The Economic Scene

 The Economic Scene

Paul Bareau, O.B.E.

Inflation Rampant

Government may cause and go, or return, nut the basic problems remains: in the case of the United Kingdom the still accelerating rate of inflation, a balance of payments deficit which shows no sign of diminution and a national mood which, so far, bears little promise of the arduous road ahead begin travelled in the spirit of dedication and comradeship which alone could achieve success. Fortunately the problems are no longer blurred by the phoney statistic which passed muster as effective election propaganda. Inflation is now seen to be primarily a cost-push phenomenon. The wages explosion which, despite the Social Contract, has rumbled continuously since the re-election of the government, promises another upward sweep in the cost of living. The recent ;norm’ in wage concessions is around 25 per cent.- and this at a time when the domestic product shows a decline, in real terms, of some 2 per cent. On 1973, when the balance of payments deficit equals about  7 per cent of the national income and when industrial investment is in dire need of reinforcement. The wage explosion is helping to stimulate consumer demand and pull in imports at a time when consumption should be reduced so as to contribute to some improvements in the balance of payments, and leave more room for productive investment. In order words basic economic trends are still moving away from orthodox, desirable objectives. 

The money supply equation must, in due course, adapt itself to this basic, cost-push charter of the current inflation. The monetarist who focus their attention on the money supply as the causal and corrective factor of inflation, are reversing the logical order of sequence. Higher cost will in due course be passed on in higher prices and this will require a greater and still greater supply of currency and credit. To cut the money supply by traditional measures of credit control, such as more special deposits and still higher interest rates, would deprive a large number of enterprises in the private sector of their one remaining source of working and medium- term capital. The result would be bankruptcies and the rise in unemployment which would assuredly cause the money taps to be turned on once again. The worst possible formula for this additional irrigation of the inflation-heavy dog would be to follow the TUC advise of extending  credit for the over-riding objective of maintaining employment in firms that would otherwise have to adjust their labour force to the state of their order book. That would subject the UK economy to further hardening of the arteries and would in due course lead to economy to further hardening of the arteries and would in due course lead to economic rigor mortis.

The November Budget

That was part of the background into which the Chancellor of the Exchequer had to fit his November budget for Britain.

It was a courageous budget for a socialist Chancellor. First because he admitted, in words and deeds, that industry had been over squeezed and must be made profitable if the economy is to expand. Secondly because he paid tribute to the banking system and place upon it- and not on some state bank- the responsibility for easing industry’s cash crisis. Thirdly, and most important, because he relied on the orthodox price mechanism and market forces to do the main part of  the anti-inflation work. It needs some grasps of economics as well as courage to appreciate and apply the principle that higher prices like higher taxes are counter inflationary, provided a tight rein is kept on the money supply: provided also, wage restraint does not crumble. It is on these two provisos that the susses of the November budget depends.

The main blot on the budget is the vast increase in the borrowing requirements- from $2.733 million last March to $6.331 million. That has weighed heavily on a gilt edged market. Of which the Chancellor will be in dire need in the months to come. The lapsing of the exchange guarantee on certain official overseas sterling balance should have been handled more discreetly. Left to the Bank of England’s diplomatic channels it would have done less damage to sterling than was done by its elevation to a n early passage in the highly publicised budget speech concerned. A most reassuring announcement in the budget speech concerned the massive reinforcement of Finance For Industry in order to provide some of the resources needed by increasing illiquid industry. There will be relief in many quarters that this will be a City of London operation and not one carrying the stamp of political intrusion and, perhaps, ultimately of state domination in the companies to be assisted.

The re-cycle race

The movements of oil money between the world money markets continue and will continue and will continue to break all records and baffle the imagination. Earlier estimates of the magnitude involved are proving near the mark. During 1974 the oil exporting countries will have accumulated current account surpluses of close on 60 billion. Some of them, such as Iran, Nigeria and Venezuela, can use a substantial proportion of their oil revenue for importing capital goods and the expensive technology and services that are diversifying their economies. These imports merchandise and invisible, are not of course deductible from the above figure, which is a net, global estimate of the unspendable and therefore investible proceeds of oil exports. The figure, however does include the grants-in-aid which some of the oil countries have made to their Arab brethren and particularly, to Egypt poor in natural resources, further impoverished by eight years blockage of the Suez Canal and ever regarded as in the front line of the battle, active or dormant against Israel.

