MONEY AND THE CITY
Panic at the bank
Nicholas Davenport
Sometimes in this column I have to interpret the City to Whitehall and sometimes Whitehall to the City, but when both are behaving in an irrational manner the job becomes very difficult. Whitehall is the worst offender. The Government was lately giving a lecture to the building societies on the social evil of dear money. A 10 per cent mortgage rate was anathema. So the societies reluctantly agreed to _ keep it at 94 per cent in spite of their fear that they would not attract enough new money by offering investors 6.4 per cent tax free. Behold, on Friday last the Government decided that shortterm interest rates were too low. So it called on the joint stock: banks for another 1 per cent in
special deposits, siphoning -ZIT £260 million from their lending resources — this was on top of the existing 3 per cent call — and advanced what used to be called Bank rate from 74 per cent to 9 per cent — a crisis rate. In order to get the discount houses to toe the line it had to alter their entire
constitutional rules. Dearer money used to be applied to slow down the economy. Now it adds to the domestic inflation, which is our besetting problem. It deliberately adds to the borrowing costs of the nationalised industries and their trading deficits. Naturally, these moves caused a panic in the gilt-edged market. Some hundred of millions of pounds were knocked off the values of the bonds held by the building societies and the insurance companies whose steadfastness in times of trouble we are reviewing this week.
The object of the Government exercise was primarily to protect sterling. Short-term rates of interest have been rising sharply in the US and in Europe. The US Federal Reserve recently raised its discount rate to 7 per cent and the American banks have been raising their base lending rates to 84 per cent while ours have been lowering them. (They have now raised them to 8 per cent.) The Bank of England is presumably hoping that the rise in " Bank rate" to 9 per cent will help to keep foreign money in London. But this frankly is just a hope. Sterling is vulnerable while the deficit on the balance of payments is mounting and while the domestic inflation is still raging.
The National Institute remarked in its last Bulletin, to which I drew attention on July 7, that there could be a "threshold " value for sterling beyond which a mounting deficit would cause a floating rate to fall significantly. The official holders in the former sterling area are still protected under the Basle agreement against a sterling drop but foreign holders are not and they will be watching the rise in the payments deficit with less complacency than we do at home. Moreover they will be watching Mr Heath's attempt to curb the inflation with increasing anxiety. The Downing Street talks are still going on but Mr Heath's offer of " threshold " wage agreements—with which he hopes to secure TUC co-operation — may strike the foreigner as potentially inflationary. If higher import prices drive up the cost of living beyond a certain point the "threshold " agreement then carries the rise automatically into higher wages and perpetuates the wage-cost inflation. Perhaps the sterling " threshold " and the wage agreement "threshold " are lin ked.
Professor Robert Nield has been adding to foreign anxieties about sterling by predicting a balance of payments deficit of £2000 million if nothing is done to reduce the £4000 million borrowing requirement of the Government. This alarm was sounded in the London and Cambridge Economic Bulletin published in the Times. The Professor will no doubt now become the guru of the school which preaches that this is a boom which must go bust. I agree with the Professor that the Government is taking big risks when it reflates on a massive scale while the exchange rate is floating and commodity prices rising on world markets. If the trate of exchange had remained fixed as at end 1972, and if imported raw materials had also remained constant, our import bill would have been about £500 million lower than it was in the first half of 1973. Mr Heath is justified in reminding us that the increase of £500 million was due 90 per cent to the rise in world prices and 10 per cent to the devaluation of sterling. I also agree with the Professor that action should immediately be taken to reduce the public sector deficit by £500 million. Mr Barber ' announced cuts in public expenditure of £500 million in 1974-75 of which £100 million was to take effect in the current financial year. But alas, this has been wiped out. Mr Barber should think again and introduce other cuts. Or he might put a special levy on banking profits which have almost doubled as a direct result of the Government's massive reflation and increase in the money supply.
The stock markets have been utterly confused by the Government's panic measures over money rates. Perhaps some operators really believed that the Government might fine the banks for doubling their profits, for when Barclays announced an 80 per cent rise in half-term profits the shares fell by 3p. It seems irrational for the market to put the banks on a price-earnings ratio of 10 while it runs up Sainsbury's shares to a price-earnings ratio of over 22. But markets have not yet settled down after the shocks delivered by the panicky Bank under its new Governor.
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