Eight per cent and all that MONEY
NICHOLAS DAVENPORT
To say that the jump in Bank rate from 7 per cent to 8 per cent last Thursday came as a shock to the City is putting it mildly. The usual com- ment, which has, of course, a political bias, was unprintable. Having devoted two and a half columns on 14 February to explaining why I had hoped such a move would be avoided, I was naturally plunged in gloom. And enraged by some of the ridiculous remarks in the foreign press! It was done, they said, to anticipate an international monetary crisis coming from the threat to the franc. As if the Bank of England could take any effective action on its own sup- posing a drastic devaluation of the franc were to upset the international money cart! It was done, others said, to read the riot act to the striking motor workers. As if British trade unions ever paid any attention to an economic dictate of the Chancellor, much less the Bank of England. Alas! it appears to have been done on account of a little local money trouble which might have been avoided.
Money rates in London were, as I have ex- plained, getting out of line. Before last week first-class borrOwers could go to their banks and pay + per cent above Bank rate for their overdrafts, that is, 74- per cent, whereas they would have to pay 9 per cent to 10 per cent in the open capital market. Naturally they clung on to their overdrafts and the banks found it impossible to reduce their advances to the low ceiling required by the Chancellor, which was 98 per cent of the November 1967 level. In Feb- ruary bank advances had actually risen and were some £200 million above the ceiling. But if this row with the local bankers was the main reason why the Chancellor felt that he had to take some monetary action why did not the Treasury order the joint stock banks to raise their 'prime' rate for first-class borrowers to 84 per cent? The banks already raise their spe- cial rates for second-class borrowers to 9 per cent or 10 per cent as the case may be. That would have dealt with this particular money trouble without using the expensive weapon of Bank rate.
Consider how expensive this extra 1 per cent is for the Treasury as guardian of the taxpayer and as caretaker of the balance of payments. The Statistical Office has just issued a statement of our net external sterling liabilities as at 31 December last. They totalled £6,032 million of which the sterling area held £2,301 million, the non-sterling area £1,649 million and the International Monetary Organisations £2,082 million. You may reckon that every extra 1 per cent costs the. Treasury nearly £50 million not only as a burden on the taxpayer but on the balance of payments as well.
And consider the poor building societies. Their rates were also out of line. They lent last year £1,578 million net at about 74 per cent on house mortgages when the market rate was 1 per cent or 2 per cent higher, and they attracted from savers £774 million in deposits and shares by paying 4+ per cent and 5 per cent respectively tax free, which was equivalent to 74 per cent and 84- per cent gross. They were able to get away with these low rates for savers—although their net receipts were £325 million less than in 1967—because middle-class people like having their income tax paid. The building societies hope to hold their present rates until the budget —they are waiting to see what contractual sav- ings scheme Mr Jenkins will offer—but they will certainly have to raise them and mortgages will cost at least 1 per cent more. Rents will also rise and wages will follow because dearer and dearer money is a symptom of a wage-cost-price infla- tion getting out of control and spiralling up- wards. I have little patience with those who argue that with a price inflation of, say, 4 per cent per annum loans at 9 per cent are really cheap because they are only costing the bor- rower 5 per cent in 'real' terms. They should read the final act in the history of the great inflations.
There is no doubt a worldwide upward move- ment in interest rates. The us Treasury Bill rate has risen to 6 per cent, the 'prime' borrow- ing rate to 7 per cent and the Euro-dollar rate to close on 84 per cent. The Euro-dollar rate has been forced up by the repatriation of Ameri- can money from Europe to meet the money squeeze at home. When President Nixon relaxes the controls over the export of American capi- tal abroad, as he has promised to do, the Euro- dollar rate will return to normal, but this is not expected in the near flnure. In the meantime we should take every step we can to insulate ourselves against follies abroad.
Everyone should know that when a price in- , flation rages dearer money has no immediate economic effects except to depress and demoral- ise keen businessmen and increase the inflation. But an 8 per cent Bank rate also kills the gilt- edged market which was once the pride of the great capital markets of London. War Loan has now dropped to 411 to yield 81 per cent and Funding 64 per cent 1985/87 at 781 xd gives a running yield of 8.2 per cent and a yield to gross redemption of just over 8.8 per cent. The Chan- cellor could stop the rot in the gilt-edged mar- ket, as I have suggested, if in the budget he would allow capital gains in government bonds to be free of long-term capital gains tax and the income from government securities treated as franked income for corporation tax. This would cause some institutions to rush to buy government bonds. In the us the local states gather in a lot of money by issuing tax- free bonds, so that the rich are encouraged to save and not to spend. If the Labour party were not so envious of wealth it would seriously con- sider adopting a similar technique here, so that the millionaire class, who are probably the best wealth-creators in the economy, can be put to better use and not driven out of the country.
The effect of the 8 per cent Bank rate on equity shares was dramatic. The Financial Times industrial share index was driven down to 465, which gave an average price/earnings ratio of 19. I emphasised last week that the sus- pense of the 'bull' market was not necessarily the start of a 'bear' market. A further fall in the index will bring some individual growth shares on a price/earnings ratio which should prove attractive to the long-term investor. LI Mr Jenkins presents a reasonable budget on 15 April there could be a sizeable post-budget recovery in our equity shares. On dips the equity market now seems a 'buy.'
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