ECONOMICS
Exchange rates governed by the Fourth Protocol
JOCK BRUCE-GARD YNE
So now we know. When the cream of the finance ministers and the central bank- ers met in Paris last month for what Chancellor Lawson likes to call 'Plaza Two', they drew up a secret 'Fourth Protocol' to define target exchange rates for each other. Or at any rate that is what we are now encouraged to believe. In Mr Lawson's phrase it is 'certainly conceiv- able': in other words we are under notice to go right ahead and conceive it. Truth to tell it isn't a very novel concept, at any rate as far as we're concerned. Throughout the Lawson incumbency the exchange rate has been the target that dare not speak its name. And in retrospect it's been a much-admired performance. Twelve months ago a committee of the House of Lords presided over by the illustrious industrialist, Lord Aldington, challenged the Chancellor to show cause how we could survive at all when the oil ran out. The Chancellor told them brus- quely that non-oil exports and domestic sales would have to take the place of oil, and that the exchange rate would have to adjust to the extent required to make this Possible. Lord Aldington and Co were scornful — as only the Upper House can be When treated with pitying condescension by a former journalist. But so far the former journalist has been right, and they have been wrong. The value of our oil sales slumped — not because the wells went dry, but because the price collapsed — much faster than the Aldington Committee had envisaged. The exchange rate did adjust; and for the first time in living memory the competitive advantage supposed to flow from a cheaper currency materialised. Only it happened in defiance of what we know of Treasury ambitions. For by early 1986 the Chancellor was making little secret of his conversion to that fashionable institution, the European Monetary Sys- tem. Had we joined the EMS fifteen months ago, the exchange rate adjustment would not presumably have taken place. The pound would have had to keep up a Spanking pace with the deutschmark, and the CBI would have screamed blue mur- der. Since they were as keen as anyone to Join the currency club, that might have served them right. They were rescued by the obstinacy of that most unclubbable of ladies, the Prime Minister.
The PM's attitude remains unchanged. Full British membership of the EMS this side of the election is still, in Mr Lawson's words, 'highly unlikely'. But there is — or at any rate we are supposed to think there is — the Fourth Protocol. We may not join the club. But she can't stop us behaving as visiting members.
What does it all mean? The 'Red Book', published on Budget Day, told us that it was 'assumed that there is no major change in either the sterling exchange rate index or the sterling/dollar exchange rate from year to year'. As it did in 1986: and look what happened then. This time, however, the assumption is backed up by repeated asser- tions from the Chancellor that he is 'per- fectly content' with the exchange rate as it is. Indeed he is subtly more precise. In the immediate aftermath of the Paris meeting Mr Lawson said he did not want sterling to fall further, nor to see a 'substantial rise'. Since then it has risen 8 cents against the dollar, 14 pfennings against the deuts- chmark, and 31/2 points against the 'basket' of our trading currency counterparts. In consequence 'perfect contentment' is, it seems, less 'lopsided'. The secret Paris accord envisaged some modest apprecia- tion of the pound; and that has now happened. We have reached our destina- tion, and we have got to try and stay there. That may not be so easy. To take the most obvious difficulty first. We can only keep in station with both the dollar and the deutschmark if those two currencies keep in station with each other. That may indeed be the intention, following 'Plaza Two'. It does not follow that it is advisable. If it is not achieved — and the dollar's performance this week has not encouraged expectations that it will be — we will have to choose. Do we try to keep step with the mark — in other words to act as if we were full members of the EMS and hope that 10 Downing Street doesn't notice? Or do we — as we have done hitherto — occupy a sort of mid-Atlantic position, drifting down (or up, as the case might be) with the dollar, but not as much?
Let us suppose however that for a time at least 'Plaza Two's' message to the markets were to impress them sufficiently to keep the major currencies more or less in convoy. Paradoxically that could make Mr Lawson's dilemma more acute. For the currency exchanges abhor a vacuum, as we know: and if the yen, the dollar and the deutschmark were reckoned to be tempor- arily in baulk then another currency would have to be put 'in play'. That currency could well be the pound. At least it looks that way just now. With our relatively high interest rates, opinion polls which suggest that a Labour Government is a rather remote threat, and a Budget which is deemed to be fiscally responsible, the pound looks well worth a punt.
To which the obvious response would be cheaper UK interest rates. Indeed the Chancellor implied as much in the Budget speech: 'the essential instrument of monet- ary policy must remain short-term interest rates'. But unfortunately when a currency happens to be fashionable (or unfashion- able, for that matter) interest rate changes are quite liable to have a perverse effect. The overseas punters pile in in expectation of a capital profit when events making the rate of interest is reduced — and then pile in some more in the hope of a repetition.
The authorities have so far seemed to be most reluctant players at this game. They finally conceded a half-point cut before the Budget with the worst grace in the world, and then another afterwards, since when the Bank of England has been fiercely signalling that that is quite enough. There are two possible explanations for this display of resistance. One is that, for all the good behaviour of the Chancellor's favourite 'little Mo' monetary indicator, the other dials continue to suggest that credit conditions are decidedly loose. The other possible explanation is that we are witnessing another display of Chancellor Lawson's scepticism about the wisdom of the markets. After all he succeeded — twice — in defying market pressures for a substantial jump in interest rates last year. So why not teach them manners once again by defying pressure for a substantial fall?
Why not, indeed? To treat the foreign exchange dealers mean and keep them keen has much to commend it, in present circumstances. Their unsatiated appetities are reflected in a continuing upward press- ure on the exchange fate, which in turn restrains price inflation on the High Street, since UK manufacturers and suppliers have to defend themselves against import competition. Only the Chancellor can't have it both ways. He can take his stand against unwanted changes in the rate of interest. Or he can take his stand against unwanted changes in the external value of the pound. But not both — or at any rate not for long.
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