In the City
The pound & franc exposed
Nicholas Davenport
The most accurate account of the sterling crisis last week was given—according to my inside' information—in the Investors Chronicle. This is what happened. On Thursday at noon a strong demand for sterling developed from a variety of commercial sources. As the exchange had been markedly steady for some months the Bank of England decided to meet this demand from its own supply in order to prevent the exchange rate rising. The market wrongly interpreted this action as an official move to make sterling cheaper for the sake of our export trade. Speculative selling then developed in great volume and the Bank lost control of the market. When the minimum lending rate (Bank rate) was marked down a further to 9 per cent on Friday, as had been decided a week before, the market again wrongly decided that an official sterling cheapening' move was on and more speculative selling followed. Again the Bank lost control, but more support was given from the reserves and order was finally restored. It cost the Bank some $600 million out of its dollar holdings to gain this temporary respite. Sterling still remains a vulnerable currency partly because our Price inflation is relatively much higher than that of our European partners and partly because our balance of payments is still heavily in the red.
It was absurd of the French to blame Mr Healey for the collapse of the franc. The franc has been overvalued in relation to the Deutschemark, the French inflation rate being much higher than the German, and it should never have rejoined 'the snake' and tied itself to the mark. It has now floated down by about 3/1 per cent.
The Economist remarked that the sterling trouble began with a Bank of England boob. Not so. It was really a chapter of accidents. It was the speculators, in fact, Who boobed, for not only did they misinterpret Bank of England action but they also misinterpreted the selling of sterling by the oil producers who had just received substantial revenue payments in sterling Which they had promptly switched into harder currencies. Nigeria was one of them and as the British High Commissioner had been falsely accused of being privy to the failed coup it was assumed in the market that the Nigerian government had decided in a huff to unload all its sterling holdings. But Nigeria, like other oil producers, has been a constant and steady seller of sterling. According to the Bank of England §ulletin the oil-producing governments reduced their sterling holdings by over 4600 million between 31 March and 31 December 1975. Their total was then
£2839 million. The total reserves in sterling held by all central monetary bodies at the end of 1975 were £4081 million. This must always signal the potential vulnerability of the pound.
The best that can be said is that its position has lately been improving and not worsening. In the first place, the rate of inflation has halved in the last half of 1975. In the second place, the deficit on the balance of payments was also halved in the course of 1975. But we must not get too optimistic about these two mercies (as, I think, the Bank of England does in its latest Bulletin). Our price inflation rate is still double that of the main industrial countries and its deceleration depends on the next round of wage restraint, on productivity improvement and on import prices. The recent fall in the sterling rate will put up import prices and add about IF pence to the cost of living while Mr Peart's farming deal with the EEC will eventually add another penny or two. As for the balance of payments, the trade figures worsened in February after some months of improvement. Deducting the surplus on invisibles, the current deficit was £129 million against £53 million in the previous month. As the world recession has bottomed and the trade balances of the countries leading the recovery have begun to deteriorate, the Bank of England expects our own trade balance, which has certainly improved a lot, to improve much further this year. But it depends on whether British industry also begins to stock up and on whether Mr Healey is forced to allow some small measure of reflation in order to secure the cooperation of the trade unions in the next round of wage restraint. So we always come back to the same thing—it depends on Mr Jack Jones and his fellow union men. The fact that the fall in the sterling exchange and the EEC compliance of Mr Peart are bound to raise the cost of living by the autumn may make the union men less accommodating.
So sterling remains precariously balanced on its tightrope. If further trouble were to come, and the Bank of England felt that it must raise Bank rate, then our industrial revival would be jeopardised. Business and housing cannot recover without cheaper money. Nor can our borrowing requirement be reduced without cheaper money. Already debt interest is going to cost us in real terms 50 per cent more between now and 1978-79. Recently the fall in interest rates abroad created a big differential in favour of sterling and allowed the Bank to bring down its minimum lending rate to 9 per cent. Cheaper money also enabled the Bank to sell £2700 million of gilt-edged stocks to the non-bank public in the nine months ending December, which was about onethird of the whole public sector borrowing requirement in that period. This brought down the rate of increase in the money supply and helped to slow down the rate of inflation. So a return of dearer money would be a disaster. Better run down the reserves to support sterling than run up the rate of interest or borrow more abroad.
As for borrowing more abroad, which gives a fictitious, that is, temporary boost to the reserves, I cannot believe that it would be prudent to go beyond the present total. Last year we borrowed $1660 million for the public sector which brought the public sector borrowing of foreign currencies at the end of 1975 up to $6421 million. Add $2500 million for the Treasury's direct borrowing and we have a total of nearly $9000 million. At this rate the interest charge on the balance of payments will soon rise to $1000 million a year, wiping out a third of the net amount we receive from our 'invisible' earnings abroad. Surely this is as far as we should dare to go.
The value of the £ fell by 5 per cent in this last exchange flurry, bringing its depreciation in terms of the major currencies to 33i per cent. At this level British manufacturers should be on a strong competitive basis in the world's markets. Indeed; all the economic forecasters, who are usually a miserable bunch, have now become more optimistic. The OECD in Paris, the National Institute of Economic and Social Research and the Bank of England in its March Bulletin, all say that the worst of the slump is over, although in the UK unemployment will still rise and recovery will be slow. The Bank Bulletin, which is my favourite, being written in better English and with less economic jargon, remarks: 'There appear fair prospects of an export-led expansion. UK exports have been less depressed than world trade and have more than held their share [i.e. have actually increased their share]. They now seem to be on a rising trend and exporters in general appear optimistic. As world recovery proceeds exports might be growing at 10 per cent a year and the economy by over 3 per cent a year by the end of 1976'. If these words impress the City the bull market in industrial shares should receive a fillip and the FT index should resume its march to 450. But I must add that a rise in interest rates would kill it dead.
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