In the City
A whiff of sulphur
Jock Bruce-Gardyne
Ithere a whiff of sulphur in the air? For 'months now the City of London has been spilt into two camps: those who see the old FT30 Index breaking the 1,000 barrier, and those who expect a 'major adjustment' to the long bull market, carrying the Index back well below 800 and leaving a lot of burnt fingers around. By the end of last week the bears seemed to have won the argument.
All sorts of bits of evidence had come together to produce a change in sentiment: the growing bitterness of the miners' strike, coupled with the threat of what Mr Knapp of the NUR calls 'experts at non- cooperation' being let loose on British Rail; the unaccustomed prospect of major disruption in German industry; half a point on UK base rates, and the rise in the US 'prime'; slithering sterling; prophecies from Dr Henry Kaufman that were even more dyspeptic than they usually are; a distinct shortage of successful funding by the Government broker; cries of outrage from the debtor governments of Latin America. But it was none of these that really gave the markets the jitters. Rather it was the crop of ugly rumours circulating — and im- mediately denied — about the credit- worthiness of Continental Illinois. Was this the beginning of the 'crisis of confidence' in the commercial banking system so long discussed and so long deferred?
By the begining of the week Continental Illinois had been succoured by its friends and neighbours. But the feeling that the US authorities were hopelessly at loggerheads with their bond markets — with the banking system in the crossfire between the two persisted. So the markets stayed uneasy.
Let us consider the evidence. Essentially the case for the prosecution rests on the proposition that the US Federal Reserve is at least actively conniving at a sharp rise in American interest rates which will abort recovery around the world and drive the Latin American and other debtor countries into default, making mincemeat of the balance-sheets of the US banks. The out- come of last week's conference in Washington of the central bankers only served to deepen the gloom. For while everyone who attended was staying mum and saying nothing, the message seemed to be that both the main suggestions for tempering the wind to hard-pressed sovereign debtors — by 'capitalising' their interest payments (i.e. deferring them to the Greek kalends), or by 'capping' the rate they have to pay (or at least pretend to pay) — had been tested and found wanting.
There is — or so it seems to me another way of interpreting the evidence. The schemes for insulating sovereign deb- tors from the impact of rising US interest rates are essentially designed to enable the Fed to concentrate on combating inflation at home. Which is surely precisely why they have so far proved unacceptable. For freedom for the Fed to tame American ex- pectations of inflation in the pipeline would both scare President Reagan's campaign managers and confront the other Summit governments with a painful choice between dearer money and cheaper currencies. To keep the Fed exposed to fears of sovereign debt default looks generally alluring.
That it involves an element of risk can hardly be gainsaid. For, as Mr Volcker once again reminded Washington the other day, there are limits to the ability of the Fed to defy the pressures of the markets for dearer money, money for which the Latin The Spectator 19 MaY 1984 Americans will say they can't pay, and won't pay. But against that it has been demonstrated time and again that they cin not have to do so. Their creditors will always agree to put up the cash for interest owed to themselves: and if the Latin Americans jib at IMF medicines prescribed for them, those too will be waived in the last resort. It therefore seems on balance wiser fi, °,r the moment to conclude that, for all the rhetoric, 'supply side economics' rule the roost. There was something touchingly familiar about Mr Regan's appeal to the Fed last week to supply 'enough money ' ,t° accommodate non-inflationary grow["' That was precisely what Lord Barber use" to call for back in 1972. Eventually the then Governor of the Bank of England, Messrs Volcker and Feldstein today, t.' driven to point out that there was no such animal as a monetary policy to restrain in flation and assure growth simultaneously[ Well, we all know who won that argurile''„
and what the consequences were.
Evidently that is not the way events are seen in Whitehall. There the message is tha.le there is 'absolutely no evidence in domes monetary conditions for active action raise interest rates': it's all the fault of 01; feckless Yanks. No evidence? That seethepitching it rather strong. I know that tin money yardstick — PSL 2 — which takes as the deposits of the building societies 7. been conveniently struck off the registet But what about house prices? And w!13, about all, about bank lending? — lenchnIL-c; be it noted, not to businesses to fintc expansion, for that is actually shritlic7; but to you and me, which grey,' by rn-es athpaance.f6 billion last year, and eontillu So perhaps it is indexed gilts that 5--h t)rhe be due to make a come-back. Before„-to decision was taken to open indexed gilt; of everyone there were alarming predictions
of
a flood of Arab gold to take advanta°eoff Mayer]( the such a haven from inflation, setti another surge in sterling. Nothing °,i xed kind occurred. On the contrary, tale e, gilts soon languished in neglect• however, that is where the GovernIIIis broker should now be looking to gel air]. funding programme moving once agiolY The alternatives do not look Particu - prepossessing. Of course the Chancellor /night tamp” ted to reduce his deficit by selling go orn merit shares in British Aerospace to . 10- (or a rival bidder if one comes along2at. deed he might be wise to do just 61,./ a remember that when Thorn bid for Eliof_ friend of mine then connected with,tile oso lice of Fair Trading was inclined to uelo the fact that the Monopolies Corranoaads could not reject a merger on the gr tors. that it was calculated to bust both Par`tiroe, That was the market suspicion a citheo the and it has proved entirely misplace d• think same, if I were a Thorn shareholder lospeet I would be in two minds about td he rear
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