In the City
The bell tolls
Tony Rudd
The crack in competence which has precipitated the plunge in the markets has come with frightening suddenness. Only a month or two back the mood was one of reasonable calm; things could have been better but the prospect of a rise in profitability in British industry next year was clear for all to see and although there might have been an intervening rise in interest rates this was expected only to be temporary. There were some indeed who, as recently as a few weeks ago, were forecasting a bull market this autumn. In a sense, the fact that sentiment was so illprepared for a change in market preference towards liquidity and away from investment, made the reckoning, when it came, feel like a major dislocation. And that is what it is. Investors have suddenly been pitched from relative security into a nightmare of falling values. The parallel is with 1929 rather than with 1974; the panic of the earlier crisis was so much greater because the collapse was so unexpected.
The question now is how far the fall will go and how widely its repercussions will be felt. At the moment the crisis is regarded by most people as purely a City event. Those of one's acquaintance who know that one works in the financial market look at one as though one had contracted a sudden dramatic and very serious disease which, however, is not contagious. They murmur how dreadful the whole thing must be for the City and thank their lucky stars that they are not involved. This naive notion that financial crises only affect financiers survived the 1974-5 crisis because that was largely confined to the financial mechanism of the country and did not spread widely into the community. Only those who had borrowed to finance the purchase of assets, property or shares were really hurt (and they were of course wiped out in many cases). Industry thought it was going bust but was very quickly saved by Mr Healey's removal of virtually all liability to corporation tax. The consequent bounce upwards in values was as dramatic as the present fall in values. The whole thing was over very quickly.
This time it may be different. The underlying causes of the present malaise are, it can be argued, fundamental and deep-seated. To take that one aspect: the rate of interest in this country and in many others is now on the way out again to levels which may well be three or four points higher than they have reached at present. We could end up with interest rates of 18 to 20 per cent or even more. With inflation running at say between 10 and 11 per cent these would represent real interest rates, adjusted for inflation, of 7 or 8 per cent. This is what the Americans already have now. Yet the average return which was earned on capital invested in the UK last year, against real terms, was 3 per cent. Now you can't run a railway or a company or a country on that basis for very long. Either interest rates have to come down or the rate of profitability has to go up, if industry is to continue.
The prospect for either of these does not seem particularly good at the moment. The unions are not in the business of lowering wage costs or of making it possible for management to put capital to work in a much more efficient way. So the prospects for real earnings, apart from a short-term recovery from the recession levels of this and last year, are not particularly good in the long term. The other side of the equation represented by interest rates or the cost of money is also not particularly right. The problem here is that although industry can hardly afford to borrow at a real rate of 7 or 8 per cent to finance investment which is going to earn 3 per cent, the Government can afford to do so, or rather it can so fix the books that it appears to be able to do so. This is the phenomenon known familiarly as 'crowding out'. It is worse really than this phrase implies. For were it not the Government having to borrow huge sums to finance its deficits, the rate of interest would, if all other things were equal, fall right back to levels not seen since 1946. For the fact is that capital as such, in the form of savings, is not in short supply, contrary to what may be a shortage elsewhere. The rate of savings in this country has never been higher. It is the same in many other countries. America has a very high level of savings too; their only problem is that they also borrow a great deal (meaning that the average person does) so that the net level of savings is on the low side. But they will soon stop borrowing at present levels of interest rates, so that the prospect for a rise in net savings in the US is, in fact, excellent. The problem is not the volume of resources so much as the society's inability to get those resources across to productive investment. And it was precisely that problem to which Keynes addressed himself in the General Theory. In 1931 an industrialist just could not earn sufficient out of profits to pay the current rate of interest of 21/2 per cent. We seem to be right back at that point during the present crisis.
If this analysis is anywhere near correct, then what we are seeing in the stock market is the start of a very big readjustment. It will spread far beyond the City. Pension funds which seem so secure now will soon become less so and the benefits expected by pensioners will fall. The security offered by the savings industry, so recklessly sold to the investing public on the back of quite unjustified tax concessions, will be proved illusory. Values of capital assets other than shares may also fall, including the stock of housing. How long the level of real wages will be maintained (as they have been so miraculously so far in this recession) is anybody's guess. Eventually the crisis will pass to the wage-earner. This time, one feels, the trouble is going to seep beyond the bounds of the square mile and ultimately into every home in the land.
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