Unease in the City MONEY
NICHOLAS DAVENPORT
You may have observed a curious phenomenon in the City—the Stock Exchange pushing up share prices to the highest point of the year while the chiefs of the cm and TUC express grave concern over the economy and manu- facturers show their lack of confidence in the future by cutting their investment in factories and plant. Last week the Financial Times index of industrial equities touched 357, which is 25 per cent above the -low point reached in November 1966. Another 5 per cent up and it will be back at the 1966 high before the great cut-back of July. Is the deflation, then, a thing of the past? Certainly Mr Callaghan has made a start on reflation. He has cut the hire purchase deposits on motor-cycles (from 40 per cent to 25 per cent) and on motor-cars (from 40 per cent to 30 per cent) and lengthened the term of repayments. He has reduced Bank rate from 7 per cent to 5+ per cent. He has promised a lOs rise in old-age pensions for Lord Mont- gomery and all in October. And he is expecting a rise in wage rates which Mr Michael Stewart puts at 6 per cent by the end of 1967. This was no doubt the basis of the Chancellor's famous budget prophecy that the national output would rise by 3 per cent between the end of 1966 and the end of 1967, a rate, he said, not far different from that of our productive potential.
But the Stock Exchange is not so gullible as to accept these estimates at their face value: Its market prices reflect the balance of the invest- ment decisions of highly sophisticated people. And they were not greatly impressed by the latest government assessment of the economic situation. Output, the Treasury says in its latest Economic Trends, has begun to re-expand but recovery has not proceeded very far. Ex- ports are not expected to rise much further. Manufacturing industry, according to the Board of Trade survey, is planning to invest this year about 8 per cent to 9 per cent less than in 1966. Distributive and other service trades seem just as cautious. And the underlying trend of un- employment, the Treasury adds, continues up-
wards. (It is now 2.2 per cent against 2 per cent in April.) According to the newspaper report of the recent Granada television broadcast on `The State of the Nation' the Prime Minister had to agree with Mr Robin Marris, the Cam- bridge economist, that a 'potentially dangerous situation' could develop next year if unemploy- ment was not brought under control and if industry did not increase investment.
The Stock Exchange is not therefore likely to be discounting the prospect of an economic miracle in 1968. The company reports which have been issued in the first half of the year indicate that the full effects of the great squeeze have not yet been felt in profit and loss accounts. Only the most sensitive cyclical industries like iron and steel and construction have as yet shown any substantial fall in profits —not to mention shipping after the seamen's strike. Worse surely may come in company reports. The recent rise in equity share prices must therefore be due to quite different causes. The first, of course, is the technical one of an insufficient supply of shares to meet even the reduced demand. The second is the sudden attack of nerves about sterling which swept the City after the Israeli victory in the Middle East. A permanently hostile Arab bloc could lead to the disruption of the whole sterling area.
I have already referred to the size of the sterling balances held by the Arab countries. They .were recently in excess of £500 million and of these Kuwait accounted for about £350 million. Up to the present Kuwait has not only kept its floating balances in sterling bonds and bills but has invested 'long' in sterling securities. This procedure could hardly be maintained if Kuwait is to bail out the bankrupt Arab states. She has already lent Egypt, Syria, Iraq and. Jordan some £50 million and has promised her `blood brothers' more financial aid in the economic war against the West. It is strange that Kuwait should single out this country for economic attack seeing that she reached her present affluence under our careful financial tutelage. Yet she persists in refusing to make direct oil shipments to Britain. The extent to which we shall have to substitute the more expensive dollar oil for the cheap sterling oil of the Middle East is not yet known but it carries a threat to our balance of payments and is a cause of anxiety for the £. If the Arab states were to go further and boycott all British trade, as we boycott Rhodesian trade, it could be just the extra blow which deprives Mr Callaghan of his expected surplus on the balance of payments this year. Certainly, the hope of a surplus of £100 million must now be abandoned.
A sudden withdrawal of the Arab sterling balances does not in itself constitute a threat to sterling, for the agreement with the Basle group of central banks provides 'us with $1,000 million credits against such an eventuality. Curiously, a switch by Kuwait from sterling into other currencies would probably end up in the Euro-dollar market and back again in London! The Euro-dollar market in London has grown so rapidly that the foreign exchange committee of the clearing banks is considering whether they should set up a dollar clearing in the City. The growth of this dollar market makes one wonder whether sterling as an international money is not already on its way out.
The persistent buying of equity shares on the London Stock Exchange must therefore be regarded as a crude form of currency hedge and I am sure that the merchant banks are at the bottom of it. They act as advisers to im- portant private and industrial funds and if they suddenly become nervous about sterling they will undoubtedly advise their clients to sell government stocks and buy equities. The life assurance managers have also been selling government stocks because they see no hope of a further decline in interest rates but on the contrary a rise. This week the American bill rate jumped nearly 1 per cent to 4.28 per cent and the government bond market fell flat on the expectation that the soaring budget deficit would force the us Treasury into the market for a medium-term loan. So the curious phenomenon of a rising equity market in a gloomy economy is not as crazy as it seems. The Stock Exchange is but the mirror of a crazy world.
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