In the City
The pull of New York
Tony Rudd
Like the rings around Saturn the London markets revolve around New York, held in tight orbit by the gravitational pull of American interest rates. Currencies, credit and commodities alike move in this exact relationship. For the time being London is a satellite. This is the result of an exercise in monetary brinkmanship in America which some would say had long since disappeared over the brink.
On one single day recently long-dated bonds in New York fell over three whole points. It is difficult to convey just how catastrophic a fall of that dimension is in terms of its damage to confidence and thus to the ability of markets to perform an everyday function. It isn't just speculators who get hurt (many people would say: who minds if they do?) — it's the actual market mechanism. The bond market in America handles the government's funding requirements, in exactly the same way as the gilt market in London handles Sir Geoffrey's borrowing requirement, but in addition it provides a large volume of money for private industry through the floating of corporate debt. The mechanics of this depends upon a series of bond houses who, operating on borrowed funds, float the debt, act as intermediaries and make a market. A three-point drop in prices in one day is enough to wipe out not just a year's profit but half the capital of some of those organisations. A series of fluctuations on that scale is enough to bring some of the largest to their knees.
But the repercussions spread more widely than that. If the professionals are willing to dump fixed interest stocks on a falling market in such a pell-mell manner, what confidence can it give to the rest of the country? If that's what the experts think of the outlook then, people will argue in the rest of the country, it must augur pretty badly for the generality. Clearly the professionals know something that the general public hasn't yet cottoned on to. That is how the lack of confidence from such events spreads throughout the financial community.
In this sense America has a real problem and, until it is solved, markets elsewhere, including those in London, will be caught up in the after-effects. We have just seen the classic combination of bearish opinion: the outlook in America was bad because the latest money supply figures indicated that the authorities had not got credit under control and would therefore have to tighten up even more, putting up interest rates, some scaremongers said, to 25 per cent, whilst other bearish commentators said that the authorities had got the situation under control and would therefore be letting interest rates fall very soon, which in turn would prompt a premature relaxation leading to a return to inflation. Either way you had to sell. It's just possible of course that these slightly crazy events might have heralded the bottom for the fixed interest market and the peak in terms of interest rates. Certainly there was a fairly quick bounce-back in the key Federal Funds Rate from over 18 per cent back to around 16 per cent (this is the rate at which the authorities supply money to the market and is a good reflection therefore of their attitude to what is happening). It would indeed be very welcome to many people around the world if this were the case and this abrupt fall did mark a turning point. But it is as yet too early to tell.
All that can be said in the meantime is that those responsible for American money and credit policy are taking a diabolical risk not only with the markets for money and credit in America but with world markets. Having jacked American interest rates up so high, these now inevitably lead the world, in effect making all other interest rates ineffective. So we can really say that for instance the Federal Funds Rate ill America is the effective rate for official funds in the world. Any country which steps out of line is just going to see its currency obliterated. Even if last week did not mark the turning point there is going to be a turning point in due course. That could come as a result of a financial crash, either of a general nature or of a specific institution (or two) which by virtue of their importance could bring a change of heart. Alternatively, the thought may eventually dawn in Washington that the policy which is leading to a destruction of the bond market is fundamentally inconsistent with the running of a substantial budget deficit (and one which in prospect is growing rather than diminishing). The only way of funding such a deficit is to sell bonds. If the Administration wipes out the mechanism for selling such bonds it quite simply can't fund the deficit.
Somebody in the Treasury responsible for debt policy has to get through the locked doors guarding those responsible for monetary policy so that the latter are forced to take into consideration the requirements of the former. If, as one suspects, the security system is keeping all commerce from getting into the hallowed precincts In which monetary policy is being evolved (of shall we say baked) then it is very meet and right for the debt men to go straight back to somebody in the Administration one step higher and if that's not effective to go right back to the President. Somebody has to tell him (the sooner the better) that a threepoint drop in the bond market in one day ts the financial equivalent of two F-14s being shot down in the Gulf of Sirte. It really matters. Until this message gets through we are all at risk. In London we need high interest rates like Sir Geoffrey Howe needs a hole in the head. We could also do without the gilt market being put into substantial reverse by the events happening in the American bond market; and it would be helpful to have the pound get back nearer towards the $2 mark, which it would in more normal circumstances.
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