MONEY AND THE CITY
How weak is sterling?
Nicholas Davenport
My parting words last week — don't sell the gilt-edged market — were prompted by Information I had received of Bank of Eng land intervention. This took an unusual form. The sensational withdrawal from London of nearly £1,000 million of 'hot' money — incidentally Mr Barber confirmed the figure of it which I gave last week — had left the joint stock banks desperately Short of cash. In fact, they told the Bank of England that they would have to sell all their ' short ' government bonds. To avoid such a catastrophe, which would have driven short-term money rates to Shocking heights, the Bank took over their ' shorts,' charging them 61 per cent for the accommodation, and graciously allowed them to cash the coupons on them as they came due. A disaster in the giltedged market was thus averted and prices rose amidst the general relief. But the Market came back again when the joint stock banks, still apparently thirsting for cash, advanced their ' base ' lending rate from 5 per cent to 6 per cent.
This rescue operation is by no means the end of the affair. In the first place, the E is still vulnerable to ' hot ' money !lights. Last year the total currency inflow into sterling amounted to £3,228 million Which explains why the reserves at the end of May were as high as £2,750 million and another £1,000 million might be Withdrawn at any moment. As the Prime Minister said in his Commons speech last Week: " A single currency can in a matter of days be shaken by movements of shortterm funds unrelated to its basic strength." Why, then, did the Government not imitate the Swiss government in putting up barricades against the inflow of 'hot' Money? (The Swiss are now talking of negative interest rates on ' hot ' money.) It Might have thought that the reserves Were big enough to take care of the potential outflow but nervous foreigners would not consider them so when they find the surplus on the British current trading account with the world fell to £55 million in the first six months of 1972 and see Mr Heath's government taking no direct action, as, President Nixon has done, to restrain the raging wage-cost inflation. As I write, the £ is down to $2.42 — a devaluation of 7 per cent from $2.60 — and looks like going lower.
There is not a single currency safe either from bear or bull attack while the dollar remains suspect and inconvertible and while no concerted action is taken to bring under national control the vast mass of Euro-dollars, now estimated at $60,000 million, which can move about from country to country at the whim of a few bank managers. The Bretton Woods system of international payments having come to an end we will probably go on for years slipping from one monetary crisis to another until the forward exchange markets break down under the pressures of coping with too many floating exchanges and so threaten the future of world trade. Then, as a matter of urgency, we shall have to call another Bretton Woods conference and try to settle the world payments system on more sensible lines. But I cannot see it happening for a long time. In the meantime we may expect to see a weak £. If the Tory government cannot control the wage-cost inflation, it is not likely to control sterling. A floating and weak £ my therefore cause our entry into the EEC to be delayed or it may cause the Germans and the French to go different monetary ways or it may cause the breakdown of the common agricultural policy. Any one of these alternatives might be a blessing in disguise. De Gaulle at one time opposed our entry into the EEC because we were the sick man of Europe.
Ministers, we know, have to pretend that all is well but the Chancellor really cannot go on saying that this is not a devaluation, that the Smithsonian $2.60 was a realistic rate and that the monetary union of EEC will be assured when we join up in January at another 'realistic' rate for sterling. Nor should he throw up his hands in horror on the television screen at the sensational riSe in the price of houses.
It was he who restored freedom to the banks, removing the ceiling on bank advances, and as he allowed the money supply to increase at the rate of over 20 per cent per annum — thanks largely to the monetary inflow of £3,228 million last year — he should not be surprised if this spills over into the housing and security markets seeing that the expansion of the
economy, which he hoped would be "well on course" of a 5 per cent growth rate, has been retarded by the miners' strike and other industrial hold-ups. Between Fe
bruary 1971 and May 1972 the combined borrowing of the personal and financial sectors increased by over £2,000 million — from £2,179 to £4,469 million — and this was the money spate which enabled the
FT index of thirty industrial shares to rise
by nearly 80 per cent from its March 1971 low and the prices of houses-to-purchase to double, treble, quadruple and quintuple according to the local price of land. When Mr Barber introduced his courageous reflationary budget, which was a stockbroker's dream, I solemnly canonised him and referred to him thereafter as Saint An thony. I now ask the City Pope, the Governor of the Bank of England, to de canonise him and remove him from the holy order of City saints. If I remember rightly, the same fate overtook Saint Hugh Dalton.
The City Pope himself is not free from blame. It was not so long ago that he was saying that he would not interfere in the gilt-edged market to stop interest rates rising. Yet he has done just that. In his famous Jane Hodge memorial lecture he said: "The burden of high interest rates on the Exchequer and balance of payments, though always a consideration, is not a foremost one." But it is — and if the present slide in long-dated bonds, now yielding 94 per cent, were to push borrowing rates in the new issue market up to 15 per cent, there would be little or no industrial investment and the expansion of the economy would peter out. If the Governor had not damped down the rise in the giltedged market by issuing two £500 million ' tap ' stocks in January this year the market would be in better shape today.' After all, the obligations of the life and pension funds are in money terms, not real terms, and their managers would find the existing high yields attractive enough if they felt the Bank of England knew what it was doing.
As for equity shares, the FT thirty index after its 80 per cent rise came back 111 per cent while the 651 share index only fell by 10 per cent. These are normal enough reactions in a long-term bull market and I was not surprised by the recovery on Monday. However, I would expect the market to remain as unsettled as the weather until it sees the Government reaching an agreement with the TUC and CBI over some plan for the voluntary restraint of wages and prices. In the six months to the end of June new issues at £637 million have doubled, according to the Midland Bank, but this increase does not mop up very much of the enlarged money supply, so that, except in the investment trust market which has been swamped with new issues, paper is not yet chasing after money. But caution is still required until the Government gets out of its economic and monetary mess.
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