The amount of oil money that will have been invested in the capital market in 1974 will probably be of the order of $56 billion. O this total about $24 billion, the largest single item, has been invested in the Euro-dollar , market mostly on short item. The next largest block is about $15 billion invested directly in dollars either in US bills and bonds or on deposit with banks in the United States. The amount invested in sterling, some of it in short-dated gilts, some in CD’s and other money market instruments, is equivalent to $9 billion. The amount deposited with the IMF under its; ‘oil facility’ and destined for the poorer countries is just over $3 billion. That leaves about $5 billion as longer-term investment in property, equities and an as yet minimal amount in old bullion.

One feature of the movement so far is the degree to which is has used open capital market and the interposition of the large commercial banks and intermediaries between the short-term leader and the usually, longer-term borrowers. Another remarkable fact if the concentration of the business on New York and London, on dollars and sterling. These, with all their defects are the only two markets and currencies with the flexibility and absorptive capacity to handle operations of this magnitude. The recent removal of the ban on payment of interest on non-resident Swiss franc accounts has caused no more than a trickle of oil money to flow through that newly opened channel. The amount invested in sterling is in the circumstances, surprising and reassuring in the short term, but full of warning for the longer run since the money is ‘bad; money-in the liquidity since of the word-which has not only financed the current account deficit, but has balanced some withdrawal of what used to be regarded as ‘good’ money, including Australian and Hong Kong balances.

The almost exclusive use of the open market and the commercial banks must soon be coming to an end, partly because of the mis-matching of the terms of assets and liabilities involved, but also because most of the banks involved are reaching the limits of the prudential or solvency rations between their own capital and reserves and their deposit liabilities. Rescue may ultimately come from the immediate assistance should be provided by the EEC initiative in which agreement has been reached for a $3 billion collective borrowing operation, the proceeds to be redistributed among the nine member countries, according to their need. At the end of the queue in all this will be the underdevelopment, non-oil countries, including those where, according to latest estimates, 20 million may die of starvation between now and the next harvest.

Controlling the Banks

Whatever may be said of the ‘renegotiation’ of the UK’s term of entry into the EEC, there is no doubt that the British influence within the Commission is having a powerful effect on the work that is being done  on the co-ordination of banking legislation. The first directive on this subject was an extraordinary amalgam of bank laws and regulation as they apply in the member states. It was an ingenious but wholly unrealistic project to construct a kind to the banking communities and Governments in al member countries. One of its defects was its attempt to cover in one document the activities of large range of institutions: large and small, fringe and beyond the fringe.

The new directive, now being studies by each delegation, is a more restricted but also a much more flexible document. It is intended to apply to the large banks. It is assumed that in due course there will be comparable directives for specialised institutions such as building societies and finance houses catering for consumer credit. The new directives thus pays special attention to the definition of an institution entitled to transact banking business and carry the appropriate name. This is essential if the basic principle of freedom of operation through branch representation at all member countries is to be applied. Provision is made for disclosure of certain ratios to be calculated at lease every three month. This is pending closer co-ordination of these ratios-some of which will need clearer definition.

Meanwhile excellent progress has been made in the vexed and complex field of ultimate responsibility for the operations and possible losses of consortium banks. This is a mater in which the Bank of England has taken the initiative-understandably so since London houses more of these hybrids than any other financial centre. What is being established is the acceptance of ultimate responsibility for such banks by their shareholding banks.  This is an issues which ranges far beyond the confines of the EEC but as with the EEC directives, it is an endeavour to improve banking supervision and thus serve a cause which in recent years has been somewhat neglected.

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