The Bank rate madness MONEY
NICHOLAS DAVENPORT
It may be true to say that Bank rate usually comes down by 3 per cent and goes up by 1 per cent at a time, but to compare last week's rise of 3 per cent with a similar one made by Chan- cellor Butler in January 1955 and condemn it as an equal blunder—just because 'Rah' had to put it up by a full 1 per cent a month later —is really a piece of arrant nonsense. The economy was overheated in 1955: it is under- heated today. After a long period of stagnation and deflation the Government is trying desper- ately hard to reflate and there are signs that some—but not all—industries are just on the upward turn if industrial unrest does not pre- vent it. The last thing that any Chancellor would want to do is to damp down incipient recovery by making money dearer to borrow. In my opinion Chancellor Callaghan was abso- lutely correct in raising Bank rate by only 3 per cent to 6 per cent. With luck it could have only a minor effect on business at home, but the extra per cent for the money merchants might have just the effect of keeping foreign money on deposit in London.
It is, of course, ridiculous that we should be forced by the inordinate rise in interest rates in America to take monetary action which is directly contrary to our economic interests at home. This is the penalty for belonging to an international monetary system which demands fixity of exchange rates—with only a small marginal allowance—so that sterling has to be supported by a higher Bank rate if money rates abroad become more attractive than those in the Lac. The absurdity of this system, which means in effect that an honest workman has to pay a higher rent for his council house when- ever the American President fights an intermin- able war in the Far East, prompted Keynes at the Macmillan committee in the early 1930s to suggest a two-tier system of interest rates— much to the horror of the then Governor of the Bank, Montagu Norman.
To anyone but Mr Max Nicholson (vide The System) it will seem extraordinary that bone- headedness at the Bank or at the Treasury or at both should have prevented this reasonable pro- posal being seriously considered in official quarters for all these thirty-five years. Is it not amazing in this enlightened age that the Bank should exercise a rigid control over the move- ment of British capital abroad and yet allow foreign capital to come and go in the City as it pleases in the random pursuit of interest gain? Why does not the Government decree that itinerant foreign money coming to London, that is, money outside the currency reserves of the sterling area countries, be paid into a special account at the Bank of England which will offer the appropriate international rate and then pass It on into the domestic channels which can afford to pay it? This would allow a two-tier system to operate in money rates and prevent domestic borrowers being penalised by any extraordinary monetary crisis abroad.
Sooner or later the Bank—and other Central Banks as well—will have to exercise some con- trol over the movement of funds in the so-called Euro-dollar market, which are probably five times as large as the volume of 'hot money' which used to move about the international monetary scene in the old days. These short- term funds, derived for the most part from the American payments deficit, can be stimulating when they finance inter-European trade but up- setting when they are suddenly switched to the American market where short-term interest rates are soaring.
Mr Callaghan, who is the first Chancellor since Dalton to feel passionately about cheap money for social investment, has done his best in conventional terms to keep interest rates down. He actually called a nionetary conference of his own at Chequers on 21 January to which he invited the finance ministers of France, Ger- many, Japan and the United States, and he got them to sign a declaration that they 'would be- have in such a way as to enable interest rates in their respective countries to be lower than they would otherwise be.' This was quite an achievement. President Johnson supported him in his State of the Union message by demanding a 6 per cent surcharge on taxation and calling upon the Federal Reserve to help lower interest rates, which they promptly did by increasing the money supply. This enabled the Chancellor to reduce our Bank rate from 7 per cent to 63 per cent on 26 January, to 6 per cent on 16 March and to 53 per cent on 4 May. But the President failed to get his tax surcharge agreed by Con- gress and as the budget deficit mounted to astronomical proportions the us Treasury had to pay higher and higher rates for its short- term finance. Mr Callaghan once more appealed for international disarmament in intereit rates at the Rio conference of the INIF in September, but the monetary situation in America was already getting out of hand.
Three-month us Treasury bills have already risen by over a point to 4.67 per cent. As the wily President is now threatening to cut Federal expenditures drastically in the states of those senators who have been opposing the tax sur- charge it is possible that he will get the Senate to pass it by January, which would allow the Federal Reserve to keep money easy enough in the next two months to prevent the Treasury bill rates from going throuih the roof. But it is a close-run thing. The obvious way out for Mr Callaghan is to allow our Treasury bill rate, which is traditionally 3 per cent below Bank rate, to rise if necessary 3 per cent above Bank rate while the American monetary crisis is being resolved. On Friday last it rose 5s to close on £5 14s 7d per cent.
One thing is clear. To allow industry to re- cover its flagging confidence and the economy
a better rate of growth, Bank rate must not be I allowed to go higher than 6 per cent. It is ready the highest in Europe. Germany au- Switzerland have 3 per cent; France end ha.. 31 per cent; Belgium and Holland 44 per cen and 43 per cent respectively; and Sweden 5 pc cent. Even Japan is just below 6 per cent. 1 an not suggesting that a rise in short-term rates necessarily puts up the cost of long-term inch!, trial borrowing—long-dated gilt-edged stoch have hardly moved in the market since the 3 per cent raise—but the market rate for first-class borrowers is already 71 per cent plus and tor second grade close on 8 per cent. Add on the cost of sinking funds and few industrial bor rowers will risk paying 10 per cent for new capital outlays with profit margins low and future demand uncertain.
Fortunately Mr Callaghan has shielded house- building in the public sector from the interes rate blow. The Housing Subsidies Act makes good to the local councils the difference between the current cost of borrowing and a 4 per cent rate on their borrowing for housing. We may therefore, hope that the revival in public sector housing will continue. But elsewhere the 6 per cent Bank rate is a threat to recovery. I beg the Chancellor to consider the two-tier plan I have ventured to submit and so try to insulate ou. deflated and bruised economy against the mad monetary attack from Washington.
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