MONEY Gilt-edged sacrifice
NICHOLAS DAVENPORT
The sudden collapse of the gilt-edged market—it has now virtually lost a six months' rise—suggests that something has gone radically wrong and I suspect that it is the administration or interpretation by the Bank of England of Mr Jenkins's financial policy which is at fault. In his Budget speech the Chancellor said that in 1970-71 we shall continue to need 'a reasonably tight monetary policy'. But he went on: 'I have also to guard against the danger that the cumulative effects of the policies followed so far might produce a greater degree of monetary stringency than is intended or necessary.' What he feared is now causing the gilt-edged market its alarm and despondency. Last week it suffered its worst fall since devaluation, some of the long- dated stocks dropping four points. The government broker was conspicuous in his refusal to play his conventional role of sup- porting the market. Certainly he took up some of the large lines of stock on offer—perhaps up to £200 million—but always at half a point or so below the market. Is it really government policy to allow the gilt-edged market to slide and the domestic rate of interest to soar willy-nilly? Or is the Bank of England wrongly in- terpreting the Chancellor's 'reasonably tight' policy on credit and money supply?
In his Budget speech Mr Jenkins drew attention to a technical point—the difference between the DCE (Domestic Credit Ex- pansion) and the money supply. The Chan- cellor went on to say that the latter would rise this year by less than the DCE and the figure he meant, it is suggested, was £800 million, which would be an increase of around 5 per cent. (The difference between the two arises mainly from banking sector transactions, banking liabilities to non- residents not being included in money supply.) But an increase of 5 per cent in the money supply would be incompatible with, say, an 8 per cent money increase in the GNP through the coming explosion of 10 per cent to 12 per cent in wage incomes. Is it seriously suggested that the Bank can resolve this clash by reducing the money supply so drastically through operations in the gilt- edged market that the growth of the economy will be stopped?
The first result of such a foolish policy would be to raise the domestic rate of in- terest to at least 10 per cent. This would be contrary to government policy in housing, in construction and in industrial investment, all of which they are anxious to reflate. Indeed, it is obvious that the Chancellor has been doing his best to get the domestic rate of interest down and insulate it against the ex- travagant rates abroad. He reduced Bank rate from the crisis level of 8 per cent to 7+ per cent on 5 March and as soon as the American banks had cut their prime rate from 84- per cent to 8 per ocnt and American Treasury bill rates had fallen to nearly 6 per cent he brought Bank rate down to 7 per cent on Budget day. This should have been sufficient to encourage the rise in the gilt- edged market to continue and to bring the yield on the 'long' tap stock down to, say, at
least 81 per cent. But the present collapse has pushed this 'long' yield up again to 94- per cent or more. This is a most damaging blow, when unemployment refrains over 600,000, to the Government's mild reflation policy and it is amazing that the Bank should have allowed it to happen. It looks as if the Bank of England really believes that one can con- trol the economy and the rate of wage demands or settlements by the ruthless con- trol of the domestic money supply. No one else does. I don't suppose the Chancellor does either—else he would not have taken the trouble to go on trying to control bank li- quidity by means of the special deposits device. The fact that he had to give an undertaking to the INF to control the Dcn does not mean that he subscribes to the Chicago University school of thought about money supply. It was fashionable at that time to follow Professor Milton Friedman, as the IMF did, and like a good politician Mr Jenkins felt he should please our largest creditor. I am sure it is only a matter of time before this , Professor's theories are discredited. One can effectively use money supply controls in war time because of war time physical controls and rationing—we did it beautifully in the last war when the Bank of England saw to it each day that the banks had a sufficient cash base to support all their undertakings—but no country has effectively used money supply controls in peace time when there are no physical controls over labour and materials and plenty of credit reserves to tap in the international capital market.
It makes one suspect that the Bank of England is clinging to the past. In the old days the most important item which went to make up the total of the DCE was the government borrowing requirement less sales of government debt to members of the public other than banks. But this has been outmoded by Mr Jenkins's conservative finance which, outshining that of Gladstone, has abolished a net borrowing requirement. For 1969-70 he achieved a total revenue surplus of £2,444 million and after meeting all his loan requirements for the nationalised industries and the local authorities he was able to repay £1,176 million of public debt!
Yet the Bank's market operations seem to be galvanised for a non-existent borrowing requirement. In the last six months of 1969 they disposed of about £500 million of Government stock to the public. In July last year they issued a 'long' tap of £400 million—Treasury 9 per cent 1994—and within ten weeks or so it was exhausted. They then issued in October another 'long'
tap of £400 million—Treasury 131 per cent 1997—and before it was exhausted they issued in January £600 million of Treasury 84- per cent 1980-82 as part conversion offer to holders of Savings 3 per cent due to be repaid in September. As this was an unsuitable stock to offer holders of a matur- ing 'short' it helped to damp down the market which, indeed, had already been over-swamped with lap' issues.
It seems that the gilt-edged market has been sacrificed on the altar of a false American god—the money supply theory—just when it had shaken off its depression and was poised for a further im- provement. Since the middle of 1969 the market had staged three recovery movements, each stronger than the one before, and the third seemed to be con- solidating a quietly firm 'bull' trend which would in due course have brought the domestic long-term rate of interest down to the 8 per cent level or below to the great ad- vantage of the building and construction in- dustries and industrial investment. The Bank of England should now have clear instruc- tions to forget Professor Friedman and the RAF and put the market to rights.
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