsense. In its quarterly Bulletin published this week the Bank appears to be becoming conscious that it may be making a fool of itself over this monetary aberration. It played down the awfulness of the rise in the rate of increase in the money supply in the first half of the year. And it did not attempt to frighten us about the rate of increase in the future. In the past three months the annual rate of increase has, in fact, been brought down from 30 per cent to under 17 per cent. As everyone should know, the upward push of the interest rate merely adds to the cost-demand inflation which is responsible for the increase in the money supply. When you push the rate over 10 per cent you begin to get the galloping inflation of some South American countries. The only sensible way to cut down on the rate of increase in the money supply is to restrict the lending power of the joint stock banks by calling for more special deposits. Due to the Bank's aberration only £200 million has so far been called for. It should now be doubled, first, because the banks' reserve assets jumped up when their large holdings of Treasury 51 per cent fell below twelve months to maturity (which is on December 10, 1973), and ;second, because the Government's borrowing requirement will shortly moveup to its seasonal peak. The banks have extended more-new credit to private borrowers in the past twelve months than they did over the previous three years.
The borrowing requirement has lately been causing some anxiety in the giltedged market. Before January next, when the great tax collections begin to come in, the Exchequer will need at least £1,000 million (not to mention the £700 million of Exchequer 6i per cent which falls due on January 15 which presumably has been taken care of). In his April budget the Chancellor remitted taxation to the tune of £1,200 million, and the borrowing requirement has risen to over £2,500 million. Thanks to' the operations of the Exchange Equalisation Fund and the sale of some stock in the gift-edged market, the Bank has been able to finance its loan expenditure so far with a slight reduction in the amount of Treasury Bills outstanding on September 30.
Clearly the Bank will prefer to finance its borrowing requirement by sales of giltedged stock to the non-banking public, which reduces the money supply, rather than by the issue of Treasury bills, which increases the money supply. And it is obvious that it could do the former if it stops playing the fool over the short-term interest rate. Indeed if it edged the shortterm interest rate down instead of up it could sell a lot of stock to the life companies and the pension funds whose actuaries are finding the yields now offered by the medium-dated and long-dated stocks very attractive. Here are some examples:
Gross Flat Red. Price Yield Yield %
One market man has been quoted as saying that if the Bank would use some of its special deposits in bringing down the short-term rate it would be able to sell £400 million of long-dated gilt-edged stocks. I think it would be able to sell much more. There would be a rush after a new ' tap' issue on terms as attractive as those I have quoted if only the market were convinced that the Government had stopped knocking the gilt-edged market and had decided to reverse its downward trend. As I write it is beginning to think so and is moving up.
The market confidence might be fully restored if it felt that the Government had taken a grip on its capital expenditure and was determined to finance it — by giltedged sales — out of the flow of savings accruing to the life and pension funds, the National Savings movement and the unit trusts. (What a great opportunity was missed when the Government failed to introduce a public unit trust and attract the public savings which prefer to go into equities rather than bonds in periods of inflation!) The news of the massive subsidies which are now to be paid to the coal industry, following on the many millions handed out to the lame ducks on the Upper Clyde and to Rolls-Royce, must cause some misgivings in the gilt-edged market about the 'borrowing requirement.' I suggest that what would encourage the market most of all would be an announcement that the Government had abandoned the idea of spending £1,000 million on a new airport at Foulness — over fifty miles from London — which the foreign airlines say they will never use. After its lame ducks the Government really should avoid a wild goose chase.
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