In the City
Money rules
Tony Rudd
At a moment when practically every- thing seems to be getting less valuable, the only safe haven seems to be money itself. This is a pretty sad commentary on the investment outlook because money is in fact currently losing about 12 per cent of its value every year in this country on the basis of the current inflation rate. The problem is that other things are going down faster. All the commodity markets are in retreat with Only one or two exotic exceptions like ?range juice (in which there is a flourishing '°rward market in America) which rose strongly last week as a result of freak snowfalls ruining the Florida crop. Isewhere everything was down, including and outstandingly gold, which has now fallen well below the $400 an ounce mark.
The fall in gold marks a real turning !Icahn. Earlier this year it had looked as though. the combination of unsettled finan- cial markets and worries over such trouble spots as Poland had at least arrested the downward movement and set the pattern for a recovery. The price did indeed rise about 20 per cent from its low point last Year of around $380: But, contrary to ex- pectations, the rise was not sustained. Part Of the reason was probably that the fall in Interest rates which was expected to occur all last year did not materialise either. And high interest rates always present an obstacle to a high price of gold, because the cost of holding the latter becomes too great
When interest rates of over 15 per cent have to be
t; forgone. Yet the Polish crisis still con- tinues and the instability in financial markets and the risks inherent in them re- ,_rriain as great as ever. There must therefore be something else pulling the price down. What it is consists of -a sustained and dragging deflation which is gripping markets everywhere. Demand is not high enough to sustain present prices, and that in turn is a result of the world recession. Yet there is more to it than that even. People who deal in markets, be it in money credit, shares or commodities are becoming daily more cautious. They are nervous. Some are nervous about their own positions which they are more qualified to judge than aLnYbOdy else. They know the truth rather than what they tell their bankers. Others are nervous about their neighbours, they are Worried about having too much lent out to borrowers who may not be able to pay either interest or principal.
The well advertised problems surroun- ding the Polish debt are the tip of the Iceberg. There are less well advertised debts turning soft every week, owed by the rest of the Iron Curtain countries to the West. Very little of the capital which was so generously heaped upon Eastern Europe by
the Western banking and credit system in the Sixties and early Seventies will ever be repaid and everybody knows this, but ap- pearances have to be kept up. In the mean- time the interest ticks away like a time bomb, adding to the weight of the problem. One day reality will have to p,revail and a colossal write-down will have to be ac- cepted. It is to be hoped that this will be done without any institution or person ac- tually being written off.
Back on our side of the Iron Curtain the huge internal investments of the leading Western economies, particularly that of the US, are becoming increasingly burden- some. Prices of most capital ,assets are no longer rising and in many cases falling, so that the balance sheet security for all the debt is being eroded. At the same time the profit-earning capacity of the capital goods in which the borrowed money has been in- vested is similarly falling or, if it has ceased to do so, is now at a very low ebb. Certainly it is far too low to meet the interest pay- ments previously incurred. So further debt is entered into in order to paper over the current difference.
What is happening now to many people in the UK housing market, namely that the capital value of the house is falling while the cost of the mortgage seems forever to rise, is exactly what has been and is still happen- ing to much of industry and commerce. The fact that all this is occurring against a backdrop of continuing inflation makes the situation even less easy to bear. At least when money last ruled, between the two world wars, it rose in value because all prices, not just those of capital assets, were falling. Today it is just the prices of capital assets which in the main are on the decline; the prices of current day-to-day articles which are consumed by industry and people alike are still rising. This makes all the more stark the lack of confidence which is leading investors away from practically all forms of investment even though the alter- native, money, is losing value at 10 per cent per annum or more, depending upon which rate of inflation you take.
It certainly seems a crazy world. To some extent it represents the price of trying to control inflation by monetary means during an unprecedentedly deep recession. Even that might be possible without the appalling side effects of high interest rates at times like these were it not for the current propen- sity of Western governments to run large public sectors and to be responsible for substantial welfare levels. One thing however is quite certain and that is that the situation can't last. it is too inherently unstable. Eventually governments will have to come to the rescue and prime the pumps, leading to a rise in values and subsequently in profitability which in turn will float off the debt. Or they will leave it too late (or not try at all) and the credit mountain will collapse leaving only those with ready change in their pocket, and some very short-term government paper, able still to enjoy the standard of living to which they became accustomed in those bad old days of the Sixties.
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